When I changed careers and became a financial advisor, I found there were many parallels between the systems engineering process I applied in my past life developing advanced technology for the defense industry, and the financial planning process I employ with clients today. They both produce a robust design that can be relied on to build a future system. Whether it is a piece of hardware that is going to fly in space, or a financial foundation for your best future life, the basic steps are the same.
In this post, I’m going to start with an overview of these basic steps and then dive deeper into different areas in future posts. If you’re an engineer, this series may resonate for you, even if you don’t know anything about financial planning. But whatever your background or profession, I hope it will give you a better understanding of how the comprehensive financial planning process works.
Step 1: Start with the end in mind
“ In both financial planning and system engineering, it’s important to know what you are trying to create.”
In both financial planning and system engineering, it’s important to know what you are trying to create. Unlike scientific research, where the motivation is to test theories and make new discoveries, once we have decided what we want to build (something specific), it’s essential to know what that something is; otherwise we will not be able to define success. This endpoint is usually referred to as the goals of a financial plan, and they serve the same function as system requirements do in engineering.
In establishing these high-level goals, it’s important to describe what the end state does not what it is. Getting too specific too early will limit the design choices that can be made, which may result in overlooking a better approach. An example from engineering could be choosing a certain material for a part, rather than setting the requirements for the structural performance, potentially allowing a less expensive choice. In financial planning, it’s important to describe the desired outcome the plan is meant to produce, how the situation will look and feel to the person setting the goals, not just focusing on a particular number that needs to be saved. Happiness means different things to different people.
Step 2: Where are we starting from
In step two, we identify what resources are available now to start making that desired future a reality. In engineering this could include the project funding, existing components that can be reused, or the availability of a certain human skill set. In financial planning, this could include existing savings, current income, workplace benefits, or owned assets, like a home or business. You must know what’s available to plan what’s next.
Step 3: What are the options
Of course, no plan or design exists in a vacuum. There are always limits around the choices that can be made. In step three, we identify constraints that are relevant to the plan. In engineering this could be anything from the availability of a certain part to the laws of physics. In financial planning, constraints can be specific to your situation and desires, like wanting to stay in the same home in retirement, or the legal directives found in your trust. Or the constraints could be more general things like tax laws and regulations, the current state of the economy or the financial markets. Not considering these constraints in the planning process will undermine the chance of success, either because the numbers don’t work, or the outcome isn’t what you wanted.
Step 4: Bring it all together
With goals defined and resources and constraints identified, the next step is to bring it all together into an initial draft plan or a system level design. This is where we get the first sense of whether we have a workable design, or if major changes will be needed.
It’s important in this step to consider the sensitivity of the results to the various inputs. In financial planning, we make lots of estimates about future economic and market performance because, well, we have no choice. We also take into account personal specifics, for example, the value of a business being sold to fund retirement in the future. What if some of these assumptions turn out to be wrong? How far off would that put us?
“ ...it's important to look at a range of possible outcomes.”
A plan for retirement many years in the future will be very sensitive to the estimate used for the inflation rate. On the other hand, if you’re very close to retirement, saving more in the next few years, may not change the probability of a successful retirement all that much. Rather than produce one “answer,” it’s important to look at a range of possible outcomes, particularly around the most sensitive unknowns of the future.
Step 5: Watch out for risks
This step in the initial planning process is critical. Instead of focusing on how to make things work, we look at what might happen to derail the plan. Risk is a complicated subject, and I will have another post in this series talking about it in more detail. But at the most general level, a risk is something whose occurrence in the future is unknown, that will have an effect, either positive or negative, on the outcome we are planning for. Human brains love to find and then focus on “the answer.” So looking for ways we might be wrong can be challenging. But taking the time to prepare our response if something unexpected happens only strengthens our plan. In engineering, we might spend some extra money to buy spare parts in case one fails. In financial planning, we might decide to purchase life insurance to replace the income that’s currently supporting a family and building a retirement nest egg. Whatever risk mitigations are needed, they should also be a part of our plan.
Step 6: Get going!
With all of the initial steps completed, it’s time to put the plan into motion! In engineering you begin the development, designing specifics of the underlying subsystems to meet the flowed down requirements. In financial planning, first actions could include opening new accounts, or changing savings rates, or reorganizing investments, to bring the person’s finances into alignment with their financial goals as established in the plan.
But while the initial planning is completed, the journey has just started and there will be obstacles along the way. In engineering, a flaw may be discovered in initial design calculations that requires revision. In financial planning, it’s essential to monitor how both economic and financial markets actually perform over time and make adjustments if necessary. And of course major life changes, anything from a layoff to a new baby, could require adjustments as well.
Every financial plan is “wrong” the moment it is labeled “final.” Financial planning is an ongoing process, and one where we often have more time and flexibility to make adjustments than the typical engineering project.
Well, that was a pretty long post, thanks for hanging in there with me! Comprehensive financial planning, like good systems engineering, is a complicated but powerful tool to help you build the desired outcome that you want in your financial future.
If there’s a topic you’d like to see me Ann-splain, let me know.