MAPS

Prioritizing Client's Goals

Financial markets are unpredictable. That uncertainty can be a major source of anxiety as investors plan for retirement and other life goals.

Most of the time, equity markets provide attractive long term returns, as shown on the chart below. The chart plots historical 10-year "real" returns (returns adjusted for inflation) for US Large Cap Equities. Each box on the chart represents a historical 10-year period. For example, the box labeled "2000" plots returns from 2000 to 2010. The chart shows median 10-year real returns for US Large Cap Equities have been almost 100% (about 7% per year).  However, although investors in the past frequently doubled their money every 10-years, the chart also shows several 10 year periods in history where equity investments lost money relative to inflation (1936 - 1946, 1968 - 1978, 2000 - 2010, etc.). The fact that equities typically produce good returns is of little comfort to an investor if they need to fund a critical life goal during a period of poor returns.

Higher Priority Means More Protection from Bad Markets

With MAPS, your client's most important goals are protected against this uncertainty. Client goals are expressed as a date (“when do I need the money?”), a dollar amount (“how much money do I need?”) and a priority (“how important is this goal within my overall life plan?”). MAPS then calculates an investment strategy that protects your client’s highest priority goals (NEEDS), even if market returns are among the worst ever seen in history (the blue shaded area in the graph). WANTS are also extremely well protected, with slightly less conservative return assumptions than those used for Needs (the orange shaded area). DREAMS assume market returns are closer to normal (the yellow shaded area). By building an investment plan that prepares for some of the worst outcomes from history, investors position themselves to survive an economic calamity and thrive in more normal market environments (the green area in the chart).

Importantly, MAPS calculates a separate investment and savings plan for each goal in the plan. If the MAPS plan supports buying a dream car or taking a dream vacation, clients can confidently spend the money required to make those dreams come true. Spending money on DREAMS does not touch the assets and savings MAPS has reserved to ensure the safety of higher priority goals such as a secure retirement.

NEEDS: NEEDS are defined as the level of spending/cashflow you must have no matter how difficult the economic and market environment. Typical NEEDS include a secure retirement, top quality health care, and possibly funding educational expenses for children and/or grandchildren. MAPS calculates the amount of assets and savings required for NEEDS to be met even in extremely poor market environments, like the inflation-wracked 1910s and 1970s or the technology and housing busts of the 2000s.

You and your client control just how conservative you want your plan to be. A very cautious client may want a 95% probability that NEEDS such as a secure retirement are met. In that case, the plan for NEEDS will be calculated using the worst 5% of assumed potential returns. Clients who believe a 90% probability for achieving their NEEDS is sufficient will have their NEEDS life plan calculated using the worst 10% of assumed potential returns (the blue area in the chart above).

The higher the probability the client selects, the more protected his or her goals are from potentially bad market environments. However, there is no free lunch in investing. The higher the probability, the more assets and savings must be devoted to the goal.

Importantly, the assets and savings devoted to NEEDS are not eligible for funding lower priority goals. Within the financial plan, these assets and savings are treated as if they have been locked away and reserved exclusively for funding the designated goal. That means clients can spend money on lower priority goals without worrying that these expenditures might endanger higher priority goals. This can provide for upside adjustments to life goals when a NEED such as funding college education has been met. If actual investment returns are better than the dire assumptions used in NEEDS calculations (which history says is very likely), then excess assets may be leftover that can be devoted to future goals. 

Wants: WANTS are those goals that should be achieved in most circumstances, but that can be deferred or possibly reduced should we experience some of the most difficult economic and market environments from history. Wants might include goals like extended family vacations, buying a second home, or making impactful charitable donations.

As with NEEDS, advisors and their clients determine how conservative the plan calculations will be for WANTS. Clients set the probability for WANTS based upon their personal decisions about how to balance their desire for security with the reality that more security requires more savings.

Some clients may decide that everything in their plan is a NEED and have overwhelming protection built into every single goal. Less conservative investors can reserve that level of protection for their “sleep at night” goals (e.g. a secure retirement), and use the WANTS definition to build a plan for goals with 80% or 85% probability of success. In that case, the assets and savings devoted toward WANTS will be calculated using the worst 15% or 20% of assumed potential returns (the orange shaded area in the graph above).

By allowing clients to define certain goals as WANTS, MAPS provides for goals that offer significant protection from difficult market environments, but that require less savings and fewer current sacrifices than higher priority NEEDS goals.

DREAMS: The message that should leap out from the historical return chart above is that, if history is any guide, markets are likely to produce returns that are far better than those assumed for NEEDS and WANTS in the MAPS process. Instead of anchoring every aspect of the financial plan to a set of ultra conservative assumptions, we think the planning process should encourage investors to dream big!

DREAMS are as diverse as the people who dream them. Some may dream of buying a Ferrari. Others may dream of sailing around the world. Still others may imagine creating a legacy for their children, their college, or their place of worship. The only common characteristic among DREAMS is the potential that these are goals that can be delayed or possibly even denied in very difficult economic environments.

DREAMS are the part of the plan that can be sacrificed in the unlikely event that the US experiences another Great Depression or 1970s style stagflation. Unlike NEEDS and WANTS, DREAMS are the optional part of the life plan that require markets to provide something closer to average returns for these dreams to come true. The good news is that average returns are more likely than the conservative assumptions used to plan for NEEDS and WANTS, according to historical market performance.

As with NEEDS and WANTS, clients define the likelihood of achieving their DREAMS. The chart above assumes a 70% probability for DREAMS. Market returns at or better than the worst 30% of history will make those dreams come true (the yellow shaded area).  

By allowing clients to prioritize goals as NEEDS, WANTS, and DREAMS, MAPS allows clients to precisely define the tradeoffs their financial plan will make between the security of their goals and the savings and sacrifices necessary to fund those goals. The mix between NEEDS, WANTS, and DREAMS is an individual decision unique to each investor.

Whether the client is cautious or confident, MAPS allows the advisor and the investor to craft a plan that reflects their preferred combination of safety and aspiration.This flexible customization will revolutionize the world of financial planning, offering advisors the opportunity to provide a new level of personal optimization for their clients within a manageable portfolio monitoring framework.

Customized Portfolio Solutions

Once goals are defined and prioritized, MAPS calculates a unique portfolio strategy customized for each client’s life plan.  Before MAPS, managing customized portfolios across a large number of clients could present an overwhelming challenge. However, MAPS uses a small number of portfolio modules (typically 5 or 6) to assemble an endless number of customized investment strategies. Through the MAPS “mass customization” process, clients get the benefit of customized investment plans while advisors get the portfolio management advantages of a small number of portfolio models.

MAPS creates customized solutions from a small set of portfolio modules by first quantifying the time horizon and risk characteristics (NEEDS, WANT, or DREAM) for each goal in the plan. These mathematical characteristics are matched against a predefined set of modular building block portfolios with offsetting risks. The client’s overall investment strategy is built by assembling these predefined portfolio modules.

Shorter term goals are aligned with shorter time horizon modules. These modules tend to have large allocations to cash and/or bonds. Longer term goals are funded through longer term modules, with higher equity weightings and therefore higher potential return. This asset/liability matching process allows endless customized investment solutions to be produced by as few as 6 portfolio modules.

Caravel recognizes that advisors often have long experience and good track records using existing portfolio solutions. As a result, MAPS can utilize an advisor’s existing portfolio strategies in developing client planning solutions. MAPS can calculate the risk score and horizon target for any asset allocation model uploaded to the system. These calculations allow MAPS to assemble an advisor’s existing portfolio strategies into customized client solutions, seamlessly incorporating an advisor’s existing portfolio models into client plans. 

The MAPS asset/liability management process provides mathematically rigorous planning solutions, but client needs are not driven exclusively by math. Risk tolerance is a very individual and emotional component of setting an appropriate portfolio strategy.

MAPS provides risk profiling tools to help advisors understand the elements of risk management that cannot be quantified by a computer model.  MAPS allows advisors to dynamically adjust proposed portfolio risk, allowing clients to see and understand the impact of more conservative or more aggressive strategies on overall plan results. Clients can then determine the portfolio risk level that strikes the right balance between their long term goals and their short term peace of mind. 

Progress Monitoring

Watching the markets daily can be stressful to both advisors and their clients. MAPS provides reassurance through volatile markets with our third step–progress monitoring. Our software keeps a continuous eye on financial markets and provides updates showing how your clients’ most important goals are protected from even severe market declines.

This online mapping tool graphically illustrates progress toward achieving each goal, providing an accurate picture of how the odds of achieving these goals change as markets fluctuate. Since NEEDS and WANTS are designed to be protected against severe market environments, clients can see how market moves tend to have very little impact on these critical goals. DREAMS are usually the only portion of the plan affected by market volatility, and these are the goals clients have determined are less vital to their life plan.

MAPS also provides continuous risk monitoring and risk management across time. If history is any guide, market returns will frequently be higher than the levels assumed for NEEDS and WANTS. Any such excess returns may accumulate over time, pushing the odds of achieving the client’s goals even higher or allowing for the addition or expansion of future goals.

Financial advisors receive automatic alerts if the passage of time indicates a needed change in portfolio strategy. MAPS calculates a portfolio risk reduction glide path that keeps an appropriate balance between the risk of the portfolio and the time frame for client goals.

Should market returns exceed the conservative assumptions used in calculating the life plan, an opportunity may arise to “lock in” a goal. Locking in a goal consists of moving portfolio assets out of riskier, higher returning assets and into low risk, low return short maturity bonds and cash. This is made possible when excess portfolio returns have increased a goal’s dedicated assets close to the value of the goal itself. MAPS alerts advisors to this opportunity as a part of its ongoing progress monitoring process. 

Time Sensitive De-risking

MAPS provides continuous risk monitoring and risk management across time using the guiding principle that risk levels need to come down over time to keep goals on track for success. By calculating a portfolio risk reduction glide path, MAPS keeps an appropriate balance between the risk of the portfolio and the time frame for client goals.

MAPS calculates the right combination of portfolio modules for each client based upon the timeframe of the client’s goals. This initial asset/liability matching must be updated as time passes and goals get closer in time. For example, a client funding college expenses may have a relatively high weighting to equities when the child is 2, but as the child ages that equity weighting should come down. By the time the child goes off to college, MAPS assumes the portfolio should be largely in cash and short maturity bonds with very little investment risk.

With MAPS, advisors can easily monitor the portfolio adjustments required to keep clients on track. The de-risking glide path built into MAPS automatically produces recommended trades that adjust portfolio risk down as goals approach. 

Time is not the only motivation for potential de-risking. If history is any guide, market returns will frequently be higher than the conservative returns assumed for funding NEEDS and WANTS. Any such excess returns may accumulate over time, pushing the odds of achieving the client’s goals even higher.