Key Financial Planning Concepts

The following are a few key concepts to think about, look for, or listen to when developing a financial plan:

Information Gathering: This is one of the first steps in the financial planning process.  Your financial advisor should gather quite a bit of information about you and your current financial status.

Setting Goals and Objectives: The next step in the planning process after information gathering—setting financial goals and objectives is a fundamental part of the planning process.

Evaluation of Financial Status: Analysis and evaluation of your current financial status sets the stage for any recommended actions.

Develop Recommendations: Recommendations should be provided after information is gathered, goals are set and financial evaluation is complete.

Actions: Actions such as product purchases, asset allocation decisions and any other transactions take place after recommendations are presented and discussed.

Risk Tolerance: A financial plan must provide an assessment of your risk tolerance and incorporate the result into the evaluation.

Time Horizon: Time horizons (for example, until retirement, in retirement, etc) are a major factor in the financial planning process.

Life Expectancy: Obviously a key part of determining how long your money needs to last.  Actuarial tables can provide estimates that are essential in the planning process.

Probability of Survival: The likelihood—based upon your current health status and mortality tables—that you will survive to a given age.

Systematic Withdrawal Program: A plan to draw-down savings to support retirement income needs.

Sustainable Spending Rate: The likelihood that your assets can support your planned level of retirement spending.

Longevity Risk: The risk of running out of money during retirement.

Liquidity Needs: A liquid asset can quickly be converted to cash.  A money market fund is liquid while a house is not.  Having some level of liquid assets in retirement is critically important because of large potential expenses such as those related to healthcare needs.

Bequest Motive: Do you care about leaving any money to heirs?  If so, then it needs to be part of the planning process because things like spending rates and annuities can deplete any resources that you would like to pass along.

Investment Costs: The cost of investing—and the cost of annuities—are a big part of the planning picture and they should be incorporated into any projections or discussion.

Personal Balance Sheet: People are like businesses—they have assets (personal savings, investments, etc) and liabilities (mortgage payments, credit card debt, etc).  The balance sheet will provide a snapshot of your net worth, or balance of your assets and liabilities.

Personal Income Statement: Same as above—what are your revenue sources (Social Security, interest income, etc) and expenses (desired spending), and how do they relate to one another.

Asset-Liability Matching: Retirement income planning is about projecting future spending rates which are liabilities.  Asset-liability matching involves creating a portfolio of assets that are appropriate for funding spending over time. 

Volatility: The level of ups and downs in capital markets such as the stock market.  High volatility is generally a bad thing for retirees. 

Sequence of Returns Risk: Suffering investment losses near the beginning of retirement can devastate even the best-laid plans.  Exposure to highly volatile assets increases sequence of returns risk.

Asset Allocation: The mix of stocks, bonds, commodities, cash and other types of assets in an investment portfolio. 

Healthcare Costs:  This is a major expense item for any retiree and has to be part of the planning process.

Long-Term Care Costs: Although uncertain, another major expense item that needs to be part of the picture.

Life Insurance: How to deal with existing policies and potentially incorporate additional insurance as part of any estate planning process.

Monte Carlo Simulation: While certainly not a silver-bullet, there is a reasonable chance that planning results and projections will be generated through Monte Carlo Simulations.