Financial Planning is often misunderstood and overlooked. Partly because most of the financial services industry shamelessly tries to sell something with every interaction, and partly because financial planning as a recognized discipline is a relatively new concept.
In today's letter, we're exploring what financial planning by a fiduciary really is.
What is Financial Planning?
Financial planning is a comprehensive, ongoing process that helps individuals and businesses set, manage, and achieve their financial goals. It's about more than just managing money; it involves strategic planning for future life events and financial needs. A financial planner assesses various aspects of finance, including savings, investments, taxes, retirement, and estate planning, to develop a unique strategy that fits the client's personal circumstances and goals.
What Financial Planning is Not
It's not just for the wealthy.
It's not a one-time event but an evolving process that adapts to changes in your life.
It's not just about insurance or investments.
When done by a fiduciary, it's not an opportunity to sell products like insurance or investments.
Ethics: Fiduciary Capacity & Confidentiality
We've all be the recipient of unwelcome sales pitches. That's why credentials like the Certified Private Wealth Advisor® certification have rigorous ethical codes.
Here's a link to read the full CPWA® Code of Professional Responsibility: https://investmentsandwealth.org/about/ethics-code
The important takeaway is their requirement to be a fiduciary for clients, which means: Act in the best interest of the client.
When acting in the best interest of you, the client, many changes happen, but the big one from above is no more shameless selling.
The Financial Planning Process
Financial planning typically follows a structured process.
Establishing and Defining the Relationship: We discuss the planning process, define both our and your responsibilities, and disclose how we will be compensated. A formal agreement laying out our mutual expectations and terms of engagement is signed at this stage.
Gathering Client Data & Setting Goals: We collect detailed financial information about your financial situation, personal and financial goals, and your attitude toward risk. Some areas we look at are income, assets, liabilities, insurance, taxes, investments, and estate documents.
Analyzing and Evaluating Your Financial Status: We analyze all the information provided to determine how you're your situation lines up with certain benchmarks and best practices, and how your goals line up with reality given current resources and financial commitments.
Developing and Presenting Financial Planning Recommendations: Based on our analysis, we develop recommendations to help you achieve your goals, and may cover areas such as savings, investments, insurance, cash flow management, tax planning, and others. We then present these recommendations, explain them thoroughly, and help you understand the importance of each decision. Based on our discussion, we will either modify recommendations or move to implementing them.
Implementing the Financial Planning Recommendations: Once you agree to the recommendations, we begin the implementation phase. We may carry out the recommendations or serve as "coaches," guiding you through the process. This may involve coordinating with other professionals, such as attorneys or accountants.
Monitoring the Financial Planning Recommendations: Since financial planning works best as an ongoing process, we regularly review your situation and adjust the recommendations as life changes occur, such as a new job, marriage, child, inheritance, etc.
Regular Review and Revision: Over time, we schedule regular reviews of the plan to ensure it continues to meet your changing needs. It's common to tweak and adjust recommendations in response to changes in your life, financial markets, tax laws, and other factors.
Key Areas of Financial Planning
Getting Organized: Creating a clear picture of where you stand today is a fundamental component of financial planning, and sets the stage for all future decisions. Common information gathered: all assets, liabilities, income streams, expenses, insurance policies, estate documents, and investment accounts.
Financial Statement Preparation & Analysis: The balance sheet provides a snapshot of your net worth (assets minus liabilities), while the cash flow statement shows your income and expenses. Analyzing these statements helps in understanding your financial health and identifying areas that need attention.
Cash Flow & Debt Management: The focus here is on managing daily finances. It involves budgeting (or reverse budgeting), tracking expenses, and ensuring that your spending aligns with your financial goals. Effective cash flow management also includes strategies for reducing and managing debt (including student loans), which is crucial for financial stability and long-term wealth accumulation.
Investment Planning: Building and managing an investment portfolio that aligns with your financial goals, risk tolerance, and time horizon is about more than just picking hot stocks. It includes selecting the right mix of asset classes, such as stocks, bonds, and real estate, and making adjustments as your goals, risk tolerance, and market conditions change.
Risk Management: Here we identify potential financial risks and discuss implementing strategies to protect against them. This often includes insurance planning, such as life, health, disability, and long-term care insurance, to safeguard against unexpected life events that could impact your financial well-being. There are several other risk management tactics to consider beyond insurance, such as account type (brokerage, 401k, Roth), partnership agreements, pre- and post-nuptial agreements, trusts, and various others.
Retirement Planning: The focus here is on ensuring you have enough funds to support your lifestyle in retirement. This includes calculating retirement needs, setting up and contributing to retirement accounts, and planning for retirement income sources. It also involves planning for healthcare expenses and strategies to manage and preserve wealth during retirement. Even if you don't want to retire in the traditional sense, planning for retirement means more options as the years progress.
Tax Planning: Aiming to minimize tax liabilities and maximize after-tax income. This includes strategies like investing in tax-efficient vehicles, timing income and deductions, and taking advantage of tax credits and deductions. Effective tax planning requires understanding how different financial decisions will impact your taxes, and proactively choosing which avenues to pursue prior to tax-filing season.
Employee Benefit Planning: This area involves optimizing the benefits offered by your employer. It includes understanding and making the most of retirement plans, health insurance, life and disability insurance, stock options, and other employee benefits. Proper planning helps maximize the value of these benefits and potentially reduce personal costs.
Estate Planning: The primary goal of estate planning is to ensure your assets are distributed according to your wishes upon your death. It typically involves creating or updating your will, setting up trusts, planning for estate taxes, and establishing powers of attorney and healthcare directives. Estate planning is a critical step in protecting your legacy and providing for your loved ones.
Education Planning: Typically for those with children or dependents planning to pursue higher education, this involves saving and investing for future education expenses. Strategies often include 529 plans or other education savings accounts, which offer tax advantages.
Special Needs Planning: The focus of special needs planning is on providing for the financial future of dependents who may have disabilities or special needs. This often includes setting up trusts, government benefit planning, and creating a long-term plan that addresses their unique care, support, and lifestyle needs.
Automation: This isn't a standard area of financial planning, but with ever-advancing technology, this is becoming increasingly important. Here we try to automate as many of the financial plans and decisions so it's one less thing to worry about on a daily basis and enhances your feelings of progress.
Enhancing Financial Planning for High-Earners and High-Net-Worth Clients
For high-earners and high-net-worth clients, financial planning and wealth management is more complex. Certified Private Wealth Advisor® designees (CPWA® designees for short) employ a more sophisticated and detailed approach to handling the complexity.
Advanced Investment Strategies: We delve into more complex investment options beyond traditional stocks, bonds, and mutual funds. This includes alternative investments, private equity, hedge funds, and structured products. In addition to aligning the investments with your risk tolerance and investment time horizon, our goal is to diversify the portfolio while optimizing for tax efficiency and accounting for other interests.
Comprehensive Risk Management: We assess not just market risk, but also the broader spectrum of risks high-net-worth individuals face, including litigation risk, reputation risk, and concentration risk from significant investments in single ventures. We then tailor insurance solutions and other strategies to mitigate these risks.
Estate Planning and Wealth Transfer: We offer advanced estate planning strategies that go beyond basic wills and trusts. This includes the use of more sophisticated tools like family limited partnerships, charitable trusts, and private foundations to reduce estate taxes and facilitate wealth transfer in line with your philanthropic goals.
Tax Optimization: Given the significant impact of taxes on wealth accumulation and transfer, we focus on strategies for tax minimization across all aspects of the client’s financial plan. This includes investment decisions, business ownership structures, and estate planning, ensuring strategies are proactive rather than reactive to tax law changes.
Concentrated Stock Management: For clients with significant investments in single stocks, often due to executive compensation or ownership in a family business, we develop strategies to manage risk and liquidity. This could involve hedging strategies, monetization, and diversification plans.
Family Governance and Legacy Planning: We assist in the creation and management of family governance structures that promote family unity, educate future generations about wealth management, and ensure the client's legacy goals are achieved. This includes facilitating family meetings, defining family mission statements, and setting up frameworks for managing family wealth.
Philanthropic Planning: We can help you articulate any philanthropic goals and implement strategies to achieve them in a tax-efficient manner. This includes advising on the creation and management of charitable foundations, donor-advised funds, and other philanthropic vehicles.
Specialized Advice for Entrepreneurs and Business Owners: In addition to the personal areas above, we can provide guidance and expertise in areas critical to entrepreneurs, such as business valuation, exit planning, and liquidity event strategies. This ensures that your business wealth is protected and integrated into their broader financial plan.
Unique Needs of Professionals, Executives, and Entrepreneurs
Below are examples of the unique challenges and opportunities associated with high incomes and business ownership.
Career Stages and Business Life Cycles:
Early Career: For professionals and entrepreneurs, this stage typically involves managing student debt, lifestyle creep, starting to invest for retirement, and laying the foundation for long-term financial growth.
Mid-Career: This stage often sees peak earning years, requiring strategies for maximizing savings, investment planning, and advanced tax strategies. For entrepreneurs, this often includes business growth and reinvestment strategies.
Late Career/Pre-Retirement: Focus shifts to retirement planning and distribution management, and estate planning. For entrepreneurs, business succession planning or exit strategies tend to become the focus.
High-Income Earning Challenges:
Tax Planning: High earners often require sophisticated tax strategies to minimize liabilities and maximize their wealth. This involves leveraging retirement accounts, tax-loss harvesting, and understanding the impact of various income sources and investments.
Investment Diversification: With larger investment portfolios, a more nuanced approach to diversification, balancing risk and returns across a broader range of asset classes may be beneficial. The incorporation of alternative investments also becomes an option.
Asset Protection: High-net-worth individuals are more exposed to legal risks. Asset protection strategies become essential, including the use of trusts, insurance products, and legal entities such as family limited partnerships.
Complexities of Business Ownership:
Business Valuation and Growth: Entrepreneurs need to constantly assess the value of their business and plan for growth. Since their personal and business finances are typically deeply intertwined, this significantly impacts personal wealth and financial planning.
Cash Flow Management: Managing personal and business cash flow is crucial. This often requires reviewing the past year's financials and projecting cash flow needs into the future in order to strike a delicate balance between reinvesting in the business and personal financial security.
Retirement Planning: Unlike traditional employees, entrepreneurs must create their own retirement plans. Depending on the size of the business, SEP IRAs, Solo 401(k)s, defined benefit plans, or other avenues may be attractive options since exits can be complex and are not guaranteed.
Unique Risks and Insurance Needs:
Liability Insurance: Professionals and business owners may require specific types of liability insurance due to the unique risks in their fields. A commonly overlooked complexity is coordinating business coverages with personal coverages and paying close attention to coverage exclusions.
Life and Disability Insurance: Considering the business and family's dependence on ongoing success of the business owner and the business, proper coverage here cannot be understated.
Estate and Legacy Planning:
Complex Estates: High-net-worth individuals often have more complex estate planning needs, involving trusts, charitable giving strategies, and tax-efficient transfer of wealth.
Business Succession: For entrepreneurs, estate planning is closely tied with business succession and exit planning. Ensuring a smooth transition and preservation of legacy is often a major point of concern.
Work-Life Balance and Lifestyle Goals:
For many high earners, financial planning is not just about wealth accumulation but achieving a level of financial independence that allows for lifestyle choices, such as early retirement or philanthropy.
I hope this has been helpful in showing the importance of financial planning and some areas of complexity and concern.
As always, please schedule time to talk if you have any questions or would like to discuss!
Have a great week!
Garrett
31 January 2024
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