Written by Kyle J Christensen, CFP, March 4, 2022
By definition, need means being in “a condition requiring supply or relief.” It means “lack of the means of subsistence; Poverty”. I don’t know about you, but as someone who does financial planning for a living, that’s an alarming definition, especially when you realize the majority of the “financial planning” in the United States follows a dogma called “needs-based analysis.”
What is needs-based analysis? It is financial planning that uses clients’ needs as the basis for products, strategies, and recommendations. In other words, find out what the client needs, and sell them that. That doesn’t sound so bad at first glance, but let’s dig a little deeper into this approach for planning.
First, and foremost, can anyone, any client, any financial advisor, any computer program, actually predict a client’s future needs? Can any of those people or things actually predict if a person is going to get sued, become sick or disabled, lose a job, get a certain rate of return on their money invested in the stock market, when the client is going to die, how they’re going to die, and so on? Are things actually predictable? I think it’s easy to accept that we are probably better at predicting weather than the future needs of our clients. And truthfully, we aren’t really great at predicting weather past about seven days. So, right from the start, the idea of having the ability to predict a client’s needs, and using that as the foundation for planning, is tremendously faulty. I like what Warren Buffett says about stock forecasters: “We’ve long felt that the only value of stock forecasters is to make fortune tellers look good.” (Warren Buffett: The Life, Lessons & Rules for Success)
Now, for a moment, let’s assume a financial advisor actually could predict a client’s future financial needs. What is a need? A need is the bare minimum a person has to have in order to succeed or to live. Is that really what people want as their financial objective? If your house burns down, would you like the insurance company to come and rebuild a house that is just sufficient for your needs, or do you want your entire house rebuilt, even though you don’t really need all of it? How much room is there for error when what you need is the goal? It’s probably a really good thing that financial planners who subscribe to the needs-based philosophy aren’t in charge of space flights with NASA. “Hello, Houston, we have a problem. We’ve run into some unexpected issues.” Houston replies, “Sorry, Captain, we only planned for what you needed. We apologize that we didn’t think of everything that could go wrong and didn’t provide you with more than what we predicted.”
Needs aren’t motivating. Consider the fact that you probably have much more than you need right now. You probably eat out. You probably have a cell phone. You probably have air conditioning in the summer and heat in the winter. You probably own a car. You probably live in a house that has more space than you absolutely need. You probably have more than one set of shoes. I could go on. You don’t need all of those things. You want those things. Wants are what motivates you. That’s your idea of success. So, shouldn’t that be your objective, financially.
If you strive for what you want, and fall a little short of that, do you still have what you need? When we have wants as our objectives, we have room for error. There’s room for everything to not work out perfectly. There’s room for the unexpected. When we use the principle of Maximum as our guide for financial planning, we have room for error. Isn’t maximum what people really want? If you knew you were going to get sued tomorrow in an auto accident, what kind of protection would you like to have in that moment? If you knew you were going to get sick and become disabled, what kind of disability protection would you want in that situation? If you knew you were going to die next week, and could make a change to your life insurance today, how much of your income and assets would you want to be able to replace? My guess is that the answer to all of these is “the best I could have,” “the most I could have.” You wouldn’t want to do a “needs-analysis” to try to minimize the amount of coverage you would have.
What about investing? Should we have the same mentality? Should we try to predict what we or our clients need twenty, thirty, forty years down the road, when we honestly have to admit that we don’t know what they’ll need next year? Why should we create an objective based on the minimum we would possibly need, which is derived from a faulty prediction of the future? No, we should implement the principle of Maximum. We should strive to be in the best position we can be in. We should strive to replace as much of our earned income as possible, not minimize it based on unknowable forecasts of the future. If we shoot for maximum, will it be enough? Who knows! That’s the point, we cannot predict what “enough” is. As such, we should save based on principle, we should protect based on principle, and we should invest based on principle, and not prediction.
Needs-based planning is minimization planning. It’s shooting for the least possible amount that a person supposedly needs. It’s not a good foundation for planning. There’s no room for error, and ultimately, it’s not what people want.
The truth is, needs-based planning is simply a selling technique, and it’s damaging to the one receiving it. Needs-based planning, by definition, never offers the client their maximum. Who’s choice should that be, the advisor’s or the client’s? Unfortunately, most financial advisors make that choice for their clients and only offer needs.
Principles-Based Financial Planners don’t plan based on needs. They plan based on wants, and they utilize principles as a guide for planning, not predictions. If you want to become a Principles-Based Financial Planner, send me a message on LinkedIn. If you want a Principles-Based Financial Planner as your planner, let me know. Either I can help you, or I can point you to another Principles-Based Financial Planner.