Best Practices: Personal Financial Planning

Personal Financial Planning

How much do you put away for retirement each month/year? Are you getting the maximum return on your investment with the least amount of risk? Will your "retirement/financial independence pot" enable you to maintain your current lifestyle or will you have to cut back once the money stops coming in? What are the odds that you will outlive your money?

If you answered "I don't know" to even one of these questions, it's time to reevaluate your personal financial plan -- assuming, of course, that you have one. If you don't, it's time to start one. Otherwise, say TEC speakers and financial planning experts Gene Hoots, Burnie Sparks and Barry Zucker, you may be in for a rude awakening when it comes time to live off the fruits of your labor.

At some point in time, you will eventually hang up your spurs and ride off into the sunset. Personal financial planning involves figuring out how much money you need at spur-hanging-up time to produce the cash flow that will sustain your lifestyle for some strategic period of time. In many ways, it's like running a business. To get the best results, you need to plan the outcome and then follow through. In essence, a personal financial plan is nothing more than a strategic plan for your money.

According to our trio of experts, it takes four basic elements to create an effective personal financial plan:

• A final destination
  
  
• A roadmap
  
  
• A team of professionals
  
  
• An understanding of basic investing principles

As a business owner, CEO or senior executive, the tools and resources needed to arrive at your financial independence are within your grasp. The sooner you start planning, the sooner you can get there. Be sure to include your spouse/significant other in the planning process.

Laying the Foundation: Taking Your Personal Financial Inventory

According to Hoots, Sparks and Zucker, conducting a personal financial inventory requires action in three broad areas.

1. Organize your financial information. Gather all the important information about your personal finances and put it in one location. This includes credit card numbers, policy numbers, financial records, wills, trusts, and other legal documents. Store copies in three separate locations -- at home, at the office and in a safe deposit box at the bank. This is also a good time to update any wills, estate plans and other key documents.
   
   
2. Create a personal financial balance sheet. Next, conduct a realistic inventory of your assets and liabilities. Include both liquid and fixed assets as well as all short- and long-term liabilities.
   
   
3. Determine your cash flow needs. To determine your current and future cash flow needs, tally up all annual living expenses, making sure to build in a reserve for irregular outlays. Then ask questions like: How much do we need each year to maintain our current lifestyle? Can we really afford our current lifestyle or are we spending beyond our means? How much will we need to live on each year after retirement? Can we realistically afford that lifestyle when we are no longer working?

"Defining your cash flow needs has tremendous ramifications for the entire financial planning process," says Hoots. "Take the time to get it right."

Before diving into the financial planning process, our experts suggest having a financial strategic planning session with your spouse. Go away to a nice hotel or a cabin in the mountains and spend a weekend talking about all the issues that affect your current and future lifestyle and cash flow needs.

Charting a Course: Creating Your Personal Financial Plan

Creating a personal financial plan requires a four-step process:

1. Take inventory. This was discussed in the previous section, "Laying the Foundation: Taking Your Personal Financial Inventory."
   
   
2. Set goals. There are many ways to set personal financial goals. One of the best approaches involves identifying how much money you need to achieve financial independence upon retirement and then devising an investment plan to help you get there. To determine your "financial independence pot":
   
   
• Identify the age at which you intend to retire and how many years you want to plan for beyond that.
  
  
• Identify how much money you need to live on per year after retirement (taking into account inflation and the future cost of living).
  
  
• Calculate the future value of your annual after-tax retirement living expenses in today's present-value dollars.
  
  
• Calculate the lump sum amount (at the time of your retirement) required to throw off your annual retirement expenses in today's dollars.
  
  
3. Select the team. A strong financial planning team consists of a financial planner/consultant, an investment manager, a broker/dealer, a custodian/trustee, an attorney, a CPA and a licensed insurance agent.
   
   
4. Develop your investing strategy. Your strategy will depend to a great extent on your long-range financial objectives. However, other factors also enter into the equation. These include things like your time horizon, risk tolerance, asset mix and the overall economic environment.

The hardest part for many investors? Sticking to the plan, say our experts. Fear, greed and impatience often conspire to throw even the best-laid plans off track. To reach your financial goals, develop the discipline, patience and tenacity to stay the course.

Understanding Investing Principles

Hoots, Sparks and Zucker believe that by adhering to certain fundamental principles, you stand a much better chance of achieving your investment goals. These include:

• Manage your personal finances like a business.
  
  
• Start early and make savings a habit.
  
  
• Be realistic about what you can accomplish.
  
  
• Understand risk.
  
  
• Don't over-estimate market returns.
  
  
• Don't strive for higher returns than you need.
  
  
• Forget about market timing.
  
  
• Don't approach investing as a hobby.

"Good investing is usually mundane, boring and repetitive," says Sparks. "The key is to paint yourself an asset allocation strategy for the long term. Once a year, accumulate your assets and figure out where you stand versus your plan. If you get off track, readjust your portfolio to get back within your guidelines. You may not end up as wealthy as Warren Buffett, but you stand a much better chance of reaching your financial goals."

Asset Allocation: The Secret to Successful Investing

Four classes of assets form the majority of most investment portfolios: cash and cash equivalents, bonds, stocks and tangible assets (i.e., real estate, gold, oil). Successful investing strategies always include a mix of these classes and aim for long-term returns. This reduces risk and increases the likelihood of getting the returns you need to achieve your financial objectives.

Another major determinant of portfolio performance is your style of investing within the stock asset class. According to Zucker, the domestic stock market has six separate and distinct styles: small cap growth, small cap value, middle cap growth, middle cap value, large cap growth and large cap value. Each stock class has different performance characteristics. They also tend to move in different directions at the same time.

Investing professionals generally define short-term volatility as "how much the value of an asset fluctuates in a given quarter or year." The greater the fluctuation, the higher the volatility. How much risk is right for you? It all depends on your time horizon, your long-term objectives and your own tolerance for volatility.

When deciding where to put your assets, say our experts, keep the following concepts in mind:

• Diversification. Dividing your investment portfolio among the different asset classes is mandatory for minimizing risk and maximizing returns.
  
  
• Re-balancing. Smart investors adjust their asset mix when one area of their portfolio starts to outperform the others.
  
  
• Reversion to the mean. The longer a particular asset exceeds average rates of return (for its class), the more likely it is to revert back to the mean and under-perform for a while.
  
  
• Dollar cost averaging. To reduce risk and smooth out the inevitable ups and downs of the stock market, invest a fixed dollar amount at regular time intervals regardless of the price level of the market.
  
  
• Focus on asset mix. The secret to success is getting the right asset mix, which should always be determined by your long-range financial goals.
  
  
• Adjusting the plan. Adjust your investing strategy only when changes occur in your personal financial life that make a meaningful difference in your investment capabilities.

Ultimately, investing involves a game of risk versus anticipated returns. The best way to lower risk and increase the odds of getting your desired returns is to create a diversified strategy that invests appropriately in all the major asset classes, develop benchmarks to measure how well you are doing, and have the discipline to stick with your plan.

Selecting Your Financial Planning Team

Two key players -- the financial planner and the investment manager -- form the core of every effective financial planning team According to Sparks, the best financial planners:

• Act as consultants rather than salespeople; they tell you how to structure things going forward without having an ax to grind or a commission to make.
  
  
• Help you identify problems and possible solutions.
  
  
• Have the training and the experience to guide you through complex investment decisions.
  
  
• Have excellent listening and counseling skills.

Your investment advisor should help you:

• Create and monitor a diversified investment portfolio.
  
  
• Achieve an appropriate return (over time) equal to the risk you are willing to take.
  
  
• Keep emotion out of the investing process.
  
  
• Stick to your investment strategy.

Once you have these two cornerstones in place, you can fill in the rest of the team. Every financial planning team should also include a:

• Broker/dealer
  
  
• Custodian/trustee
  
  
• Attorney
  
  
• CPA
  
  
• Insurance agent

In some cases, one person can fill more than one role. Regardless of how many people are on your team, encourage them to communicate with each other on all major decisions.

According to our experts, however, smart investors invariably go with experienced money managers. To pick the right one for you, compare apples to apples, track their long-term performance and look for consistency in investing style Above all, get to know your investment manager. Make sure their investment philosophy agrees with yours.

When selecting any advisor for your team, our experts offer these final tips:

• Hire only licensed and/or registered advisors.
  
  
• Avoid anyone who tries to sell you the latest "hot" product on the market without any explanation of why it suits your needs.
  
  
• Avoid "lone wolf" types who can't work together well on a team. Look for someone who makes objective, not emotional, investing decisions.
  
  
• Use fee-based, rather than hourly rate, advisors.

Avoiding Common Investing Mistakes

To stay on track to reach your financial destination, avoid these common investing mistakes:

• Lack of a plan or strategy
  
  
• Failure to stay the course
  
  
• Following the vogue
  
  
• Acting on tips
  
  
• Lack of (or inadequate) diversification
  
  
• Short-term thinking
  
  
• Chasing returns without understanding the risk
  
  
• Trying to achieve higher returns than you need
  
  
• Selecting investments based on returns alone
  
  
• Failure to admit mistakes

"Successful investing has little to do with being right or wrong," notes Sparks. "It's all about systematically doing the right things to win, even if you have to admit mistakes from time to time."

Investing in Chaotic Markets

In the face of uncertain financial markets, how should one invest? Our experts offer the following insights:

• Stick with your plan. Remember that you're investing for the long term.
  
  
• Learn to live with reasonable returns. Again, that's reasonable returns over the long term.
  
  
• Turn off the TV. Don't let the bright lights and glamour of the financial media distract you from your long-range objectives.
  
  
• Diversify. To protect against wild market fluctuations, consider adding more diversity to your portfolio.
  
  
• Look for bargains. While maintaining your long-range perspective, look for investments that "go on sale" when their value drops precipitously.

Above all, don't try to predict the future.

"Don't let anyone tell you they know where the market is headed," asserts Sparks, "because even the pros don't know for sure. More than ever, investors need to position their portfolios for the long term, have reasonable expectations and view downdrafts as opportunities to buy.".

"My advice is to stick with your plan and dollar average into the market from this pointon," adds Hoots. "Look for sound value stocks -- those still at low P/E ratios -- but have a well-diversified portfolio to minimize risk. Revisit your plan on a regular basis to make sure your asset allocation continues to match your desired rate of return, and make adjustments where necessary. Good investing is like the old fable between the tortoise and the hare, and we all know who won that race."

Contributing Experts:

Gene Hoots

Gene Hoots is a founding principal of CornerCap Investment Counsel, an investment firm that manages portfolios for high net worth individuals and institutions. He formerly served as president of RJR Investment Management, a captive investment division of RJR Nabisco, where he managed $600 million of RJR pension assets and was responsible for $4 billion invested in 27 countries. Hoots has more than 25 years' experience in assisting companies and high-wealth families with a disciplined investment process that builds wealth. He currently addresses TEC groups on the subject of optimizing wealth.

Burnie Sparks

Burnie Sparks is president of the Private Client Group for Bailard, Biehl & Kaiser, an investment advisory firm that creates innovative investment solutions for the unique needs of high net worth and institutional investors. Prior to joining BB&K in 1981, he managed institutional and high net worth investment portfolios in BankAmerica Corporation's Capital Counseling Division. A former TEC member, Sparks is well-known for his work as the keynote speaker of BB&K's Personal Money Management seminars. He has delivered more than 100 TEC presentations on the subject of "What Everyone Needs to Know About Personal Money Management."

Barry H. Zucker

Barry H. Zucker is president and CEO of J.B. Hanauer & Co., a full-service financial services firm specializing in wealth management for the affluent investor. In his 30 years with Hanauer, he has held positions as fixed income trader, account executive, sales manager and branch manager. He has also served as a member of Hanauer's board of directors since 1981. Zucker is actively involved with The Bond Market Association, and has served on its board of directors for three years. He has also served as a member of the Advisory Board to the New Jersey Bureau of Securities. A long-time member of TEC 334, he currently addresses TEC groups on the subject of wealth management.

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