1. 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. 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. 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. 4 Financial Planners  Steps in the financial planning process Implement  Responsibility Monitor  How often? Quarterly, annually, life changing events

5. 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. 6 Communication for Financial Professionals  Interviewing  Leading questions  Why questions  Question bombardment

7. 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. 8 Communication for Financial Professionals  Advising Providing guidance Make sure you first understand client’s goals and needs.

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

10. 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. 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. 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. 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. 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 10-15 years ahead  Planning for retirement  Mental accounts Too much emphasis on lost funds Breaking even Results of friends’ investments

15. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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?