Ch3.ppt

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Ch3.ppt

  1. 1. Chapter 3: Steps in the Financial Planning Process Chapter 4: Tools in the Financial Planning Process Financial Planning
  2. 2. Financial Planners <ul><li>Steps in the financial planning process… </li></ul><ul><ul><li>Establish a relationship </li></ul></ul><ul><ul><ul><li>Compensation </li></ul></ul></ul><ul><ul><ul><ul><li>Commission </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Fee only </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Percent of assets </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Retainer </li></ul></ul></ul></ul><ul><ul><li>Gather data and define client goals </li></ul></ul><ul><ul><ul><li>Goals </li></ul></ul></ul><ul><ul><ul><ul><li>Feelings about money </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Means to accomplish goals??? </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><li>Risk tolerance/risk capacity </li></ul></ul></ul></ul>
  3. 3. Financial Planners <ul><li>Steps in the financial planning process </li></ul><ul><ul><li>Analyze and evaluate financial status </li></ul></ul><ul><ul><ul><li>Savings: three months??? </li></ul></ul></ul><ul><ul><li>Develop and present financial plan </li></ul></ul><ul><ul><ul><li>Alternatives </li></ul></ul></ul><ul><ul><ul><ul><li>Projected income/expenses </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Annual through retirement/death </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><li>Projected assets/liabilities </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Annual through retirement/death </li></ul></ul></ul></ul></ul>
  4. 4. Financial Planners <ul><li>Steps in the financial planning process </li></ul><ul><ul><li>Implement </li></ul></ul><ul><ul><ul><li>Responsibility </li></ul></ul></ul><ul><ul><li>Monitor </li></ul></ul><ul><ul><ul><li>How often? </li></ul></ul></ul><ul><ul><ul><ul><li>Quarterly, annually, life changing events </li></ul></ul></ul></ul>
  5. 5. Communication for Financial Professionals <ul><li>Interviewing </li></ul><ul><ul><li>Gathering information </li></ul></ul><ul><ul><ul><li>Questionnaires </li></ul></ul></ul><ul><ul><ul><li>Closed ended questions </li></ul></ul></ul><ul><ul><ul><ul><li>List life insurance policies </li></ul></ul></ul></ul><ul><ul><ul><li>Open ended questions </li></ul></ul></ul><ul><ul><ul><ul><li>What are your thoughts on the adequacy of your life insurance coverage? </li></ul></ul></ul></ul><ul><ul><ul><ul><li>What experience from your childhood had the greatest impact on your perception of financial security? </li></ul></ul></ul></ul>
  6. 6. Communication for Financial Professionals <ul><li>Interviewing </li></ul><ul><ul><ul><li>Leading questions </li></ul></ul></ul><ul><ul><ul><li>Why questions </li></ul></ul></ul><ul><ul><ul><li>Question bombardment </li></ul></ul></ul>
  7. 7. Communication for Financial Professionals <ul><li>Counseling </li></ul><ul><ul><li>Responsibility for establishing goals and taking action belongs to client </li></ul></ul><ul><ul><li>Financial goals and needs are closely related to personal goals </li></ul></ul>
  8. 8. Communication for Financial Professionals <ul><li>Advising </li></ul><ul><ul><li>Providing guidance </li></ul></ul><ul><ul><li>Make sure you first understand client’s goals and needs. </li></ul></ul>
  9. 9. Communication for Financial Professionals <ul><li>Effective financial professionals </li></ul><ul><ul><li>Know yourself </li></ul></ul><ul><ul><li>Be yourself </li></ul></ul><ul><ul><li>Respect client </li></ul></ul><ul><ul><li>Accept views that differ from your own </li></ul></ul>
  10. 10. Communication for Financial Professionals <ul><li>“Attending” skills </li></ul><ul><ul><li>Maintain eye contact </li></ul></ul><ul><ul><li>Face the other person </li></ul></ul><ul><ul><li>Be relaxed </li></ul></ul><ul><li>Active listening </li></ul><ul><ul><li>Can put yourself in client’s shoes; see client’s perspective </li></ul></ul><ul><ul><li>Can paraphrase client’s statements </li></ul></ul>
  11. 11. Risk Tolerance <ul><li>Prior to making investment and risk management recommendations, planner must determine client’s risk tolerance </li></ul><ul><li>Investments </li></ul><ul><ul><li>Risk tolerance versus risk capacity </li></ul></ul><ul><li>Focus on goal and take minimum risk to achieve goals </li></ul><ul><li>Look at prior investments to determine risk tolerance </li></ul>
  12. 12. Risk tolerance <ul><li>Risk aversion </li></ul><ul><ul><li>Most people: loss averse </li></ul></ul><ul><ul><ul><li>Difficulty accepting losses </li></ul></ul></ul><ul><ul><ul><li>Potential losses are measure of risk </li></ul></ul></ul><ul><li>If we can measure risk tolerance, </li></ul><ul><ul><li>why do we have investors’ returns in mutual funds lower than returns of mutual funds??? </li></ul></ul><ul><ul><ul><li>Average ten-year return: </li></ul></ul></ul><ul><ul><ul><ul><li>For fund: 15.05% </li></ul></ul></ul></ul><ul><ul><ul><ul><li>For investors: -1.46% </li></ul></ul></ul></ul>
  13. 13. Irrational behavior <ul><li>Most people are overconfident about their decision making skills </li></ul><ul><ul><li>Study: individuals who didn’t know how much they needed to save for retirement were confident they had enough </li></ul></ul><ul><li>Most people put too much emphasis on recent events </li></ul><ul><ul><li>Expect what just happened to happen again </li></ul></ul><ul><ul><li>Look for patterns: pigeons versus humans </li></ul></ul><ul><ul><ul><li>Flip coin: tails, get corn </li></ul></ul></ul><ul><li>Availability bias: </li></ul><ul><ul><li>Focus on events that personally experienced </li></ul></ul><ul><ul><li>Focus on events that are publicized </li></ul></ul>
  14. 14. Irrational behavior <ul><li>Denial of risk: can’t happen to me </li></ul><ul><li>Familiarity bias </li></ul><ul><ul><li>International stocks </li></ul></ul><ul><ul><li>Invest in employer’s stock; local companies </li></ul></ul><ul><li>Control bias </li></ul><ul><ul><li>Not in control </li></ul></ul><ul><li>Time horizon </li></ul><ul><ul><li>People can’t plan more than 10-15 years ahead </li></ul></ul><ul><ul><ul><li>Planning for retirement </li></ul></ul></ul><ul><li>Mental accounts </li></ul><ul><ul><li>Too much emphasis on lost funds </li></ul></ul><ul><ul><li>Breaking even </li></ul></ul><ul><ul><li>Results of friends’ investments </li></ul></ul>
  15. 15. Risk Tolerance <ul><li>Individuals who take physical or social risk may not necessarily take monetary risk </li></ul><ul><li>Monetary risk takers </li></ul><ul><ul><li>Read about investments </li></ul></ul><ul><ul><li>Confident in their investment abilities </li></ul></ul><ul><ul><ul><li>Believe investment results are based on skill; not luck </li></ul></ul></ul><ul><ul><li>Clear financial goals </li></ul></ul><ul><ul><li>Invested as a young person </li></ul></ul><ul><ul><li>People who earned their wealth </li></ul></ul>
  16. 16. Risk Tolerance <ul><li>Older individuals: tend to have less risk tolerance </li></ul><ul><li>Gender: no difference </li></ul><ul><li>Professionals: higher risk tolerance </li></ul><ul><li>Married individuals: higher risk tolerance if both partners work </li></ul>
  17. 17. Assessing risk tolerance <ul><li>Quantitative </li></ul><ul><ul><li>Questionnaires </li></ul></ul><ul><ul><ul><li>Norms </li></ul></ul></ul><ul><ul><ul><li>Leading questions </li></ul></ul></ul><ul><ul><ul><li>Framing questions </li></ul></ul></ul><ul><ul><ul><li>Series of questions better than few questions </li></ul></ul></ul><ul><ul><ul><li>Use more than one questionnaire </li></ul></ul></ul><ul><li>Qualitative </li></ul><ul><ul><li>Individuals tend to overstate their risk tolerance </li></ul></ul>
  18. 18. Assessing risk tolerance <ul><li>Investment objectives </li></ul><ul><ul><li>May not reflect risk tolerance </li></ul></ul><ul><li>Current portfolio </li></ul><ul><ul><li>Does client understand risk of asset classes? </li></ul></ul><ul><ul><ul><li>What happens to bond prices when interest rates increase? </li></ul></ul></ul><ul><li>Amount of client debt </li></ul><ul><li>Amount of deductibles </li></ul><ul><li>Job tenure </li></ul><ul><li>Type of home mortgage </li></ul>
  19. 19. Principles of Financial Planning <ul><li>Before invest, insure </li></ul><ul><li>Take risk consistent with tolerance, capacity and goals </li></ul><ul><ul><li>Education savings risk tolerance </li></ul></ul><ul><li>Diversification </li></ul><ul><li>Make savings automatic </li></ul><ul><ul><li>Dollar cost averaging </li></ul></ul><ul><li>Increase rate of investing instead of rate of return </li></ul>
  20. 20. Principles of Financial Planning <ul><li>It’s not what you make, it’s what you keep </li></ul><ul><li>Tax efficient investing </li></ul><ul><ul><li>Real estate </li></ul></ul><ul><ul><li>Roth IRA/401(k) </li></ul></ul><ul><ul><li>Defer taxes???? Future rates </li></ul></ul><ul><ul><li>Diversify taxability of investments </li></ul></ul><ul><li>Repaying debt can be your best investment </li></ul>
  21. 21. Investment Vehicles <ul><li>Mutual funds: </li></ul><ul><ul><li>Pool funds from investors to invest in stocks, bonds and/or other types of securities </li></ul></ul><ul><ul><li>Each share represents investor’s proportionate interest in portfolio </li></ul></ul><ul><ul><li>Priced at the end of trading </li></ul></ul><ul><ul><li>Advantages </li></ul></ul><ul><ul><ul><li>Low minimum investments </li></ul></ul></ul><ul><ul><ul><ul><li>Automatic investment programs </li></ul></ul></ul></ul><ul><ul><ul><li>Diversification </li></ul></ul></ul><ul><ul><ul><li>Professional management </li></ul></ul></ul>
  22. 22. Investment Vehicles <ul><li>Open-end mutual funds </li></ul><ul><ul><li>Grow by issuing shares </li></ul></ul><ul><ul><ul><li>Unless fund is closed if it gets too large </li></ul></ul></ul><ul><ul><li>Costs </li></ul></ul><ul><ul><ul><li>Load </li></ul></ul></ul><ul><ul><ul><ul><li>Class A: load but lower 12b-1 and annual expenses </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Class B: no front-end load but higher annual expenses </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Class C: lower load than Class A or B </li></ul></ul></ul></ul><ul><ul><ul><li>No load </li></ul></ul></ul><ul><ul><ul><li>Deferred sales charges </li></ul></ul></ul><ul><ul><ul><ul><li>Holding of funds </li></ul></ul></ul></ul><ul><ul><ul><li>Management fees </li></ul></ul></ul><ul><ul><ul><ul><li>Equities: 1 – 1.5%; bonds .5%, for example </li></ul></ul></ul></ul><ul><ul><ul><li>12b-1 fees: brokers, advertising </li></ul></ul></ul><ul><ul><ul><li>Portfolio turnover: commissions </li></ul></ul></ul>
  23. 23. Investment Vehicles <ul><li>Open-end mutual funds </li></ul><ul><ul><li>Distributions of realized capital gains </li></ul></ul><ul><ul><ul><li>Generally in December </li></ul></ul></ul><ul><ul><ul><li>Reinvest </li></ul></ul></ul><ul><li>Closed-end mutual funds </li></ul><ul><ul><li>Trade on exchange; no additional shares issued </li></ul></ul><ul><ul><ul><li>Traditional open-end mutual funds grow by issuing shares </li></ul></ul></ul><ul><li>Unit investment trusts: </li></ul><ul><ul><li>Portfolio of bonds; not actively managed </li></ul></ul><ul><li>REITs: own diversified portfolio of real estate </li></ul><ul><li>Privately/separately managed accounts </li></ul><ul><ul><li>Own shares of stock rather than mutual funds </li></ul></ul><ul><ul><ul><li>Removes layer of fees </li></ul></ul></ul><ul><ul><ul><li>Control timing of sales; taxable gains/losses </li></ul></ul></ul>
  24. 24. Investment Vehicles <ul><li>ETFs </li></ul><ul><ul><li>Match performance of index: S&P 500, GSCI </li></ul></ul><ul><ul><ul><li>Diversification or specific industry </li></ul></ul></ul><ul><ul><ul><li>Can be traded like stocks: limit order; short </li></ul></ul></ul><ul><ul><ul><ul><li>Features not available with traditional mutual funds </li></ul></ul></ul></ul><ul><li>Hedge funds </li></ul><ul><ul><li>Private, unregistered investments pools </li></ul></ul><ul><ul><li>Not subject to regulations governing mutual funds </li></ul></ul><ul><ul><li>Short/long; leveraged; principal protected notes </li></ul></ul><ul><ul><li>High fees </li></ul></ul><ul><ul><li>Low correlation with equities? </li></ul></ul>

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