CERTIFIED FINANCIAL PLANNER™, are experts in comprehensive financial planning. They help people with cash flow analysis and budgeting, goal planning, debt management, insurance and risk management to protect your income and dependants, employer contributory pension plan or group RSP allocations, estate planning, taxes, career, life planning, college and university funding, buying a home, retirement projections and anything else that comes along. No magic, just math supported by broad experience. Sometimes, they are simply answering, “Do I (we) have enough”? Maybe, “How much can I afford to give the kids”?
However, the first question to the financial planner is often about the investments. An experienced planner should stop you and make it very clear that it is the comprehensive financial planning that will lead to any relationship. As such, we will charge fees for this advice and expertise just like any consultant in a specialized field. Advice for a Fee based on a specific area of expertise. We coach, manage and guide our clients. We get paid based on the advice and the guidance and help in controlling the client’s emotions. This is why they hire us. There’s no ambiguity and that is our point. We work hard at telling all that we meet that financial planning is not investment planning and is very important in its own right.
It gets confusing because most financial planners also help with the client’s investment management to some degree. Although it is not mandatory that they use their financial planner as their investment manager, it does make sense and is often the best value proposition. Since the planner has the most intimate understanding of their personal finances, they can provide them with investment advice and management that fits with their overall strategy. But again this is a separate area not covered in the basic financial planning and should be treated as such.
Investment management is certainly a different skillset than cash flow and retirement planning and it’s important to separate one from the other. Your investment advisor should provide services like risk education, determine risk tolerance – both ability and willingness, manager selection, investment selection, portfolio design, asset allocation and investment management (rebalancing, market analysis, portfolio analysis). Certainly investment management is related to financial planning but is distinct from it.
We believe strongly that investment management should not be commenced without financial planning.
It is unfortunate that it is investment management; and primarily investment or manager selection, that drives most relationships between clients and advisors. Clients incorrectly believe they should just seek to make more money on their investments and focuses here. In September 2012, Morningstar, a very large service provider to the investment community, published a research paper titled Alpha, Beta, and Now… Gamma. This paper proposed that it is not investment/manager selection that has the greatest impact on retirement portfolios; rather it is making more intelligent financial planning decisions.
The research paper attempts to “…quantify the additional expected retirement income achieved by an individual investor from making more intelligent financial planning decisions…” we focus on five fundamental financial planning decisions/techniques: a total wealth framework to determine the optimal asset allocation, a dynamic withdrawal strategy, incorporating guaranteed income products (i.e., annuities), tax-efficient decisions, and liability-relative asset allocation optimization.
We estimate a retiree can expect to generate 29% more income on a “utility-adjusted” basis using a Gamma-efficient retirement income… This additional income is equivalent to an annual arithmetic return increase of +1.82%… which represents a significant improvement in portfolio efficiency for a retiree. Unlike traditional alpha, which can be hard to predict, we find that… can be achieved by anyone following an efficient financial planning strategy.” So what are intelligent financial planning decisions a Certified Financial Planner can help me with? Let’s see.
1) A total wealth framework to determine the optimal asset allocation
Your current advisor or bank asks you to answer an investment questionnaire and then discusses it with you. This is an attempt to establish risk tolerance and risk preference (i.e., an investor’s aversion to or comfort with risk). This, however, ignores your risk capacity (i.e., an investor’s ability to assume risk). Asset allocation should be based on a combination of risk preference and risk capacity, and primarily risk capacity. The only way to establish risk capacity is through a thorough examination of your total financial picture. A review of assets, liabilities, current spending and future spending expectations, income sources both now and in the future, etc. In other words, a full financial review of the persons involved. Commonly called a financial plan.
2) A dynamic withdrawal strategy
You probably are contemplating a static withdrawal strategy. An amount based on 4% of assets adjusted for inflation each year is very common. The future will not be steady and unwavering, so why should the withdrawals. Your withdrawal plan should be adjustable to future realities, not the past plans.
3) Incorporating guaranteed income products (i.e., annuities)
The key here is risk shifting or hedging your risk. Annuities and other guaranteed products (such as long term GICs) place the future performance worries onto the provider of the product and remove the risk from you.
4) Tax-efficient decisions
You should hold assets in the accounts that are the most tax-wise for those types of investments. Ensure that your withdrawal strategy is also generating income in the most beneficial manner. It is not just about this year. A good goal is to lower your lifetime total tax bill to the lowest possible amount. Access to a skilled tax consultant is essential.
5) Liability-relative asset allocation optimization
The risk associated with currencies, inflation and timing of withdrawals as they relate to the future are an important part of establishing the optimal portfolio allocation.