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© 2007 ME™ - Your Money Education Resource™

Chapter 3: Steps in the Financial Planning Process Chapter 4: Tools in the Financial Planning Process

Financial Planning

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Financial Planners Steps in the financial planning process…

Establish a relationship Compensation

Commission Fee only Percent of assets Retainer

Gather data and define client goals Goals

Feelings about money Means to accomplish goals???

Risk tolerance/risk capacity

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Financial Planners Steps in the financial planning process

Analyze and evaluate financial status Savings: three months???

Develop and present financial plan Alternatives

Projected income/expenses Annual through retirement/death

Projected assets/liabilities Annual through retirement/death

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Financial Planners

Steps in the financial planning process Implement

Responsibility Monitor

How often? Quarterly, annually, life changing events

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Communication for Financial Professionals

Interviewing Gathering information

Questionnaires Closed ended questions

List life insurance policies Open ended questions

What are your thoughts on the adequacy of your life insurance coverage?

What experience from your childhood had the greatest impact on your perception of financial security?

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Communication for Financial Professionals

Interviewing Leading questions Why questions Question bombardment

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Communication for Financial Professionals

Counseling Responsibility for establishing goals and

taking action belongs to client Financial goals and needs are closely

related to personal goals

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Communication for Financial Professionals

Advising Providing guidance Make sure you first understand client’s

goals and needs.

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Communication for Financial Professionals

Effective financial professionals Know yourself Be yourself Respect client Accept views that differ from your own

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Communication for Financial Professionals

“Attending” skills Maintain eye contact Face the other person Be relaxed

Active listening Can put yourself in client’s shoes; see

client’s perspective Can paraphrase client’s statements

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Risk Tolerance Prior to making investment and risk

management recommendations, planner must determine client’s risk tolerance

Investments Risk tolerance versus risk capacity

Focus on goal and take minimum risk to achieve goals

Look at prior investments to determine risk tolerance

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Risk tolerance Risk aversion

Most people: loss averse Difficulty accepting losses Potential losses are measure of risk

If we can measure risk tolerance, why do we have investors’ returns in mutual

funds lower than returns of mutual funds??? Average ten-year return:

For fund: 15.05% For investors: -1.46%

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Irrational behavior Most people are overconfident about their decision

making skills Study: individuals who didn’t know how much they needed

to save for retirement were confident they had enough Most people put too much emphasis on recent events

Expect what just happened to happen again Look for patterns: pigeons versus humans

Flip coin: tails, get corn Availability bias:

Focus on events that personally experienced Focus on events that are publicized

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Irrational behavior Denial of risk: can’t happen to me Familiarity bias

International stocks Invest in employer’s stock; local companies

Control bias Not in control

Time horizon People can’t plan more than 10-15 years ahead

Planning for retirement Mental accounts

Too much emphasis on lost funds Breaking even Results of friends’ investments

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Risk Tolerance Individuals who take physical or social risk

may not necessarily take monetary risk Monetary risk takers

Read about investments Confident in their investment abilities

Believe investment results are based on skill; not luck

Clear financial goals Invested as a young person People who earned their wealth

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Risk Tolerance

Older individuals: tend to have less risk tolerance

Gender: no difference Professionals: higher risk tolerance Married individuals: higher risk

tolerance if both partners work

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Assessing risk tolerance Quantitative

Questionnaires Norms Leading questions Framing questions Series of questions better than few questions Use more than one questionnaire

Qualitative Individuals tend to overstate their risk tolerance

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Assessing risk tolerance Investment objectives

May not reflect risk tolerance Current portfolio

Does client understand risk of asset classes? What happens to bond prices when interest

rates increase? Amount of client debt Amount of deductibles Job tenure Type of home mortgage

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Principles of Financial Planning Before invest, insure Take risk consistent with tolerance,

capacity and goals Education savings risk tolerance

Diversification Make savings automatic

Dollar cost averaging Increase rate of investing instead of

rate of return

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Principles of Financial Planning It’s not what you make, it’s what you

keep Tax efficient investing

Real estate Roth IRA/401(k) Defer taxes???? Future rates Diversify taxability of investments

Repaying debt can be your best investment

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Investment Vehicles Mutual funds:

Pool funds from investors to invest in stocks, bonds and/or other types of securities

Each share represents investor’s proportionate interest in portfolio

Priced at the end of trading Advantages

Low minimum investments Automatic investment programs

Diversification Professional management

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Investment Vehicles Open-end mutual funds

Grow by issuing shares Unless fund is closed if it gets too large

Costs Load

Class A: load but lower 12b-1 and annual expenses Class B: no front-end load but higher annual expenses Class C: lower load than Class A or B

No load Deferred sales charges

Holding of funds Management fees

Equities: 1 – 1.5%; bonds .5%, for example 12b-1 fees: brokers, advertising Portfolio turnover: commissions

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Investment Vehicles Open-end mutual funds

Distributions of realized capital gains Generally in December Reinvest

Closed-end mutual funds Trade on exchange; no additional shares issued

Traditional open-end mutual funds grow by issuing shares Unit investment trusts:

Portfolio of bonds; not actively managed REITs: own diversified portfolio of real estate Privately/separately managed accounts

Own shares of stock rather than mutual funds Removes layer of fees Control timing of sales; taxable gains/losses

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Investment Vehicles ETFs

Match performance of index: S&P 500, GSCI Diversification or specific industry Can be traded like stocks: limit order; short

Features not available with traditional mutual funds Hedge funds

Private, unregistered investments pools Not subject to regulations governing mutual funds Short/long; leveraged; principal protected notes High fees Low correlation with equities?