John & Joan Smith Financial PlanDisclaimer
This hypothetical financial plan is being presented to illustrate both the process of financial planning and what a financial plan actually looks like at Financial Life Advisors. The characters and circumstances are completely fictional and are for illustrative purposes only. You should seek the advice of a qualified professional for your particular situation and should not rely upon any of the information herein to make personal financial decisions.
Hypothetical investment returns presented in this financial plan are based upon historical market index performance and are not indicative of future results. Actual indexes cannot be purchased. Further information about the financial plans investment assumptions are disclosed in the financial plan.
Under the Certified Financial Planner Board of Standards, Inc. “Standards of Professional Conduct” there are six steps to the financial planning process. Financial Life Advisors (FLA) adheres to these Standards of Professional Conduct. The example of the Smith’s will walk through what to expect when working with FLA and how all of those steps are implemented at FLA.
Fictional Case Study
John and Joan Smith are a normal, middle-aged couple. They were contemplating their retirement and realized that there are many moving parts to their personal finances. They had investments accounts all over the place, were unsure of when they should file for Social Security benefits, thought they had adequate insurance coverage, and were unsure whether they had enough financial resources to last the rest of their lives.
After doing some internet research and talking to friends, the Smiths decide to enlist the help of a financial planner. They decided that they should hire a CERTIFIED FINANCIAL PLANNER(tm) professional because of the fiduciary standard of care and the level of training required to be a CFP(R)professional. Financial Life Advisors has two advisors who hold the CFP(R) certification. Jim Oliver CPA/PFS, CFP(R) and Ben Gurwitz, CFP(R) provide all of the financial planning and investment management services at FLA.
John and Joan filled out a quick worksheet prior to the initial consultation with FLA. The worksheet outlined the basics of their situation and helped the FLA advisor figure out what additional questions needed to be asked prior to beginning the financial planning process. After the initial one hour free consultation, FLA provided a fixed fee quote for the cost of the stand alone financial plan (Step 1 – Establish the Scope of the Engagement). This way, John and Joan knew what would be involved in the financial planning process, how much the plan would cost, and what they could expect to get from their financial plan.
After signing the Financial Planning Agreement, John and Joan met with their FLA advisor to provide copies of their insurance policies, financial statements, income tax returns, Social Security statements, and their wills. During this second meeting with the financial planner, John and Joan then explained, in detail, what they wanted retirement to be like. With the help of their FLA advisor, they outlined each one of their retirement goals (Step 2 – Gather Information).
After talking, the following goals were outlined by level of importance ranked from 10 (highest) to 1 (lowest).
All costs are in today’s dollars:
Importance - Goal
10 - Would both like to retire when John is 65, but would be okay with John working until he is 67.
8 - Replace vehicles every 5 years until age 75, then move down to one car. (New cars value $40,000)
6 - Want to be able to take a luxury vacation in retirement every year until they are 80. ($10,000-$8,000)
5 - Purchase a coastal vacation home ($300,000) with annual expenses of $20,000.
John & Joan have the following assets:
- Cash (bank accounts/CDs/Money Market) $80,000
- Brokerage account (stocks/bonds) $350,000 current value, $450,000 basis)
- Retirement Annuity ($220,000 current value, $100,000 basis)
- Joan’s IRA ($300,000)
- John’s 401(k) account ($550,000), employer match is 3%
- John is eligible for a pension which will pay 40% of his salary for life without inflation adjustments or a survivor benefit at age 65.
- Home is worth $450,000 with a $100,000 mortgage at a 5.4% interest rate
- John’s BMW is 3 years old and worth $25,000. The loan balance is $10,000.
- Joan’s Lexus is 6 years old and worth $15,000.
- John’s life insurance coverage is through work ($300,000) at $100/month.
- Joan’s life insurance coverage is a whole life policy ($100,000 death benefit, $30,000 cash value, $25,000 basis) at $85/month.
- John has a disability policy through work which replaces 60% of his income if he becomes disabled; Joan has no disability insurance.
- John and Joan have no long term care insurance.
- John and Joan have homeowners and auto property coverage, but no umbrella liability.
- John is maxing out his 401(k) annually. Joan does not have a retirement plan and is self-employed.
- John grosses approx $120,000 per year; Joan makes approx $60,000.
- John and Joan drafted wills when their kids were young. They have not been updated since.
- After taking a comprehensive risk tolerance questionnaire it was determined that John was an aggressive investor and Joan, a conservative investor.
- The Smith’s spend approximately $5,000 a month on utilities, entertainment, food, and other regular living expenses.
- Of all investable assets, the overall fixed income to equity ratio is 33% fixed income and 67% equities (33/67).
- John’s Social Security statement shows him receiving $1,600 month at age 66; Joan’s shows $900 at age 66.
The FLA advisor who worked with the Smith’s then went back and reviewed all of the detailed information provided during the retirement goals and information gathering meeting. Using software from Morningstar® and MoneyGuideProTM the FLA advisor entered all financial assets, property, income, and retirement goals into the financial planning software.
Note: The MoneyGuideProTM software is powerful financial planning software which is only available to financial advisors and other financial professionals.
MoneyGuideProTM can calculate the effect of inflation, tax rates, and investment returns almost instantaneously. This powerful software allows the FLA advisor to make various adjustments and changes to the financial plan and then almost instantly see the potential outcomes (Step 3 – Analyze the Situation) of those changes.
In addition to the retirement plan projections, the provisions of the existing will, a recent income tax return, and a review of each insurance policy contract were completed by the FLA advisor. These documents were checked to see if potential opportunities or threats existed.
Note: Inadequate or improper insurance coverage could be wasting money or may not protect in the event of catastrophic financial loss. An out of date will can direct actions which are no longer desired or applicable. Income tax returns can also shed light on potential tax strategies which may be beneficial.
After running various simulations and trying different scenarios, the financial plan was presented to John & Joan (Step 4 – Recommend a Plan). The financial plan had first been calculated assuming the Smith’s had continued on their current course of action and pursue all of their stated goals. This calculation showed whether or not their current plan was feasible or not. For the Smith’s it was assumed they had paid off their mortgage and cars before retirement.
The MoneyGuideProTM software calculates a financial plan three different ways. The first method (average return) assumes the long-term average expected return for the selected portfolio and sees if the expected cash flows cover the expected goals. The second method (bad timing) assumes that in the first two years, the portfolio suffers a statistically large decline in value. Then, after that initial decline, the long-term average return is used after that. The final method (Monte Carlo) takes the historical relationships between asset classes and simulates possible returns each year. It then runs 10,000 simulations to see how many times out of 100 (both good and bad) the plan has sufficient assets to fund retirement goals. This is commonly referred to as a Monte Carlo analysis. The Monte Carlo Analysis shows a probability of success between 1% and 100%.
After entering all the stated retirement goals and using their existing asset allocation, the financial plan showed a probability of success of 69% (See a copy of the financial plan). This meant that without changing anything, there was some weakness to the current financial plan. The FLA advisor then simulated the financial plan in the circumstance that John passes away early at the age of 75. Because of the drop in pension and Social Security income which would result from John’s passing, the probability of success for the plan dropped to 56%.
John and Joan were alarmed by the fragility of their retirement plans. John suggested that they would just have to work longer and become more aggressive with their investments. Joan said that she didn’t want to get more aggressive and that they should scrap the vacation home on the coast. The beauty of the financial planning software is that any of the suggested alterations could be tested in real time to see the effect of those goal changes on the plan’s probability of success.
The Smith’s FLA advisor helped them make some reasonable changes to the financial plan which both John and Joan could agree on. Even though he is a more aggressive investor, John was surprised to find out that lowering the risk of investments actually increased the probability of success. With more risk, the potential for a large loss in the short run can permanently damage the financial plan. When the portfolio risk was decreased, the potential outcomes were much less varied, and the ultimate probability of success increased.
The Smith’s wanted to make sure their plan would be successful, so for the financial plan, they wanted to assume the untimely passing of John at age 75 and still assume John’s retirement at age 65. (click here to see the financial plan). With the following modifications the probability of success went up to 76% even though both the assumption of an early passing of John and a targeted retirement of 65 reduced the financial resources to fully fund the retirement goals.
In the end the Smith’s decided on making some minor goal modifications:
After talking about it, John and Joan did not have a problem working a few extra years. If they keep the above modifications and end up working until John is 67, the probability of success went up to 88%. What’s more, when the CFP(R)adjusted the software to show that John lives a long, happy life, the probability of success went up to 99%. The Smith’s will wait and see how things go as they approach age 65. Their goals may change, or they may feel differently about retirement at that time, but now they do feel better about knowing that no matter what they decide, they have a sense of what type of lifestyle is within their means.
- Reduce portfolio risk profile from 33/67 to 60/40 (fixed/equity).
- Change from replacing cars every 5 years to every 7 years.
- Reducing the luxury vacation budget from $10,000 to $9,000 per year.
- Buying a slightly less expensive coast vacation home $250,000 instead of $300,000.
- With a lower vacation house value annual costs decrease from $20,000 to $18,000.
- Joan is going to set up a SEP IRA and save an additional $1,000 per month until retirement.
During the insurance review, the Smith’s FLA advisor discovered that they do not have an umbrella liability policy. This gap in coverage left a huge liability uncovered. For several hundred dollars a year, they added 2 million dollars of blanket liability coverage. They were also underinsured on the contents coverage of their homeowners, and so they raised their deductibles on their home and auto policies. The additional coverage was almost completely offset by the decrease in premium from increasing deductibles. These changes to property and casualty insurance increased the out-of-pocket costs moderately, but those same changes increased the catastrophic loss coverage tremendously.
It was also recommended that Joan cash in her whole life policy. The insurance coverage was no longer needed, and the tax cost to terminate the contract was minimal. It was also suggested that the Smith’s take a look at long term care insurance and disability insurance for Joan. The Smith’s asked for a professional referral to an attorney who helped the update their will, as well as execute a living will, medical directives, and durable powers of attorney.
Implementation & Monitoring
After completing the financial plan, John and John decided to retain Financial Life Advisors to manage their investments and be available to update the financial plan and provide ongoing advice. (Step 5 – Implement the Plan) FLA handled all of the paperwork to move the IRA, brokerage, and annuity to be managed at a discount broker and custodian. FLA also set up the SEP IRA account for Joan to start saving additional retirement funds in. Coordinating with the Smith’s CPA, their FLA advisor worked through the tax implications of reallocating their portfolio in line with the new lower risk asset allocation.
John and Joan’s FLA advisor worked with their existing insurance agent to modify their property coverage and helped coordinate with their attorney when their will and other estate planning documents were being updated. To explore long term care and disability insurance, their FLA advisor then solicited multiple bids on long term care and disability insurance from several independent agents for comparison.
After the financial plan was first put in place, the Smith’s had their portfolio reviewed at least quarterly by their FLA advisor. As questions have come up, the Smith’s contact FLA for financial advice without additional charges. (Step 6 – Monitor & Adjust the Plan) The financial plan is updated annually and as changes in tax, investment and insurance change, FLA will reaches out to the Smiths, giving information about financial opportunities and threats to their retirement plan. As tax laws and their situation may change, FLA is available to be involved in the estate planning process as needed. FLA takes a team approach, and multiple professionals are familiar with each client’s particular situation. The Smith’s have found that the long-term relationship and team approach of Financial Life Advisors has put their minds at ease as they now feel they have a true financial advocate in their corner.
This firm is not a CPA firm.
Financial Life Advisors (FLA), a Registered Investment Adviser, and Jim Oliver & Associates, P.C. (JOA) are under common ownership and control. Team Oliver is used to describe collaborative services of both firms. Professional tax services are provided by JOA and investment advisory services are provided by FLA, each under separate agreements.