Education over fear

Guiding clients past short-term fears
with Monte Carlo education.

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Clients commonly focus too much on the short-term ups and downs. In response to short-term downs, they may abandon plans that are best for their long-term goals. This presents financial planners a most-important responsibility -- educate clients to look beyond the short-term ups and downs, to focus on the long-term goal. Educate clients to tolerate short-term ups and downs, along the way to best prospects for the long-term goals.

Fear-based planning tools -- Unfortunately, many planning tools push the planner and client in just the opposite direction. By applying or advocating portfolio selection based on what they call “risk tolerance”, these tools endorse making long-term choices based on short-term fears instead of long-term goals. For the client, this commonly leads to plans with far greater risk of low or inadequate results for the long-term plan and goal. For financial planners, these tools create the appearance of sacrificing clients’ long-term interests to avoid hard work of client education.

Of course, this is not what financial planners intend. Instead, what planners want and need is tools for more effective client education -- for showing clients that tolerating short-term ups and downs along the way can vastly improve the prospects for long-term goals.

The Monte Carlo education answer -- For this most-important planner responsibility,  Monte Carlo simulation can offer unrivaled client education power.  

To deliver this client-education power, individual simulations are shown year by year, as illustrated on the graph at right.

With a graph like this, showing simulations of the future for the client’s plan, you can give the client the best possible preparation for likely ups and downs ahead. You are showing the client vivid, visual, memorable graphic pictures of what the client is likely to experience on the way to the long-term goal.

PATHFINDER delivers these simulations dynamically. Each simulation works its way through the years one by one. You can have the client “experience” ups and downs before the simulation gets to the end and reveals its final result. This is just what the client will experience in the years ahead with the plan, just what the client needs to be prepared to tolerate.

Of course, a client will prefer much smoother paths to the long-term result.

In answer to this desire, with Monte Carlo simulation you can deliver the world’s most effective visual education on short term versus long term.

Show the client a comparison of two sets of year-by-year simulations for her plan -- one set of simulations with the best portfolio, another with a more “conservative” portfolio with much smaller standard deviation, such as mostly bonds.  

This kind of comparison is shown at right -- red for the best portfolio, blue for the mostly-bonds portfolio.

This graph shows exactly what is most important for clients to see. Compared to best portfolios for long-term plans and goals, there are others with much smaller short-term ups and downs -- but for long-term goals, their results are almost certain to be much lower.

Or put the other way, the client can see that by tolerating the larger short-term ups and downs along the way, with the best portfolio shown in red, the client has far better prospects for long-term results -- for the goal. This graph shows this lesson visually, as clearly and memorably as it can be shown.

The client can see very clearly that for results for the long-term plan and goal, the portfolio with smaller short-term ups and downs -- smaller return-rate standard deviation -- has far more risk.

Of course, with even the most effective client education tools, short-term fears and reactions will remain. Compromises will have to be made between clients’ long-term interests and short-term fears. But with Monte Carlo simulation applied and delivered as illustrated above, financial planners can do the best that can be done to serve their clients’ interests, and fulfill their own professional responsibilities.

Most Monte Carlo simulation tools are focused on showing probabilities for the long-term result for the plan, which is an essential application. But if clients are not sufficiently educated to stay with the plan, and abandon the plan along the way, all the analysis to assess the probabilities for the long-term result will be for naught. For this reason, the kind of client education illustrated above is a MOST important part of effective financial planning use of Monte Carlo simulation.