A financial plan is the heart of the financial advising process. In a way, it’s the map for your client’s money, there to guide them financially from where they are today to where they want to be. Without a plan, investors are just paddling in an open sea, hoping their direction and speed will be enough to get them to their destination.
Given the financial plan’s importance to the planning process, advisors and clients alike must understand what a financial plan is and the key elements that make a good plan.
What Is a Financial Plan?
A financial plan is a document that takes a holistic look at a client’s entire financial picture and advises how to achieve financial goals, says Dan Keady, chief financial planning strategist at TIAA in Charlotte, North Carolina. It will incorporate your client’s “needs, wants and wishes while taking into account her comfort level with risk.”
Financial plans are generally created using financial planning software and can incorporate many facets of planning. For instance, the retirement plan element often includes an analysis showing the impacts of taking money from different accounts, both qualified and nonqualified, for income and a comparison of the tax implications of each scenario, says Kelly Campbell, a certified financial planner and chairman and CEO of Campbell Wealth Management in Alexandria, Virginia.
“Many plans will also look at the required rate of return someone needs to achieve their goals,” Campbell says. “This can give a good indication to someone as to how they should invest their portfolio.”
Creating a Financial Plan
A financial plan requires the right elements to rise to its full potential. To create a good financial plan, be sure to include the following elements:
- A net worth statement or detailed cash flow analysis. Financial planning starts with understanding your client’s current finances. “This might mean that, among other things, a plan should include a net worth statement or a detailed cash flow analysis to understand how funds are coming and going,” says Martin Schamis, head of wealth planning at Janney Montgomery Scott in Philadelphia.
- Your client’s assets and liabilities. A good financial planning strategy includes documentation of all investable assets that can be used to reach a client’s goals as well as detailed liabilities and current and anticipated spending, says Tammy McKennon, a financial advisor with Edward Jones in Newport Beach, California.
- A strategy to meet both short-term and long-term goals. “Most plans think about just retirement and the future, but a good financial plan thinks about your life goals from the present to the future,” says Aditi Javeri Gokhale, chief commercial officer and president of investment products and services at Northwestern Mutual in Milwaukee. “Too often, consumers see financial planning as something that prepares for the future, which is abstract. Financial planning also has to include how people can live their dreams today – whether it’s buying a new car, planning a family vacation, or funding for college tuition – all while you prepare for long-term goals like retirement.”
- Hypothetical simulations and risk assessment. The challenge with connecting the dots on your client’s financial road map is that a lot can happen between today and tomorrow. “This is where hypothetical scenarios, Monte Carlo simulations, risk assessments, and other common tools come into play,” Schamis says. By running these simulations, you can test a financial plan to determine its chances of success.
- Use conservative assumptions. “I always ask clients to project their anticipated spending, and we then use conservative assumptions on the growth of their assets to document a very realistic expectation of outcomes,” McKennon says. “We add additional layers of the sequencing of investment returns, which gives additional confidence to our results.”
- A holistic review of your client’s finances. While undergoing the entire financial planning process, you’ll often find other aspects of your client’s finances that need to be reviewed, says Greg Wells, regional director, and partner at EP Wealth Advisors in Torrance, California. This may include looking at whether your client is saving enough and tax analysis to make sure what’s set aside is being saved in the most tax-efficient manner. You may need to review the estate plan to make sure future wishes will be taken care of as well.
“A financial plan needs to help people both protect and prosper,” Javeri says. “In other words, both protect what someone has with insurance while growing wealth through investments.”
After all this, a financial plan may seem like a purely analytical enterprise, but there is much more to financial planning than just numbers, says Atlanta-based Daniel Crosby, a chief behavioral officer at Orion Advisor Solutions.
“A good financial plan is rooted in a deep understanding of a person’s psychology and includes choosing goals that are sufficiently motivating, making those goals vivid over time, anticipating behavioral roadblocks to success, and creating contingencies for when life doesn’t go as planned,” Crosby says. “Even the best-laid financial plan will encounter bumps along the way, and at those times, an understanding of investor psychology becomes critical.”
How to Make a Financial Plan
Financial planning begins with active listening and often asking deep questions to truly understand what matters to your client, Javeri says. “Financial plans cannot take a one-size-fits-all approach. During the conversation, it’s important to identify which life goals are most important to the client, so that a financial road map can be designed to achieve them.”
You can follow these steps to create a personalized financial plan:
- Get to know your clients: Getting to know your clients is critically important when creating the financial plan, Keady says. “A client’s family, culture, environment and career will help the advisor navigate the client’s views and relationship with financial planning.”
- Ask questions to understand your clients and their goals: Keady tells advisors to ask questions about estimated retirement age, paying off debt, college funding goals, or plans for leaving an inheritance. You should be as thorough and detailed as possible when gathering information. “This is often cumbersome, and most clients say we ask for more information than anyone else has ever asked for,” Wells says. “But the better data we have, the better output we can provide.”
- Use a form to gather client information: Keady recommends having a form to help you gather all this information as well as your client’s financial data, such as risk tolerance, income, estimated expenses, insurance policies, and bank and investment account statements.
- Be systematic in your data gathering: Despite the strong human element to financial planning, the data gathering part of creating a plan should be done systematically, Campbell says. “One-off planning is not very helpful to the client nor the advisor. Having a systematic process for planning typically utilizes certain software packages, and the process is typically streamlined.”
- Communicate how you create the plan with the client: After you gather the necessary data, you can create the financial plan. “Be sure to understand and communicate all assumptions and the Monte Carlo results,” Wells says. “Keep the details in place for future reviews and plans to compare.”
- Provide the final plan with a list of action items to complete: “The action items follow-up is also very important to make sure the plan is followed and continues to move along the correct path in the future,” Wells says.
Following up is key because the financial plan is only the beginning of your client’s financial journey – and it may not be an easy journey, even with that plan in place.
“With the current level of financial fragility we see, clients are probably not going to be able to meet all of their financial goals,” Keady says. “The best advisor will be able to review when a client is not successful (and), more importantly, explain to a client the steps they can take to move toward a successful financial path.”