Last Updated on 01/09/2023 by Carl-Peter Lehmann

Case Study

Through our case study below, we aim to support the argument for Why an Outcomes-based Financial Plan is Invaluable. A trust company, who manages trusts on behalf of beneficiaries with special needs, asked us to compare the investment product they were invested in, to other products currently in the market. It was through this process, that we showed the trustees that building an outcomes-based financial plan had significant consequences for the income beneficiaries – and that it was too important to ignore. Whilst the case study was based on a special needs trust, the rationale will hold true for any investor – especially those receiving an income, such as retirees.

Background: A special trust was formed for a girl with special needs (she is now 16). We’ll call her Kay (not her real name). Kay was born with Cerebral Palsy.  Thankfully, her health is good, and she is doing well.  Her life expectancy is expected to be above average for someone with her condition. The trust was funded from compensation from a dereliction claim against the MEC for Health and is designed to take care of Kay’s general wellbeing, maintenance, and education. The Trust purchased a house for Kay to live in, and the trust takes care of all Kay’s daily expenses.

For the purposes of this case study, we have made a distinction between FIXED and VARIABLE EXPENSES.

Fixed expenses include those that are generally fixed in nature. These include items such as Trustee and Trust administration costs, as well as a stipend of R20 000 per month for Kay. The variable expenses are variable in nature, and include items such as physio, schooling, transport, additional medical expenses as well as maintenance of property and other general personal expenses.  Due to the nature of the condition, medical expenses can often be unexpected and very expensive. At present, we can assume the following monthly expenses need to be provided for by the Trust.

Fixed:      R55 000

Variable: R20 000

The trustees manage a money market account for the “every day” spending, and a further amount R23 770 151 is invested with a local investment company through a local advisor (not Henceforward). 

These funds need to be readily available to be able to “top up” the money market account as and when the trustees need the funds.

The Advice She Was Given

Looking at some of the documentation presented, we were able to determine the following. The advisor met with client and trustees to understand what was needed.  The advisor also conducted a Risk Profile Questionnaire. The results of the risk profile suggested the funds should be managed conservatively.

The investment advisor recommended a conservative fund.  The fund aims to provide investors with a high level of income over the short term. The preservation of capital is of primary importance. The fund will consist primarily of income orientated assets with limited exposure to equities (maximum of 20%). Investors in this fund have an investment horizon of 1 year or longer.

The advisor charged an initial commission of 2.3% excluding Vat on the original investment amount of R22 937 195.45. This amounted to R606 688.82 in commission which reduced the available capital to be invested for the beneficiaries. (I doubt the value of advice could amount to this amount if truth be told). Furthermore, the investment advisor charges an annual advice fee of 0.65% of the investment value per year. This is excluding VAT payable monthly.  On the current investment value this equates to R14 806.82 per month.

Flawed Assumptions

By using an Integrated Cash Flow modelling tool, we can visually depict the projected cash flow given our assumptions. These would include current income and expenditure in the scenario provided. In other words, this is the scenario of Kay’s current investment plan.

The advice process followed could be depicted in the diagram below: The answers of the risk profile decides the asset allocation (conservative). This then determines the return (low) which eventually impacts the lifestyle that Kay can enjoy, all things being equal.

Is This an Optimal Approach?

Looking at the cashflow model it is clear that the current trajectory is far from ideal.  The model suggests that Kay will run out of money by the age of 40. Generally, there are few basic strategies that you can use in different combinations to achieve your financial goals. Some of these include:

• targeting a higher investment return will allow your savings to grow at a faster rate. When implementing this strategy, it is important to assess whether the level of risk you take on is appropriate for you and your lifestyle objectives.
   
• spending less in certain areas and using these funds in areas that have been identified as higher priorities (Managing expenses in the trust to an absolute necessity or reducing the stipend
  
  investing in different assets – such as fixed annuities
  

Each option will be examined in more detail below, but everything begins with understanding what outcome needs to be achieved for a particular person/entity (in this case the trust on behalf of Kay) and the most effective way for doing so.

Lifestyle Financial Planning: A Different way to look at things

Lifestyle Financial Planning begins with the end in mind by making investment decisions that reflect an understanding of the outcome needed based on a particular person’s needs – essentially an outcomes based approach. We believe that traditional risk profiling is fundamentally flawed, as it guides investors into a strategy that they think they need. This may be based on certain biases that they hold.

As this case study illustrates, the investment advisor guided the Trustees into a conservative investment strategy based on the risk profile completed. This process did not consider what was needed – an outcome which is able to provide Kay with an income for as long as she is alive – which current modelling suggesting the Trust is likely to run out of money before Kay reaches the age of 40

Suggested Approach: Targeting a Higher Return

By using an outcomes-based approach to determine what investment strategy would most likely be able to provide Kay with an income for life (until the age of 80 and adjusted annually for inflation) – a very different strategy would be recommended. Assuming an inflation rate of 6% p.a., using the appropriate mathematical modelling, suggests that an investment return of inflation plus 4% per year is needed to provide Kay with an income for life.

By using the appropriate targeted return investment strategy designed to achieve specific outcomes that an investor requires, it is far more likely to achieve a successful outcome that delivers what is required.

 In this case, an investment strategy that uses a targeted return outcome of Inflation plus 3-5% will be far more likely to help provide Kay with an income for the rest of her life. – which goes to support Why an Outcomes-based Financial Plan is Invaluable

Does that mean there is more investment risk?

There is no such thing as risk free (even money in the bank carries risk). There are simply different kinds of risk and understanding these is important in being able to achieve successful investment outcomes.

• volatility risk is the risk of losing an investment value fluctuating (up and down) based underlying market conditions.
• capital adequacy risk is the risk of not having sufficient capital (our running out of capital) and is the most dangerous risk because most people underestimate the probabilities of this happening.
• inflation risk is the risk of capital losing its purchasing power, which means money is worth less and less over time.
• liquidity risk is the risk of not be able to access the money when needed.

Many people associate the primary investment risk as being volatility risk (investment value moving up and down).

However, understanding the variability of returns of a particular investment strategy, provides great comfort what realistic return expectations a strategy should provide, and why the adage in terms of achieving the most successful investment outcome, is simply a question of ‘time.’

By using the actual range of returns achieved for the Inflation Plus 3-5% strategy this is clearly visible.

In the first year by way of example – the range of returns one can expect is anything between -11.9% and +33.7% (i.e., highly volatile). In statistical terms what that means is that there is a 13% probability of achieving a return of between 0 and -11.9% (i.e., negative); and an 87% probability of achieving a return of between 0% and 26% (the yellow bit on the graph).

Over time however it becomes clear that the volatility risk reduces and by year 5 the probability of losing money on this investment strategy is almost zero.

The major risk with the current investment strategy is capital adequacy because there is a high probability the trust will deplete its capital by the time Kay reaches the age of 40.

But by understanding the outcome needed and adapting the investment strategy to an approach that is more likely to provide Kay with an income for life (and understanding that volatility is not actually something to fear) – there should be sufficient capital to provide Kay with an income until the age of 80.

Why Spending Less and Reducing Charges can have a meaningful impact

Spending less and reducing charges are another important consideration in attempting to ensure the sustainability of a sum of capital over the long term. Spending less might not always be a viable option depending on the needs and circumstances of the investor.

However, reducing investment related charges can also make a significant impact in ensuring the sustainability of the capital at hand.

This example demonstrates the impact of reducing the investment related charges – i.e., the ongoing advice charge of 0.65% p.a. (which currently equates to almost R15,000 per month).

On a proposed fixed advice fee for trusts that starts at R2500 per month (that would replace the ongoing advice fee) and that is tied to a specific menu of ongoing services – the trustees are far more likely to achieve an outcome that exceeds their expectations and more importantly, does what is in the beneficiary’s best interests.  (The initial commission paid of over R600,000 is something we would never condone or consider because it is neither fair nor reasonable).

Assuming no initial commission was paid, and on the proposed ongoing fee of R2,500 per month, the graph that follows demonstrates that the capital needed to provide Kay with a comfortable life would last well beyond the age of 100. The impact a small change can make!

Conclusion: Why an Outcomes based financial plan is best

By adopting an outcomes-based approach that understands what is needed and implementing an investment strategy to reflect that, the probability of achieving a successful outcome is increased significantly. This is clearly demonstrated in the proposed modelling – Kay can now maintain this level of lifestyle for much longer. Understanding the impact investment fees and charges have can also make a meaningful difference to the sustainability of the invested capital and by adopting a policy that is both fair and appropriate for all stakeholders, it will ensure that everyone’s interests are correctly served. This approach is valuable to all investors – especially those needing to draw an income from their investments. From the case study above, it is very clear why an Outcomes-based Financial Plan is Invaluable.

Henceforward follows a lifestyle financial planning approach, which ultimately focus on why an Outcomes-based Financial Plan is Invaluable. We adopt a simple service led fee model, determined at the outset of the relationship. This fee is directly correlated to the level of service and advice provided. We aim to provide an unbiased and impartial relationship driven approach whereby we always act in your best interests and do what’s right for you, without any conflicts of interest.

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