What is financial planning?

Mar 25, 2021 | News


Financial planning is defined as a process of developing strategies to assist clients in managing their financial affairs to meet financial goals in pursuit of financial wellbeing. Often when we ask a new client if they have a financial plan the answer is an emphatic yes, yet when we inspect their schedule there is a lack of synergy and direction. Some may have unnecessary risk benefits resulting in wasteful expenditure that could be better allocated into an investment or vice versa and others may be completely exposed to a potential unforeseen risk event such as death or disability. Unfortunately, the elementary yet fundamental steps in building a proper financial plan – such as setting clear objectives, the compilation of a budget, prioritization of financial and personal needs – are not given enough attention from the outset and products are simply sold and purchased without due consideration on its efficacy to the person or the plan. Investment planning is an important element of a person’s broader financial plan where initial careful consideration can make all the difference to the journey and the destination. When we advise clients on investment planning, we often refer to the three P’s. In order of priority these are – Portfolio, Product and Platform. Let’s probe these concepts a little further.

Portfolio refers to the return an investment strategy must deliver to meet a financial objective. When constructing an investment strategy an adviser must pay careful attention to an investor’s return requirement, risk capacity and risk tolerance. Let us call this our three-dimensional cube conundrum as illustrated. Calculating the return required is a relatively simple but important mathematical calculation. Contribution X Time X Return = Fund Value. For most investors time
and money are fixed and their return profile becomes the gearbox. Remember though that if an investor must aim for a higher return to reach an objective, they must also accept a higher level of investment risk. This forms part one of our cube conundrum. Risk capacity refers to the ability of an investor to tolerate poor performance of a particular investment strategy because that investor has other investments with different strategies that performed well over the same time. This second part of the conundrum is often diametrically opposed to the first. An investor who is required to take more risk to meet their objective, often lacks the capacity to absorb the uncertainty that is inherent in taking that extra risk. Risk tolerance means considering an investors emotional response and behavioural traits through different market cycles. Naturally, most investors want the best return while assuming the least amount of risk which maybe possible in Wonderland but here on Planet Earth the decision is a strict trade-off between what keeps you comfortable and what is necessary. Let us attempt a gastronomical analogy. Some investors find comfort in cash and store all the wealth in this conservative and predictable asset class. Like constantly relying on your 10-minute spaghetti bolognaise – no mess or fuss. Only problem is your body needs a little more nutrition, but this means moving out your comfort zone. The investor who only focusses on comfort must be reminded of how chronic inflation can be to ones purchasing power. Alternatively, when markets are cooking and suddenly everyone is a Michelin chef with an unbeatable dish, investors need reminding of their allergies and the last time they had lobster thermidor they broke out in hives and battled to breath. Diversification is the only free lunch in this game that balances the opposing objectives of preservation and growth and with the right advice one can comfortably hit the spot. The below graph and table can assist investors understand the trade-off between different investment strategies and the range of outcomes.

Product is the second most important P. If you take all the glossy marketing from all the investment houses and boil down the variety of offerings you would ultimately find the same products that provide the same features. Sure, there may be slight nuances between this provider’s product and that one but I am referring to core features that actually matter and when properly combined create an optimal and robust financial plan. The adviser must consider the investors competing needs such as accessibility to cash, the need for growth, taxation on growth and the costs and distribution of assets at death. Then thread a needle through one product at a time that when drawn and stitched together provides financial comfort.

Often, I hear investors ascribe performance to the product and not the portfolio. Suppose your investment analysis shows you need 8% return per annum to reach your investment goal and your adviser constructs a moderate investment strategy to achieve that goal. The important question is what product should that investment strategy be plugged into, given the different product features. Is accessibility or tax efficiency a priority? If you don’t need access to funds it makes sense to use a retirement annuity or tax-free savings account and benefit from no tax on growth. Conversely the need for access to funds may necessitate the use of a different product. All products on modern investment platforms effectively cost the same and the focus on which product is most suitable should depend on how that product’s features align with your needs and improve the effectiveness of your financial plan.

Platform is the least important P in our humble view. Platforms are administrators which offer the same products and the same portfolios at close to the same costs and the choice of platform will not materially affect whether you achieve your financial goal or not – the caveat being with specific reference to modern investment platforms known as linked investment service providers (LISP) and not older traditional insurance platforms which are often more expensive. A simple analogy is likening a LISP to your preferred grocer. Wherever you choose to shop we all have access to the same basket of commodities. Investors often mistake the need to diversify at platform level but remember that your funds flow through the platform and then through the product and ultimately into the portfolio which is where diversification counts. Platforms fees reduce as the total value of an investor’s assets increase and for this reason, we advocate that investors consolidate their products onto one platform wherever possible.

There is a fair amount of global research (see annexure below) that quantifies the value of financial advice. However, for a financial plan to properly succeed there must be constructive collaboration between the adviser and client. Providing advice on portfolio, product and platform is important but equally important is how an adviser helps manage your behaviour, decisions and discipline. As an example investors in the market this time last year had good reason to worry. A global virus pandemic was unfolding and markets were gripped by uncertainty. While the nature of the crisis was novel the human response was predictable and worldwide markets crashed in panic. The recovery was as fast as the crash and markets have experienced good growth since then. Consequently those investors who heeded advice, checked their behaviour and stuck to their strategy have been rewarded for their resolve.


Most of the research attempts to answer the following broad question: “Are there major differences in the financial position of investors who consulted advisors early on in their lives, and investors who did not. What drives these differences?” There are four main pieces of research often cited in this space (three from the USA and one from Canada). Skimming through the conclusions of these four reports, however, a very interesting pattern emerges:

The Investment Funds Institute of Canada Value of Advice report (2012) concludes that households who consult with advisors continuously for 7-14 years end up with almost double the household assets than households without an advisor. The difference is ascribed almost entirely to the fact that advised households have a much higher savings discipline.

The US National Bureau of Economic Research into the Market for Financial Advice (2012) highlighted the dangers of advisors who merely chase portfolio returns, or who are encouraged to ‘trade portfolios’ aggressively. It is claimed that such advisors reinforce the negative behavioural biases of their clients, destroying value.

Alpha, Beta, and Now…. Gamma by Morningstar (2013) investigated how improved income drawdown strategies could benefit pensioners. It estimated an increased portfolio return of around 1.8% p.a. through improving the financial decision-making of retirees.

In Putting a value on your value: Quantifying Vanguard Advisors’ Alpha (2014) Vanguard analysed the impact of various financial advisor activities on client portfolio performances. It estimated a potential positive portfolio performance impact in the order of 3% p.a. after fees from the following sources: Appropriate portfolio construction (0.75% p.a.); Ongoing rebalancing of portfolio and managing income drawdowns (0.75% p.a.); Behavioural coaching (1.5% p.a.).

Looking at the headline conclusions from these four research reports, one cannot but notice how every report highlights the importance of a financial advisor managing a client’s financial behaviour, decisions and discipline.