Financial modelling or Cash flow modelling as it is also known involves assessing a client’s current and forecasted wealth, along with money coming in (income) and money going out (expenditure). It enables us to create a picture of your finances both now and in the future. As a result, we can recommend the best course of action for a client, along with the right asset allocation.
Cash flow modelling is particularly useful where different scenarios are illustrated based on decisions that you might make throughout your lifetime. It can be used to illustrate scenarios of different income requirements depending on changing investment returns.
If you are in drawdown will find cash flow modelling particularly important. This is because drawdown involves more risks than a pension fund in the accumulation phase. The usual investment risks are amplified because withdrawals are being taken from the fund, and often these withdrawals are higher than the natural income (i.e. dividends, interest etc.) achieved by the fund.
Some modelling involves a highly detailed assessment of expenditure. This can be valuable if it causes you to think about your retirement needs in detail and the outcome is a realistic estimate of expenditure. Many clients are not prepared to undertake the work involved and may not be able to forecast their expenditure in granular detail. In this case, it can still be worth making broad estimates of expenditure based on current patterns, but with some allowance for relevant changes in circumstances, such as ceasing to travel to work on a daily basis.
If you wish to flexibly access their pension fund, a cash flow model may be used to give a forecast of your fund in the future so that you can reasonably decide how much to withdraw each year. The withdrawals eventually chosen will be based on your objectives and circumstances, for example:
• Only draw the natural income from the portfolio to keep the capital value of the fund intact, which can then be passed onto children. This approach may allow one-off capital withdrawals to be taken occasionally if the portfolio increases in value.
• Withdraw enough income and capital each year to provide an income for life. The cash flow model may be used to work out how much can be taken so that even though the fund value may be depleted it should not run out.
• Ignore the cash flow model and withdraw a chosen amount even if the fund is in danger of being fully depleted. This may be possible, for example, because you have other investments that you can use if absolutely necessary.
The cash flow model will be based on certain assumptions about investment returns. These are usually based on average annualised returns and ignore the real-life fluctuations that can take place. This can give misleading results. These assumptions will never be completely accurate, so regular reviews and reassessments are needed to make sure you remain on track.
Where cash flow modelling is used, we need to ensure that the cash flow model does not treat expected returns as linear, but instead considers a range of possible outcomes. Cash flow projections should be updated on an annual basis to reflect changing circumstances and to review any assumptions used.
If you are interested in the benefits that Financial modelling or cash flow modelling can provide then please get in touch. We are a firm of Independent Financial Advisers based in Shrewsbury and we serve clients in Shropshire and all over the UK. Please don’t hesitate to contact one of our Financial Planners if you would like to find out more.