Creating a Plan:
A financial plan is essentially a road map for achieving personal financial goals. It is a strategy that shows individuals how to achieve their goals in line with their financial resources. Creating a plan requires four steps, including
1. Gather and organize all relevant information
2. Analyze the information
3. Align financial resources and goals
4. Make recommendations for achieving goals and improving financial management.
Planning Steps in Detail
Part 1: Gather and organize relevant information
Before you can formulate a plan, you must determine the financial resources that are available to help activate the plan and achieve the goals. The balance sheet and income statement help assess an individual's financial resources; these financial statements were explained in Lesson 1. While gathering financial information, always assess its accuracy and completeness.
Both qualitative and quantitative information is provided in the Allen Family Scenario and supporting exhibits. Some information will be ready for you to use; other information will have to be organized and summarized.
Qualitative issues concern the individual's goals and risk tolerance. Personal goals drive the plan, and the overall purpose of creating a plan is to devise a strategy that will help achieve those goals. In attempting to fund goals, individuals will have to make investment decisions. Investment choices will be influenced by the individual's risk tolerance (ability, willingness, and unique circumstances) to go after higher returns, where needed, with increased risk.
Relevant quantitative information may be found in such places as insurance contracts, tax returns, investment reports, statements issued by employers such as pension plan documents, bank records, and existing legal documents such as a will. It is critical to construct a personal balance sheet and income statement (also known as a personal cash flow statement). While gathering financial information, one should always assess the accuracy and completeness of the information.
Part 2: Analyze the information
This Part is a two-tiered process. On one level, the financial information contained in the balance sheet and income statement will be evaluated using the ratios and techniques identified and discussed in the course. On another level, all relevant financial information will be assessed with a view to identifying issues that could be better managed. The issues to be considered are related to the general areas of tax planning, debt and cash management, risk management, investment management, retirement planning, and estate planning.
The following is a summary of some key strategies under each of these general topic areas. Consider the following key strategies as you analyze the Allen Family Scenario.
Tax
- Make maximum use of credits and deductions.
- Split income without invoking attribution rules.
- Defer income by making maximum use of RRSPs, RRIFs, and other registered products.
- Defer capital gains on investments.
- Avoid taxation on investment income through the use of TFSAs.
- Subject to risk tolerances, select investments that have tax-favored returns such as eligible dividends and capital gains.
- Set up a bona fide loan with family members.
- Consider second generation income on investments.
- Income splitting after retirement through the use of spousal RRSPs.
Debt and cash management
- Minimize service charges.
- Do not keep an excessive amount invested in low-return savings accounts.
- Choose the type of credit card that offers the desired features at the lowest cost.
- Use cheaper debt to pay off high-rate debt such as credit card balances.
- Substitute deductible debt for non-deductible debt.
- Use strategies to reduce the interest cost of loans.
Risk management
- Identify potential risks and the economic loss that could result.
- Identify the frequency and severity of potential risks.
- Consider strategies for managing the significant risks.
- Assess the features of existing insurance contracts (limits, exclusions, and deductibles).
- Identify any inadequacies in existing life, medical, disability, property, and liability insurance coverage.
- Suggest the type and amount of any needed additional coverage.
Investments
- Establish individual risk tolerances.
- Assess the kinds of risks to which the current portfolio is exposed (interest rate, inflation, business, financial, liquidity, market, political, exchange rate, call).
- Assess the suitability of investments in light of risk tolerance.
- Establish investment objectives-identify the motive for trying to accumulate greater wealth or cash flow.
- Assess the current asset allocation of the portfolio and suggest a more appropriate allocation.
- Suggest ways to better diversify the investment portfolio.
- Suggest specific types of investments that would better meet personal needs and objectives, and provide a better risk-return payoff.
Retirement
- Identify the sources and amounts of retirement income (government, employer, sheltered, and non-sheltered investments).
- Suggest appropriate strategies for deregistering/rolling over RRSPs.
- Identify retirement living expenses.
- Calculate any retirement income shortfall.
- Develop a strategy to cover any shortfall.
- Suggest possible strategies for generating more income in retirement.
Estate
- Determine if a valid and up-to-date will exists.
- Determine if appropriate guardians, powers of attorney, and executors are named.
- Determine if beneficiaries are named in RRSPs and insurance policies.
- Consider the appropriateness of trusts to care for special needs.
- Suggest suitable types of trusts that could be used.
- Assess whether holding property jointly or in common is appropriate.
- Develop strategies to minimize probate fees.
- Consider a living will/personal directive.
- Consider letters of last instructions.
Part 3: Align financial resources and goals
Create a budget to support and accompany your plan. Forecast expected income, expenses, and surplus cash. Insert the costs of goals into the budget in the proper time frame. If the goals throw the budget out of balance, adjustments must be made. Another approach is to prioritize goals and to limit oneself to a subset of the entire wish list.
Remember that if you fund goals from cash or investments, you must adjust net worth. When cash or an investment is liquidated to purchase an asset (e.g., a new car) there will be no change in net worth; if the finances are expensed for something like a vacation, then net worth will be reduced.
Part 4: Make recommendations
The last Part is to bring all identified problems, opportunities for improvement, and a proposed budget together in the form of a recommended strategy. The resulting plan outlines the things that can be done to achieve the individual's goals and better manage tax, investment, cash, debt, insurance, retirement, and estate issues. In the context of an actual financial planning relationship between a client and a planner, both parties will work at the strategy and fine-tune until it is acceptable and feasible.
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