General Principles of
Financial Planning
Topic 1: Financial Planning Process
• Learning Objectives
(a) Diagram the personal financial planning process
as defined by the CFP Board’s Job Task Domains
and Financial Planning Practice Standards.
(b) Recognize unethical practices in the financial
planning profession based on the CFP Board
Standards of Professional Conduct.
Topic 1: Financial Planning Process
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Purpose and benefits
Six step process
Responsibilities
Financial planning methodology
Ethical issues
Assessing risk tolerance
Topic 1: Purpose and Benefits of the
Financial Planning Process
• Purpose
– To prepare a road map for clients to follow in
accomplishing their financial objectives
• Benefits
– To derive various solutions toward the
accomplishment of significant goals and the
satisfactory resolution of client issues
Topic 1: Six Steps in the Financial
Planning Process (EGADIM)
1.
2.
3.
4.
5.
6.
Establish and define the relationship
Gather client data, including goals and objectives
Analyze information
Develop the plan
Implement the plan
Monitor the plan
Topic 1 Step 1: Establishing the ClientPlanner Relationship
• Among the topics to be addressed in this step
are:
– Identifying the services that will be provided
– Describing how the planner will be compensated
– Identifying the specific responsibilities of both the
planner and the client
– Deciding on the time frame of the engagement
– Discussing any other matters needed to define or
limit the engagement’s scope
Topic 1: Factors Used to Determine if a
Planner is Practicing Financial Planning
• Four factors used by CFP Board to determine if
a planner is practicing financial planning or
the material elements of financial planning
– Client’s understanding and intent
– Comprehensiveness of data-gathering
– Breadth and depth of recommendations
– Degree to which multiple subject areas are
involved
Topic 1: Rule 1.3
• If the services include financial planning or the
material elements of the financial planning
process, the certificant or the certificant’s
employer shall enter into a written agreement
governing the financial planning services
(“Agreement”). The Agreement shall specify:
– The parties to the Agreement
– The date of the Agreement and its duration
– How and on what terms each party can terminate the
Agreement
– The services to be provided as part of the Agreement
Topic 1: Rule 2.2
• A certificant shall disclose to a prospective client or
client the following information:
– Description of compensation, including the terms under which
the certificant or certificant’s employer may receive any other
sources of compensation and what those payments are based
on
– Conflicts of interest
– Material information that could reasonably be expected to
affect the client’s decision to engage the certificant, including
information about the certificant’s areas of expertise
– Contact information for certificant and employer
– If the services include financial planning or the material
elements of financial planning, these disclosures must be in
writing
• The certificant shall timely disclose to the client any
material changes to the above information
Topic 1 Step 2: Establishing the Client’s Goals
and Objectives and Gathering Information
• Establishing goals and objectives
– Quantify specific financial goals in dollar terms and
within definite time frames
– General aspirations must be specified in detail
– Rank the objectives according to the client’s
priorities
– Examine the objectives with due regard to the
client’s limited resources and other constraints
Topic 1: Typical Information Gathered
• Assets - FMV, basis, date acquired, and related debts
• Liabilities - Debts, alimony and support
• Life insurance - Policy amounts, beneficiary designations,
and premium payments
• Income - Wages, salary and other income
• Expenditures - Current budget, savings and investments
• Investments - Risk-tolerance and investment objectives
• Estate planning - Wills, trusts, gifts, inheritances, and
impact of future earnings
• Retirement planning - Retirement age, travel goals, and
part-time consulting
• Miscellaneous - Disability income, medical expenses,
education, and hobbies
Class Exercise
• The following list contains common data-gathering questions. Brainstorm
ways to change the wording of each question to encourage the client to offer
qualitative details. In other words, turn the closed-end question into an openend question.
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1) How much life insurance do you have?
2) Do you have long-term care insurance?
3) Do you have a will?
4) Who is the beneficiary on your retirement accounts and life insurance
policies?
5) Do you have a retirement plan at work?
6) Do you have an IRA?
7) What kinds of investments have you owned in the past?
8) What is the purpose of the money in this account?
9) At what age do you plan to retire?
10) What are your financial goals?
11) Are there any “special needs” children or grandchildren in your family?
Topic 1: Problems With Gathering
Information
• If the planner has made reasonable effort to
obtain pertinent information from the client
but the client has failed to provide the
information, the planner may need to:
– Redefine the scope of the engagement to exclude
the area for which there is missing information
– Terminate the engagement
Topic 1 – Step 3: Steps for Analyzing and
Evaluating the Information Gathered
• Review
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Financial statements
Cash flow statements
Insurance policies
Wills
Trusts
Buy-sell agreements
• Analyze the information
– To determine the strengths and weaknesses in the client’s financial
position
• Evaluate
– The client’s objectives in view of available resources
– The economic conditions as they relate to future resources and cash
flow for the client
Topic 1 Step 4: Developing the Plan
• Identify the strategies and products available
for achieving the client’s objectives
– Educate the client as to the alternatives and
advantages and disadvantages of each alternative,
including maintaining the status quo
• Select the most appropriate strategies and
products from those available
– Provide additional disclosures based on product
recommendations
Topic 1 Step 5: Implementing the Plan
• Work closely with other professionals to carry
out the financial plan designed for the client
• Define what the planner will do and when,
and what the client will do and when
Topic 1 Step 6: Monitoring the Plan
• Periodically review the plan to determine the
significance of any changes in:
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Federal tax laws
Economic conditions
Available investment techniques
Client’s goals and objectives
• If new areas of planning arise that were not part
of the original scope of the engagement, the
planner and client will need to go back to step 1
and redefine the scope of the engagement
Topic 1: Responsibilities
• Typically, the financial planner is responsible
for all six steps in the financial planning
process
• The client will be responsible for:
– Providing all of the necessary information
– Reviewing the recommended plan
– Some of the implementation
– Monitoring the plan
Topic 1: Financial Planning Methodology
• Single-purpose view
– A single financial product or service can be considered
financial planning
• Multiple-purpose view
– Financial planning must deal with a broad range of financial
concerns, such as investments, insurance, and taxes
• Comprehensive view
– True financial planning must cover all of the client’s financial
concerns and goals
• Purist view
– Comprehensive planning done in a single client engagement
(with ongoing monitoring), on a fee-only basis
Topic 1: Ethical Issues
• The difference between compliance and ethics
– Compliance is upholding the law
– Ethics is doing what is morally correct rather than
merely doing what is legally acceptable
• CFP Board’s Code of Ethics and Professional
Responsibility will be discussed in detail in
Topics 76 - 78
Topic 1, Part 2: Assessing Risk
Tolerance
• Four life situations involving risk
– Monetary
– Physical
– Social
– Ethical
• Planners should not assume monetary risk
tolerance based on a client being risk tolerant
in other areas
Characteristics of Risk Averters versus
Risk Takers
Risk Averter
Perceive risk as danger
Tend to overestimate risk
Prefer low variability of possible
results
Focus on worst-case scenario
Tend to be pessimistic
Tend to like structure
Tend to dislike change
Prefer certainty
Risk Taker
Perceive risk as opportunity
Tend to underestimate risk
Prefer high variability of
possible results
Focus on best-case scenario
Tend to be optimistic
Tend to prefer ambiguity
Tend to enjoy change
Prefer uncertainty
Demographics and Risk Tolerance
Tendency to be LESS risk tolerant
Tendency to be MORE risk tolerant
Inherited wealth
Lower degree of formal education
First-born children
Married with dependents
Work in public sector
Nonprofessional
Same job for long time
Lower-level managers
Compensated by salary
Earned wealth
Higher degree of formal education
Later-born children
Single
Work in private sector
Professional
Changes jobs often
Upper-level managers
Compensated by commission
Investment Risk Tolerance
• Understanding the trade-off between risk and return
• Perceived risk is the individual’s interpretation of a
risky situation
• Bounded rationality
– There are limits on how rationally human beings can act in
many situations
• Risk tolerance versus risk capacity
– Risk tolerance = the amount of risk a client is willing to
take on
– Risk capacity = the amount of risk the client can afford to
take on
• Use of risk tolerance questionnaires
• End of Topic 1