What is financial planning? In defining what financial planning is not, let me quote from Mark Twain: “When your outgo exceeds your income, your upkeep will be your downfall.” Financial planning is a calling to serve others, whether in helping a client with a single transaction, or creating an all-inclusive plan for an individual, family, or business.
Recent research has found that the general public is confused about who truly is a financial planner. On the positive side, however, the public has begun to understand that whoever a financial planner is, they (the public) had better “get on the bandwagon,” because he or she must be important!
Young people, in particular, ascribe a high level of importance to financial planning. More and more of them are realizing that they must be more attentive in planning their future and their retirement, since they believe they no longer can depend on the government, Social Security, and employer pension benefits to help them attain desired goals and objectives.
In recent years, financial planning has rapidly evolved in response to the demand for assistance in working through the increasingly complex web of tax laws and financial strategies and products. People also are gaining a better basic understanding of what their needs are, and this has also fostered the growth of financial planning.
Whether the financial planner helps solve a single issue or develops a comprehensive lifetime plan, the financial planning process addresses all aspects of a client’s financial circumstances, goals, and objectives. The planner examines income production and management, asset accumulation and protection, tax management, and retirement, education, and estate planning. Financial planners have recently expanded their services to address family values, philanthropy, and family management through financial strategies. The financial planner may sometimes work with a team of related professionals, who together integrate and coordinate strategies for attaining the overall objectives of the client.
Financial Information Analysis
The steps in the financial planning process are:
- Have the client establish financial goals and objectives.
- Collect and analyze relevant personal and financial information to form a knowledge base of the client’s current financial position.
- Relate the current financial position to the client’s stated goals and objectives.
- Develop a plan of action and secure the client’s agreement to the plan.
- Implement the plan of action.
- Monitor the plan for results over time to determine whether any adjustments are needed.
Understanding the client’s balance sheet – assets, liabilities, and net worth that represents his or her financial wealth – is critical to evaluating a client’s current financial position. With a thorough analysis of the balance sheet, including liquidity, profitability, solvency, and asset utilization ratios, the planner can evaluate the effectiveness of the client’s financial activities.
It’s equally important to study and understand the client’s cash-flow statement. Unlike the balance sheet, the cash-flow statement converts all aspects of an individual’s or a business’s wealth to a cash basis. The management of cash flow has three basic components: cash-flow analysis, cash-flow planning, and cash-flow budgeting. Cash-flow management is especially helpful when a client wants to accomplish any of the following objectives:
- Measure periodic progress toward achievement of specific goals.
- Monitor complex elements of economic activity
- Evaluate the economic performance of cash flow.
- Plan a budget and control household expenses
- Develop guidelines for multiple financial investments and activities.
- Monitor performance of securities investments, rental property, or a closely held business.
- Reposition assets as necessary to help accomplish objectives.
Every client wants the highest possible investment returns over time–within their risk tolerance. Effective financial planning requires determining a client’s risk-taking propensity and recommending investments consistent with that risk profile. There are three basic risk profiles: risk tolerance, risk indifference, and risk aversion. One is no better or worse than the other. The planner’s job is to identify a client’s profile and then offer advice based on it.
The majority of investors are either risk indifferent or risk averse. They may accept risk within strict limits, but only if they can obtain more than a proportionate increase from investment returns. A good financial planner never loses sight of the truism that “the higher the risk, the higher the return.” Risk averse clients usually select safer investments with a higher current income flow, such as CDs, Treasury bills, and bonds, rather than investments with greater long-term growth potential and less current income. Factors for assessing a client’s risk profile are his or her
- ratio of higher risk to lower risk investments
- ratio of liabilities to net worth
- ratio of liabilities to gross income
- ratio of life insurance to annual salary
- number of voluntary career changes
- percentage of annual income spent on recreational gambling
A professional financial planner must maintain an in-depth knowledge of current state and federal tax laws and keep informed of any changes in the law.