ifp 35 the financial planning process

7/31/2019 Ifp 35 the Financial Planning Process

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237Financial Planning HandbookPDP

Chapter 35


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238 Financial Planning Handbook PDP

The Financial Planning Process

Financial planning is a highly personalized service. It is not a product. It is a cyclical service thatconstantly repeats as client needs change over time. Preparation and implementation of the financialplan is a long-term relationship and not a one-off exercise.

For the success of the financial planning exercise, it is essential that the prospective client should have

complete confidence in the financial planners capabilities. Confidence is built when the planner can

demonstrate adequate knowledge, technical depth and complete dependability.

Also remember that financial planning is a two-way interaction between the client and the planner. It is

not and should not be treated as a one-way prescription which is to be given by the planner to the client.

Both the planner and the client have certain responsibilities to make the exercise a success.

The Planning Process

The preparation of the financial plan is a multi-dimensional process. It requires the planner to collect as

much information as possible about the current resources, assets and liabilities of the client. The planner

needs to analyze the collected information from a number of different aspects to develop an optimal

financial plan.

To prepare and implement a comprehensive and effective financial plan, the Financial Planning Standards

Board recommends the following 6-step process:

Let us look at the above steps in more detail.

1. Establish the Client-Planner Relationship

Before approaching a client, it is important for the financial planner to clearly understand his own role.

The role of the financial planner is not to suggest get-rich-quick schemes. Rather, it is to evaluate and

study the clients' needs, gather and analyze data and prepare a financial plan for now and for the future.

Preparation and implementation of the financial plan is a long-term relationship and not a one-off exercise.

A financial planner has to prepare a plan that helps his clients:

Organize their finances

Improve their cash flows


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Lower their personal income taxes

Plan for their retirement

Improve their investment performance

Lower their investment risk

Insure themselves appropriately and reduce insurance costs Minimize their estate settlement costs

To achieve this, the planner needs to answer the following questions:

What is the most immediate concern of the client?

What is the clients current financial situation?

What are the clients immediate and long-term needs?

What is the gap between the clients needs and the current financial situation?

What services can you apply to the clients needs?

How would the client benefit from your service portfolio?

What is the estimated time frame to complete the plan and accomplish goals?

Is your role likely to be of an adviser, motivator, teacher, or director?

Client agreements and confidentiality clauses

When a client utilizes the services of a financial planner, he/she shares financial and other personal

information with the planner that is normally not shared with anyone else. The client-planner relationship

presupposes a very high level of trust between the two parties. Consequently, the planner is under

obligation to maintain utmost confidentiality of this information.

To prevent unnecessary litigation and disputes in the future, it is recommended that the financial planner

should enter into a client agreement which formalizes the relationship with the client and establishes the

basis on which the service would be provided. Such an agreement is also referred to as the 'Letter ofEngagement.'

See Annexure at the end of this chapter for a sample 'Letter of Engagement.'

2. Gather clients data and determine goals and expectations

The next step involves researching and collecting information that will help the financial planner design

and implement a successful financial plan. There are two aspects to this exercise:

(a) Understanding the client's current financial position.

(b) Getting to know the client's financial goals, objectives and requirements.

The first helps the financial planner understand where the client is at the moment and the second helps

the financial planner understand where the client wishes to go.

Formulation of Goals

Financial goals are the milestones that the client hopes to reach with the help of his financial resources.

These milestones could be concerning different aspects of life like:

Saving for marriage / childbirth

Buying a new car / house / electronic equipment

Creating a corpus for retirement

Creating a corpus for children's education


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Adequately insuring self and family

Creating cash reserves for emergency usage etc.

The financial planner should ensure that the goals are:

Specific;

Realistic;

Measurable / Quantifiable in money terms; and

To be achieved within a specific time period

Once the client has stated clear, quantifiable goals for financial planning, the next step is to rank those

goals in order of importance. This is necessary because most clients do not have the resources to fulfil

all their goals. The financial planner must make it clear to the client that less important goals must be

sacrificed or postponed to achieve the more important ones.

This done, the financial planner needs to work out the amount of money available for achieving these

goals. To achieve most financial goals, the client would need to start saving and investing appropriately.

Therefore it is important for the financial planner to know where the money to invest will be coming from.

Gathering Data

There are two types of data to gather from the client - quantitative and qualitative.

Quantitative Data

Quantitative data provides specific information concerning a client along with numerical details concerning

his/her financial status. It also provides the basis for the many financial analyses that the financial

planner needs to perform.

Examples of quantitative data include the following:

General family profile

Names, addresses, and phone numbers of family members

Assets and liabilities

Cash inflows and outflows

Insurance policy information

Employee benefit and pension plan information

Tax returns for the last three years

Details on current investments

Retirement benefits available

Client-owned business information

Copies of wills and trusts

Qualitative Data

Qualitative information provides general information concerning a client's goals, lifestyle, health status,

risk tolerance level, employment status, hobbies, attitudes, and fears. Knowing a client's specific goals,

such as planning to move when retiring at age fifty-five, funding a child's college education and expenses,

starting an expensive hobby just before retirement, or traveling extensively during retirement, is important

to the success of any financial plan.


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Examples of qualitative data include the following:

Goals and objectives

Health status of client and family members

Interests and hobbies

Expectations about employment

Risk tolerance level

Anticipated changes in current/future lifestyle

Other planning assumptions

A sample format for collecting data is provided for your reference in Annexure 2 at the end of this

chapter.

3. Analyze clients objectives, needs and current financial situation

Preparation of the Client's Personal Financial Statements

Preparation of the Cashflow Statement and the Budget

Prioritizing Goals

The next step is to prioritize the financial goals of the client and work out the amounts that are required

to be invested towards achieving these goals.

Evaluate Qualitative Factors

Qualitative factors have a significant bearing on the financial plan for a client. The client's tolerance

towards risk, investment preferences, current health status etc. need to be kept in mind while evaluating

alternative strategies.

4. Develop appropriate strategies and present the financial plan

A financial planner needs to develop appropriate strategies for the client in the following areas:

Cash flow management

Insurance planning

Investment planning

Retirement planning

Income tax planning

Estate planning

Let us look at these in more detail.

Cash flow management

Cash flow management is the means for funding clients goals in other planning areas, therefore, generally

it is the starting point of the planning process. Once the cash flow management plan is in place, the

inflows have to be channeled in one of the three areas - expenses, reserves for emergencies and capital

accumulation.


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Once your clients have planned to maximize income and minimize spending, they need the planner's

help to plan for their insurance, investment, education, income tax, retirement, and their estate.

Insurance Planning

People buy insurance to take care of various risks that can cause financial loss. Insurance mitigates

risks by transfering risk from an individual to a large group of people. Insurance companies collect small

amounts from their clients and pays lumpsums to those who suffer losses.

Some of the specific reasons why people purchase insurance are to provide themselves with the funds

necessary:

To maintain their existing lifestyle after the death of a loved one (life insurance);

To ensure continuity of income (disability insurance);

To pay medical bills (health insurance);

To replace or repair a tangible item (home owners and automobile insurance).

The financial planner's job is to help clients identify the risks that they are exposed to, and construct a

plan of action to provide adequate insurance against those risks.

The planner needs to carefully gather data about the client to be able to identify all the risks that he is

exposed to. The planner then needs to estimate the amount of insurance that would adequately cover the

identified risks.


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Important

While under-insuring can be highly damaging, over-insuring can adversely affect the lifestyle of the client

by reducing the available cash flow.

The financial planner also needs to determine which insurance policy will be best for the client. There are

a huge number of permutations and combinations of features available, which can be confusing for theclient. A financial planner can help the client choose the optimal policy using his specialized knowledge.

Investment Planning

Investment planning is critical for helping clients reach their financial goals. Every client has different levels of

risk appetite and thus the investment needs of every client are different. It is the financial planner's job to

construct an investment plan appropriate to the client's need his age & the life cycle, he is in.

The investment planning process comprises three steps:

Let us look at these in more detail.

Defining investment parameters

The financial planner needs to perform an assessment to understand the client's position on each of the

following:

Risk tolerance level - the amount of risk that the client is comfortable with. From the investment

perspective, this usually means the extent of variability in returns available from an investment.

Time horizon - the time period for which the client is willing to invest.

Liquidity concerns - the extent of liquidity (or the lack thereof) that a client is willing to live with. Typically,

older individuals or those with no steady source of income prefer liquidity over the quantum of return.

Income tax consequences - the tax benefits available for different classes of investments and the

client's eligibility for the same.

Managing client expectations

Once the financial planner is aware of the client's concerns, he/she needs to educate the clients about

investing. The planner needs to explain what investing can and cannot do. It is important to explain the

benefits and pitfalls as well as the key concepts such as the types of risk investors are exposed to, rates

of return, and the risk/return trade-off present in investing.


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Selecting appropriate investment vehicles

The last step is to help the client objectively determine investment strategies for achieving financial

goals. The financial planner needs to advise the client on the types of investment vehicles to select. In

selecting investment vehicles, investors essentially have two options: debt or equity. Depending on his

assessment of the risk profile and return expectations of the client, the financial planner also needs to

advise the client about the percentage allocations to each class of investment.

Tax planning

Tax planning is all about using any allowable strategy to reduce or shift either current or future tax

liabilities. Clients require tax planning so as to maximize their cash flows for other activities. It is not a

financial goal in itself.

For many people, income taxes are their biggest expense and therefore deserve special attention. The

financial planner's role is not to prepare the client's income tax return; rather, it is to identify potential tax

savings opportunities. Depending upon the prevalent tax laws, tax savings may be available on investments

made in insurance, stocks etc.

The financial planner's job is to help the client minimize taxes, not to evade them.

Estate Planning

This is a very important area for the financial planner because for a majority of people, estate planning is

the most neglected and ignored part of their personal finances. Estate planning is crucial as a means of

providing for one's family over the long term. Failing to plan for the legal and financial aftermath of death

usually results in much heartache and pain for the survivors.

The financial planner should ensure that the client makes a will and appoints an executor to his estate

during his lifetime. He should also ensure that appropriate nominations for all assets are in place.

The financial planner should guide the client in setting up the distribution of his estate in a manner thatminimizes the tax impact on the heirs.

Retirement Planning

The purpose of retirement planning is to ensure that the client will be able to maintain her current standard

of living after retirement, even in the absence of regular cash inflows by way of income. For this, a

financial planner will need to discuss the following broad aspects of retirement with clients:

Discuss with clients as to what is important to them after retirement.

Help the client in setting realistic retirement goals.

Determine the total amount of money that a client needs for retirement. This is usually done by going

through a retirement needs analysis.

Advise the client on the various retirement plan options.

Design a financial plan that helps the client achieve her goals.

5. Implement the financial plan

The financial plan is the result of a long process of probing, information collecting, interpretation, and

synthesis. Its acceptability depends on the planner's accurate understanding of the client's needs. Most

times, the recommendations need to be fine-tuned before the client fully agrees to implement the plan.


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It is advisable that the planner should first discuss the general recommendations with the client informally.

This allows the clients to indicate their preferences and opinions on the options that have been designed.

Involving the client in this manner builds ownership and commitment. Once the planner and the client

agree on recommendations, a concise written proposal is prepared along these lines:

An overview of the client's short- and long-term goals. The client's current financial strengths and weaknesses and implications the financial plan.

The client's financial objectives anchored to current resources.

A detailed summation of all recommendations.

The financial plan from mutually selected recommendations.

A comprehensive economic overview of the client's financial plan, supported by financial statements.

A step-by-step implementation and monitoring plan.

Despite all the work that has gone into preparing it, the financial plan solves the client's problems only on

paper. The real hard work begins later when the recommendations have to be turned into reality. The last

section of the plan proposal is perhaps the most important. It describes how the planner and the client

will work together to implement the plan.

The step-by-step blueprint must be specific. It should lay out in sequence the tasks, decisions, and

assessments to be made along the way to financial success. It should be clarified with the client as to

who will initiate action on each recommendation, and with what results.

If the compensation structure for the financial planner is fee-only, then the involvement of the planner in

the actual implementation of the financial plan - that is, selection of investment vehicles - will not be

direct. In this scenario, the planner would need to refer the client to an internal associate, stock-broker,

lawyer, or other financial product specialist.

A specialist is a product salesperson (e.g. insurance agent, mutual fund broker, stock broker) or a fee-

based expert (e.g. lawyer) who works in highly defined, technical financial areas. Technical experts knowtheir fields very well and can suggest products tailored to the client's objectives, resources, and risk

profile.

The planner needs to review the specialist's proposal to make sure it fits the client's needs and other

parts of the financial plan. Ideally, the financial planner should recommend several specialists in the

same field to the client. This ensures the planner's neutrality and places the task of selection on the

client. The planner should make sure that the specialists' perspective - aggressive or conservative - is

compatible with the client's.

The financial planner may have to play the role of motivator to the client because implementing the

financial plan is the most difficult step in the entire process. It often requires multiple sacrifices from the

client and forces a lot of self-discipline on the client. Therefore, the client needs constant motivation andprodding to implement the plan.

If the client does not implement the plan, it is an opportunity loss for the financial planner in terms of

future business because the client has probably spent a lot of time in providing the planner with the

desired information but is no closer to financial security.

The planner needs to remember that the client's financial plan is worthless on paper but potentially

priceless, if implemented in the true spirit.


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6. Monitor the financial plan

The final step in the financial planning process is periodic monitoring of the plan. This is essential

because financial goals and objectives are not fixed but are continuously changing in responses to

changes/events in the client's life.

Some events that may cause change in the financial goals of a client are: marriage / divorce

birth of one or more children

death of a spouse

disability or illness of self/parents/children/spouse

loss of employment for self/parents/children/spouse

moving from one job to another

moving from one location to another

Depending on the compensation model fully paid on the delivery of the financial plan or commission on plan

performance the financial planner will take a low or high profile in monitoring the plan with the client.

Even if the fee is fully paid upfront, the financial planner should always be interested in monitoring

the performance of the financial plan. The reasons for this are:

Every satisfied client can be used as a reference to generate more leads for future business.

Financial and personal conditions keep on changing, and the planner may be required to do more

work. This is typically true of tax saving strategies since tax laws change almost every year.

Economic conditions, inflation, and interest rates keep on fluctuating. A plan devised for inflationary

times may not be suitable for times when the rate of inflation is declining. The planner needs to work

with the client to modify the plan as circumstances change.

If the planner is a specialist selling products, there is always the potential for more sales.

By being involved with the monitoring of the plan, the planner would come to know what strategies

work and why. With experience, this can become the competitive advantage for the planner.

The planner should schedule periodic review sessions with each client to evaluate the course of the

financial plan. The planner should also educate the client to get in touch if any of the life-changing events

listed earlier occur.

A good model to use in monitoring a financial plan is to start with the assumptions.

When was the plan written?

What assumptions were made about the client's financial condition and personal situation and the

general economy?

How have these assumptions changed in the last six to nine months?

Are the assumptions now more or less favorable?

Does the planner expect the new assumptions to prevail long enough to make changes to the

financial plan?


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