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Financial Planning

Financial Planning. Chapter 3: Steps in the Financial Planning Process Chapter 4: Tools in the Financial Planning Process. Financial Planners. Steps in the financial planning process… Establish a relationship Compensation Commission Fee only Percent of assets Retainer

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Financial Planning

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  1. Financial Planning Chapter 3: Steps in the Financial Planning Process Chapter 4: Tools in the Financial Planning Process

  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 10-15 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?

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