What is Financial Planning Anyway?

Not all financial planners prepare financial plans! Not all financial plans look alike or provide the same type of information.

Comprehensive Planning
Here is what NAPFA (National Association of Personal Financial Advisors) has to say about financial planning. Rod is a NAPFA-Registered Financial Advisor and provides comprehensive financial plans.

“NAPFA-Registered Financial Advisors are primarily engaged in providing comprehensive financial planning. Most of the nation’s financial advisors pay lip service to comprehensive planning but few actually provide it. In recent years, largely because of the runaway stock market of the 1990s, the practice and public perception of financial planning tended to be overly focused on investments in general, and stocks in particular – a trend encouraged and reinforced by the fact that most providers of financial advice benefit from the sale of financial products.

“As a result, many members of the public have received a painful reminder frequently forgotten: the value of investments can fall as well as rise. If they were relying on a financial advisor who was merely providing investment advice, they are probably surprised by and poorly prepared for the bear market.

“Why? If an advisor doesn’t understand the client’s full picture, the quality of advice in any one area, including investment advice, can suffer significantly. Competent and informed investment decisions must take into account all the other factors that comprise an investor’s financial profile, including tax, estate planning, insurance, risk tolerance, specific family circumstances and ultimate financial goals. A truly comprehensive financial plan, therefore, is much more than investment advice. It is an all-purpose tool that enables planner and client, working together, to make better financial decisions because each individual decision is made within the context of the full picture.” (Source: www.napfa.org/consumer/faq.asp)

Financial Projections

The financial planning profession began in 1973 and is immature when compared to the CPA profession, which dates back to 1887. CPAs have been preparing financial projections for decades under a specific set of profession standards. By contrast, a CFP^® has only a few general guidelines they must follow.

Financial Planning Assumptions

Financial plans consist of several components – assumptions, financial model or calculations and report. Assumptions are the most critical element, in my view. Following the maxim – “garbage in, garbage out” – a financial planning report is only as accurate as the assumptions used to create the plan. Here are some of the assumptions that are typically found in one of our financial plans.

·         Expected future inflation rate, including alternative rates under various scenarios.

·         Expected long-term total return on investments

o       Returns are dissected by appreciation, taxable and non-taxable cash income, reinvested or distributed.

o       Returns are usually modeled under various scenarios.

o       Portfolios are further split into qualified retirement, taxable brokerage and Roth IRAs.

o       Expected time of investment sales, and amount of gains on sales.

·         Details of expenses by category and income by category, including changes in various expenses as future circumstances change and savings for periodic large expenditures such as vehicles or travel.

·         Expected future federal and state income and estate tax rates.

·         Expected future levels of auto, home, health, disability, umbrella, life and long-term care insurance coverage, costs, benefit levels, cash value accumulations, etc.

Hopefully, the list of typical assumptions demonstrates the depth to which we identify assumed future events. Typically, the list of assumptions is several pages in length.

“What if” Scenarios

Some financial planners illustrate a single projection of most likely events and the time of their occurrence. Such a short-cut decimates the value of the financial plan. An important feature of our financial plans is to project various alternative scenarios, such as premature death, total disability, extended long-term incapacity, early retirement, heightened inflation and reduced investment returns. Some scenarios may be alternatives under consideration. Others are, hopefully, remote possibilities. The purpose for modeling alternative scenarios is either (1) to test the adequacy of insurance protection, (2) to identify the optimal combination or timing of multiple events, or (3) to help the client decide upon key alternatives, like buying a vacation home, when to retire, or starting a new business.