FUND CH3 Financial Planning Approaches: Analysis and Recommendations

Question 1

What 6 pieces of information does the life cycle approach gathers and analyze?

Answer 1

o Ages of client and spouse
o Marital status
o Number and ages of children and grandchildren
o Family income by each contributor
o Family net worth
o Whether the client is self-employed or an employee

Question 2

What are 3 advantages of the pie chart approach

Answer 2

• A pie chart forces the client to focus on the fact that there is only one pie.
• People can only spend what they have and visualizing where the money goes is often a sobering lesson.
• The pie chart is an effective analytical and illustrative tool for financial planning clients

Question 3

What 4 types of ratios does the financial statement and ratio analysis approach use?

Answer 3

o Liquidity ratios
o Debt ratios
o Ratios for financial security goals
o Performance ratios

Question 4

3 things about two-step/three panel approach

Answer 4

• The two-step approach recommends covering risks and saving and investing.
• It looks at personal risks as potentially leading to catastrophic loss or dependence on someone else for well being.
• The two-step approach considers savings and investments as the path to financial security or independence.

Question 5

present value of goals approach

Answer 5

The present value of goals approach takes each short,
intermediate, and long-term goal, determines each individual present value, then sums these present values together and then reduces them by current resources (investment assets and cash and cash equivalents) and then treats the net PV as an
obligation to be retired over the remaining work life expectancy at a discount rate equal to the expected portfolio rate of return.

Question 6

What is metrics approach and what are 3 common benchmarks for it?

Answer 6

• The metrics approach provides example benchmarks for the financial planner and client to use as guidance for necessary comprehensive financial goals and objectives.
•  common benchmarks for:
o Risk management
o Short-term Savings
o Long-term Savings

Question 7

What is cash flow approach and its 4 categories of recommendations?

Answer 7

• The cash flow approach adjusts the cash flows on the income statement by forecasting what they would be after implementing all of the recommendations.
• The approach separates the recommendations impact into four categories:
o No cash flow impact.
o Annual recurring positive (very few) or negative cash flow impact.
o One-time nonrecurring positive (sale of an asset) or
negative (pay off debt) cash flow impact.
o Impact which affects the client in a positive or negative way, but does not affect his cash flow on the income statement.

Question 8

What are 4 things about the strategic approach

Answer 8

• The strategic approach is led by a client mission statement, a set of goals, and a set of objectives.
• A need-driven list of client goals is created.
• A detailed list of objectives is devised that will all together result in the accomplishment of the mission of the client’s financial planning.
• The strategic approach takes into consideration needs versus wants.

Question 9

What are the 7 Approaches to Financial Planning

Answer 9

• The life cycle approach
• The pie chart approach
• The financial statement and ratio analysis approach
• The two-step/three-panel approach
• The metrics approach
• The cash flow approach
• The strategic approach

Question 10

Emergency Fund Ratio

Answer 10

Emergency Fund Ratio= cash/ monthly non discretionary cash flows for unemployment, disability – 3-6 mo.

• Discretionary cash flows are those expenses which can be avoided in the event of loss of income
• Non-discretionary cash flows are mostly fixed expenses which are required to be met regardless of loss of income.

Question 11

Current Ratio

Answer 11

Current Ratio = cash/current liabilities (within next yr) - higher then 3

Current liabilities represent those liabilities that will be paid within the next year.

Question 12

Housing Ratio 1 and 2

Answer 12

Housing Ratio 1 = housing costs/monthly gross pay

Question 13

Debt to Total Assets Ratio

Answer 13

Debt to Total Assets Ratio= total debt/total assets

The debt to total assets ratio is a leverage ratio reflecting what portion of assets a client has financed or is owned by creditors.

Question 14

Net Worth to Total Assets Ratio

Answer 14

Net Worth to Total Assets Ratio= net worth/ total assets

The net worth to total assets ratio provides the percentage of total assets owned or paid for by the client.

Question 15

Savings Rate Ratio

Answer 15

Savings Rate=savings + employer match / gross pay=benchmark depends on client goals

The savings rate is critical to achieve long-term goals
including retirement, education funding, large lump sum expenditures and legacy plans.

Question 16

4 Debt Ratios

Answer 16

o Housing ratio 1 (basic)
o Housing ratio 2 (broad)
o Debt to total assets ratio
o Net worth to total assets ratio

Question 17

What do the Ratios for Financial Security Goals do? And what are the 2 most common ratios used

Answer 17

These ratios assess the progress that the client is making toward achieving long-term goals.
• The two most common ratios used are the savings rate and the investment assets to gross pay ratio.

Question 18

Investment Assets to Gross Pay Ratio

Answer 18

Investment Assets to Gross Pay=Investment assets + cash/ Gross Pay

Saving 10-13 percent of gross pay would be sufficient only if the client begins saving at age 25.
• The investment assets to gross pay benchmark is calculated by age and is generally reliable for a wide range of income levels (e.g., $30,000 to $300,000 annual income).

Question 19

Performance ratios

Answer 19

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Question 20

Life Cycle Approach Phases

Answer 20

Asset Accumulation Phase
Conservation/Risk Mgmt Phase
Distribution /Gifting Phase

Question 21

Conservation/Risk Mgmt Phase

Answer 21

characterized by an increase in cash flow, assets, and net worth with some decrease in the proportional use of debt

Question 22

Asset Accumulation Phase

Answer 22

The Asset Accumulation Phase is characterized by limited excess funds for investing, high degree of debt-to-net worth, and low net worth

Question 23

The Distribution/Gifting Phase

Answer 23

The Distribution/Gifting Phase is characterized by excess relative cash flows, low debt, and high relative net worth

Question 24

Brandon and Jill are married. Brandon is a teacher and earns $40,000 per year. He contributes 8% of his salary to his retirement plan. His employer also makes a matching contribution of 6% of his salary. Jill stays at home with their children and contributes $2,500 to an IRA. What is their total saving rate?

Answer 24

20.3%
For married people, you add both spouses’ contributions and income plus any employer match. Savings Rate = (Employee Contributions + Employer Contributions) ÷ Gross Pay =[(Brandon’s Contribution of $3,200 + Employer Contribution of $2,400 + Jill’s IRA Contribution of 2,500) ÷ $40,000].