Financial Planner


Financial Planner
Pretend that you are your own financial planner and write a one to two page double spaced letter to yourself addressing at least two of the three learning goals of this lesson.
Learning Goals
1. Identify opportunities and challenges related to your cash inflows and outflows and make recommendations to assist yourself in meeting your current needs and long-term financial goals.
2. Explain the need for liquid assets and emergency funds and recommend strategies for accumulating the appropriate levels of funds.
3. Calculate savings required to meet financial goals and recommend how to incorporate planned savings into your cash flow plan.


About Cash Flow Management
The primary components of cash flow management include income, fixed expenses, variable expenses, and savings contributions. Income earned by the client may include salary, interest, dividend, pension, business income, and alimony received. Examples of fixed expenses include mortgage payments, automobile payments, student loan payments, property taxes, insurance premiums, and federal and state income tax withholdings. Variable expenses are more discretionary than fixed expenses over the short term, and include items such as entertainment expenses and vacation expenses.
The statement of income and expenses is a financial statement that represents all of the client’s income, including both earned and expected income, less all expenses incurred during the specified time period. This statement is typically prepared on an annual basis but can be prepared for a monthly or quarterly period of time. Additionally, the statement of income and expenses does not include nonrecurring transactions such as the sale of stock or an employer’s contribution to a retirement plan. Understanding a client’s cash flow can provide valuable information in understanding a client’s financial priorities by providing a snapshot of the client’s financial situation. The statement of income and expenses should be viewed with the balance sheet to provide the financial planner with a more accurate picture of a client’s financial situation.
The financial planner should identify opportunities and challenges related to a client’s cash inflows and outflows. For example, having a positive cash flow will afford the client options to save for long-term goals such as education and retirement. Conversely, a negative cash flow may lead the client to having excess debt and additional costs due to interest. The financial planner should calculate the amount of savings required to meet the client’s financial goals and recommend how to incorporate planned saving contributions into the cash flow plan. The financial planner should also communicate the need for liquid assets and emergency funds and recommend strategies for accumulating the appropriate levels of funds. The financial planner should also work with clients to identify non-financial resources that they may use to achieve financial goals. Understanding a client’s cash flow plan is essential to financial planning.
An analysis of a client’s cash flow may serve as a wake-up call. By all accounts, the United States recently went through its longest (December 2007 through June 2009) and by most measures worst economic recession since the Great Depression, labeled the Great Recession. Leading up to the Great Recession, housing prices soared and consumerism was rampant. A bubble in home prices allowed many consumers to borrow massively. The economic downturn was marked with rising unemployment, decreasing spending, and falling housing prices with threats of foreclosure. Many families continue to struggle daily to make ends meet as they try to recover from the recession. At a time when many Americans are trying to dig their way out of debt, they have no emergency funds and little or no retirement savings. Additionally, workers who faced long periods of unemployment may have depleted their savings.
Learn more about cash flow statements and analysis from the video clip posted below


Establishing Goals and Defining Assumptions
The planner and client must work together to mutually define the client’s goals and objectives for the financial plan. Goals and objectives provide a roadmap for the financial planning process. The planner must keep the client’s values, attitudes, expectations, and time horizons in mind as they affect the goals, needs, and priorities of the client. The planner might have different ideas of what a priority would be – for the planner, retirement might be a priority over saving for their child’s education. It’s important to remember, don’t make the plan your plan, make the plan your client’s plan.
As a general rule, goals tend to be broad, while objectives are narrower. However, these terms can be used interchangeably in this course, and both goals and objectives must be measurable. For example, say your goal is that you want to retire. Is that a good goal? According to your textbook, that’s a goal because it’s broad, but the objective would have to be more specific. In this case, a more appropriate statement would be, “I want to retire at age 65 with an annual income of $50,000 per year.” For our purposes, goals and objectives are expected to be this specific because they provide more information upon which to base your assumptions and planning strategies.
Additionally, the planner must collect and analyze both internal and external data. Internal data are those specifically pertaining to the client, such as income, investments, insurance policies, and so on. External data are factors such as federal income tax rates, interest rates, and inflation rates.
Establishing Assumptions
The planner along with the client, must establish reasonable assumptions. Some of these assumptions include:
• what constitutes an emergency fund (e.g., savings provisions).
• emergency fund ratio (the number of months of coverage by cash and cash equivalents of non-discretionary cash flows).
• debt ratios – what is an appropriate benchmark for this client? When will the client be out of debt?
• retirement – the retirement age, the percentage of pre-retirement income needed to maintain the retirement lifestyle, the retirement life expectancy, any legacy requirements, inflation rates, tax rates, and investment returns consistent with the client’s risk tolerance and actual portfolio asset allocation.
• education goals – ages of children, education inflation rate, current costs of relevant education.
• any lump-sum goals – today’s cost, the inflation rate, the amount needed to provide an adequate down payment.
Once these assumptions have been addressed, we are ready to begin exploring approaches to the financial planning process


Approaches to Financial Planning
There are several different approaches to the financial planning process. Using any one of the methods on its own will not likely be adequate to develop a comprehensive financial plan, while employing all of the approaches may create redundancy, but considered together will probably produce a comprehensive financial plan. An experienced financial planner may find it sufficient to only use a few.
Seven possible approaches are listed below with a brief description. Three common approaches – the life cycle, pie chart, and financial statement and ratio analysis approaches, are explained in more detail. Click on the title of each approach to learn more about it.


Life cycle approach

Data collection is quick and simple and relatively non-threatening to the client. It provides the planner with a brief overview of the client’s financialprofile.
The life cycle approach is somewhat of a pigeonhole analysis, meaning that a client’s financial position is based more on what peers in similar categories have or spend. The life cycle analysis is based upon such things as the client’s age, marital status, income, number of young dependent children, and so on. If you’re a 28 year old, married with two small children, and you’re making an income of $75,000, how do you compare to other people in the same life cycle?
Although this doesn’t deal with the client’s specific goals, it still provides a good starting point and can be used early in the planning process to compare where the client currently sits financially compared to their peers
This approach gathers and analyzes the following information:
• The ages of the client and spouse
• The client’s marital status
• The number and ages of children and grandchildren of the client
• The family income by each income contributor
• The family net worth
• Whether the client is self-employed or is an employee or unemployed or retired
Many people fit into similar profiles. The asset accumulation phase is usually early 20s to mid 50s when additional cash flow for investing is low and debt to net worth is high. The conservation (risk management) phase is from late 20s to early 70s, where cash flow, assets, and net worth have increased and debt has decreased somewhat. Untimely death becomes a priority during this phase. The distribution (gifting) phase is usually from mid 40s to end of life and occurs when the individual has high cash flow, low debt, and high net worth. The client’s life phase helps us to understand their risks and likely goals. It is entirely possible for a given client to be in two or even all three of the phases at once. Because of special circumstances, such as the early death of a spouse, the conservation phase may come before the asset accumulation phase for a client.

The pie chart

The pie chart approach provides a visual representation of how the client spends money. It is generally used after the collection of internal data and the preparation of financial statements.
The pie chart approach represents client spending in a visually stimulating way that helps the client realize spending habits and budget breakdown. The video below provides a full explanation of this approach.

The next method I want to discuss is the pie chart approach. The pie chart forces the client to focus on the fact that there is only one pie. You only have so much money to spend – that is your pie. So people can only spend what they have and it allows the client to visualize where the money goes. And this is often an eye-opening experience for the client.
So in this example of the pie chart, we’re looking at this client spends twenty five percent of their income on taxes, twenty eight percent on housing costs, they save twelve percent of their income, and so on. So then with this data, the client can look at benchmarks. So what is the typical person spend on taxes of their income? Typically it’s between fifteen and thirty percent, so they’re within that range, twenty-five percent. Savings, typically it’s between 10 and 18 percent. Again this client is saving twelve percent, so they’re within the benchmark, and so on. So it gives the client a good overview of where they stand amongst their peers, and it’s a visual that the client can see.




Risk Tolerance and Asset Allocation
Last module, we did a risk tolerance questionnaire. For risk tolerance, the greater your score, the more risk you can take. The more risk you take, the higher return you can expect. It is important to understand the amount of risk the client can take, and for that we would conduct an asset allocation. Asset allocation is how we allocate the investments amongst different asset classes. We’re going to get into investments and asset classes in more detail in future lessons.
For right now, let’s just say that in simplest form, there are four asset classes: cash, bonds, stock, and real estate. If you have a low risk tolerance, then you’re going to be mostly invested in cash and bonds. Bonds are just a loan, and you’re the lender. You’re lending a business or a government agency money and they pay you interest. Bonds are more secure than stock because if you own stock, there are no guarantees. If a company does poorly, you will lose money with stock. But, if the company is profitable, then the income earned by the company is shared with you because you’re part owner of the company. However, if the company goes bankrupt your stock could be worthless. The company would sell off its assets and from the money generated from this sale they would first need to pay off bond holders, the stock holders would then receive whatever is left. So, it’s important to be aware of the client’s risk tolerance and then design the appropriate asset allocation.