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Unit 2 Budgeting and Financial Plan
Chapter 2, 4 and 5
Learning Outcomes
Explain the functional and compliance
significance of each step of the financial
planning process.
Evaluate the financial goals.
Apply the life cycle theory to anticipate and
assess a persons financial needs.
Prepare and interpret a household financial
statement and saving plan.
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Explain record of advice (ROA) and different
types of statements of advice (SOA) as well
as when are they required.
Specify the components of a comprehensive
SOA and its legally required features.
Compliance issues in providing financial
advice.
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The Six-Step Financial Planning Process
1. Collect and assess the financial data of the client.
2. Determine the objectives and goals of the client.
3. Identify any financial problems that may exist.
4. Prepare a written plan which contains alternatives
and recommendations.
5. Implement the agreed written plan.
6. Review the plan.
Note: A FSG must be provided before any financial
advice can be given. Also note how RG146 skills
requirements mirror this list.
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Step 1 - Collect Client Data
It is both a legal requirement and common
sense for the financial advisor to be aware of
the clients specific circumstances.
RG175 Know the client rule (reasonable inquiries)
FoFA Best interest rule
Usually a combination of chats, interview and
questionnaire instrument would be used
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Qualitative Data
Employment
Family relationships
Life style and habits
Life goals and objectives
Issues and concerns
Preconceptions as to the clients needs in
retirement
Clarify and verify to mutual common
understanding
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Quantitative Data
Financial data (household financial
statement)
income and expenditure statement
balance sheet
Financial objectives
Timing and level of future income required
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Other Assessed Data
Risk Tolerance Assessment
Portfolio pickers are usually based on risk
attitude, experience, horizon: AMP, Colonial
Psychometrics are based on psychological
measurements and theory: Myers Briggs, DISC,
Moneymax, Proquest/Finametrica
Financial Literacy Assessment
Securities
Return and risk
Longevity
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Steps 2 and 3: Determine the Clients Objectives
and Goals and Identify Any Financial Issues
The financial advisor has to work with the
client to determine the goals both for the
Short Term usually <12 months
Medium Term usually 15 years
Long Term usually >5 years
Horizon, dollar value and other constraints
The financial advisor must work with the
client to prioritise goals and determine trade-
offs given the level of resources.
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Lifecycle Theory
Each life stage presents differing issues and
problems.
1. savings versus consumption phase
2. early family formation
3. wealth accumulation phase
4. approaching retirement
5. post-retirement
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Budgeting and Saving
No saving, no sure wealth!
Estimating income
Estimating expenditure
ASIC budget planner
Preparation of a cash budget
Comparison of actual to budget
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Source Documents and Record Keeping
Home, safe and computer
Bank account and credit card statements
Loan, mortgage, and land title documents
Investment holding and distribution
statements
Various salaries and bills
Tax returns and assessments
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Savings Tips
If one is doing a budget
Plan for fun
Allow for lifecycle differences
Stick to the budget or Pay Yourself First!
Utilize direct deposits and automatic transfers
Remind yourself the goals in saving and investing
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Assessing Financial Position
Use of financial ratios in reviewing financial
position and habits
Solvency (Net worth) ratio =Total net worth/ total asset
Liquidity ratio =Liquid asset / current debt
Savings ratio=cash surplus / income after tax
Debt service ratio =total monthly loan payment / monthly
gross income
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Common Lifestyle Fine-tuning Solutions
Save more and spend less
Work longer
Spouse back to work
Postpone planned retirement
Accept a lower income in retirement
Accept a higher level of investment risk and
seek higher returns
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An Example: The OBriens
J ohn (computer analyst) and Irene (sales
rep) OBrien, in their mid-20s, married for 4
yrs
Savings
$15000 equity in their home and other assets.
$10000 in saving accounts and stocks
Family income >expense, therefore did not
do a financial plan
Irene has just learned that she is two month
pregnant.
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INCOME&EXPENDITURESTATEMENT
INCOME AMOUNT
John 38,350
Irene 26,000
TOTALINCOME $64,350
EXPENSES
Mortgagepayments 8,000
Gas,electric,water,rates 3,390
Phone 640
CableTV 480
Food 4,200
Autoloanpayments 2,150
Transportationexpense 2,800
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Medicalexpenses unreimbursed 600
Clothingexpense 2,300
Homeownersinsurancepremiums 400
Autoinsurancepremiums 800
Incometaxespaid 16,940
Vacation(triptoEurope) 5,000
Recreationandentertainment 4,000
Creditcardloanpayments 2,210
Purchaseofshares 7,500
Additiontomoneymarketaccount Cash
Fund 500
TOTALEXPENSES $61,910
CASHSURPLUS(DEFICIT) $2,440
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Key Ratios
Solvency (Net worth)
=$28,745/$104,070 =27.6%
Liquidity =$3,070/$2,675 =1.15
Savings =$2,440/(64,350$16,940) =5.1%
Debt Service
Debt service =$8,000 +$2,150 +$2,210 =$12,360
Gross income =$64,350 (two income) =>19.2%
=$38,350 (one income) =>32%
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What problems could be expected for
the OBriens in future?
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Legal Requirements of a SOA
The Financial Services Reform Act 2001
introduced the requirement to provide clients
with a Statement of Advice (SOA).
See RG175 for details
No advice SOA
Limited SOA
Comprehensive SOA
No fixed SOA format prescribed
There are sample SOA from ASIC and FPA
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A Record of Advice (ROA) may be used
instead of an SOA if
Small amount of funds, <$15,000, to be invested.
It is free advice with no remuneration.
When providing further advice to a client when the
basis of advice is not significantly different from
the advice in the previous SOA.
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Step 4: The preparation of a written plan
Most SOAs are written with a standardised
format.
They start with:
a personalised and complying covering letter
a standardised and complying cover page
an Executive Summary
a Table of Contents
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Covering Letter
Language
professional but not necessarily formal
clear and concise and readily understandable to
the client
For compliance, the covering letter should
be written on letterhead with contact information
include the name of the licensee and its licence
number and ABN; and
be signed by the financial advisor, stating that he
or she is an Authorised Representative (or
Representative) of the Licensed Dealer.
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Invite the client to contact the financial advisor if any
of the information is incorrect or if the client requires
clarification
It also needs to warn the client that decisions
regarding implementation of the SOA must be
made within e.g. 30 days.
It is also important to get the client to understand the
need for annual reviews.
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Cover Page
All SOAs require a cover page that provides
the following information:
that it is a Statement of Advice;
the name of the plan recipient;
the date that the plan becomes effective;
the name and contact details of the financial
advisor who provided the plan;
the name and contact details of the licensee
who authorised the SOA;
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a statement that the plan is private and
confidential; and
a warning box that reminds the client that
this is an important document
it should be read carefully and in full
if the client has any questions the client should
speak with the financial advisor
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Executive Summary
No more than two pages in length and in
bullet point form.
Sets out the key personal details of the client
Summarises the clients goals and objectives
States each main recommendation
The expected outcomes
Confirm likely goal achievement
Warning in relation to projections
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Table of Contents
This page clearly outlines the structure of the
plan
Make sure all pages are numbered, even
those in appendices.
Keep to major headings so that the plan does
not seem to be overly complex.
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The body of the SOA usually has six distinct
parts:
the basis for advice
the recommendations
an implementation schedule
disclosures and disclaimers
client sign-off (Authority to Proceed)
appendix (including product disclosure
statements).
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The Basis for Advice
This section must have:
A clear and concise restatement of all of the
pertinent client information
Current and future cash flow and saving
estimates
A chart/table of clients assets and liabilities
An analysis of the clients current
investments
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A full discussion of the clients personal risk
tolerance
A list/discussion of all personal and financial
assumptions
A discussion of the clients concerns and
issues that may impede goal achievement
A source and use of funds chart if it will
clarify the clients situation and the funds
available for investing.
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Cash flow, Assets and Liabilities
The purpose here is to establish the
resources available
The amount and timing of debts and other
liabilities should be listed here as well
After setting aside money/borrowing capacity
for an emergency fund to meet any
unexpected needs for immediate cash, the
planner can start to optimize from this base
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Assumptions
The SOA need to state the assumptions
Personal: personal events in the future, ongoing
receipt of current income levels, and continuation
of good health
Environmental: behaviours of markets,
regulations, inflation etc.
It would be prudent to discuss the
reasonableness of the return assumptions given
the asset allocation choice.
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The financial advisor must ensure that the
client understands
the need for these assumptions and
how they will impact the advice being given.
These assumptions will need to be tested at
each annual review.
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Risk Tolerance Assessment
A full discussion of the clients personal risk
tolerance, asset allocation preference and
what benchmark asset allocation the client
will need to accept to achieve his or her
goals.
The SOA need to specify the benchmark
asset allocation the client will need to accept
if he or she is going to achieve stated goals.
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Longevity
ABS life expectancy at birth
Average number of years that a newborn is
expected to live if current mortality rates continue
to apply.
Life expectancy at current age
www.mylongevity.com.au
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The Recommendations
Statement of Strategy
The client needs to see a clear statement of
the strategy behind the recommendations.
The strategy must be flexible enough to
deal with the likely changes of circumstances that
most clients experience and
be supported by recommendations which are
detailed and specific to a clients individual needs.
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Investment Recommendations
Investment recommendations
first be generic/strategic
should move from the most tax-effective (usually
superannuation) to the least tax effective (usually
managed funds).
Each recommendation must be referenced to
the clients risk tolerance asset allocation or
the asset allocation agreed to by the client.
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Within the investment strategy, it is important
to consider the most appropriate investment
vehicles (tax structures), for example:
holding assets personally (direct investments);
unit trusts;
insurance bonds;
superannuation-based investments; and
retirement and non-retirement income streams.
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Taxation
Advisors should seek to recommend tax-
effective outcomes consistent with the
clients ability to accept legislative risk.
Wherever a discussion of taxation occurs,
the financial advisor must clearly inform the
client that he or she is may not be a tax
advisor.
The Tax Practitioner Board is expected to
finalize the training requirement for financial
planner who want to offer tax advice in 2014.
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Superannuation, Retirement Planning and
Social Security Issues
This part consider the best use of
superannuation balances and possible social
security benefits.
It should also take into consideration such
issues as changes in the ability to make
additional contributions to superannuation
and the changes to taxation and social
security assessments.
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Risk Management and Insurance Cover
Most financial advisors do not discuss
insurance issues sufficiently with their clients.
This discussion is essential, given that
unforseen events may cause financial loss.
A full review, including estimated cover
requirements, must be completed even if the
client will be referred to a specialist for
specific product advice.
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Estate Planning
Most clients are uncomfortable discussing death,
wills and disposal of their wealth.
However, it is important to point out to clients the
importance of having a written structure (a will) to
back up their wishes on the transference of their
wealth.
It is the advisors responsibility to discuss these
matters with the client and prepare the client for a
visit to an appropriate legal professional.
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Specific Product Recommendations
After the generic discussion on strategies,
specific products may be recommended.
It is necessary to clearly identify the
characteristics of each product, the product
provider and how the product matches the
clients risk profile and financial needs.
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RG175 Know Your Product Rule
Licensees research to generate the
Approved Product List is not sufficient.
Personal research and not just access to
research.
Adviser need to take reasonable care and
diligence to understand the products
recommended, the likely risk and rewards,
and consider a reasonable range of
alternative products.
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Post-Implementation Cash Flow
It is important to include indicative costs for
additional insurance and the cost of legal
work and periodic reviews.
Show the client that he or she still has
enough money to manage daily living
requirements after implementing the
recommendations.
Some licensee prohibit adviser to provide
investment projection in order to avoid
potential legal claims.
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Fees, Commissions and Conflicts
RG 175 requires dollar value of
remuneration, commission, other benefits
and conflicts be disclosed.
See RG175.177-185 in completing the Group
SOA assignment.
Best practice requires that a financial advisor
disclose in dollar and percentage terms.
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Disclosure of Capacity
The financial advisor reminds the client what
areas of financial advice he or she may
provide and the types of products and
services he or she can offer.
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Disclaimers
Disclaimers act as a warning as to how the
information provided in the plan can be used
and that it is specific to the client and not for
general use.
The disclaimer points out to the client upon
what the client can rely.
Disclaimers are used to avoid possible legal
action by making the client aware of the
scope of the advice.
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Monitor and Review Process
This needs to be personalised for the specific
client.
The client needs to see why it is so important
for his or her goal achievement to undertake
an annual review.
The client needs to know what the annual
review process will be, what will be
discussed, and the cost, even if it is only a
statement that the cost of the annual review
will be covered by trailing commissions from
the investments made.
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Implementation Schedule
Statement of all actions
The more detailed the schedule is, the more
likely plan implementation will go smoothly.
It should include
who, what, when, how much
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Authority to Proceed
It asks the client to confirm that he or she has
received and read the Financial Services Guide
agrees with the risk tolerance assessment
has received and read the Privacy Statement and so on.
The letter should have
all product recommendations listed,
in whose name the product is to be purchased
the amount of the initial investment
There should be a place for the client(s) to sign and
date the document.
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Appendices
Strictly limited
They should contain the financial worksheets that
back up the recommendations in the SOA and
summary graphs.
Do not place educational materials in here.
Cluttering up a SOA with generic educational
materials is seen as a major flaw by ASIC.
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Step 5: Implement the Agreed Plan
The implementation of the recommendations
can make or break the relationship with the
client.
It is the financial advisors responsibility to
monitor the implementation process,
ensuring that each step is completed in a
timely and accurate manner.
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Step 6: Review the Plan
Essential to allow for the changing
nature of the clients circumstances
external environment
financial markets
Exactly the same as that of the initial
financial review
Overall strategy, portfolio and insurance
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ASIC Retirement Advice Shadow Shopping
Exercise (2012, Report 279)
3% good; 58% adequate; 39% poor
Risk tolerance assessment and longevity
analysis lack rigorous and independent
tools.
Retirement planning involves complex advice
and should be given more attention.
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ASIC found good quality SOAs have the
following features:
Clearly defined scope
Assisted clients to form realistic and measurable
objectives about their retirement
Good budgeting and cash flow projections
Offer and compare multiple strategies
Logical, well-structured and easy to understand
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Compliance Issues and Penalties
Information gathering
Subject to compliance audit
Privacy Act; Privacy Amendment (Private Sector)
Act
FPAs member are required to securely stored the
data for 7 years
Standardised, reliable and valid risk
tolerance assessment for each client
Simple, appropriate, goal-based strategies
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Full disclosure and informed consent
Avoid misleading and deceptive conduct;
include omission
ASICs Penalties
Enforceable undertaking
Remove or limit licence
Banning an adviser
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Recap
The 6 step financial planning process
Data and record keeping
Qualitative and financial data
Assessed (risk profile, literacy and longevity)
Goals
hidden goals (use the life cycle theory)
return, horizon, constraints
Budget a saving plan or pay-yourself first
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ROA vs SOA
The structure, content and requirements for
each component of a statement of advice
RG175 prescribes conduct and disclosure
(i.e. rules about FSG, SOA, fee disclosure)
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RG 146 Skills and Financial Planning
Specialization Requirements
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