Close Close
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards

Financial Planning > Tax Planning

Temperament & Tools

Your article was successfully shared with the contacts you provided.

When you consider the financial planning industry as a profession, the future is extremely bright. This is partly because the financial planner is the only advisor who can–and must, I’d argue–gather such a comprehensive amount of client information. Being privy to such a wide range of personal and confidential data brings with it a significant responsibility to act in the client’s best interests or, should I say, in a fiduciary capacity. Moreover, following the fiduciary path can easily place the planner in the enviable position of gatekeeper, or single most trusted advisor. To accomplish this, the practitioner must not only have a keen intuitive sense, but also superior tools at their disposal. These tools are a significant key in creating the type of analysis a client will highly value.

When you examine the landscape of current financial planning software, you find strengths and weaknesses with each application. The existence of these shortcomings has driven some practitioners to create proprietary planning software.

In an attempt to help you, my peers, provide better planning to your clients, I’ll explain the process I follow and the proprietary planning tool I have developed over a period of several years. The type of software, and the planning process itself, is only limited by our imagination and our ability to bring our vision into reality. This is precisely the path I am traveling. Let’s take a closer look together.

Determining How Much

Have you ever had a client ask you, “What amount of annual spending in retirement is reasonable?” Perhaps they asked if $75,000 was prudent. What did you say?

The trend chart above displays the ending value of a client’s financial assets in the 30th year based on five different spending levels. Annual withdrawals start at $55,000, increase in increments of $10,000, and peak at $95,000 (Y axis). After the first year, withdrawals are adjusted for inflation. We began with a portfolio of $1 million; assumed a 7% annual return, and a standard deviation of 10%. Monte Carlo simulation was employed on all five scenarios with 1,000 trials on each.

So what does the chart mean? The red shaded area measures the 95th percentile while the narrow blue line measures the 5th percentile and is centered on the median. As you can easily see, the point at which the blue line falls below $0 (X Axis) is just before the third scenario. This would indicate that spending $75,000 may exhaust the assets prematurely.

This chart is helpful if you’d like to view multiple scenarios simultaneously

Financial Planning Software

Your opinion concerning the purpose of financial planning will greatly influence your software selection. For instance, if your primary focus is on helping clients plan for retirement, you may not be interested in software which includes estate planning.

The software decision is also greatly affected by your definition of a financial plan. Although there is general agreement on the difference between comprehensive and modular planning, there is some inconsistency on what constitutes comprehensive. Is it a comprehensive plan when you include three modules? How about four or five? I define a comprehensive plan very broadly. As such, I prefer software which analyzes a very wide range of areas. Perhaps I’m just picky, but since I couldn’t find that “perfect” solution, I built my own. In my practice, I use an Excel spreadsheet with about 70 different tabs and an add-on called Crystal Ball. Crystal Ball is a tremendous application providing Monte Carlo simulation, optimization, and much more.

When a client engages you to prepare a financial plan, it is frequently because they are seeking answers to specific questions. While this is typically the case, most clients will have blind spots or issues for which they need help but were unaware.

There are a number of important questions an advisor should address in the planning process. Here are a few of the questions I seek to answer for clients:

What’s the probability of running out of money?

What is the annual investment return needed to reach all financial goals (i.e. required return)?

What is a safe withdrawal rate (see chart above)?

What is the amount of capital needed to fully fund all goals (i.e. critical capital required)?

What’s the probability of experiencing negative returns in the portfolio?

Does the client need life insurance and, if so, how much?

Is long-term care insurance necessary?

What’s the probability of exceeding the Federal estate tax threshold?

What’s the probability of leaving a legacy of a specific amount at a specific point in time?

What are the client’s debt ratios and are they in line with standard guidelines?

The Required Return

This is one of the most important questions you will answer. Basically, the required return is what the client needs to earn in order to achieve all goals. If this figure is 8%, then a portfolio of CDs will probably fall short. On the other hand, if it is 4% then why assume unnecessary risk? In this case, a portfolio of lower-risk vehicles could easily accomplish the task. Knowing the client’s required return will enable you to create a portfolio where the level of risk assumed is appropriate to the risk needed to reach their goals.

If all you do is fill out a risk questionnaire (which measures a client’s willingness to take risk) and create a portfolio based solely on its findings, then you’re flying blind. Without determining the return necessary to achieve all goals, how will you know if you’re on target? The probability of achieving a client’s required return should also be analyzed for various time periods (see chart below).

Now, let’s examine the planning process.

Planning Process

Most practitioners divide the financial planning process into six distinct steps. I prefer to use three phases; 1) the initial phase, 2) the implementation phase, and 3) the monitoring phase. The initial phase includes gathering and verifying the data, inputting the data, putting the plan together, and presenting the results to the client. The implementation phase is where the plan is put in motion and the monitoring phase consists of checking the progress through periodic updates. Let’s take a closer look at each phase.

Phase One: Gathering Client Data

There are basically two types of information you’ll gather: quantitative and qualitative. Not only will you need to know the facts and figures pertaining to their assets and liabilities, but you should also understand how they feel about certain issues. Look beyond the obvious. When you’re gathering information about a client’s goals, ask why that goal is important. Try and discover the “why” or motive behind the answer, not just the “what.” If you do this, it will separate you from advisors who are simply looking for the next sale.

How do you gather client data? Do you wing it or do you use a pre-printed questionnaire? In the past, I used a legal pad, but sometimes failed to get all of the data I needed. So I created a standardized questionnaire to assure I would capture everything necessary to create a comprehensive plan. When developing this questionnaire, it’s important to have a clear idea of the output you desire. For example, if your financial plan will incorporate the income tax benefits due to the depreciation on real property, you’ll need to know what type of property it is, the fair market value at the time of purchase, and the date of purchase. It’s better to gather more than you’ll need than not enough. This will assure the input is as accurate as possible.

Phase Two: Creating the Plan

During this step I have a few standard forms sitting on my desk so that I can make notes along the way. These notes include: scenarios to run, gaps in the client’s situation, additional information needed, and possible recommendations. It’s very important to keep track of your thoughts as you proceed. After you finish the input, and prior to preparing the final document, verify the data. This is extremely important and will assure that you haven’t missed anything. After all, you wouldn’t want to be in the middle of a plan presentation and discover an error, right? To verify the data, I send an e-mail to the client with the client’s financial statement and a cash flow summary attached. Once the client validates the information, I prepare the final document. Running multiple scenarios, I will stress test various metrics to assure we have a viable plan. Let’s look closer at this.

Stress testing is just what it sounds like, a test to determine the breaking point of something. Let’s assume your client asks how much they can safely spend each year and not exhaust their funds. They further stipulate that a 10% probability of running out of money is acceptable, but would be uncomfortable with anything higher. Clearly Monte Carlo simulation is well suited to answer questions addressing the probability of some future occurrence, but it is not particularly adept in this case, which is better suited for optimization. This is because Monte Carlo uses a series of inputs to forecast future probabilities and optimization works in reverse. Optimization uses a desired future outcome to determine an optimal input. What if the client needed or wanted to spend more than the optimized amount indicated? He could increase his savings, delay retirement, or perhaps seek a higher investment return. Your goal is to find a realistic solution, and that’s where having a quality tool can help.

Phase Three: Putting it All Together

After you have completed all scenarios and performed the appropriate stress tests, it’s time to put the plan together. The last item I prepare is the recommendations. I use a Word document which is divided into various headings such as retirement, risk management, estate planning, and so forth. Each section contains my thoughts on the proposed recommendations. The final page of the template includes a table with a list of abbreviated recommendations.

Financial planning is as beneficial to the advisor as it is for the client. Obviously, the client receives peace of mind, but the advisor now has a complete view of the client’s situation. This puts the advisor in the best possible position to provide quality advice which is something the client will greatly appreciate. Remember, clients aren’t buying a book, they’re buying advice.

Presenting a financial plan to a client is the point where you, the advisor, can shine. Clients need to see you really care and that you have a comprehensive understanding of their situation. I present most plans in my conference room. I display their plan on the hi-def TV and a printed version is available on the table.

After reviewing the plan, I present the recommendations to the client. The last column of the final page of the recommendations has a place for the client to indicate whether they agree, disagree, or need more explanation. Moreover, I have them initial each recommendation to confirm that it has been discussed. This is very important. For instance, let’s say your client did not have a will. You prepare the financial plan and recommend that he obtain one. You might even recommend a few attorneys. After procrastinating for six months he gets hit by a bus and dies. His heirs learn that you prepared a financial plan for him. Furthermore, the absence of a will created a squabble over his estate and the heirs ask why you failed to recommend a will for their dearly departed loved one. Can you prove what you recommended? You can if the client initialed each recommendation. Remember, it’s not what you say you did; it’s what you can prove that matters.

Implementing and Monitoring the Plan

Once the plan has been presented, it needs to be implemented. This is often where the process bogs down. If it just sits on a bookshelf or in the filing cabinet, it has not accomplished anything. In addition, tracking the implementation phase is crucial. Who will be responsible for each task? How will you, as the advisor, keep track of what has been done and follow up on those items which are outstanding? Managing this process can be challenging and the potential for something falling through the cracks is high.

I use an implementation schedule which estimates the time it will take to complete this phase. I also recommend that a copy of the plan be given to their CPA and attorney. With this, they will be able to see how the client’s assets are positioned. This may even reduce the attorney’s fee. The attorney will usually gather a list of a client’s assets, but will not project their growth. Since I’ve already gathered a great deal of data, if the attorney charges by the hour, it should take fewer hours. Plus, if the plan is of high quality, placing it in front of the client’s other advisors may lead to additional referrals.

The implementation phase can be more easily managed with appropriate technology. Very soon I will have the ability to post the recommendations on a private client portal of my Web site where the client–or I–can simply check off items as they are completed. Then, when an item is checked, an automatic e-mail will be sent to the other party.

Finally, at the end of the implementation phase I will verify that each item has been sufficiently addressed.

Once the implementation phase has been completed and verified, it’s important to monitor the client’s progress. For instance, if we assumed their assets would grow at an annual rate of 7% in the absence of any withdrawals, then a year later their value should be higher. What if the markets were unkind during this period? Then the value of their assets would be less than projected. If the required return was 7% and the portfolio underperformed, then the new required return would increase. To the contrary, if we exceeded our target and thus were ahead of projections, the required return would be less than 7%. Hence, the planning process is ongoing and dynamic and we should never leave the results to chance.

Getting Paid for the Plan

There are various opinions on the appropriate amount to charge for planning services. Moreover, the amount will vary based on geographic location, level of wealth, plan complexity, and the planner’s view of her services. Many planners are shy about charging planning fees. If you are providing something of value, why shouldn’t you be compensated? I charge one fee for planning and a separate fee for asset management. They are, after all, two distinct services.

Whatever you charge for the initial planning engagement, annual retainer fees are something to consider. This is especially relevant if you are serious about providing ongoing progress updates.

My retainer fees are 35% to 50% of the first year fee. So if the first year’s fee was $4,000, the retainer fee might be $1,400 to $2,000.

Using a comprehensive approach to a client’s situation is a win-win for everyone involved. By placing the client’s interests first, as a fiduciary, we are also helping ourselves. If we exceed the client’s expectations we will have happy clients and happy clients will refer their friends and associates.

If you want to develop the very best marketing plan possible, serve your clients as you’d like to be served. Sounds like the Golden Rule, does it not?


© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.