Clients frequently seek financial guidance in order to get assistance in making wise investment decisions. However, investments are instruments that you use to reach your financial goals. By focusing only on investments you are focusing on the tools and not focusing on your objective, which is to use the right tools (investments, etc.) to grow your wealth.
To keep your focus on your objective (growing wealth) it is important to have a comprehensive financial plan.
Here are the essential components of a complete financial plan:
1. A complete review of your current situation and future goals.
A comprehensive financial plan is about numbers, but it’s also about life. It is important to consider your family’s current situation, both its opportunities and its challenges. In developing your financial goals, it is important to consider your hopes and plans for tomorrow. A complete financial plan begins with a thorough review of what is most important to you.
During the initial review process, your should consider:
- Your family members
- Your family’s values
- Your concerns
- Your opportunities
- Your challenges
- Your goals
You should review your family’s financial information, which includes:
- Estate planning documents
2. A timeframe for your financial and lifestyle goals
A comprehensive financial plan should identify what you hope to achieve and when you want to achieve it. It is important to precisely state and prioritize your goals.
For example, an early-career person might determine:
- Short-term objectives: saving for a downpayment on a house or building up an emergency fund.
- Middle-term objectives: putting aside money for a child’s college expenses.
- Longer-term objectives: building funds for retirement or work-optional living.
Late-career people might set the following as their objectives:
- Short-term objectives: using catch-up contributions in order to increase the balances in retirement accounts.
- Longer-term objectives: charitable giving, wealth transfers to family members, and other legacy planning.
3. A portfolio that helps you achieve these goals
You can’t plan for a goal you haven’t set. Similarly, you can’t make investment decisions without a clear picture of your present monetary situation and a clear understanding of your objectives and limitations. Once you have this, the next step is to determine your asset allocation–the mixture of assets that will help you accomplish your objectives and goals—which takes into consideration your ability to bear risk and your willingness to bear risk.
Your ability to take on risk is something that can be measured in an objective manner. It can be determined through tools such as risk questionnaires and by evaluating your responses to Monte Carlo simulations. On the other hand, your willingness to assume risk is subjective. In order to determine your willingness to bear risk, you have to work through a series of questions that aim to assess your comfort with different types of risk.
Only after all of this preliminary work should you then turn to creating a diversified investment portfolio that is appropriate for your unique situation.
- For some investors, simple lowest-cost portfolios are the best option.
- Other investors have the ability and willingness to assume more risk and would better-served with a portfolio of risker assets that aim to achieve higher returns in the long run.
- Other investors may prefer a strategy seeking to minimize downside risk in order to protect their investments in volatile markets.
4. Test the plan against future stresses
Economic conditions in the future will have a significant impact on whether or not your plan will be able to fund your financial goals. It is not possible to predict the future. It is possible, however, to plan for the future.
Once you have determined a suitable investment portfolio, it is important to stress test it by analyzing it through many different market situations. This analysis is called a Monte Carlo analysis, which simulates thousands of different market scenarios and analyzes how your portfolio will act in each of these situations. The result in each scenario will be “pass” or “fail,” meaning that your portfolio was able to provide you with the financial resources necessary to meet your goals or it failed to do so. You don’t need a score of 100% to consider your plan a success. Your plan is successful when 85% of the scenarios show that the financial resources you have will be able to meet your financial objectives.
Once you have these results, you can alter the inputs and assumptions of your plan in order to see the impact they have on the likelihood of your success. By using Monte Carlo analysis, you have the ability to see how different strategies and tactics will impact your financial goals.
5. Estate planning
If already have estate planning documents in place, a financial advisor will be able to examine your papers and see if anything is lacking or needs to be updated. If you have not yet begun the estate planning process, an advisor may assist you in expressing your wishes and offering suggestions to an attorney who will then craft those documents for you.
Estate planning is an essential component of a complete financial plan because it directs how assets will go to your beneficiaries. This enables you to ensure that your assets will be distributed the way you intend.
6. Insurance Review
Insurance is important in your financial plan because it aims to protect you and your family should something unfortunate occur. It is important to review the adequacy of your life, long-term care, disability, and other types of insurance to ensure that your policies adequately protect you and your assets.
Disability insurance is critical for nearly everyone in their working years. Life insurance is vital for those who are in their working years and have others who depending on their income.
People who sell insurance do not have to abide by the fiduciary standard of care. This means that they do not have to work in your best interest. However, when a fiduciary financial advisor reviews your existing insurance plans they do have to abide by the fiduciary standard. This means that they are required to offer advice that is in your best interest. (However, not all financial advisors are fiduciaries.)
7. Forward-looking tax planning
We can’t avoid paying taxes, but there is no reason to pay more than you have to. Incorporating tax planning into your financial plan will help you preserve more of your money. Proper tax planning can have a huge impact on your wealth.
Financial advisers can provide you with comprehensive tax planning to help avoid significant, unexpected tax bills. They can also assist you with strategies like lumping charitable contributions, tax-loss harvesting, and strategic Roth IRA conversions. If you currently have a CPA, your advisor can partner with them.
8. Continuous monitoring and regular adjustments
Financial plans should be updated as situations in your life change and as your financial goals shift. Unfortunately, it can be difficult to adhere to a schedule to review your financial plan. However, this review should be done on a regular basis to make sure that your plan is still on track for your situatio