THE IMPORTANCE OF AN ANNUAL FINANCIAL CHECKUP

It’s one of the six steps of the financial planning process. But, oftentimes, it’s the one step that gets overlooked. It’s the sixth step – the annual financial check-up.

The annual financial check-up is indeed the most important of the financial planning steps. And yet, financial planners and clients sometimes downplay its significance.

What is the annual review and why is it so important? In short, the annual review is the opportunity to measure a client’s progress against their plan of action. It’s also the one time when planners and clients can examine the many changes that typically occur any given 12-month period – the birth of a child, the death of a loved one, the loss of a job, a major purchase – and then readjust the client’s financial plan, charting a new course if need be or further affirming the client’s progress towards their personal financial goal achievement.

Indeed, lives are seldom static and that’s why financial plans are not necessarily set-and-forget documents. But what exactly should financial planners and clients examine in their annual meetings? And when should they conduct their annual meetings.

Typically, financial planners will collect a client’s data, prioritize their goals, examine their resources, make recommendations, and implement a plan as part of the financial planning process. In an annual review, the financial planner will do much of the same and then some. They will first typically examine a client’s progress against the plan time frames. This sort of monitoring benefits both planners and their clients. Clients get an opportunity to step back from their busy lives and review their goals and confirm that their priorities remain the same Planners have a chance to reconnect with their clients to affirm their positive actions towards goal achievement or to help refocus them so that they don’t get too far off track. And planners get a chance to enhance the relationship and trust.

In some cases, planners and clients will want to establish a regular appointment, meeting on an annual basis, and in some cases on a quarterly or semi-annual basis. Typically, the planner and client will review in these meetings short-term goals, examining what if anything may have changed. In some cases, the planner will make changes to a client’s investment portfolio in light of tactical or strategic asset allocation models in place. In other cases, a planner will suggest changes based on certain life events. The birth of a child or grandchild may require a discussion about 529 plans. A divorce may require changing beneficiary designations on retirement accounts and life insurance policies.

In addition a planner may want to review with their clients new research that has become available in the interim to either confirm rationale or provide a basis to alter a client’s short-term or long-term strategies. For instance, new research that shows the escalating costs of nursing homes or health care in retirement wouldn’t change the goal of “secure long-term retirement,” but it would change the strategy to achieve that goal.

Besides reviewing family developments, planners would also address in an annual review regulatory and other changes that could affect adversely or positively a client’s financial plan. The new Medicare Part D plan or the introduction of the Roth 401(k) could prove useful to some clients. In other cases, the annual review is a chance to review potential changes, changes in the federal estate tax laws, for instance, and devise possible plans of actions.

Planners and clients will often want to measure the “performance” of the investment portfolio as part of the annual review. Typically, performance should be measured against several benchmarks, the most important of which is the client’s own personal goals. For instance, if the planner and the client established that a portfolio should grow by 5 percent per year before taxes then the performance should

be measured against that yard stick. To be sure, it’s important that portfolios be measured against standard benchmarks. But only as a point of reference. Meeting personal investment goals is far more important that over performing or underperforming the Dow Jones industrial average. By and large, it’s imprudent for planners and clients to make wholesale changes to a portfolio bases solely on one quarter as well as one year of performance.

In summary, annual reviews provide a chance for planners to examine a client’s long-term goals. These reviews can establish whether the client is generally on course to meet their goals. It’s also a chance to review changes that have occurred and begin to anticipate changes that may occur. It’s a chance to implement any new plan of action that has been developed in light of changing goals or changing performance. And then last, the annual review provides the perfect opportunity to establish future review meetings.

One of the most important worksheets to review is a balance sheet or net worth statement. If reaching all of the client’s goals will require a net worth of $1 million at some point in the future, it is the balance sheet that will demonstrate movement toward or away from that goal. It is a road map. When going out of town, a map is almost always consulted before and during the trip. Progress toward your ultimate destination is noted by each passing town or landmark. It is easy to see when you move off track and what corrections should be made to get you back on the correct path in the least amount of time or distance. The balance sheet measures your progress toward your monetary goal in a finite manner. What the numbers show from year-to-year are not as important as what they show after several years looked at as a whole.

May 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA.

THE TRUTH ABOUT SMALL-BUSINESS SUCCESSION PLANNING

Of all the things facing a man or woman from the moment he or she becomes chief executive officer of a large company, few have a higher priority than determining who will succeed him or her when it becomes necessary.

This is critically important for a large public company with thousands of employees and thousands upon thousands of stockholders. It is no less important for a small company with relatively few employees depend on it for their livelihood.

While large companies typically have board committees and/or staff whose sole responsibility is to develop and implement detailed procedures for identifying potential CEO’s both within and outside the company, small companies usually have less structured practices.

They may be as simple as choosing an obvious candidate, such as an only child of the founder or, perhaps at least on an interim basis, the most senior employee if the child is too young. “Though inevitable, succession is often the least planned and, consequently, the most perilous event for a family business,” the U.S. Small Business Administration asserts in a paper entitled Family-Owned Business Success: Leveraging Advantages and Mastering Challenges. “History has shown that only one in three firms will survive the transition to the second generation. Only 10 percent of the original group will survive into the third generation of ownership.”

Given the increasingly complex challenges that small and large businesses alike face these days—whether from government regulation, international competition, new technologies, rapid obsolescence of products, or other factors—simple procedures and searches limited to family or current staff may no longer suffice. In order for a business to have a future, serious issues must be addressed and answered over and over again, often with the help of a financial planner or adviser who can help a business owner through the process. Among these are:
· If a family member is the obvious heir apparent, is he or she really able and willing to handle the job for the indefinite or possible immediate future? “It’s never too early to start” training a successor from within the family, the SBA points out. “By elementary school age, youngsters can stuff envelopes and help with office housekeeping chores. As they mature, their participation can grow accordingly…Experts also recommend that the incoming generation work in the broader business world before permanently joining the family venture.”
· If the obvious heir apparent is not the best choice, is another family member, perhaps not previously considered, better able and willing to do the job? The decision must be based on the ability of whomever is considered to do the job well, not based on age, relationship, gender, or education. “Separation of family relationships and business is especially essential at this juncture,” the agency advises. “The decision must be based on qualifications regardless of family dynamics.” Business owners also need a backup plan should family member or other heir apparent fail to run the business appropriately.
· If no family member is able and willing to lead the company for the foreseeable future, does it make sense to look elsewhere within the company before going outside, or does it make more sense to sell the business?
· In former case, would the most senior employee necessarily be the best qualified candidate or would a younger one be a better prospect?
· If no employee is qualified and willing to lead the company at this point in its history and it would become necessary to go outside, would current employees who considered themselves to be eligible become sufficiently disappointed, risking the loss of their experience?
· What sort of compensation and benefits package would it take to attract a suitable candidate, and can the company afford to offer it?
· If the compensation package were to involve equity, does anything need to be done to facilitate consensus among current owners to accept the arrangement? Business owners will need to determine the value of the business as part of any succession planning exercise. Likewise, owners need to structure the sale of the business to children or other successors.
· Given the importance of retaining principal current employees, what plans must be made (a) to properly communicate to them the rationale for going outside and (b) to enhance compensation and/or benefits to keep them? “These key players need reassurance that they have a place after the incumbent retires,” the SBA stresses. “Conversely, incumbents need to help them understand that they must enthusiastically support the succession process and the incoming leadership.”

Recommending that family businesses should begin to plan for succession “a decade or more” before the events, the SBA explains, “Having time to discuss issues and options will increase the odds for success while building family acceptance…

“Once the succession process is put in motion, the family needs to set a date when the retiring owner cedes full control to the new leadership.”

Retiring founders need to prepare themselves for the changes, too. They will have to move from a time in which their businesses were their lives, where most of their friends were business associates, and where they had few outside interests to a time in which they may find fulfillment elsewhere, perhaps mentoring, or serving non-profit organizations, charitable organizations, or other businesses. Some may want to start all over again, founding new businesses in new fields.


May 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA.