After completing the task of data collection, the planner can begin analyzing the financial and nonfinancial data. So the planner must develop reasonable and supportable assumptions on which such an analysis would be based.
Developing assumptions can involve both a delicate and an arduous process.
Basic assumptions can be specified either by the client or by the planner. Where appropriate, these can also be jointly developed after an in-depth discussion between the financial planner and the client. For example, in one instance the client may unilaterally decide to send his or her son to an expensive Ivy League school. In another instance, both the client and the planner may jointly map out the nature of the client’s risk tolerance. Of course, assumptions of a techni- cal nature, such as rates of returns on investments, correlations, inflation-rate expectations, and future costs of health care, are generally assumed to be the financial planner’s responsibility.
Regardless of the source, for a financial plan to be credible, it must be based on reasonable assumptions. Those that are too aggressive, such as unreasonably
high investment growth rate and relatively short longevity factor, generally lead to disappointing outcomes. Of course, if a client insists on making an aggressive assumption that is counterproductive, the planner has the responsibility for presenting all the relevant facts so the client can realize the consequences of making such an improper assumption. A case in point: Based solely on the expe- rience of his father and grandfather, both of whom died early from massive heart attacks, a client wishes the planner to develop a financial plan on the assumption that after retirement he will live only for five years. While that could well turn out to be true, in creating a financial plan it is not advisable to make such a short-sighted assumption. In such a situation, the planner should try to dissuade the client. A modification of unrealistic goals constitutes a challenge for the financial planner. Changing unrealistic goals is an important work. Why is it so difficult? It can be a multifaceted problem. It can include psychological, emotional, and social issues, any of which can be beyond the planner’s compe- tency. This is because, to solve this type of problem, psychological, emotional, and social factors may have to be handled, each of which can turn out to be complicated and beyond the scope of financial planning. Consider the case of a client with a lavish lifestyle who wishes to retire early. While under the right cir- cumstances this would be a lofty goal, it could become a prescription for disaster. That is because the retirement income possibly will not support such a lifestyle. If the retirement income and the available investment funds cannot support such a lifestyle, a serious discussion of all the relevant factors with the planner is required between the planner and the client.
In developing a comprehensive financial plan, a financial planner needs a set of assumptions. The key assumptions include the following:
• Client-specified assumptions
Goal prioritization
Tolerance for risk
Special situations (e.g., planning for dependents with special needs)
• Budgeting assumptions
Projected incomes (amounts and risk of income volatility)
Monthly expenses
Timing and future cost of planned major expenditures
Annual living expense needs
• Health assumptions
Longevity expectations
Family health risk factors
Projected health care costs
• Economic and investment-related assumptions
Reinvestment rates
Future volatility and correlation data
Business cycle forecasts
Inflation and interest rate assumptions
• Higher education assumptions
Type of school the child(ren) require
Client’s funding intentions
Future cost of schooling
• Tax planning assumptions
Change in tax rates and brackets (legislation)
Charitable wishes
• Retirement planning assumptions
Desired age of retirement
Retirement income needs
Longevity in retirement
Sources and projected level of systematic income
Amount of Social Security benefit
• Estate planning assumptions
Family boundaries
Client’s distribution and privacy wishes
Legacy wishes of the client (e.g., dollar amounts)
Change in estate tax legislation
• Business assumptions
Future valuation
Disposition wishes.
Plan Presentation
Having collected the relevant data and made realistic assumptions, with care the planner should develop a comprehensive financial plan. Once completed, the plan should be presented with details so the client will have an opportunity to analyze all aspects of it. Unquestionably, that constitutes one of the most important aspects of financial planning.
At this point, the objective of the planner should be to listen to the client’s comments, criticisms, and pointed questions. Here, the valuable information
can be gathered as to the following plan aspects: (a) strengths and weakness, (b) existing gaps, (c) possibilities that some of the goals would not be attained, and (d) misinterpretation of the nature of the client’s risk tolerance, reluc- tance to implement the plan effectively, and several other concerns not dis- cussed in the previous sections.
In assessing each content area, planners should use content knowledge and experience, and utilize planning tools such as calculators, software programs, ratio analysis, and trend analysis. They should employ various planning tools (dis- cussed in subsequent chapters). The following is a demonstration of the applica- tion of SWOT (strengths, weaknesses, opportunities, and threats) analysis.
Risk Management. Evelyn (aged 30) and Michael Martin (aged 32) have engaged Judy Camp to develop a comprehensive financial plan. In analyzing their risk management program, Judy: (a) reviews the individual insurance policies and employee benefit items, (b) looks for glaring gaps in the total risk management plan, (c) determines if the risk management basics are covered by these plans, and (d) evaluates the current coverage vis-à-vis the clients’ specific needs. When analyzing the insurance coverage, Judy critically examines the “red flag” items, including:
• Life insurance
Benefit amount that is too low relative to needs
Duration of coverage that does not match the needs (e.g., term insur- ance when client has a permanent need)
Coverage strictly dependent on continued employment (e.g., group term life)
Beneficiary designations do not reflect current intention
• Health care coverage
Lack of adequate coverage that creates catastrophic risk exposure
Low lifetime caps
High stop losses
• Disability
Inadequate income replacement
Too short of a benefit period
Too long of a waiting period
Definition that is too strict and limits ability to access coverage
• Homeowner’s coverage
Home covered for an amount that fails to fulfill 80/20 rule
Missing important riders
• Auto coverage
Inadequate liability coverage for family risk exposures
Lack of uninsured motorist coverage
Collision insurance that does not align with auto value
• Liability
Insufficient coverage based on client’s net worth and exposures
Failure to maintain adequate underlying liability coverage.
Clearly, the “SWOT and gap” analysis provides an efficient means of conducting a systematic review of the clients’ risk management coverage. The planner moves through each content area looking for existing gaps in coverage. That helps the planner determine the best means of closing these gaps.