How do you begin? What is the process? Who is on your team? First, you will need to know the primary categories of financial planning:
Investment planning: What are your objectives and risk tolerance?
What are the trade-offs between the two? How do you diversify out of concentrated stock positions (such as company stock)? Does your asset allocation reflect your actual needs and preferences? Let’s say you decide you want a conservative portfolio, but it turns out that your ad- visor has been investing heavily in the volatile technology sector. First, you’ll need to find this out, and second, correct it.
Tax planning: What is your current income tax situation? Are you saving for retirement, or for your children’s educational needs, in a
tax-efficient manner? Is your income tax return prepared in a fashion that appropriately minimizes your taxes? What will your taxes look like over the next five years? How can you lower them? Are you sell- ing assets, moving, getting a raise, or anticipating some other major life event? If so, make sure you are doing the right thing in terms of taxes. A fundamental goal is to minimize those taxes, so you must always be on the lookout for smart ways to do so.
Insurance planning: What are your objectives in minimizing financial risk? To meet them, should you have an umbrella excess liability pol- icy? A personal corporate board liability policy? Does your company provide you with indemnity coverage? Is it enough? Do you have suf- ficient assets to protect your family if you were to die tomorrow?
Should insurance vehicles play a role in your investment planning and retirement planning?
Retirement planning: When do you want to retire and how much income will you need to do so given your desired lifestyle? What vehi- cles are available to save for retirement? Once you are able to answer these questions, you must then detail your cash flow, which consists of your monthly expenses including your mortgage (or rent), automobile payments, food expenditures, insurance costs, and so on. Next, detail your income. Then place your lists side by side to see if money earned from stocks, bonds, mutual fund dividends, interest, and any other in- come (such as pensions or Social Security) will cover all those monthly expenses. It’s important to remember that some of these costs are fixed, including basic necessities such as health insurance premiums and mortgage payments. No matter how frugal you want to be, you can’t cut back on these expenses. But other expenses, such as food and entertainment, are variable, and if you wish to economize, don’t dine in fancy restaurants every night or go to the theater twice a week.
Estate planning: How do you want your assets distributed? Should you leave all of them to your spouse and depend on him or her to take care of your children? Or should you use a specialized trust to ensure that your assets pass to your children upon your spouse’s death?
Should you use trusts? If so, what kind? A credit shelter trust? A char- itable remainder trust? A generation skipping trust? Whom should you appoint as your executors, trustees, and guardians for your children?
During the process of developing these various and equally important aspects of a financial plan, there are seven steps to consider:
1.Creating a team
2.Gathering data
3.Identifying and prioritizing goals and objectives
4.Analyzing data
5.Reviewing potential strategies
6.Agreeing on strategies
7.Implementing your plan Creating a Team
You must either commit to planning all of your own finances or hire a professional financial planner. As already mentioned, few people have the time, resources, or expertise to handle all these tasks themselves.
Even financial planners don’t do it all by themselves; they need to work with other advisors, including your lawyer, accountant, insurance broker, and investment counselor. I was trained in the financial plan- ning disciplines and have stayed well-informed, but it was impossible for me to do my own financial planning, my job, and pay attention to the rest of my life. I needed the help of financial planners. I didn’t
abandon my responsibilities in the process; I just participated in a more disciplined process.
If you’re married, it’s also a good idea to ask your spouse to join the team. Planning is most often productive when it’s done as a family.
Although married couples don’t necessarily share their financial secrets (even though it doesn’t always seem this way, financial planners are not marriage counselors), the more each of you knows about the other’s financial status, the better off you will be in an emergency. I am a true believer in complete disclosure between spouses, as well as arriving at mutually agreed upon goals and risk tolerances.
Gathering Data
Financial planning means stepping back and focusing on what you own. Where is your money? Do you even know? Do you have all of your account numbers handy? Is your money in your name, your spouse’s, or in a joint account? What portions of your assets are liquid, deferred, or locked up in life insurance or real estate? Do you know what liquid assets are? If you had to, could you fill out a balance sheet for your assets? Do you understand your cash flow? Do you know how much money you spend each month? Do you remember who is the beneficiary of your accounts? Many people don’t recall that they des- ignated a beneficiary on their 401(k) a long time ago, and have never changed it. We’ve seen cases where someone has remarried, and only after his or her death did we discover that the former spouse was still listed as the beneficiary for the entire 401(k).
In other words, you must gather the data. To do this, you need to assemble such items as your current will, prior two years of Federal, state, and local income tax returns, current gift tax returns, all trust agreements in which you or your family have an interest, all other family agreements (e.g., family limited partnerships, separation or
property settlement agreements), all insurance policies including prop- erty and liability policies and life, health, and disability policies, state- ments of company benefits, IRAs, Keogh plans, and so on. It can be quite formidable to gather all this data, and it’s not unusual for clients to begin the financial planning process, realize how much work it entails, and then not return with their completed materials for over a year. By the way, once you gather your data, do your best to keep it current so you don’t have to go through the exercise every few years.
Identifying and Prioritizing Goals and Objectives
Financial planning also means deciding what you want to do with your assets. What are your goals? Do you want to retire young, or do you plan to work for the rest of your life? Do you know how much money you’ll need before you can retire? Are you one of those people who thinks a great deal about retirement, but hasn’t written a will yet?
Do you know what you want your will to accomplish? Do you know what you want for your children? Some people want to leave their children everything they have, while others feel that their children should make it on their own and leaving them anything would be a mistake. Maybe you understand your goals in one area of your life, but not in others. Good financial planning involves all areas of your financial life.
For some, this step can bring their values system to light. Perhaps you’ve spent your entire life making money, but now you want to give much of it away to a specific cause you admire. Or now that you’ve reached a certain income level, you’re ready to try a new career—or no career at all.
Sometimes, when we talk to prospective clients, they’ll explain that they are well acquainted with the idea of risk, and they under- stand that’s it’s an important element of investing. They tell us they want to take risks to earn a good return. Then, when we look over their
financial information, we discover that they’re almost entirely invested in low-risk, low-return bonds. Others may admit that they have a low tolerance for risk, and we discover that they’ve put all of their money into one stock because they trust that company and feel it is fool- proof—as though any company, no matter how solid, can guarantee that it will never have a bad year. Investing in one stock, no matter how safe you think it is, is in fact a high-risk behavior.
As you can see, the process of clarifying your desires can reveal disconnects that planning can correct. I can’t put it more strongly: You must identify and prioritize your goals and objectives so your finances can be structured to meet them.
Analyzing Data
Arraying the data in schedules allows you and your team to appropri- ately analyze data and identify trends and issues—see examples of schedules in the Appendix.
Reviewing Potential Strategies
Once the data analysis is completed, the task of reviewing the analysis against your desired goals and objectives becomes paramount. This process can be quite fluid; your goals and objectives may change as trade-offs are examined.
For example, we’ve had clients who, once their finances were organized, were able to make other major life decisions. One couple realized that they had enough money for one of them to quit his or her job and stay at home with their children. Another client who was sin- gle had always wanted to sail around the world but never had taken the time off from his busy job as an executive vice president at an insurance company to see whether he had enough to do so. Once we’d gone over his papers, he realized that he did have the money to quit
his job and take a year off. (Unlike most people with dreams, this man actually quit his job and after buying a sailboat, traveled from California all the way to the east coast of Africa before deciding that sailing halfway around the world was good enough. He then returned to San Francisco and a new job.)
Agreeing on Strategies
The strategies you settled on need to be put in writing. Based on them, a plan has to be compiled for final review.
Implementing Your Plan
A detailed report of the steps you will take needs to be prepared, including due dates, and all responsibilities must be assigned to the appropriate members of your team. In addition, someone must take responsibility for follow-up. Your financial planner may assume this task, but sometimes you may wish to do it yourself. This final step is crucial. Failure to complete one part of the plan may well place your entire plan at risk. For example, suppose one of your plan’s elements is moving assets into separate names to take advantage of opportuni- ties to save on estate taxes. This may sound like a simple task, but the failure to complete it properly may not only eliminate the estate tax saving you desire, but in so doing leave insufficient assets to provide the survivorship income you had hoped for.
Creating and implementing your plan requires discipline and common sense. Your plan shouldn’t be too cumbersome or difficult to accomplish. Deciding that you are going to save more each month toward retirement, and running your numbers based on that assump- tion, is a mistake if the required sacrifices cannot be made. A truly smart plan on paper may not be a smart plan in practice if it simply isn’t practical.