If the term “financial planners” evokes visions of equities and equity mutual funds—selected to implement financial plans they developed for clients in accordance with their investment goals and tolerance for investment risk—it should not be surprising.
Equity Ownership in America, 2005, a study recently released by the Investment Company Institute and the Securities Industry Association, found that more than 75 percent of the millions who own equities and equity funds outside employer plans bought them through financial planners and other professional financial advisers.
But financial plans leading to ownership of portfolios of equities and equity funds are hardly planners’ only services. They not only have delved increasingly into areas beyond investment advice, they also have met clients’ needs for more of their life goals, giving rise to the concept of financial life planning.
Some may think that financial planning is a one dimensional process involving technical skills, such as Monte Carlo projections, retirement income calculations, investment analyses and asset allocation. But with financial life planning, planners may ask questions like, “If you could live your ‘ideal calendar,’ what activities would be on that calendar?” Questions like this get more to the heart of really good financial planning and its natural extension… ‘life planning.’
The underlying premise is self-evident: people have different goals during different stages of their lives and may not have the confidence—or the necessary time—to deal with them on their own. Life planning is also about raising a person’s awareness of the things they do daily, which they may do automatically, which really should involve choices. By helping people think outside the box of their daily assumptions and helping them identify choices, life planning helps them get more from their financial resources. The roles of financial life planners, as they see them, are essentially to help clients to do at least four things:
When initially formulating plans, define and rank clients’ goals at each stage
Identify what the goals require of them as they approach each stage
Implement plans by advising clients on managing their affairs to realize goals
Monitoring implementation and changes in clients’ circumstances to modify plans, goals, and goals’ requirements as necessary.
The number of stages into which clients’ lives are divided will, of course, vary based on a number of factors such as the ages at which plans are initiated, the paths which careers take, and the career vs. leisure activity decisions made along the way.
A few examples will illustrate the types of life stages that people experience and the types of goals associated with them:
Start of career
·Analyses on which to base a choice of employer when lucky enough to be faced with more than one job offer. Of note, the job offer analysis may well be a financial one only, which in life planning would be part of it. A life planner might dig deeper to find out lifestyle requirements of different jobs, longer range opportunity and wealth building opportunity. They might even ask the question, “Which one would you love?” It's not that the planner is trying to become a career counselor, but rather to help a person make good choices towards a more rewarding and secure life.
·Budgeting to provide for both paying off student loans and contributing to employers’ tax-deferred savings or retirement plans as soon as eligible.
·Choices among employer plan options.
Marriage
·Economic considerations associated with decision as to whether both spouses will have jobs.
·Choice of residence, factoring in economics of renting vs. buying.
·Integration of investment portfolios beyond employer plans (if any).
·Optimizing taxes on investments and other income sources to maximize after-tax income (including handling of capital gains and losses).
Obtaining appropriate life insurance coverage.
Revision of wills.
Initiating savings for college if children are in the future.
Mid to Late Careers
Adjust portfolio and employer plan’s asset allocation.
Advise—and, if necessary, oversee—parents with respect to their retirement assets and residence.
Acquisition of retirement cottage, factoring in economic considerations such as estate taxes.
End of Careers
Early vs. “normal” retirement.
Decisions regarding Social Security.
Need of long-term care insurance.
Updating wills, including provisions for universities and other nonprofits.
These are just a few of the functions performed in financial life planning. A financial life planner will explore much more deeply with his or her clients those personal characteristics that influence their financial choices, including fears, dreams, family circumstances, work-life balance, values and volunteer commitments.
Once the financial life planner has explored the above (and more), a financial plan can be designed within the context of life stages that reflects what is most meaningful in the client's life and how they define true wealth.
December 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC, a local member of the FPA.
MAKING AND KEEPING INVESTMENT PORTFOLIO AND FINANCIAL PLANNING RESOLUTIONS FOR 2006
Even if you aren’t among those who normally make New Year’s resolutions—and keep them—this may be a time when you will want to make and keep them in the year to come.
With the Standard & Poor’s 500 Stock Index up 1.05 percent through October and the average U.S. taxable investment grade bond returning an almost identical 1.12 percent, as indicated by the Citigroup Broad Investment-Grade Bond Index, barring a year-end rally, 2005 could wind up as a flat year in both stock and bond markets.
Whether the ultimate results are flat, up a little, or down a little, you could be thinking of adjusting your portfolio to improve its performance by taking bigger risks—perhaps more than would be appropriate for you. Given the potential losses inherent in such a strategy, the following resolutions may be helpful as you consider your year-end strategy:
Allocate your assets among bonds, stocks, money market instruments, and funds in proportions that reflect the amount of risk necessary to achieve your goals. In some cases, that may mean that portfolios don’t need to be or shouldn’t be more conservative ‘just because’ someone is older. It should really be about allocating for your particular goals and needs, not ‘just because’ you are at a certain age or spending level. Disregard recommendations of all-purpose model portfolios’ asset allocations. They may indicate how various investment strategists feel about the near-term attractiveness of stocks and bonds but weren’t offered with your particular investment goals and risk tolerance in mind.
Have realistic expectations of performance. The years of exceptional annual returns for stocks, on the average, are a memory now. Annual returns averaging below the long-term average of about 10 percent annually seem more likely in the foreseeable future. Whatever they are, the average returns for balanced portfolios are likely to be single-digit.
Resolve to maximize your net returns by holding down (a) excessive commissions when buying or selling individual securities and mutual funds and (b) excessive expenses when investing in mutual funds. When investing in taxable accounts, be mindful of the tax consequences of owning mutual funds that make large taxable distributions of realized short- and long-term capital gains. Recent research published in the Journal of Financial Planning suggests that funds with low turnover and long-term capital gains still belong in taxable accounts and that funds that have large amounts of short-term gains distributions should be placed in retirement accounts, such as IRAs, 401(k)s, or other tax-deferred accounts.
When investing for income, resist the temptation of chasing high yields. Higher yields are generally associated with higher risk, and with some investments what appears to be yield may actually be a return of capital.
Don’t forget bond funds. Tax-exempt state or local government bonds or “municipal” bond funds, whose yields are usually lower than those of taxable issues of comparable credit quality and maturity, may pay you more than you’d have left after taxes when investing in the comparable taxable securities. Do the math: compare your prospective after-tax income from the taxable securities with what you’d get from the tax-exempts.
Accept that there is no shortcut to mutual fund selection. Whether you do it or an adviser does it for you, funds have to be studied—primarily in funds’ own, SEC-mandated literature—to determine their suitability. Data indicating superior past performance—which funds must report in accordance with SEC regulations and update periodically—don’t assure you of superior future performance. Neither do ratings, such as the 5-star ratings for risk-adjusted performance calculated by Morningstar. They may provide you an additional dimension of past performance, but, as Morningstar has long reminded investors, they don’t have predictive value. Such data constitute the beginning, not the end, of the selection process, indicating which funds’ literature you might study.
Don’t be too impressed by high absolute returns. Compare past performance data for an equity fund with performance data for the same periods for the S&P, Russell, or other index—for the broad stock market, for large or small companies’ stocks, for growth or value stocks, and so on—which the fund management has chosen as its benchmark. You may also compare them with data for peer funds computed by Lipper or Morningstar. By focusing on relative returns, such comparisons tell you whether the fund has performed as well as could be expected, better, or worse, given the stocks it owns.
Always remember that stocks and bonds—and the funds that own them—are long-term investments, requiring patience and the ability to ride out market volatility. Stocks and stock funds are unlikely to be, as magazine covers will have you believe, “the 10 (whatever) you must own in 2006.”
December 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided byBold Financial Planning, LLC, a local member of the FPA.
There is perhaps no financial product more confusing today than equity-index annuities or EIAs. On the surface, EIAs are somewhat simple. Like most annuities, EIAs are nothing more than a contract between you and an insurance company in which the company promises to make periodic payments or a lump-sum payment to you, starting immediately or at some future time, according to the NASD.
But EIAs are more complex than traditional fixed annuities or variable annuities. As with fixed annuities, they provide a guaranteed minimum return, typically 90 percent of the premium paid at a 3 percent annual interest rate. However, EIAs also typically provide a potential upside amount tied to an equity index, similar to variable annuities.
Herein lies much of the confusion. EIAs give you more risk but more potential return than fixed annuities but less risk and less potential return than variable annuities. How so? According to the Securities and Exchange Commission (SEC), EIAs work as follows: During the accumulation period – when you make either a lump-sum payment or a series of payments – the insurance company “credits” you with a return that is based on changes in an equity index, such as the S&P 500 Composite Stock Price Index, but not necessarily equal to the full total return of the index.
The variations in insurance company crediting procedures add much to the complexity of EIAs. These deviations from a uniform standard often contain several features that can affect your return. And you should fully understand how an EIA computes its index-linked crediting rate before you buy such a product. EIAs typically include one or several of the following three common features used to compute the return:
Participation Rates. The participation rate determines how much of the index’s increase will be used to compute the index-linked interest rate. For example, if the participation rate is 90 percent and the index increases 5 percent, the return credited to your annuity would be 4.5 percent.
Crediting Rate Caps. Some EIAs set a maximum rate that the equity-indexed annuity can be credited in a year. If a contract has an upper limit, or cap, of 7 percent and the index linked to the annuity gained 7.2 percent, only 7 percent would be credited to the annuity.
Margin/Spread/Administrative Fee. The index-linked return for some EIAs is determined by subtracting a percentage from any gain in the index. This fee is sometimes called the “margin,” “spread,” or “administrative fee.” In the case of an EIA with a “spread” of 3 percent, if the index gained 9 percent, the return credited to the annuity would be 6 percent (9 - 3 = 6).
Another feature that can affect an EIA’s return is its “indexing method,” which identifies how the amount of change in the relevant index is determined to calculate the crediting rate. According to the SEC and NASD, common indexing methods, which may apply annually or only at the end of a set number of years, include:
Point-to-Point. This method credits an index-linked return according to any increase in index value from the beginning to the end of the contract’s term.
Monthly Averaging. This method determines the amount of return to credit based on the average value of the index over a period of months (typically calculated over 12-month periods, on the contract anniversary date).
High Water Mark. This method credits an index-linked return according to any increase in index value from the index level at the beginning of the contract’s term to the highest index value at various points during the contract’s term, often annual anniversaries of when the EIA was purchased.
EIAs can also be confusing because of other potentially pricey features. If you surrender your EIA early, you may have to pay a significant surrender charge to the insurance company, plus a 10 percent tax penalty on earnings to the IRS if you are below 59½ years of age. The SEC also says you can still lose money if your guarantee is based on an amount that’s less than the full amount of your purchase payments. And, in some cases, the SEC says insurance companies may not credit you with index-linked interest if you do not hold your contract to maturity, foregoing all of your credited returns over the years to instead receive only the minimum guarantee.
In short, do your homework before you purchase an EIA. Understand how it works, what factors to consider in making your decision, and how you can avoid common problems. It may be possible, less expensive and less complicated to accomplish the same investment goal with a combination of a no-load equity index mutual funds and zero-coupon bonds.
December 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC a local member of the FPA.
