A case study comparing intermediation and holistic financial planning.
Introduction
In this case study, we explore the financial journey of Tom, a 40-year-old individual planning his estate until the age of 90. We’ll evaluate his current financial status, project his savings and expenditures up to his retirement at 65, and extend this projection until his planned lifespan of 90 years. Additionally, we will analyse two alternative scenarios: one with an additional 2% annual growth on his savings and another with an additional 2% annual growth on his earnings while extending his working years to age 85. This comprehensive analysis will underscore the profound impact of human capital development versus mere financial capital growth.
Tom asks the question, “Will I outlive my capital?” For simplicity, in the base case we assume no real growth in earnings or savings after taxes and charges.
Current Financial Situation
- House value: £350,000
- Financial assets: £250,000
- Annual income: £50,000
- Savings rate: 10% of income
- Annual savings: £5,000
- Annual expenditures: £45,000
Projection Until Retirement at Age 65
Tom plans to work for another 25 years until he turns 65. Here’s a breakdown of his financial outlook during this period:
- Total savings over 25 years: £5,000 x 25 = £125,000
- Financial assets at retirement: £250,000 (current) + £125,000 (savings) = £375,000
Expenditures and Assets During Retirement (Age 65 to 90)
Upon retirement, Tom will stop earning but will continue to incur expenses. We project his expenditures from age 65 to 90:
- Annual expenditures during retirement: £45,000
- Total expenditures over 25 years: £45,000 x 25 = £1,125,000
Estate Calculation at Age 90
To determine Tom’s estate value at age 90, we subtract his total retirement expenditures from his financial assets and house value:
- Financial asset shortfall: £1,125,000 – £375,000 = £750,000
- Remaining house value: £350,000 – £750,000 = -£400,000
This calculation reveals that Tom will have a deficit of £400,000 at age 90 if his earnings and savings do not grow. In other words, Tom is forecast to outlive his capital and needs a financial plan to make good the shortfall.
Meet Dick
Dick is a Financial Adviser, otherwise known as an intermediating financial planner. Dick’s service proposition focuses on delivering superior investment returns. With Dick’s strategy, Tom expects to achieve an addition annual growth of 2% on his life savings.
Dick’s Proposition: 2% Per Annum Growth on Savings
- Financial assets at retirement (65 years old): £570,000 (an extra £195,000)
- Total expenditures over next 25 years: £1,125,000
- Financial shortfall at age 90: £197,000
- Estate value at age 90: £350,000 – £197,000= £153,000
Tom ‘s capital suvives him. Tom had to release equity from his property to meet expenses at age 86. With a 2% annual growth on savings, Tom’s estate reduces to £153,000 at age 90.
Meet Harry
Harry is a Life Planner, otherwise known as a non-intermediating financial planner. Harry’s service proposition focuses on developing Tom’s Human Capital (“present value of future earnings”, CFA Institute), whilst Tom achieves market returns on his financial assets. Harry talks about human capital development, well-being, and discovering work that doesn’t feel like work from which Tom will never wish to retire.
Harry’s Proposition: 2% Per Annum Growth on Earnings and Retires at 85
- Initial annual income: £50,000
- Income growth rate: 2% per annum
- Total working years: 45 years (age 40 to 85)
- Financial assets at age 65: £537,000 (£33k less than Dick’s forecast, but £162k more than the base case scenario)
- Financial surplus at retirement (85 years old): £1,470,000
- Estate value at age 90: £350,000 + £1,290,000 = £1,640,000
By focusing on increasing Tom’s earnings and extending his working years to 85, Tom lives out his years in the family home and his estate at age 90 significantly improves to £1,640,000. Tom could use the surplus to improve his lifestyle or leave a legacy.
Tom’s residual estate is more than 10-times larger with Harry, than with Dick. In truth, after fees are taken into consideration, Dick’s portfolio is not expected to outperform Tom’s self-invested portfolio in low-cost well diversified investments readily available on a variety of direct-to-consumer platforms.
Summary
As Dick’s client, Tom’s estate stands at £153,000 at age 90, while as Harry’s client, it rises dramatically to £1.64 million. This stark contrast highlights the substantial benefit of human capital development—where increasing earnings through prolonged, fulfilling work results in a more robust financial future. This approach ensures that Tom not only avoids downsizing during retirement but also leaves a substantial residual estate.
Another benefit for Tom is improved health life and life expectancy from a focus on well-being, which studies show helps you live longer better.
As Stephen R. Covey said:
“If you want to die early, retire to golf and fishing and sit around swallowing prescriptions and occasionally seeing your grandkids.”
This case study underscores the importance of holistic financial planning that emphasises personal development and career growth over merely seeking higher returns on investments. By investing in oneself, the path to financial success becomes clearer and more attainable.
Conclusion
Tom’s case illustrates the significant difference between traditional financial planning focused on intermediation and a more holistic approach that prioritises human capital. Encouraging individuals to find work they are passionate about, extending their productive years, and focusing on continuous personal growth can lead to more secure and prosperous financial futures.
This approach aligns seamlessly with the ethos of the Academy of Life Planning, fostering a blend of financial security and personal fulfillment. If you want to find out how you can transition your financial planning proposition to be more about human capital than financial capital, contact us to find out more.
This blog is for informational purposes and not professional financial advice.
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