1 © 2007 ME™ - Your Money Education Resource™ Chapter 3: Steps in the Financial Planning Process Chapter 4: Tools in the Financial Planning Process Financial Planning

2 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

3 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

4 Financial Planners  Steps in the financial planning process Implement  Responsibility Monitor  How often? Quarterly, annually, life changing events

5 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?

6 Communication for Financial Professionals  Interviewing  Leading questions  Why questions  Question bombardment

7 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

8 Communication for Financial Professionals  Advising Providing guidance Make sure you first understand client’s goals and needs.

9 Communication for Financial Professionals  Effective financial professionals Know yourself Be yourself Respect client Accept views that differ from your own

10 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

11 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

12 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%

13 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

14 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 years ahead  Planning for retirement  Mental accounts Too much emphasis on lost funds Breaking even Results of friends’ investments

15 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

16 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

17 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

18 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

19 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

20 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

21 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

22 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

23 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

24 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?