The Financial Planning Process


by Igor Tiguy, CFP®, AIF®, MSPFP, Director, Planning Services

In an earlier blog post, I introduced our Behavior Gap series of articles, which use Carl Richards’ insightful Behavior Gap sketches to illustrate various financial planning and investment concepts. My earlier post brought attention to the wide gap between market returns and investor returns, showing that the average investor doesn’t fully capture the market’s performance – likely due to poor market-timing decisions. The article inferred that a likely contributor to this shortfall in investor returns is the lack of a personalized strategic goal-based financial plan.

The importance of having a plan cannot be overemphasized. A well-crafted personal financial plan is tailored to each investor’s goals, time horizon, and risk tolerance. It helps the investor stay on track and make strategic and tactical, instead of emotional, investment decisions. It also helps to frame, or benchmark, the performance of her investment accounts. For example, if, through the process of crafting a personal financial plan, an investor learns that she needs to average a 6% annual rate of return to reach her goal of retiring at 65 and spending $100,000 per year – then that’s the annual return benchmark she should concentrate on. It shouldn’t matter what the S&P 500 returned that year, or what her neighbor claims his portfolio returned. If the investor simply follows her financial plan, periodically checking in on whether or not she’s on track to reach her goals, and periodically rebalancing her portfolios, she won’t be swayed into making poor market-timing decisions and fall victim to the volatility of the markets. Most importantly, having a plan reduces investors’ money-related stress, and helps them to sleep better at night.

A high-level view of the process to create a personal financial plan is beautifully simple. The first step is to set financial goals. The most common financial goal is the age at which the investor would like to retire, and the desired annual spending at retirement. Other common goals include: buying a house or a car, children’s education, starting a business, contributing to charity, and building up a legacy to pass down to the next generation. These goals should be quantified, with the amount saved for each goal and the time horizon until reaching the goal being most important. These goals should also be ranked in priority, as it is possible that the investor won’t be able to achieve all of his goals without taking undue risks – so instead, he can concentrate on achieving the most important ones. For larger goals, it is best to create separate investment accounts with their own asset allocation.

The second step is to create a plan to reach these goals. Among other factors, the plan should consider:

  • The investor’s current assets and debt (including interest rates on any loans)
  • Budget, cash flows, and annual savings
  • Current macroeconomic and geopolitical global market environment and the corresponding outlook on market opportunities – which will help with the design of the asset allocations
  • Goal amounts, time horizons, and priority
  • Investment risk tolerance
  • Rates of return (taking into consideration tax and inflation implications) needed to meet the stated goals
  • Tax, estate, insurance, and charitable implications

It is important to “put the plan down on paper,” recording all the goals, assumptions, current financial positions, and outlining steps that need to be taken to implement the plan and review it going forward.

The final step is to find investments that fit the plan. The most important aspect in designing a portfolio is constructing the overall asset allocation. Some studies have shown that around 90% of the portfolio returns can be attributable to picking the right asset classes, while only 10% or so is attributable to selecting the specific stocks, bonds, mutual funds, or ETFs. Going through the first two steps of the financial planning process, the investor should know the desired rate/s of return to reach his financial goals. He should also have developed an outlook for the global markets’ opportunities. Based on these assumptions the investor can now design an asset allocation, and start evaluating specific investments that will be used for each of the selected asset classes.

It is important to periodically monitor the plan once it is designed and implemented. Typically, an annual review should be sufficient to determine whether or not the plan is still on track, to rebalance as necessary, and to make possible adjustments based on changes to the initial goals or new goals being added. Keep in mind, you don’t have to go it alone. My recommendation would be to work with a financial advisor to create, implement, monitor and update a financial plan that’s right for you.

Recommended Posts