Articles and advertisements often tout the merits of financial plans. From the viewpoints of a financial advisor, they are an easy $500 or more. From a public perspective, they are often worth less than the paper they are written on.

Nobel laureate Dr. William S. Sharpe perhaps best summed up the problem with financial plans in his white paper, “Financial Planning in Fantasyland.” As Dr. Sharpe noted, such sage advice as “spend less than you earn” and “save more money” hardly justify the costs of such plans.

Financial plans usually calculate financial needs based on a constant growth percentage and/or a constant rate of return on investments. Sorry, the world just does not operate that way, leading to calculations that are questionable at best, and at worst, outright fraud.

The software programs used to produce such financial calculations and financial plans are notorious for being unstable and, as a result, produce calculations and financial/investment recommendations that are both counter-intuitive and potentially disastrous. Such programs are subject to the “garbage in, garbage out’ syndrome, where slight errors in input data can result in significantly larger errors in the computer program’s calculations.

Very few people ever go over the spreadsheets usually provided within financial plans to verify the calculations. Were they to do so, they would usually find obvious errors, therefore nullifying both the calculations themselves and the recommendations based on such calculations.

Perhaps the biggest issue with financial plans is the asset allocation recommendations which usually is the key component of a financial plan. What most of the public is not told is that the risk and return numbers used in preparing such asset allocation recommendations are not based on the actual numbers for the investments a financial advisor may eventually recommend. The numbers used in such asset allocation models are the risk and return numbers for stock market indexes and/or index-based mutual funds.

Stock market-based index mutual funds generally have significantly lower annual expenses than the commission-based, actively managed mutual funds that most financial advisors recommend. Higher fees reduce an investor’s end return. Each additional 1 percent in fees reduces an investor’s end return by approximately 17 percent over a 20 year period.

Various studies have documented the fact that actively managed mutual funds have historically under-performed passive indexed-based mutual funds.

Given these facts, one might understand why financial advisors do not offer to go back and provide a revised financial plan and asset allocation model for a customer. Providing such a revised plan/model would clearly raise questions as to the value of both the financial advisor and his advice.

Bottom line: If you have had a financial plan prepared or are considering having one done, insist on having the financial advisor prepare a second asset allocation model based on the financial advisor’s recommendations before actually purchasing any investment products. If you have already had a plan done and have already purchased investment products from a financial advisor, a forensic analysis of your investment portfolio may result in improving your investment return by addressing funds with excessive annual fees and addressing potential risk management issues.

To learn more about James Watkins, visit CommonSense InvestSense.