Financial Planning and Analysis Final

What is personal financial planning?

Comprehensive process of formulating, implementing, and monitoring financial decisions into an integrated on that guides an individual or family to achieve financial goals

Define the process of financial planning

Understand situation

Identify goals

Analyze current situation

Develop recommendations

Present recommendations

Implement recommendations

Monitor progress

Internal data

Family, insurance, banking, investments, taxes, retirement, employee benefits, estate planning, financial statements (and goals)

External data

Interest rates, housing market, job market, investment market, business cycles, cost of living, inflation, cost of medical care and education, tax rates

Engagement letter elements

Defining parties, duration, services, fees, conditions for termination. Time horizon, responsibilities

Benefits of using a professional financial planner

More knowledge, education, objectivity, experience

Job outlook for financial planning profession

4% growth from 2019-2029. Increased need bc baby boomers; earnings around 90k

3 general schools of thought for counseling

Developmental: development occurs in stages

Humanistic: people are inherently good; goal is to establish personal responsibility within client

Cognitive-behavioral: animal research (learning principles) counselor is expert but a working alliance exists

Open vs. closed questions

Open questions give a longer answer

Benefits and drawbacks of “why” question

Can help understand goals and biases; may make the client feel attacked

Options if you sense a client is saying one thing but believes another

Clarify to ensure accuracy; repeat specific words

4 basic premises of traditional finance

Investors are rational

Markets are efficient

Mean-variance portfolio theory governs

Returns are determined by risk (beta)

4 basic premises of behavioral finance

Investors are normal

Markets are inefficient

The behavioral portfolio theory governs

Risk alone does not determine returns

Difference between normal and rational investor

Normal investors make mistakes because of cognitive biases

Explain the reasoning behind someone buying lottery tickets and insurance at the same time

Lottery allows increasing wealth; insurance prevents losing wealth

Evaluating portfolio as a whole vs. mental layers

MVT consider portfolio as a whole and covariance (diversity)

Behavioral look at each individual accounts and allow judgment

What to do if client’s heuristic is clouding judgment?

Communicate flawed logic, ask questions

How can client’s socialization impact the planning process?

Will be reflected in goals and relationship with professional

Five stages of change

Precontemplation

Contemplation

Planning

Action

Maintenance

Importance of understanding a client’s money beliefs

Can have positive or negative impact on process and goals

Money beliefs

Money avoidance

Money worship

Money status

Money vigilance

Money disorders

Compulsive buying

Hoarding

Gambling

Workaholism

Financial dependence

Financial enabling

Common money conflicts

Financial infidelity

Saving

Spending

Priorities

Requests from others

Financial enmeshment

Warning signs of financial exploitation

Sudden changes in account balances, abrupt changes to will, etc.

Values-based financial planning

Reflects client’s personal views and passions

SDT

Competence, relatedness, autonomy = self motivation

Choice architecture

Default option is optimal

SFT

Assumes that the client wants to make change; empower them to do so

8 approaches to financial planning analysis and recommendations

Life cycle

Pie chart

Financial statement and ratio

Two step/panel

Present value of goals

Metric

Cash flow

Strategic

3 phases of life cycle approach

Asset accumulation

Conservation

Distribution

Income statement pie chart

Where income is going

Balance sheet pie chart

Assets; cash; liabilities

Advantage to pie charts

Visualize situation

Liquidity ratios

Emergency fund and current ratio

Discretionary vs. non-discretionary

Discretionary can be avoided in the event of a loss of income

4 debt ratios

Housing ratio 1

Housing ratios 2

Debt-to-total assets

Net worth-to-total assets

Average savings rate for retirement and average retirement withdrawal rate

10-13 for 25-35 year old

4 percent withdrawal

Common performance ratios

Return on investments

Return on assets

Return on net worth

Three panels

Panel one is risk and insurance

2 is short term savings

3 is long term savings

Two step approach

Cover risk and improve saving and investing

Why is present value approach easy to understand

Required savings amount is calculated (easy goal to set)

Usefulness of metrics approach

Example benchmarks so clients know where they stand

Usefulness of cash flow approach

Adjust discretionary cash flow for “purchasing” recommendations

Strategic approach

Appealing to a client that has a mission; broad goal narrowed to specific objectives

Should portfolio income be part of the savings ratio

No because they are part of investment return (dont want to double count)

Major asset categories

Cash and cash equivalents

Investment assets

Personal use assets

Major liability categories

Short-term

Long-term

How are asset and liability values reflected on the balance sheet?

Assets at fmv

Liabilities at principal owed

Footnotes with extra info

Define and discuss net worth category

Assets - liabilities = net worth

Documents a client can provide to the financial planner as sources of info to properly prepare f/s

Bank statements

Brokerage statements

Loan amortization schedules

Tax returns

Life insurance policy statements

W-2s

Credit card statements

Billing statements

Common forms of property ownership

Sole

JTWROS

Tenancy by the entirety

Community property

Income and savings contribution categories on I/s

Income is inflow; savings are outflows from I/s

Expense on I/s and variable vs. fixed expenses

Expenses paid over period covered; fixed are not discretionary (mortgage, loans); variable are discretionary (vacation, gifts, entertainment)

Net discretionary cash flow

Amount of c/f available after all savings, expenses, and taxes have been paid

Purpose of statement of net worth

Explains changes in net worth between two balance sheets

Purpose of cash flow statement

Explains how cash was used between two balance sheets

What should be on forecasted f/s?

Inflation adjusted income and expenses, implementation of recommendations, any other adjustments

Purpose in creating a client’s budget

Evaluate client’s saving and spending behavior; establish plan that assists client’s in attaining goals

Purpose of FSA

Measure client’s progress towards goals; use analysis to find trends

Vertical and horizontal analysis

Vertical is each line on the statement as percent of whole

Horizontal is each item compared to other time periods

Ratio analysis

Process of calculating key financial ratios and comparing those to benchmarks

Define emergency fund ratio

Measures how many months of non-discretionary expenses the client has in cash or cash equivalents (3-6 month goal)

Define housing ratios 1 and 2

1: determines if the amount of income and housing debt is appropriate and affordable

2: determines if the total amount of debt is appropriate for the level of income

Savings rate

Ratio for financial security goals that measures the amount a client is saving towards a retirement goal (savings and employer match as a percentage of gross pay)

Performance ratios

Calculate the return a client is receiving: ROA, RONW, ROI

Personal risk management process

Determine objectives of risk management program

Identifying the client’s risk exposure

Evaluating the identified risks for probability of occurrence and severity of loss

Determining the alternatives for managing the risks

Selecting the alternatives for each risk

Implementing risk management selected recommendations

Periodically reviewing the risk management program

4 responses to managing risk

Avoidance

Reduction

Retention

Transfer

Peril

Proximate or actual cause of a loss

3 main types of hazard

Physical

Moral

Morale

Unique characteristics of insurance contract

Unilateral

Aleatory

Adhesive

Utmost good faith

Indemnity

Insurable interest

Payment of premiums

3 methods to determine amount of life insurance needed

Human life value

Financial needs

Capitalization of earnings

Term life insurance

Stated period; lower price; renewed annually; increasing premiums based on increased risk of mortality

Own occupation and any occupation disability

Own occupation: usual duties

Any occupation: work in any capacity

Determines if benefits can continue

Homeowners insurance policy

Dwelling, dwelling extensions, personal property, loss oof use, medical payments for others, and liability (not flood or earth movement); separate policies for location specific risks

Personal automobile policy (PAP)

Protects against loss for liability and property losses including comprehensive and collision; liability, medical, uninsured motorists, comprehensive, collision property, etc.

Need for personal liability insurance

Excess liability insurance to cover incidence of catastrophic liability awards

Noncancelable vs. guaranteed renewable

Noncancelable: ensures that insurance cannot be canceled and premiums will remain fixed

Guaranteed renewable: obligates insurer to continue coverage as long as premiums are paid; premiums may increase

Time value of money

Mathematical concept that determines the value of money over a period of time at a given rate of interest

Present vs. future value

PV: value today of future cash payments

FV: value in the future of present amount

Four steps to TVM calculations

Timeline

TVM values

Clear calculator

Populate TVM variables in calculator

Present value of a future amount

Current value of a future amount discount over time

Define future value of lump-sum amount

Value of present amount after earning interest over a period of time

Ordinary annuity vs. annuity due

OA: payments at end of period

AD: payments at beginning of period

PV of OA

Today’s value of an even cash flow paid over time at end of period

PV of AD

Today’s value of an even cash flow paid over time at beginning of period

FV of OA

Value of equal payments at some point in the future (end of period)

FV of AD

Value of equal payments at some point in the future (beg of period)

OA annuity with lump-sum vs. AD with lump-sum

OA payments will be received at end and AD will be received at beginning of period

NPV

Measures excess or shortfall of cash flows based on discounted PV of future cash flows

IRR

Compounded annual rate of return for the comparison of projects or investments with differing costs and cash flows

Inflation adjusted rate of return

Nominal rate of return after inflation is taken into account

Amortization schedule

Illustrates interest payments

Serial payment

Payment that increases each period to keep up with inflation

Other uses for TVM

Other goals

3 methods for expected family contribution

Regular

Simplified

Automatically assessed

Grant vs. loan

Grant does not require repayment

Repayment options for a Stanford loan

Standard

Extended

Graduated

Income Based (IBR): SAVE, REPAYE, PAYE

2 types of PLUS loans

Parent

Graduate/Professional

Consequences of default on student loans

Credit score

Garnishment

Tax refund withheld

2 types of qualified tuition plans

Prepaid (purchase credits today)

529 (save with tax benefits)