Using Cash Flow Planning to Determine Client Risk Tolerance

By Kevin Gibbons


While cash flow planning has always been a integral part of financial planning, it has recently become a much more prevalent part of the financial planning conversations. Both advisors and clients are appreciating the importance of understanding where clients stand in their day to day spending and how to best spend their money. A good cash flow plan not only shows the client where their money comes from and goes, but considers their goals, emotions, daily habits and routines and provides a follow-up process to keep the client on track. It is a living, breathing document that guides the client through their everyday life in accordance with the goals you have established together.

But a cash flow plan can be used for other, not so obvious, purposes as well. In November of 2018, Damian Fantato wrote in FTAdvisor about the British Financial Conduct Authority’s expectations on capacity for loss. Mr. Fantato reported Rory Percival, the FCA’s former technical specialist, saying “If you are asking the client what their capacity for loss is, you are not meeting the FCA’s expectations because you are not getting the right answer. The client, in most cases, cannot tell you what their capacity for loss is. They find it difficult to divorce their emotional response to loss. Instead, ask them what they do know, which is how much income they need to maintain their standard of living.”

Mr. Percival raises the very common concern that when you ask a person how much risk they can tolerate, you get an answer to the question of “what level of risk makes you feel uncomfortable?” While a client’s emotion and comfort are important considerations in developing any plan, they are only part of the equation. He recommends using cash flow planning to determine the fiscal capacity for loss as opposed to the emotional capacity.

How might this work? At The Savvy Life, while our core service is helping people modify their spending when it exceeds their income, we often prepare Spending Plans (our term for cash flow plans) for clients who just need a reassurance that they are in fact living within their means, or want to be sure that their spending truly lines up with their mid- and long-term goals. When they see the organized breakdown of their routine and extraordinary spending, they have the confidence to spend within that plan without worrying about what they do not know.

Likewise, if a client has a very low emotional risk tolerance when it comes to investments, possibly sacrificing ROI for security, a detailed cash flow plan can show them that their actual financial situation can accommodate a higher risk investment strategy. Taken at its simplest level, why are some people overly risk-adverse when it comes to investments? Because they are afraid they will lose the money they need to maintain the lifestyle they desire. A detailed cash flow plan, which shows them where they stand financially on a day to day, practical basis, can help both the advisor and the client determine a suitable, acceptable level of risk.

This approach can work in two cases. For the client who has the resources, but is opposed to the riskier investments, the cash flow plan can show that the funds can be invested in a way to increase net worth without affecting their lifestyle, even if the investments perform at the lower end of expectations. For the client who is risk adverse but is living beyond the means of their current investment strategy, a cash flow plan can show the gap in clear, daily (or monthly) terms that is easier for the client to understand. In that case, the client can make the choice as to whether to increase their risk tolerance towards the investment strategy (thereby increasing potential returns) or decreasing their lifestyle spending to match the lower expected earnings. The key in both cases is using the cash flow plan to explicitly show the client the relation between the expected income from the investment strategy and their immediate and future expenses in terms they deal with on a daily basis.

Investment risk tolerance is a highly emotional subject for most clients. You cannot ignore that aspect in your analysis. But by using a detailed cash flow plan, you can present the client with the empirical data in a way they are used to thinking about (money flow on a daily basis) to influence that tolerance.


Kevin Gibbons is Vice President of The Savvy Life and co-author of the best-selling book Living the Savvy Life: The Savvy Woman’s Guide to Smart Spending and Rich Living.  The team at The Savvy Life works with financial advisors’ clients doing cash flow planning based on the goals they’ve outlined with their advisor.  They’ve been doing this for the past seven years as an outside resource for advisors working with over 525 clients.