Your IndustryFeb 24 2022

Planning for future goals against current inflation

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Planning for future goals against current inflation
Credit: Suzy Hazelwood from Pexels

Rosie Hooper, chartered financial planner at Quilter Private Client Advisers, likens cash flow modelling to a long journey with a sat nav.

“We sit [with the client] at the beginning of the journey and we say, this is your destination, and these are all the things that might affect you on the journey.

“Then when they come and see you after, say, six months, and you assumed that inflation’s going to be 5 per cent, but actually it’s dropped down to 3 per cent for example, you turn around and say, ‘Actually, it’s not that bad, the sat nav has corrected itself again’, that is, the cash flow.

“It’s not five hours to the destination, it’s actually four hours and 40 minutes. And that’s what the cash flow is designed to do – reset itself at every touchpoint.”

Staying the course

The Bank of England expects inflation to rise further to around 7 per cent in the spring, and for inflation to be close to its 2 per cent target in around two years’ time.

CPI inflation is projected to fall back after a peak in April, according to the BoE, as the contribution from energy prices fades, global bottlenecks ease and domestic cost pressures lessen somewhat as demand weakens and unemployment rises.

While the CPI 12-month rate has remained above 2 per cent since August, Nicholas Sinclair-Wilson, chartered financial planner at BRI Wealth Management, says he would be reluctant to assume an inflation rate of 6 per cent or 7 per cent, for example, across his cash flows.

“It would be foolish to take the last six or 12 months as a snapshot and then apply that moving forwards.

“Someone who’s fairly early into that accumulation phase of building up their assets, I don’t think it would be fair to suddenly assume a 6 or 7 per cent inflationary rate.

“Maybe you tweak it upwards slightly for prudence, so instead of 3 per cent, maybe 3.5 or 4 per cent, if there was a longer period of time.

“But someone who’s maybe at the other end of that scale and is in their 70s and has been decumulating quite comfortably, you might not jump to increasing the inflation rate or assumption significantly.

“It might be slightly alarming for the client [if] you said ‘we’re okay’ for the past 20 years and suddenly it’s all going wrong. And it might not be particularly fair in terms of an actual good basis of assumption moving forwards.”

William Stevens, head of financial planning at Killik & Co, says he would generally work on a practice of taking a historic long-term average, and base it on the fact that inflation and living costs are likely to move around within that period.

Sam Cowan, chartered financial planner at Charles Stanley, agrees that cash flow models will typically retain longer-term assumptions that do not vary based on current rates, and that models should be reviewed at least annually.

“Inflation, expected growth rates and interest rates will remain constant (for example, 1 per cent interest, 3 per cent inflation, 5 per cent investment growth) rather than adjusting the longer-term rates every year to the current rates."

While the general consensus is that cash flow models are reviewed on an annual basis – outside of significant changes to a client’s circumstances or objectives – Hooper at Quilter suggests the frequency of reviews should be determined by the client, rather than the adviser.

“I don’t think it’s how often an adviser should review the cash flow model. I think the key question is, how often does the client crave the reviews? For some clients, once a year is absolutely fine and that’s all they crave.”

More art than science

Like anything forward looking, Stevens says that cash flow modelling should always be taken with a pinch of salt.

“It’s not an exact science, it is an art. It is built around making quite a lot of assumptions.

“If you change those assumptions even slightly, if you’ve got a long enough time horizon and you’re looking at planning pre-retirement... you might have a 40-year time horizon to look at, so it’s important to be sensible with the assumptions, and to have some sort of science behind them.

“That’s where I think looking at long-term historic averages probably delivers the easiest way to work out what those assumptions should be.

“But then also it is important to recognise that with cash flow modelling, not too much weight should be hung on the individual numbers, but more focus needs to go on the direction of travel and the general trend.

“Are you moving in the right direction slowly over time, or are you moving in the wrong direction slightly over time, and therefore do we need to course correct for those changes?”

Chloe Cheung is a features writer at FTAdviser