The value of proper and proactive financial planning

Financial planning may have a nebulous meaning to a lot of people. Financial planning involves a holistic approach to looking at all aspects of a client’s finances and deriving a strategy (or “plan”) that enables the client to reach his or her financial goals with the least amount of risk.

A “holistic” plan encompasses every aspect of the client’s finances: assets, liabilities, income, expenses, taxes and savings, retirement, and estate planning goals. Financial planning offers many significant benefits, both monetary and emotional, to individuals and families of all income and asset levels. Here are a few of those benefits.

1. Better informed financial decisions. The client is in an improved position to make better-informed decisions about his/her finances by having a more complete understanding of her current financial position and of the options available to achieve an optimal financial path forward.

2. Avoiding serious financial mistakes. Studies have shown that working with a financial planner significantly reduces the risk of making a material financial mistake that could derail one’s financial goals. Mistakes could be things like a large expense or untimely withdrawals from a tax-advantaged account such as an IRA or 401k.

3. Better investment returns. Two recent studies, one by Vanguard and one by Russell Investments, both showed that clients who worked with a financial planner had annual investment returns that were up to 3.75% per year higher than those who did not work with a financial planner. Some of the reasons for this are better investment discipline, avoidance of market timing, use of lower cost investments, portfolio rebalancing, and appropriate asset allocation.

4. Advanced planning tools/software. Modern financial planning software offers planners robust tools with which to analyze a wide range of aspects of a client’s finances. Examples of these tools include cash flow and tax analysis, expense analysis, capital growth analysis, and Monte Carlo simulations.

5. Experience of a seasoned, credentialed advisor. An experienced planner with strong credentials, such as the Certified Financial Planner (CFP) certification, can provide superior insights into how best to set up and interpret a financial plan. A good planner can also provide stronger judgment based on experience, in important planning assumptions such as inflation, investment returns, and tax issues that can have a material impact on the plan outcome.

6. Risk Management. A sound financial plan should provide the key financial parameters that are necessary for the client to achieve his or her goals. Using tools like multiple scenario analysis, a good planner can assess the risks inherent in the plan and offer solutions to mitigate those risks.

7. Confidence and peace of mind. A recent Northwestern Mutual study showed that people who work with a financial planner reported significantly lower levels of financial anxiety, higher levels of happiness, and better sleep. The reasons for this are clear: being proactive and having a plan to address one’s financial future lead to increased confidence in dealing with financial matters.

Robert Toomey, CFA/CFP, is Vice President of Research for S. R. Schill & Associates on Mercer Island.