During my PhD, I’ve taught numerous classes related to personal financial planning. In these classes, I’ve noticed that many students don’t understand the financial planning process. If my students don’t understand the process, and they are enrolled in a CFP® Board registered academic program, then what about the general public? I’m guessing few individuals outside of the financial industry have an accurate understanding of financial planning.
This lack of understanding is exacerbated by the hoards of people calling themselves “financial advisors” or “financial planners” or “financial consultants” or “financial brokers” or “wealth managers.” All of the different titles and job descriptions are confusing, and confusion ultimately reduces consumer demand in a knowledge based profession.
If you’re considering hiring professional help, you need to know what to expect from a good financial planner, and how to tell the difference between a salesperson and someone who offers fiduciary financial planning advice. Hopefully this article will lead you in that direction.
What Financial Planning is NOT
Before I describe the financial planning process, let’s clear up a major misconception surrounding the profession:
Financial planning is not synonymous with asset management, stock picking, or investing.
Investing is an important part of the financial planning process, but it’s only one small part of the overall plan.
Low-cost index funds, robo-advisors, and automated investment platforms have made investing ridiculously easy for everyone. With a few clicks of the mouse, anyone can establish a well-diversified, low-cost portfolio of index funds. I believe this trend will continue to accelerate, making it harder for brokers and salespeople to sell commissioned investment products (most of which should not exist anymore).
What is Financial Planning?
Financial planning is about using your money to achieve your goals.
A financial plan should begin with a series of questions about you. For example:
- What do you want to achieve in the next 5, 10, 20 years?
- What are the most important things in your life?
- What activities make you happy?
- What are your core values?
These questions should make you think about your life, goals, and priorities. Without a clear understanding of these things, it’s impossible to create a personal financial plan.
You may be asking, what about the financial aspect? Well, that’s part of the process, but it’s secondary. Your financial assets are the means by which you achieve your goals. You must define your goals before worrying about the dollars and cents.
Financial planning is an ongoing process.
Your life circumstances, goals, and values will change over time. A good financial plan allows for that change.
Financial planning is multifaceted.
A customized financial plan should consider all of the following (and more):
Cash Flow Management
- How much money are you making, spending, and saving?
- What is your savings rate?
- Do you have an adequate emergency fund?
- Where should you hold that emergency fund to obtain the highest risk-adjusted return?
- How much debt? At what interest rate? What are the minimum monthly payments?
- Do you qualify for any Government loan forgiveness programs?
- Should you prioritize debt repayment over saving and investing?
- Do you own a home, rent, or something else?
- Should you refinance your mortgage?
- Should you use a HELOC as an emergency fund?
- Should you consider a reverse mortgage during retirement?
- Do you want to return to school? Do other members of your family?
- What funding vehicles are available, and which is most appropriate given your situation?
- If you can’t do both, should you save for college or fund your retirement?
- What is your career and income potential?
- Do you enjoy your work, or are you looking for something different?
- What benefits are offered at your job? Are you properly utilizing them, or paying for unnecessary benefits?
- How much are you paying in fees and what are the available investment options?
- Are you utilizing available retirement plans?
- Does Traditional or Roth make more sense for you?
- How risky are your investments, given your risk tolerance?
- Do you have adequate coverage for your home, cars, etc.?
- Do you need life insurance, disability insurance, or an umbrella policy?
- Should you consider switching providers to save money?
- Do you have adequate savings to fund your retirement?
- Should you consider purchasing an annuity to provide guaranteed income?
- How can we plan retirement income distributions to minimize the tax burden?
- Have you completed the essential estate planning documents (will, power of attorney, etc.)?
- Will you have a taxable estate? If so, how can we minimize taxation?
- Should you consider whole life insurance or a trust?
Sound financial planning requires a significant investment in human capital, and a competent financial planner should have a thorough understanding of the content areas described above. Without this knowledge base, how can a planner add value to your life?
There are some great financial planners out there, and some terrible ones. It’s mixed bag, and I’ve seen numerous brokers masquerading as financial planners, despite having zero financial planning education. An individual’s level of education, training and experience will make a big difference in their ability to provide sound financial advice.
Why Does it Matter?
Financial planning can improve many aspects of your life:
Clarity for your financial life – Knowing your cash flows can help you identify problem areas, and can ultimately help you better manage the resources available to you.
A positive mentality – Taking control of your financial situation can improve your outlook on life. Instead of being worried or anxious about money, you can rest assured knowing that your money is being used to fund your goals and dreams.
More confidence – According to a CFP Board survey, 52% of those with a financial plan feel “very confident” about managing their money. Only 30% of those without a plan feel the same way. Having a tailored financial plan helps you feel in control of your finances.
More wealth – That same survey, among other research, shows that financial planning often leads to high levels of wealth for clients. You won’t get rich overnight, but a financial plan can help you be more intentional with your spending, saving, and investing decisions.