Understanding What Financial Help You Need
Bonnie Kirchner
Like doctors, there are a lot of different types of financial advisors out there. Typical areas of expertise and the planning that can be incorporated, depending on your situation, include
• Tax Planning: Analysis of the existing tax situation, proper preparation of tax documents, and implementation of income tax liability reduction techniques leading to increased cash flow. Tax laws change nearly every year; thus, planning should be reviewed regularly.
• Estate Planning: Preparation for the preservation and efficient transfer of assets to the next generation and/or beneficial entities, including charitable. Estate settlement can be quite expensive when no plan is in place because of the expenses of probate and potential estate and/or inheritance taxes that can come into play on both the federal and state levels. Estates not taxed federally can be impacted by hefty state inheritance or estate taxes. What’s more, assets can end up in the wrong hands if no planning is done. Plan development and execution will typically require the involvement of an attorney, if the advisor is not a member of the legal profession, to prepare legal documents. Typical documents most people should execute and keep up to date include the will (directs how and to whom assets should be transferred), healthcare directives (appoints individuals to make healthcare decisions in the event of incapacitation), and power of attorney (appoints individuals to make business decisions in the event of incapacitation). The more complex a situation is, often the more planning is required.
• Investment Strategy: Review of existing assets, how they are held and invested, development of goals and objectives, as well as an investment policy statement, asset allocation development, and asset selection and possibly implementation and continuous monitoring of the resulting portfolio.
• Cash Flow and Budgeting: Analysis of existing sources of income and spending habits most needed in cases of negative cash flow, increasing debt balances and declining or stagnant net worth growth. Many individuals ignore the problem of negative cash flow and wait too long to get help, digging themselves into holes they can’t get out of. A regular cash flow check, either self-performed or with the assistance of an advisor, can prevent bigger problems down the road. An advisor focused in this area can help restructure debt to reduce interest rates and potentially payments, as well as recommend reasonable spending goals. Successful budgeting does, however, require discipline by the individual once an advisor has assisted in putting plans together.
• Retirement: Determination of the future cost of retirement based on desired spending, understanding of existing and potential resources (pension, Social Security), development of a savings plan road map based on time frame, risk tolerance, and incorporation of other goals, such as college funding. Proper retirement planning requires an understanding of the existing tax situation and what it is likely to be at the time of retirement to determine what types of savings vehicles might work best and complement the existing tax environment.
• Risk Management (Insurance): Analysis of existing vulnerabilities to personal liability and loss as well as existing assets and protective programs already in place to discover gaps where coverage is needed or where excesses exist. Risk management planning also means understanding your existing resources, what risks you can afford to cover yourself, and insuring those areas that could create financial hazards. Resulting recommendations might be to alter or purchase additional automobile, homeowners, umbrella, health, disability, life, and/or long-term care insurance coverage.
• College Funding: Understanding the future cost of potential higher learning institutions as well as existing resources and potential support programs. College costs continue to rise at a rate higher than inflation; thus, planning should begin as soon as possible. Savings vehicles for the particular purpose of education funding have been developed, such as the 529 Plan and the Coverdell Education Savings Account (ESA) or Education IRA to help with the tax efficient savings of education funds. However, existence of these accounts can affect potential financial aid resource availability in the future. Thus, it is important to develop a strategy that will maximize all available resources.
Though many advisors have general knowledge in most financial planning areas, they tend to spend more time working in some areas than others, depending on how their practices have evolved over time and where their own interests lie. Most people have planning needs in each of these areas, as well. After all, we all need to manage cash flow effectively to get by. Most of us are subject to income taxation, must plan for our retirements, protect ourselves along the way, and have a desire to direct our accumulations once our “cases mature.” Financial planning should be approached in a holistic manner. Each of these areas affects the others: a focus on college funding could jeopardize a balanced budget, or poor retirement income planning could produce an unreasonable tax bill. An effective and efficient financial plan will emphasize those planning aspects that cooperate, such as decreasing taxes to increase cash flow, and coordinate those that conflict in the way retirement and education planning do. Financial planning itself is in conflict with financial goals as it can be somewhat costly. It is worth the investment and typically pays for itself over time by bringing balance and financial efficiency into the picture. It is for these reasons that you do want to work with someone with expertise in the area where you need to focus but who will also pay attention to any implications recommended adjustments could cause to the big picture.
Financial planning means making priorities. Many people have too few dollars chasing expensive financial goals. A good advisor will help you understand the price tags associated with various goals and help you make savings priorities. An efficient financial plan is one where the whole is greater than the sum of its parts and each of those parts are working together like a well-oiled machine. Of course, there will be disruptions to the plan over time, which is why it is important to periodically review the plan, especially during periods of change. The overall plan should have a “check up” on its financial health once a year just as many of us do for our physical health on an annual basis. I find tax time is a good time of year to do this because financial records are pulled together for purposes of income tax return preparation. It is a good time to do a quick net worth check (how much you own minus how much you owe) and compare it to the year prior. It is certainly a good sign if it is increasing as long as it is growing as fast as you need it to in order to meet your financial goals. If the net worth is decreasing or not growing adequately, it’s time to evaluate why. Is it because of a bad year for the financial markets? Was there a change in income resources? Was there a large expenditure during the year either anticipated or not? If it was unexpected, this might be an indication of gaps in your risk management planning. Perhaps the decline is due to poor cash management, in which case you need to address the situation and get it in line before spending gets out of control.
The need for financial planning or a revisit to an existing plan can also be influenced by life changes and circumstances; providential, emotionally neutral, unfortunate, and tragic. In my own situation, I was forced to reevaluate my entire financial picture and plans when my then husband blew up everything in my life (and those of so many others) with his dramatic confession. As with many of life’s curve balls, it took years to sort out, and I continue to be affected by what he did even now, five years later. As with many situational changes, it has required a lot of patience and the need to keep my emotions in check. Emotions sometimes work against us in choosing and maintaining a proper course. A good financial advisor addresses change from a non-emotional viewpoint and steers his or her clients down a logical path.
Proper planning can be protective against change, but it is most likely that your financial setup will have the need for a review when life sends you on a detour, big or small, or you could end up getting lost! Whether you have been working with an advisor or not, times when you should take a nonemotional look at your financial situation and whether or not it needs alterations include:
• Tax Planning: Marriage, divorce, birth or loss of a child, new job or loss of a job, inheritance, employer benefit changes, disability, uninsured loss or liability, tax law changes, market volatility, and portfolio adjustments
• Estate Planning: Marriage, divorce, birth or loss of a child, new job or loss of a job, inheritance, employer benefit changes, disability, uninsured loss or liability, and estate tax law changes
• Investment Strategy: Marriage, divorce, birth or loss of a child, new job or loss of a job, inheritance, employer benefit changes, disability, uninsured loss or liability, tax law changes, market volatility, and cyclical changes in the economy
• Tax Planning: Marriage, divorce, birth or loss of a child, new job or loss of a job, inheritance, employer benefit changes, disability, uninsured loss or liability, tax law changes, and market volatility
• Cash Flow and Budgeting: Marriage, divorce, birth or loss of a child, new job or loss of a job, inheritance, employer benefit changes, disability, uninsured loss or liability, tax law changes, and market volatility
• Retirement: Marriage, divorce, birth or loss of a child, new job or loss of a job, inheritance, employer benefit changes, disability, uninsured loss or liability, tax law changes, and market volatility
• Risk Management (Insurance): Marriage, divorce, birth or loss of a child, new job or loss of a job, inheritance, employer benefit changes, disability, uninsured loss or liability, and market volatility
• College Funding: Marriage, divorce, birth or loss of a child, new job or loss of a job, inheritance, employer benefit changes, disability, uninsured loss or liability, tax law changes, and market volatility
As you can see, all these areas of financial planning intersect and overlap in various ways. It is for this reason each area needs to be addressed in conjunction with any effects on or influences by the other components of an efficient financial plan.
To better understand what you need out of a financial advisor, you may want to prepare two very basic accounting worksheets: the income statement and the balance sheet. I know for anyone who’s ever taken any sort of accounting class in high school or college the thought of preparing these documents can cause you to cringe. But it’s not that bad, really! What’s more is the preparation of these statements will make you better prepared to meet and interview a financial professional. A trained advisor will be able to learn a lot about you quickly from the income statement and balance sheet and probably make some initial indications on how they can help you. Let’s take them one at a time.
Income Statement
Add up your sources of income:
• Wages
• Rental property
• Social Security or other benefits
• Pensions
• Investment income
• Annuity payments
Add up all of your expenses:
• Mortgage and/or rent payment
• Home equity payment
• Taxes
• Utilities
• Transportation (gas, repairs)
• Car Loan
• Credit card payments
• Student loan payments
• Groceries
• Clothing
• Entertainment and dining out
• Memberships
• Vacations
• Retirement and investment contributions
Now subtract the total of what you spend from your total income to get your cash flow. Is this number positive or negative?
If it is a negative, you are likely living beyond your means and on borrowed funds. You are likely to need someone who can help you manage credit and put you on the right road to a balanced budget.
Once your budget is balanced, then you can focus on investing toward future goals.
It is a great sign if your cash flow is positive. This indicates you are living within your means and should have additional dollars to put to work toward meeting your financial objectives. Thus, you should be working with an advisor who has experience in planning for the particular goals in which you have an interest, such as college funding or retirement planning, and who can also educate you about and guide you to appropriate investment vehicles and assets to help you work your way toward your goals. She should also assist you in defining actual dollar amounts to strive for to meet your objectives and help you determine what amount you should be putting away on a regular basis.
If your cash flow is negative but positive after removing retirement and investment contributions, then you do need to place some focus on budgeting, but you are in a good position to start saving toward your financial objectives more effectively.
Tax sensitivity is important when it comes to goal planning. Sometimes increasing positive cash flow can be achieved simply by changing how you are investing. If the types of investments you own are creating a lot of taxable income, your overall rate of return will be diminished. After all, it’s not what you make, but what you keep! Proper utilization of retirement plans, tax-deferred, and tax*free vehicles are ways an advisor can help you become more tax efficient in your planning approach. The resulting decrease in income tax liability should have a positive impact on your cash flow.
Tax planning and finding an advisor who specializes in this area should be a priority in the event your taxes are a large percentage of your income. Though many advisors have basic tax knowledge and enough to assist those wishing to do tax-efficient investing and goal funding, the more complex your situation, the greater importance needs to be placed on finding someone with expertise. This person might also be a tax preparer and/or an accountant.
For a lot of people, creating a balance sheet is easier than the income statement.
Balance Sheet
Add up everything you own:
• House value
• Other property (vacation home, real assets of significant value)
• Retirement accounts
• Investment accounts
• Savings accounts
• Checking accounts
Add up everything you owe:
• Mortgage
• Home equity
• Car loans
• Credit cards
• Student loans
• Personal loans
Now subtract the total of what you owe from the total of what you own, and you will have your net worth. Is it positive or negative?
If it is negative, you are probably living beyond your means and relying on credit to get by. Budgeting will need to be addressed as part of your overall financial plan and before you tackle other financial goals and objectives.
Budgeting will also need to be addressed if your net worth is zero. In this case, you are essentially running in quicksand and getting nowhere, but you are at least in a position to make some adjustments so that you can start saving toward your financial goals, thus improving your net worth calculation as a result.
A positive net worth means that you are likely living within your means, probably have positive cash flow, and are already moving toward creating assets to fund financial objectives, even if it is unconsciously. You are in a good position to start fine-tuning your existing financial organization into a more efficient and effective financial plan. Many people in this position don’t bother taking additional steps to define goals and put plans in place because there are no apparent problems. As one of my former associates used to say, “If you don’t know where you’re going, any road will take you there.” You want to know where your destination is and determine the most efficient path to get you there. There are likely to be disruptions along the way. If you don’t make provisions for these risks to your plan, they could become sinkholes that jeopardize your financial success. Just because there are no gaping problems, you can’t become complacent. Don’t be like so many Americans who spend more time planning their vacations than their financial futures!