What’s In a Plan: Key Plan Characteristics 
Micah Porter, CFA, CFP®

Nearly every client engagement we have begins with a financial plan. Although the plan addresses a number of issues, from estate plan to tax to portfolio design, the core piece of the plan is the plan framework that outlines how a client can maximize the probability that they’ll meet their plan goals.

The framework rests on a set of assumptions – some, like savings rates and expenses, driven by what the client believes is feasible, while others are based on economic and market data. Lastly, because market returns are somewhat unpredictable, we use a series of stress tests to minimize the chance that poor market performance at the wrong time will disrupt a plan.

The plan serves a number of purposes. First and foremost, it answers the question of whether or not clients are likely to meet their financial goals. In the process of formulating the plan, clients also achieve clarity on what the financial goals are and what the client needs to do to meet those goals. Lastly, the plan provides a framework in which clients can explore their options, and it identifies risks that could derail the ability to meet financial goals.

Given the central importance of the plan in the value we provide for clients, I thought it would be useful to review a few of the stress tests and assumptions we use in the plan. For this newsletter, we’ll focus on the stress tests and they are as follows:

Bad Timing – bad timing is one of the stress tests we use to account for the fact that market returns are not constant from year-to-year. This is key to the success of a plan, as the sequence of returns from year-to-year is almost as important as the overall average portfolio return.

The worst time to have a sharp downturn in the market is the year of retirement and the year thereafter (or, if you are already retired, this year and next year). The reason is that should the market drop at that point, clients are typically no longer investing, and thus don’t benefit from the ability to buy investments at lower prices. Further, unlike later in retirement when most portfolios have grown substantially, the portfolio at the outset of retirement is relatively smaller. The goal of the stress test is to construct a plan that results in which all goals are fully funded even if the market undergoes a sharp downturn at retirement.

Monte Carlo –Monte Carlo is another method to examine the impact that the sequence of returns has on overall likelihood of plan success. However, Monte Carlo differs from bad timing in that it doesn’t examine the impact of a sharp downturn at retirement. Rather Monte Carlo constructs multiple different paths to achieving the target long term return and then measures the percentage of those paths in which the portfolio was not exhausted before the end of the plan.

The minimum percentage we deem acceptable depends upon the client’s age, and the minimum threshold increases with the client’s age. For clients in their 30s or 40s, a probability of success in the mid to high 70% range is acceptable, while for a client in their 80s, we’d like to see a probability of success in the mid to upper 80 percent range.

What we find with Monte Carlo is that if we can achieve those thresholds, the probability of success tends to creep up over time if the client executes on those parts of the plan he or she can control. The reason is that the most unfavorable paths – those that are mathematically possible but practically extremely unlikely –   don’t occur and those particular paths fall away leading to an increasing probability of success.

In the next newsletter, I’ll continue the deep dive on examining plans with an overview of plan assumptions.

An Update on the Fiduciary Standard and Why it Matters
Micah Porter, CFA, CFP®

One of the more pitched battles going on within the financial services industry is over the fiduciary standard. While the phrase itself is fairly stilted, the concept underlying the phrase is of utmost importance to investors and to those who would profit from providing advice.

Put simply, the fiduciary standard requires the investment adviser to act solely in the best interest of the investor at all times. All Registered Investment Advisers – including Minerva – are held to a fiduciary standard and are subject to oversight by the Securities and Exchange Commission or a state regulator. The standard itself is simple and straightforward and typically when it comes to investing, things that are simple and straightforward are to the benefit of the investor.

There is a second standard used by brokers – who can also refer to themselves as financial advisors – that is known as the suitability standard. The standard itself is a good deal less stringent than the fiduciary standard, and it simply requires that the investment be suitable for the investor without regard for the cost of the investment. Those that adhere to this standard are not regulated by the SEC or state regulators, but rather by FINRA, a self regulatory body created and funded the Wall Street firms and the brokers that work for those firms.

The pitched battle has come about in recent years because as part of the Dodd Frank bill, the SEC was tasked with investigating whether there should be a uniform fiduciary standard for all who call themselves financial advisers. The Wall Street firms have fought a uniform fiduciary standard tooth and nail, claiming that it would drive up costs and make it unprofitable to serve lower net worth investors. Separately, the Department of Labor is considering a rule requiring those who provide advice on retirement accounts to adhere to the fiduciary standard. Wall Street, predictably, is fighting that as well and unfortunately it appears as if the Department of Labor may water down requirements such that they have less of a positive impact for investors.

In spite of the difficulties both the SEC and Department of Labor have had in promoting the fiduciary standard, we still view the developments over the last few years as positive for investors for two reasons. First, their actions have raised awareness of the difference between the two standards and called into question why Wall Street wouldn’t want to put such a simple, straightforward standard in place. Second, there is still a reasonable chance that the fiduciary standard – even if a bit watered down – will become more commonplace within the industry and investors will benefit from that.