Personal Economic Coach is the process of setting financial wants and creating a strategy to achieve them. One important aspect of this process is the use of economic models to forecast future financial performance, determine the optimal allocation of assets, and simulate different scenarios. Several types of models are used in the financial industry so let’s take a look at a few.
Discounted cash flow (DCF) models are one of the most commonly used financial models in financial planning but it looks at the future by looking backward. This model determines the present value of future cash flows by discounting them to the present using a discount rate. This is useful for evaluating investments and determining whether they are likely to generate a return that exceeds the cost of capital. In the DCF models, it’s not possible to see the progression of wealth in a holistic view. It also uses math to predict a future event, ignoring the future unknown variables that can exist. One important point to remember is, “Money is not math and math is not money” there are too many unknown variables that will keep the predicted results from happening.
Monte Carlo simulations are another popular financial model used in financial planning. This model is used to simulate the outcomes of different scenarios, such as changes in the stock market or interest rates. This allows financial planners to assess the potential risks and returns of different investment strategies. This type of simulation is just like printing a ledger, running many different scenarios, and then picking one. You can’t see what is going on, just guessing.
The Black-Scholes option pricing model is a model used for pricing options. The option pricing model is used to determine the price of an option based on a number of factors, such as the underlying stock price, strike price, volatility, and time to expiration. This model is commonly used by financial planners to evaluate options trades and determine the potential returns and risks associated with different options strategies. This is not a financial planning model in that it is a high-level options model. This model will not give you a total view of your financial world but is micro in nature.
Personal Economic Coach uses the Macro Model from the Leap System which has been around for over 40 years and is very popular with a small segment of the financial planning world. The reason for this is it allows the planner to plan for the client regardless of commissions and work in the best interest of the client. It shows the whole financial picture for the client all on one page and then enables simulation out into the future showing the good points and bad that the client has to deal with. Most times the client will choose to eliminate their inefficiencies when moving through their financial future. In down markets, clients don’t lose wealth since in the protection, savings, and growth model the clients are insulated from downturns and ride the upturns. Clients are protected from financial distractions.
In addition to these models, financial planners may also use other tools such as risk management models, asset allocation models, and financial forecasting models to make informed decisions about investments, savings, and retirement planning.
Overall, financial planning using models allows financial planners to make more informed decisions and provide their clients with a more comprehensive financial plan. By using these models, financial planners can better understand the potential outcomes of different financial decisions and make more accurate predictions about future financial performance.
It is important to note that financial planning is not just about analyzing data and running models. It is also about understanding the client’s wants and dreams, values, and risk tolerance, and tailoring the plan accordingly. The models are just tools in the financial planner’s toolbox, which when combined with the human touch, can help the clients achieve their financial wants and dreams easily.