A financial planner begins the planning process by qualifying the potential client. The planner begins by asking questions, such as “Is this someone I wish to work with?” and “Do the needs of the client match my areas of competency and align with my business model?” In general, job-task activities associated with qualifying a potential client includes:
• Understanding client’s goals, needs, circumstances, and expectations
• Describing financial planning process to the prospective client
• Explaining the scope of the services to be provided
• Assessing the planner’s ability to serve a client’s needs.
An important caveat should be added here. While every financial plan should complete a set of established planning steps, not all engagements have to achieve that level of comprehensiveness or sophistication required to complete the 10 steps presented earlier. In fact, financial planners offer services at differ- ent levels of sophistication. This accommodates clients with differing needs and goals. For instance, the American Institute of Certified Public Accountants (AICPA) has identified the following three levels of service: consultant engage- ments, segment planning engagements, and comprehensive personal financial engagements. A consultation is an informal or unstructured financial planning arrangement that explores the nature and depth of the financial problem by requiring the prospective client to fill out an initial financial profile (or predata gathering) form. The consultation process generally ends with determining whether the client needs a more formal type of engagement. It is communi- cated in the form of an oral or written report. Individual planners across the country refer to various levels and types of services by names as retirement planning, investment planning, tax planning, and comprehensive financial planning. Regardless of the level or type of service performed, there is no sub- stitute for a professional approach to every type of financial planning.
Typically, an initial, informational interview is designed to qualify a potential client. During this interview, the focus is on understanding qualitative issues (such as core values, goals, dreams, and fears) instead of collecting quantitative data (such as bank account values, insurance policies owned, and so on). During this initial contact the planner might ask questions such as: (a) What transpired in your life that persuaded you to see me? (b) What are your goals and dreams?
(c) What types of people and things are most important to you? (d) What could we do for you so a year from now you would consider our relationship to be successful? Qualitative questions like these help the planner determine if the profile of the person fits the planner’s target clientele. Of course during this inter- view the potential client also has the right to collect critical information about the practice. For instance, a potential client may ask: (a) How does your planning firm operate based on its core values and planning philosophy? (b) How would your planning services help me? (c) How should I view the establishment of a long-term relationship with your planning practice? (d) Do I have to buy from you all the products you recommend? (e) How does the planner get paid? Is he or she a commission or fee only planner? In short, the informational interview is
a two-way street: In this meeting the planner sizes up the client while the client also evaluates the planner.
Here are two real-life examples that demonstrate the importance of qualifying a prospective client before starting the planning process.
1
Bob Smith and his fiancée Jane Coy have approached Karl Dixon to develop a comprehensive financial plan for them. Bob was a registered pharmacist in Cleveland for 20 years but has recently been forced to move to Phoenix, Arizona, for health reasons. He sold his pharmaceutical business in Cleveland and is contemplating buying a suitable business in Phoenix. Jane is a tenured school teacher in Cleveland and currently earns an annual salary of $48,000. She partici- pates in the school’s retirement benefit plan and enjoys the usual (health, disability, eye care, and so on) fringe benefits. Bob and Jane are planning to get married in a few months and settle down in Phoenix. This is a second marriage for both. There appears to be a great deal of understanding, flexibility, and open communication between them. Karl Dixon’s responsibility is to develop a comprehensive financial plan by assuming that Bob and Jane are married, even though they will not be officially married for several months.
The couple’s situation is straightforward, or so it seems on the surface. But after the initial interview, Karl realizes that his responsibility would have to extend far beyond developing a comprehensive financial plan. Bob Smith loves Jane and has no problem assuming that Jane will quit her teaching job, lose her $48,000 teaching salary plus the associated fringe benefits, settle down in Phoenix, and be content playing the role of an unemployed housewife. Jane Coy views the situation very differently, however. She fears that after marriage, she will lose a lot: (a) an annual salary of $48,000 plus future increments, (b) school’s retirement contribution, (c) all the fringe benefits, (d) financial independence, (e) significant loss generated by a forced sale of the home, (f) option to retire at the age of 59 with full retirement benefits, currently offered by her school system to all employees with at least 25 years of service. Jane also resents the fact that Bob is totally opposed to financing her daughter’s education at an Ivy League school where she is definitely headed. As a fair compensation for all the potential losses, before marriage Jane wants Bob to pay her $400,000, a demand Bob rejects out of hand. Bob is willing to take the financial responsibility for Jane only after marriage, and he considers that to be a fair deal.
If Karl accepts this couple as his client, his task would be far more complicated than he was initially led to believe. He would be loaded with psychological problems. This case illustrates the importance of using qualitative data in financial planning.
2
Robert Powers, 52, and Janet Powers, 49, are a happily married couple.
They have three children, aged 28, 25, and 23. Both Robert and Janet believe their financial situation is in shambles, and they need a financial planner to bring order to their chaotic financial situation. The Powers have approached Bill Kifer to develop a financial plan. They are willing to pay a handsome planning fee.
During the initial interview, Robert strongly suggested that his mother’s net worth (in excess of $2 million) should be treated as part of their financial assets. After briefly review- ing the Powers’ financial information Bill felt that, with the exception of Bob’s unusual suggestion, the case was straightforward.
As the interview progressed, however, Bill discovered several interesting facts. Robert, now 52, is currently unemployed and has no intention of returning to work. He is the only child and will inherit his mother’s estate of over $2 million. The mother is 85 years old and Robert argues that since he would have all of her money very soon it makes no sense for him to go back to work. But this fact alone has become a source of friction between the couple. Janet strongly believes that Robert should not count on receiving this money soon, if at all, because his mother could still live for a long time, and could, Janet adds, possibly lose all her wealth through bad investments, escalating medical expenses, or donation to her favorite charity. That creates a big planning headache: Robert wants Bill to include his mother’s net worth in their plan, whereas Janet wants him to ignore the mother’s estate.
Another family matter that is creating friction between Robert and Jane is that their three children are now grown-up adults and should be established. Unfortunately, that is not the case. None of them has more than a high school education, regular employment, or even any means of support. The oldest has a complicated health problem, but physically the other two are healthy. All three children live at home and are dependent on their parents for financial support. Robert is upset about the situation. He believes that the only way to resolve this problem is throw the children out of the house and force them to become responsible human beings. Janet, however, believes that since the failure is on the part of the parents they should start funding separate trusts set up for each of the three children.
There is also an emotional problem that affects the family’s current financial situation.
Since Janet is compelled to earn a livelihood because Robert refuses to work, Janet wants her salary to be spent solely on herself. She does not want it to be used for supporting the family. Robert disagrees. He believes family finances should never be split in that fashion.
It is a potential financial nightmare. Bill Kifer has to decide if he should even consider accepting the Powers as his long-term clients.
The two cases presented here call for a few general observations in the running of a financial planning practice. Regardless of their orientation and expecta- tions, initially what clients really need is a subjective, rather than an objective, perspective of their personal finances. True, a financial planner should be well versed with the mechanics of plan development and implementation. But the planner should also be able to blend mechanical expertise with human under- standing in developing acceptable solutions that will serve the clients. In the final analysis, then, the long-term success of a planning process is assured when the financial planner is able to establish an honest, open, and professional relationship with the right type of clients.
Engagement Letter
Once the financial planner and the prospective client agree that it is beneficial to establish a professional relationship, it is time to sign a formal contract, com- monly known as the engagement letter. This letter should include the following:
• Client and planner identification and signatures
• Documentation of the scope of engagement
• List of planner and client responsibilities
• Terms of the contract and the method of termination
• Disclosure of existing and potential conflicts of interest
• Supply to the client of additional material information of importance
• Compensation arrangements
• Required disclosures, including applicable regulations.
After both the financial planner and the potential client have decided to work together, if licensed as a registered investment advisor with the Securities and Exchange Commission (SEC), the financial planner is obliged to provide the client with a planning brochure in compliance with SEC Rule 204-3, commonly known as the Brochure Rule. This brochure describes the financial planning ser- vices offered. It specifies that, should the client implement, through the planner, plan recommendations that generate commissions. The planner will earn these commissions in addition to the fee for developing the financial plan (conflict of interest rule). This Brochure Rule can also be satisfied by providing the client with ADV (Part II) of the registered investment advisor.
Once the Brochure Rule is completed, the parties can sign a formal contract, known as the engagement letter. Covering all the items listed earlier, this contract should also include a provision allowing the client to cancel it within five business days and have the advance planning fee, if any, fully refunded.
This provision makes it possible for the client to subsequently review the
contract and the brochure and, if desired, have the documents reviewed by an attorney. Such a provision also helps to emphasize that, by signing the contract, both parties have made a decision to establish a long relationship.
The signing of the engagement letter by both parties completes all the initial signing rituals and signals the initiation of the next phase of the financial planning process.