Chapter 01 – The financial planning process

The financial planning process is a complex and continuous series of steps, with continual feedback loops, designed to ensure your clients receives the best possible advice regarding their financial planning profile, including specific product advice, estate planning, super,  asset protection, taxation planning and lifestyle and retirement management.

Dover advisers follow a systematic process to ensure their client’s statements of advice, or financial plans, are effective and efficient, and 100% compliant with the Corporations Act and related legislation. This system also means Dover advisers stand out from the pack, with their statements of advice displaying a technical edge and creativity suitable to each client and making sure each client receives the best possible advice and service, surpassing industry norms and standards.

This part of the Dover Way focuses on the steps to be taken by advisers up to the preparation of a detailed financial plan, or statement of advice, and provides guidance and suggestions on how to get the most out of this process to make sure clients statements of advice are as effective as possible and all compliance requirements are satisfied.

A reasonable basis for your advice

Advisers must be able to show that they have obtained all necessary and relevant information relating to a client before providing any financial product advice.

Advisers must provide advice that is specific to the client and suits their circumstances if they are to comply with the Corporations Law rules for financial planning.

A five steps approach to financial planning

Conventional financial planning theory uses a five step financial planning process to take each client through the journey of developing a competent financial plan.

The five steps build on each other and may be depicted as a pyramid, with each step building on its predecessors.

five-step-approach-to-financial-planning

[expand title=’Step 1 – Collect and analyse client data and Step 2 – Identify client objectives’ tag=’h3′] It’s arguably artificial, if educationally useful, to separate out steps 1 and 2. In the real world they merge together, occurring almost simultaneously, and with continual formal and informal loopbacks to allow the financial planner to prepare to put pen to paper in a final series of written recommendations contained in the formal financial plan, or “statement of advice” as it is called in the Corporations Law.

The collection and analysis of your client’s information is the critical first step in the client advice process. It’s critical because if the information is not complete and accurate then everything built on it will be flawed.

Information will normally be collected and analysed in a formal meeting, but will also be contained in telephone discussions, fact finders, risk analysis questionnaires, e-mails and letters, original documents such as tax returns and wills, previous financial plans and other media.

Information will focus on the financial, but will also include non-financial information such as age, marital status, work and lifestyle balance issues, concerns about relatives, career and family aspiration, personal philosophies and ethical viewpoints and other personal criteria.

Advisers need to be empathetic with clients, to assist those clients to overcome an understandable reluctance to divulge personal information. Advisers need also to compare this information with other information and filter it to identify exaggeration, incompleteness or bias.

First impressions count. Your general demeanour and presentation at the information-collection phase will go a long way to ensuring a successful financial planning experience for both you and your client. Good verbal communications, a professional interview technique and a confident and personable manner are essential personal skills for meeting these standards.

Your financial services guide

Your financial services guide should be provided to your client as soon as part 1 of the financial planning process starts.

Your financial services guide will set out all necessary information including how you are paid and what happens if your client has a complaint about your services.

Fact finder and other data collection tools

Good practice requires a formal data collection tool to be created for all clients and up-dated on a regular basis. This data collection tool should be designed with external audit by Dover and, ultimately, ASIC, well in mind. The records should show that the representative has been detailed, thorough and complete in collecting and collating relevant documents.

A fact finder should include:

  • contact details;
  • personal details such as age, marital status, family relations, health and so on;
  • income details;
  • current wealth details;
  • the amount and composition of debt;
  • super details;
  • estate planning details;
  • retirement plans and expectations; and
  • any matters the client wishes to specifically

Best interests duty

You should bear in mind that section 961B of the Corporations Act requires advisers to act in the best interests of the client in relation to all advice. In order to act in the client’s best interest the Act states that advisers must consider the following:

  • the position that the client would have been in if the client did not follow the advice;
  • all the facts at the time that the advice is provided that the adviser had, or should have had;
  • the subject matter of the advice sought by the client;
  • the client’s objectives, financial situation and needs;
  • where relevant, product features that you particularly value, provided that you understand the cost of, and are prepared to pay for, those features;
  • that when the client follow the advice, the benefit received by the client is more than trivial; and
  • whether a reasonable adviser would consider that the client would be in a better position, at the time of the advice, if the advice was followed and/or implemented.

ASIC Regulatory Guide 175: Licensing Financial Product Advisers – Conduct and Disclosure, states that in order to meet the best interest duty advisers must:

  • explain any limitations in the advice they can give to clients, either in product types (e.g. insurance or investments) or in product providers (e.g. products from a limited range of companies);
  • not misrepresent to clients their skills, competency, experience, expertise, capacity or benefits they might receive;
  • clearly explain their professional services to clients and document the scope of work that clients have agreed for them to do, including the specific services they will provide;
  • explain and disclose to clients how much they will charge clients and the costs clients will incur if they proceed with the planner’s recommendation;
  • explain and disclose the product and administration costs associated with their financial recommendations to clients;
  • clearly explain to clients the reasons why they have recommended a financial product to them and why they will be in a better position if they followed that advice;
  • make financial recommendations that most financial planners would view as giving clients a better outcome if they followed the advice.

The best interest duty encompasses the “know your client rule”, which requires adviser to have due consideration to the client’s relevant circumstances, goals, objectives, financial needs and tolerance to risk. It is therefore vital that in the initial meeting and discussions with the client, the adviser collects all the necessary information regarding the client in order to have a reasonable basis to prepare advice.

Risk profiling

Risk profiling is the process of measuring and identifying a client’s attitude to risk, particularly the concept of downside risk. Downside risk is the possibility or probability of an investment earning less than its expected rate of return. Financial planning theory accepts that there is an inverse relationship between risk and return and that, generally-speaking, higher expected returns bring with them higher expected risk.

Risk profiling is a notoriously difficult area, and a finite discussion is beyond the scope of this guide.

Dover takes the view that all clients should be assumed to be “conservative” and risk averse, unless two conditions are met. These conditions are that:

  1. the client says that they want to invest in a growth-oriented strategy (the ‘subjective test’); and
  2. a reasonable financial planner would agree that the client’s investments should be more growth-oriented (the ‘objective’ and ‘reasonableness’ tests).

When considering these two conditions you will need to have a discussion with your clients regarding their attitude towards investing, with reference to their personal circumstances and experience. Factors that should be discussed include the client’s age, health, income (size, stability and longevity), wealth position, occupation, education, training and prior investment experience. All of these factors will provide the adviser with guidance on whether a reasonable financial planner would assess the client as something other than a conservative investor.

For example, a thirty five year old professional with a university education, wealthy parents, no dependents and a successful background in share investing may be assessed as being less risk-averse and therefore more suited to high growth assets and high (deductible) debt levels. This assessment passes each of the subjective test, the objective test and the reasonableness test. On the other hand, a fifty five year old retiree, of modest means, and with a low level of financial literacy should remain classified as a conservative investor. This is the case even if they claim otherwise: their self-assessment may pass the subjective test, but it would fail the objective test and the reasonableness test.

Obviously there will be significant differences in the statement of advice prepared for each client. Client attitudes to risk are generally classified as follows:

  1. Ultra Conservative – Cash Management
    For ultra conservative investors, risk tolerance is extremely low and there is a short time-frame for investment. Such clients are not comfortable with growth assets. The most appropriate investments for them are cash-based investments such as bank accounts, cash management trusts and term deposits.
  2. Conservative
    Conservative investors are generally averse to risk and would be substantially affected by investment losses. Such investors feel more comfortable maintaining what they already have. They are content to accept lower potential returns so as to avoid taking on the greater risk involved with higher potential returns. Based on this risk profile, the preferred investment mix would generally be in defensive assets, such as bonds, cash, term deposits and fixed interests funds, with a small proportion in growth assets, such as shares and property investments. Below is the general asset mix for a conservative investor:
    Defensive Growth
    Cash 25% Australian Equities 15%
    Fixed Interest 40% International Equities 15%
        REITs and Infrastructure 5%
        Alternatives 5%
      65%   35%
  3. Moderately-Conservative
    Moderately-conservative investors can tolerate low levels of variability in returns and prefer to avoid large fluctuations in short-term performance. While increasing wealth is not paramount and there may be some nervousness about investing, these investors are prepared to accept some risks to capital for the chance of moderate growth. Clients with this risk profile generally prefer a balanced mix of defensive assets, such as bonds, cash, term deposits and fixed interests funds, and growth assets, such as shares and property investments. Below is the general asset mix for a moderately-conservative investor:
    Defensive Growth
    Cash 15% Australian Equities 21.5%
    Fixed Interest 29% International Equities 13.5%
        REITs and Infrastructure 8.5%
        Alternatives 12.5%
      44%   56%
  4. Balanced
    Balanced investors look to achieve modest growth in capital while at the same time aiming to protect the wealth they already have. They understand that they may experience short term fluctuations in performance in order to gain potentially higher returns over the long term. Clients with this risk profile are comfortable investing more towards growth assets such as shares and property. Below is the general asset mix for a balanced investor:
    Defensive Growth
    Cash 5% Australian Equities 28%
    Fixed Interest 18% International Equities 17%
        REITs and Infrastructure 12%
        Alternatives 20%
      23%   77%
  5. Growth
    Growth investors seek a higher return for a greater potential in their wealth. They are prepared to accept high levels of volatility in their portfolio in the pursuit of increased wealth over the longer term. Clients with this risk profile are comfortable investing most of their assets into growth-focused investments such as shares and property, with a smaller percentage held in ‘defensive’ assets such as bonds, cash, term deposits and fixed interests funds. Below is the general asset mix for a growth investor:
    Defensive Growth
    Cash 2.5% Australian Equities 34%
    Fixed Interest 9% International Equities 23.5%
        REITs and Infrastructure 13.5%
        Alternatives 17.5%
      11.5%   88.5%
  6. High Growth
    High growth investors pursue wealth creation and are prepared to reduce portfolio ‘balance’ in pursuit of higher potential long-term gains. They are comfortable with a portfolio that includes a substantial proportion of high risk investments and are prepared to accept short term fluctuations in performance. Clients with this risk profile generally prefer a portfolio that focuses solely on growth assets such as shares and property. Below is the general asset mix for a high growth investor:
    Defensive Growth
    Cash 0% Australian Equities 40%
    Fixed Interest 0% International Equities 30%
        REITs and Infrastructure 15%
        Alternatives 15%
      0%   100%

    Client attitude to risk will change over time, and may change quickly due to changed personal circumstances (for example: the loss of employment) or changed macro-economic circumstances, (for example: rising interest rates). It is critical that all clients, particularly growth investors, are monitored and reviewed on a continuous basis and that the adviser is aware of the possibility of investment preferences and attitudes to risk changing. A good rule of thumb is the “can you sleep at night test”. If a client is worried or concerned, and if you like “cannot sleep at night” then it is a good sign that the recommendation is outside of their risk profile and should not be implemented.

    Generally, advisors should adopt a conservative approach and should not recommend gearing or borrowing to acquire growth assets unless the risks have been clearly and unambiguously explained to clients in writing with appropriate warnings – and the clients have consented in writing to this.

Risk analysis studies

Fina Metrica Pty Ltd is a firm providing research into risk analysis. Its co-founders, Geoff Davey and Paul Resnik, have prepared a paper entitled “Risk Tolerance, Risk Profiling and the Financial Planning Process”.

The paper studies adviser attitudes to risk tolerance questionnaires and the role these tools have in the financial planning process, and discusses advisers’ predictive capabilities and the inherent limitations in these capabilities explained by behavioural psychology.

Some things we know about risk tolerance include:

  • risk tolerance is normally distributed and standard statistical techniques can be applied;
  • males are more risk tolerant than females;
  • risk tolerance increases with age;
  • risk tolerance appears to increase with income, wealth and education;
  • risk tolerance appears to decrease with marriage and the number of dependants a client has;
  • international studies are applicable to Australia; and
  • financial advisers tend to be more risk tolerant than the average investor (which is a word of caution about imposing your own views on what a client should or should not do).

Sometimes risk tolerance and a client’s financial goals are inconsistent. Clients need to take more risk than they would like if they are to meet their financial goals. This may create a need to change the goals or, alternatively, to educate about risk, if the client’s objectives are to be met within their risk preferences.

Fina Metrica Pty Ltd identifies three risk-related issues in portfolio creation. These are:

  • the client’s “risk tolerance”;
  • the risk required to achieve the client’s financial objectives, i.e. “risk required”; and
  • the “crystallised risk” a client could accept without changing their financial objectives, i.e. “risk capacity”.

Examples are created to explain how these concepts influence the creation of a statement of advice or financial plan. The paper concludes:

“A psychometric assessment of risk tolerance provided a firm, plain-English foundation for exploring options with a client. It underwrites a transparent process that leads to the optimal (based on the client’s values) strategies for the client. It is an essential ingredient in a financial planning process that leads to the client’s properly informed commitment to both the plan and the portfolio.”

You can download this paper at www.riskprofiling.com or here: Risk Tolerance, Risk profiling and the Financial Planning Process.[/expand]

[expand title=’Step 3 – Prepare the Statement of Advice ‘ tag=’h3’]

This is the major task that presents to you and it is discussed in detail Chapter 01 – Effective statements of advice.[/expand]

[expand title=”Step 4 – Implement the Statement of Advice recommendations” tag=”h3″]

The statement of advice (“SOA”) should clearly set out who is responsible for implementing the SOA’s recommendations. As far as possible the responsibility for implementation should lie directly or indirectly with the adviser. This ensures that implementation actually occurs.

Some recommendations will need to be implemented by the client. For example, a conversation with an employer regarding reducing working hours, in anticipation of starting a transition to retirement pension, is a conversation only a client can have.

Some recommendations will need to be implemented by another adviser. For example, a recommendation to execute fresh wills creating testamentary trusts can only be completed by a solicitor. However, the adviser should be responsible for making sure the wills are prepared and signed even to the extent of delivering the completed wills to the client and making sure they are signed and witnessed properly.

Many recommendations will be implemented directly by the adviser, such as arranging the placement of a financial product such as a managed fund or a term insurance policy.

Implementation should be actively monitored as ultimately the adviser is responsible for making sure that things go to plan.

“Authority to proceed” documents should be signed and placed on the client file as a record and proof of the adviser’s authority to act on the client’s behalf.[/expand]

[expand title=”Step 5 – Review and monitor the SOA for changing objectives and other circumstances” tag=”h3″]

The final step in the financial planning process commences almost as soon as the SOA recommendations have been implemented, if not earlier.

Good practice requires the adviser to constantly review and monitor the SOA for changing objectives and other circumstances. These include:

  • underlying performance of recommended financial products;
  • continuing suitability and likely future performance of recommended financial products;
  • the client’s changing financial position, including income level and wealth level;
  • the client’s changing attitude to risk;
  • changing legislative environment; and
  • changing economic

These present opportunities for advisers to build more solid relationships with their clients.

The simplest and easiest way to review and monitor the SOA is to arrange regular review meetings, say once every six months. This can be combined with a newsletter, blog or similar service where the adviser provides general advice (identified as such) to keep clients generally aware of changing circumstances and the need for regular meetings and one-off meetings if a specific change occurs.

Good practice requires regular invitations to meet to discuss any matters of concern.[/expand]

A never ending cycle

Step 5, being the review and monitoring process naturally leads back into steps 1 and 2, being the collection of client data, and so the financial planning cycle continues.

five-step-cycle-to-financial-planning

The Dover Group