7.3 Advice and recommendations

Question 1

What are the 6 sequence of steps the financial planning process should ideally adopt?

Answer 1

1. Identify and quantify the financial planner relationship
2. Collect data to establish the client’s current circumstances
3. Analyse different options to meet any identified shortcomings
4. Prepare a report and arrange a meeting with the client
5. Implement the plan
6. Monitor and review the plan

Question 2

Name 7 asset classes.

Answer 2

1. Cash
2. Government bonds (UK and international)
3. Corporate bonds (UK and international)
4. Shares (UK, European, US, Asia and other global)
5. Property (UK and international)
6. Commodities (international)
7. Other alternatives (private equity, hedge funds, antiques, timber etc.)

Question 3

What is the key decision for the investor and for the advisor?

Answer 3

The key decision for the investor and for the advisor is which asset classes to choose and in what combination. Many academic studies have concluded that asset allocation is the single most important factor in determining returns of an investment portfolio.

Question 4

What are the 3 clear requirements the client’s Investment Policy Statement (IPS) contains to assist with asset allocation?

Answer 4

1. The required return
2. The specified level of risk
3. The required level of liquidity to meet spending

Question 5

What are most retail investors’ portfolios often constructed of?

Answer 5

A mix of shares and bonds

Question 6

What has traditionally been used by institutional rather than retail investors?

Answer 6

Alternative investments such as commodities and private equity, although attractive, have traditionally been used by institutional rather than retail investors. There is, however, an increasing interest in alternative asset classes in the investment marketplace.

Question 7

Once a client’s risk tolerance is established, what do many companies use to tailor a suitable asset allocation in order to meet the client’s objectives?

Answer 7

A mix of shares, bonds and cash.

Question 8

What is cash used for in asset allocation?

Answer 8

Cash is used to establish an emergency fund for the client and is also a home for short-term planned expenditure.

Question 9

What is essential for the asset allocation to take into account?

Answer 9

The client’s planned and emergency liquidity needs.

Question 10

Once cash has been allocated what happens to the balance of the fund?

Answer 10

The balance of the fund is therefore available for investment according to the client’s investment horizon. Changing the mix of shares and bonds can result in a wide spectrum of portfolios that can be suitable for a wide range of clients.

Question 11

What is mean variance optimisation (MVO)?

Answer 11

Portfolio managers often use computing power to determine the weights to invest in different assets. The computer program aims to optimise the risk and return relationship i.e. to maximise the return (the mean) and to minimise the risk (the variance). This process is called mean variance optimisation (MVO).

Question 12

Retail clients will often choose to hand over the investment decisions to an expert by choosing a collective vehicle to invest in. Name 3 examples of collective vehicles.

Answer 12

1. Unit trusts
2. Investment Companies with Variable Capital (ICVCs)
3. Investment trust companies

Question 13

What are the 4 important considerations retail clients should take into account when choosing a collective vehicle to invest in?

Answer 13

1. Past performance
2. Charges
3. Stability of the product provider
4. Stability and independence of the trustee/custodian

Question 14

Where can retail investors go to gain important information needed to decide whether to invest in a collective vehicle?

Answer 14

Most of the relevant information can be gained from the fund management group in the form of a Key Information Document (KID), or, in the case of a UCITS fund, a Key Investor Information Document (KIID).

Question 15

Put yourself in the position of an independent financial advisor (IFA). Assuming two investment funds have a comparable asset mix and comparable performance, how do you choose which is the most suitable fund for your client?

Answer 15

One of the key criterion in making this choice must be to compare the level of and impact of charges in each fund. There are many elements that can impact on charges that could be implicit or explicit.

Question 16

Name 5 examples of explicit costs.

Answer 16

1. Advisor fees
2. Broker fees
3. Initial charges and management fees of product providers
4. Stamp duty reserve tax
5. PTM (Panel of Takeovers and Mergers) levy on the London Stock Exchange to fund the Takeover Panel

Question 17

Name 4 examples of implicit costs.

Answer 17

1. The bid/offer spread
2. The price impact of the trade – large orders can move the price
3. Opportunity cost – the cost of waiting
4. The cost of dealing within a fund

Question 18

During a client fact-find, the advisor collects further information about these borrowings to build a more detailed picture of these financial commitments. List 6 pieces of information which are typical for an advisor to collect.

Answer 18

1. The lender
2. The term of the loan
3. The repayment method i.e. capital and interest or interest only
4. The interest rate and APR
5. The monthly repayment
6. Check if any early repayment penalties apply – if yes, what level

Question 19

How can advisors help clients in terms of borrowing?

Answer 19

Many clients do not always consider the cheapest way to borrow and often end up with expensive borrowings, such as high credit card or store card balances charging very high rates of interest. Advisors can assist clients in re-organising borrowings to restructure these kinds of debts and reduce monthly repayments.

Question 20

Are interest rates set by lenders the same for everyone?

Answer 20

No! Rates will vary depending upon your credit history.

Question 21

What are the estimated interest rates for clients with a clean credit history for the 5 common forms of credit?

Answer 21

1. Bank of England base: 0.5% (as at October 2014).
2. Mortgage rates: 2.5% – 6% (APRs will be higher once we take into account fees).
3. Unsecured loan rates: 7% – 15%.
4. Credit cards: 15% – 20%.
5. Store cards: 20% – 35%.

Question 22

Consider a client that wants to invest a lump sum but also has some of these borrowings. How should the advisor proceed?

Answer 22

Clearly, it is quite possible that the return on any investment may be less than the cost of the borrowing. If this is the case the client would be best advised to repay the borrowing.

Question 23

What are the 6 additional considerations the advisor must explore with the client when it comes to the option of repaying or part repaying debts?

Answer 23

1. Wanting access to the money in the future – if repayment is made to a mortgage, the client no longer has access to the funds in the future unless they sell the property or raise a new loan
2. The client’s overall risk tolerance – if the client is not willing to take investment risk then it is likely that repaying debts would be advisable
3. Important to avoid paying early repayment penalties
4. Useful to firstly repay the debts with the highest rate of interest
5. Important for a client to retain sufficient liquid funds for emergencies/unplanned expenditure
6. When comparing investment returns with borrowings remember to compare the ‘after tax’ investment return

Question 24

What is the key thing a client and advisor should speak about when a client has debt?

Answer 24

To sum up, the advisor and client should explore the option of paying off debt before investing.

Question 25

What is advisable when the cost of borrowing is higher than the likely investment return?

Answer 25

Where the cost of borrowing is higher than the likely investment return, it is advisable to consider paying off the debt before investing.

Question 26

How can we assess the performance of a fund or an investment manager?

Answer 26

Investment performance is usually monitored by comparing it to a relevant benchmark.

Question 27

What are the three main ways in which portfolio performance is assessed?

Answer 27

1. Comparison with a relevant bond, stock market or custom (composite) index
2. Comparison to similar funds or a relevant sector comparison
3. Comparable funds should have similar investment objectives and constraints

Question 28

Is financial planning a one-off process?

Answer 28

NO! In part, this is because of the possibility of change.

Question 29

Give 3 examples of things that can cause a client’s plans to change.

Answer 29

1. The environment changes, for example, the tax regime or loss of employment
2. The client changes their circumstances, needs, wants and aspirations. For example, marriage or divorce, or has a child
3. The client changes their attitudes to finance becoming more or less risk-averse

Question 30

Why should a client regularly review their investment policy statement (IPS)?

Answer 30

In order to monitor how well they are sticking to it and how likely the goals are to be achieved.

Question 31

What are advisors required to do in terms of ongoing reviews?

Answer 31

The adviser should agree early on whether ongoing monitoring and review is going to fall within his remit. If so, the adviser should advise the customer of how frequently he can expect to see an update of the plan and any new recommendations. Periodic reviews to clients should include the up-to-date value of the customer’s investments.