Module 3 Approaches to Financial Planning

Module 3

Approaches to

Financial Planning

Financial Planning Overview Study Guide for 300

Study Sheet

-PHASES -TWO-STEP APPROACH

-ASSET ACCUMULATION PHASE -COVER RISKS

-CONSERVATION/RISK MANAGEMENT PHASE -SAVE AND INVEST

-DISTRIBUTION/GIFTING PHASE -THREE-PANEL APPROACH

-COMMON GOALS -COVER CATASTROPHIC RISKS

-COMMON RISKS -MANAGE DEBT

-MEET FINANCIAL GOALS

-STRATEGIC APPROACH -PIE CHART APPROACH

-DEFINE GOALS -PRESENT VALUE APPROACH

-DEFINE OBJECTIVES -RATIO ANALYSIS APPROACH

-CASH FLOW APPROACH -METRICS APPROACH

-STEPS

-CASH FLOW STATEMENT

-SAVINGS

-EXPENSES

-SAVINGS RATE

-STEPS IN PROCESS -CASH FLOW APPROACH

-DETERMINE INCOME -RATIO APPROACH

-DETERMINE EXPENSES -BENCHMARK

-PRESENT EXPENSES

-NET DISCRETIONARY CASH FLOW

-RECTIFY GOALS

FINANCIAL PLANNING

APPROACHES

BUDGETING AND SAVING

BUDGETING SAVING

-BUDGETING TIPS

LIFE CYCLE APPROACH PANEL APPROACHS

FINANCIAL PLANNING

APPROACHES

STRATEGIC AND CASH FLOW

APPROACH

OTHER APPROACHES

Module 3

Financial Planning Overview Study Guide for 300 Module Outline

Module 3

Chapter 3

Approaches to Financial

Planning

Objectives



Obj I: The Life Cycle Approach



Obj II: Panel Approaches



Obj III: Strategic and Cash-flow Approaches



Obj IV: Other Approaches to Financial Planning



Obj V: Budgeting and Saving

The Life Cycle Approach

Financial Planning Overview Study Guide for 300 Module Outline

Life Cycle Approach



The life cycle approach is an approach to

financial planning.

 Broad view of the client financial profile.

 Matches a client’s goals with their current

stage in the life cycle.



A majority of a client’s goals and lifestyle can be

explained by their stage in the life cycle.

Life Cycle Approach



Three distinct stages:

 Asset accumulation phase.

 Conservation/risk management phase.

 Distribution/gifting phase.



Each client is different.

 Risks/goals may not always align with those

in the stage they would expect to be in given

their age.

 Can be in multiple stages at once.

Asset Accumulation Phase



Asset Accumulation Phase.

 Early 20s to mid 50s.

 Usually begins when client enters work

force.

 Primary focus is on accumulating assets.

 Additional cash for investing is low.

 Debt to net worth is high.

Financial Planning Overview Study Guide for 300 Module Outline

Conservation Phase



Second phase is Wealth Conservation phase.

 Also known as risk management phase.

 Late 20s (or early 30s) to early 70s.

 Usually starts when client is considering

starting a family.



Stage when wealth conservation and risk

management are the focus.

Conservation Phase



Need to plan for events that could impact long-

term planning goals and financial stability.

 Untimely death.

 Accidents and illnesses.

 Unemployment.

Distribution Phase



The last phase is the Wealth Distribution/Gifting

phase.

 Mid 50s to end-of-life.



Client is concerned with living off accumulated

assets.

 Also concerned with preserving wealth for

future generations or philanthropic purposes.



High cash flow, low debt, high net worth.

Financial Planning Overview Study Guide for 300 Module Outline

Life Cycle Approach



Clients can be in two or even all phases at once.

 Conservation phase may come before the

accumulation phase if there is early death.



Common life-cycle goals:

 Starting a family.

 Retirement planning.



Common risks:

 Disability.

 Untimely death.

 Liability.

Practice



Juanita, age 60, is married and has two daughters in

college. Her primary goals are saving for retirement,

supporting her daughters until they graduate from

college, and structuring her estate to provide for her

daughters and their future families. Which phase(s)

of the life-cycle approach is Juanita most likely in?

 A. The asset-accumulation and conservation/risk

management phases.

 B. The distribution/gifting phase.

 C. The conservation/risk management phase.

 D. The conservation/risk management and

distribution/gifting phases.

Panel Approaches

Financial Planning Overview Study Guide for 300 Module Outline

Two-Step Approach



The Two-Step approach involves managing risk

and saving/investing.

 Step 1 – cover the risks.

 Personal risks potentially lead to

catastrophic loss.

 Insurance is recommended to cover the

risks of premature death or disability.

 Step 2 – save and invest.

 Saving for goals and investing for

retirement occurs during this step.

Three-Panel Approach



The three-panel approach is similar to the two-

step approach.

 Second step is further divided into short-term

and long-term savings.



Panels of the three-panel approach:

 Panel 1 – cover catastrophic risks.

 Panel 2 – meet short-term obligations and

manage debt.

 Panel 3 – meet financial security goals.

Panel 1



Panel 1 involves risk management.

 Personal, property, and liability risks.

 Catastrophic risks must be covered.



Evaluate need for:

 Life insurance.

 Health, disability, and long-term care

insurance.

 Property and liability insurance.

Financial Planning Overview Study Guide for 300 Module Outline

Panel 2



Panel 2 involves short-term savings and

managing debt.

 Focus on meeting short-term obligations.



Evaluate adequacy of:

 Emergency fund.

 Housing costs.

 Income spent on debt other than housing

debt.

Panel 3



Panel 3 involves long-term savings and

investments.

 Focus on being financially secure.



Evaluate progress toward:

 Retirement goal.

 Education funding.

 Large purchase goal.

 Document creation (POAs, etc.).

Practice



Evaluating a client’s proportion of income spent

on housing would fall into:

 A. Panel 1 of the three-panel approach.

 B. Panel 2 of the three-panel approach.

 C. Panel 3 of the three-panel approach.

 D. The distribution phase of the life-cycle

approach.

Financial Planning Overview Study Guide for 300 Module Outline

Strategic and Cash-flow

Approaches

Strategic Approach



The strategic approach to financial planning

combines big-picture goals and the external

environment.

 Considers needs vs. wants.



Includes SWOT analysis:

 Strengths.

 Weaknesses.

 Opportunities.

 Threats.

Strategic Approach



The strategic approach codifies client goals and

objectives into a mission statement.

 Brief long-term statement of the financial

plan’s overarching purpose or mission.



Strategic approach defines:

 Goals – broadly defined.

 Adequate emergency fund.

 Objectives – divide goals into discrete and

actionable steps.

Financial Planning Overview Study Guide for 300 Module Outline

Cash Flow Approach



Planners using strategic approach method often

follow with using the cash flow approach.

 Approach uses statement of income and

expenses to make recommendations.



Steps of cash flow approach:

 Recommendations with positive cash flow

impact are prioritized and implemented.

 Clients identify recommendations with a

negative cash flow impact.

 Positive cash flows are used to “purchase”

the negative cash flow recommendations.

Cash Flow Approach



Ways insurance recommendations would affect

cash flow:

 Positive impact – raise deductibles, eliminate

duplicate coverage, reduce coverage, replace

policy.

 Negative impact – lower deductibles, purchase

new insurance, increase existing coverage.

 No impact – change beneficiary, reassign

policy, stop driving uninsured vehicle.

Cash Flow Statement



The Cash Flow Statement is used to determine

how much income the client is receiving and

how much the client is spending.

 Statement of Income and Expenses.



Prepared for a certain period of time.

 Typically prepared on an annual basis.

Net cash flow = Income – Savings – Expenses

Financial Planning Overview Study Guide for 300 Module Outline

Savings



Determining how much a client should be

saving is one of the most important elements of

financial planning.

 Financial goals almost always require the

accumulation and growth of assets.



Taxable savings accounts are taxable in the

year income is earned.

 High yield savings accounts, brokerage

accounts, etc.

Savings



Tax-Deferred Savings accounts grow tax-

deferred until the funds are distributed.

 Contributions may reduce taxable income.

 Includes most retirement accounts.

 Traditional IRAs, SEPs, SIMPLE IRAs,

401(k) plans, 403(b) plans.

Savings



Tax-Free Savings accounts offer tax-deferred

growth and allow for tax-free withdrawals.

 Roth IRAs.

 Health savings accounts.

 Section 529 College Savings Plans.

Financial Planning Overview Study Guide for 300 Module Outline

Expenses



Expenses on a Cash Flow Statement are often

broken down into:

 Living expenses – groceries, utilities, rent,

internet, insurance.

 Can be classified as discretionary or non-

discretionary.

 Debt payments – mortgage, credit cards.

 Insurance expenses – life, disability, health.

 Taxes – income, real estate.

Net Discretionary Cash Flow



Formula for Net Discretionary Cash Flow:

 Income – Savings – Expenses



Financial planning recommendations are made

on the basis of available cash flow.

 Long-term success is only possible with

positive cash flow.

 Negative cash flow must be resolved by

increasing income or reducing expenses.

Net Discretionary Cash Flow



Discretionary expenses are expenses a

household can survive without.

 Nonessential spending.

 Includes entertainment, vacations, hobbies,

restaurants, and gym memberships.



Non-discretionary expenses are necessary

expenses.

 Includes taxes, groceries, and debt.

Financial Planning Overview Study Guide for 300 Module Outline

Cash Flow Statement Limitations



A limitation of a cash flow statement is that only

recurring income and expenses are included.

 Some excluded items can have significant

implications for the plan.



Non-recurring transactions are not reported on

the Cash Flow Statement.

 Includes gifts and inheritances.

 Should not be ignored.

Practice



Which one of the following insurance strategies

will result in a positive cash flow?

 A. Changing the beneficiary from a spouse to

a child.

 B. Increasing insurance deductibles.

 C. Raising the amount of long-term care

insurance coverage.

 D. Switching from term life insurance to

whole life insurance.

Other Approaches to

Financial Planning

Financial Planning Overview Study Guide for 300 Module Outline

Financial Planning Approaches



Several additional approaches to financial

planning exist.

 Pie Chart approach.

 Present Value of All Goals approach.

 Ratio Analysis approach.

 Metrics approach.

Pie Chart Approach



The Pie Chart approach provides visual display

of the balance sheet and cash flow statement.

 Created after internal data has been collected

and financial statements are prepared.

 Displays percentages of finances.



Helps client visualize:

 Percentage of pay that is being saved.

 Percentage of pay spent on housing.

 Percentage of pay that is remaining.

Present Value Approach



The Present Value of All Goals Approach is a

multi-step process.

 Gives clients a single dollar value to meet all

their lifetime goals.

 Quantifies the amount the client would need

to start saving today.



This method puts a price tag on all of the

client’s lifetime goals.

Financial Planning Overview Study Guide for 300 Module Outline

Present Value Approach



Steps of Present Value approach:

 Determine individual PVs of each goal.

 Sum the PVs.

 Reduce the total by the current resources

available.

 Determine amount of additional savings

needed to fund goals.

 Considered a debt obligation to be retired

over the remaining work life expectancy.

Ratio Analysis Approach



The Financial Statement and Ratio Analysis

Approach uses data within financial statements.

 Calculates ratios that are used to gauge

financial health.



Categories of ratios:

 Liquidity ratios.

 Debt ratios.

 Financial security ratios.

 Performance ratios.

Metrics Approach



The Metrics approach provides quantitative

benchmarks as guidance for achieving goals.

 Helps to establish objectives that are

measurable with ratio analysis.

 Benchmarks may be stated qualitatively as

“rules of thumb.”

Financial Planning Overview Study Guide for 300 Module Outline

Practice



Which of the following best describes the metrics

approach to financial planning?

 A. An advisor computes a variety of ratios which

are then used to gauge a client’s financial

health.

 B. An advisor gives their client a single dollar

value to meet all their lifetime goals.

 C. An advisor provides a visual display of the

balance sheet and cash flow statements.

 D. An advisor provides quantitative benchmarks

for their client to use as guidance for achieving

comprehensive financial goals.

Budgeting and Saving

Budgeting



Important tips for successful budgeting:

 Be realistic with spending behavior.

 Include an expense line item for

miscellaneous expenses and unforeseen

expenses.

 Being successful with a budget takes

practice.

Financial Planning Overview Study Guide for 300 Module Outline

Budgeting Process



Steps of the budgeting process:

 Determine client’s income for a time period.

 Determine fixed and variable expenses for the

same time period.

 Fixed – stable and predictable.

 Often non-discretionary.

 Variable – usually discretionary.

Budgeting Process



Steps of the budgeting process:

 Present expenses to the client.

 Expenses as a percentage of income are

generally level or decreasing over time.

 Determine if net discretionary cash flow is

positive or negative.

 If negative, expenses must be reduced, or

income needs to increase.

 Rectify client’s goals and planner

recommendations with client’s cash flow.

Savings Rate



A savings rate can be calculated and compared

to appropriate benchmarks.

 Cash flow approach – savings rate equals:

 Income – Savings – Expenses

 Ratio approach – savings rate equals:

 (Savings + Employer Match)/Gross Pay



Compare savings rate to benchmark.

Financial Planning Overview Study Guide for 300 Module Outline

Benchmark Savings Rate



Appropriate benchmark for a client’s savings

rate depends on various factors.

 Annual income, current investment balance,

rate of return, and inflation rate.



Generally, younger clients and clients with

fewer goals have lower savings rate

benchmarks.



Older clients and clients with more goals have

higher savings rate benchmarks.

Practice



What is the first step in the budgeting process?

 A. Determine the client’s income.

 B. Determine the client’s expenses.

 C. Determine the client’s net discretionary

cash flow.

 D. Determine the client’s goals.

Practice



Janet Smith receives a salary of $150,000. She

saves $10,000 in a Section 529 plan for her son

and contributes $12,000 to her 401(k) plan. Her

employer also makes a $4,000 matching

contribution to her 401(k) plan. Assuming Janet

also contributes $2,000 into a traditional IRA,

what is her savings rate?

 A. 9.3%

 B. 12%

 C. 17.33%

 D. 18.67%