Women going through divorce are faced with what can feel like never-ending questions, decisions, and emotions. To make the best legal decisions, you hire a family law attorney that is familiar with and experienced in the divorce process in your state of residence. You may also hire a divorce financial planner or Certified Divorce Financial Analyst to help with the personal financial considerations leading up to and throughout your divorce process. And depending on your situation, you may also need the assistance of a forensic accountant, a mediator, or other professionals that could play a role on your “divorce team.”
With a full complement of professionals working for you during a divorce, you likely feel pretty confident about your chances for an equitable financial settlement. But you may still be getting less income or assets than you deserve.
And the culprit is divorce planning software.
In my work with women going through divorce, many legal and financial professionals use software like FinPlan, Family Law Software or Divorce Settlement Analyst Software. And this can be problematic for you. You see, while each of these software tools is necessary in helping divorce professionals and their clients determine the legal and tax considerations involved in different divorce settlement scenarios, they all fall short in one crucial area.
They each use fixed investment return assumptions. And this can cost you a lot of money.
Let me explain . . .
If you and your husband currently have $1 million in liquid pre-divorce savings and investments, traditional divorce planning software would require that your attorney or financial planner insert a fixed return assumption into the divorce software to project how much these assets might be worth in the future.
For instance, if you have $1 million today and we assume it grows at 7% per year, it will be worth almost $2 million in 10 years. And this is typical of what the above divorce planning software asks your divorce professionals to do. They have to plug in an assumed future rate of growth for investment assets. And the software assumes you’ll receive this same return each and every year.
This is a big, and potentially costly, problem for 2 reasons:
- No one knows how investments will perform in the future, and
- Investments don’t follow a nice, steady path and provide the same fixed return each and every year.
I hope the first point above is abundantly clear to you. If anyone says or implies that they know (or even have a good hunch) how a non-guaranteed investment will perform in the future, they’re misleading themselves, they’re misleading you, or likely both.
When it comes to the future, it’s unclear and uncertain.
For more detail about the second point above, you may be interested in this video I published recently.
This issue about how investments don’t behave as simply as a fixed return would indicate requires a little more explanation, and I’ll expand on it further in my next blog post. Until then, just be aware that relying on software that bases its calculations on simple, fixed returns can be misleading at best.
At and its worst, it could be very costly in calculating your divorce settlement and establishing your negotiating position in the divorce process.
Today, I’d like to use a more practical example.
Let’s assume that today you have $750,000 and you need $2,000,000 in 10 years. You plan to add $25,000 to this investment every year. In addition, you’ll add another $75,000 in year 3 and you’ll add another $125,000 in year 5. In year 7, you’ll withdraw $250,000.
To get to your $2 million goal in 10 years and after accounting for these hypothetical cash flows into and out of the portfolio, you’ll need to average 8.12% over the 10 years.
Here’s what it looks like with a fixed rate assumption of 8.12% each and every year:
What the table above demonstrates is that given the assumptions outlined above and if we are able to achieve a fixed investment return of 8.12% each and every year, we’ll achieve our goal of $2 million at the end of 10 years. The red box with the zero in it reflects that we wind up with $2 million exactly with no surplus or shortfall. Also of note, since this depicts a fixed annual return of 8.12% each year, our average return for the entire 10 years is also 8.12%
But if 8.12% is our average return, in reality it isn’t prudent to assume we’ll achieve this return each and every year.
As an example, see the following:
In this example, we see two side-by-side illustrations using the same assumptions as above.
And I’d like to point out that each of these illustrations has an average return of 8.12% over the 10 years.
However, instead of showing a simple, fixed 8.12% return each and every year, we’re seeing the impact of your actual sequence of returns and cashflow in and out of the portfolio to your dollar wealth over time.
In the first column above, you’ll see we start out with positive investment returns in green for the first seven years and have negative returns in the final 3 years. In the 2nd column above, you’ll see the same exact returns except the negative returns happen in the first 3 years instead of the last 3 years.
The impact to your actual dollar wealth?
Depending on what your actual annual return sequence is as we’ve illustrated above, you could wind up short of your goal by over $76,000 as we see on the left or exceed your goal by almost $260,000 as we see on the right.
Also, it’s worth pointing out that if your goal was $2 million, you exceeded this in year 5 based on the numbers in the left-hand illustration above. So with regular reviews, you could have achieved your goal 5 years early and you could have reduced your investment risk or you could have added additional goals to your plan.
Your financial plan and your investment portfolio should never be “set it and forget it.”
I could show dozens of other examples of how your year-to-year return sequence will impact your dollar wealth, but I hope you’re beginning to see the problem with simple, fixed investment return assumptions. And if you’re planning for 20, 30 or 40 years from today, the problem just becomes bigger.
If you or your divorce attorney or your divorce financial planner is relying on bad divorce planning software which requires you to input a fixed investment return assumption, it could easily overstate (or understate) what you may have in future financial resources.
The solution is to throw fixed rate investment assumptions out the window and replace them with probability analysis. For more on how this works, see my previous post on Monte Carlo simulation. In fact, here’s a graphical tool you can use to play around with how probability analysis works with regard to your financial planning and investing.
You need to rely on your attorney for legal advice and carefully consider the tax implications of any decisions or settlement options you consider. But when it comes to future financial planning and portfolio projections, DO NOT rely on software or any other tool that bases its calculations on fixed investment returns.
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