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- Chapter 20
Completing the Process
1
- Chapter Goals
Complete the financial planning project.
Explain the importance of planning integration.
Demonstrate how PFP theory can improve the
practice of financial planning.
Use overall planning tools such as SWOT, scenario
and sensitivity analysis.
List the keys to a successful plan.
2
- Overview
Integration: The process of combining, of making
something into a completed whole.
In personal financial planning it means evaluating
costs and benefits over time to find the best path to
our goals. Integration is often overlooked or given
less emphasis than is warranted.
Given limited resources, you cannot make correct
choices without weighing alternatives for spending
your monies.
3
- PFP Theory
Concepts underlying PFP theory:
– The household is an enterprise that operates like a business.
– The goal of PFP is to provide the highest standard of living
possible for household “member-owners” over their life cycle.
– For a given time devoted to work, the goal becomes
maximization of discretionary expenditures.
– Household finance supports the enterprise, which needs cash
flow and appropriate methods for allocating its limited resources
over time.
– Personal financial planning provides the strategic approach for
solving household financial decisions.
– Personal financial planning decisions are made on an integrated
basis that takes into account all household assets and liabilities.
– Total Portfolio Management provides the solution for personal
financial planning’s overall objective and the household’s overall
4 goal.
- PFP Theory, cont.
Distinguishing features and benefits of PFP theory:
5
- The Financial Plan
PFP theory explains how the PFP process should
ideally be done.
The financial plan, using the theory as an
underpinning, is a mapping out of the practical steps
through which a particular goal or goals are to be
accomplished.
For comprehensive financial planning, a detailed
written financial plan is desirable.
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- The Financial Plan, cont.
A financial plan has several advantages:
– It imposes overall structure on the process through specific
steps that should be taken.
– It compels you to order your priorities and provide a specific
financial solution using integrative techniques. In other words,
it aids decision making.
– It presents a document to refer back to so that you can
compare actual with projected results and refresh your
memory as thoughts of the original steps fade.
– It provides a numerical base for adjustments as goals and
resources change in the future.
The need for the plan to integrate all financial actions
arises from the limited resources households have.
Actions in one area often affect planning for other
7 activities.
- The Financial Plan, cont.
The need for the plan to integrate all financial actions
arises from the limited resources households have.
Actions in one area often affect planning for other
activities.
Before making final judgments it is advisable to
examine your work by reviewing each step in the
financial planning process and adding new tools that
can help you in making integrated decisions.
The series of questions we will next consider helps
assure that you will complete the process properly.
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- The Financial Plan, cont.
Establish the Scope of the Activity
– Have you analyzed all areas that you intended to?
– Is the scope established broad enough?
For example, in a comprehensive plan, if provisions have been
made for retirement, has long-term care insurance been
considered?
Gather the Data and Identify Goals
– Has all information been gathered and is it available for use?
– Has the true goal been ascertained?
For example, the statement “I am satisfied with my current life
style; my main goal is to have a roof over my head” can mask
larger goals.
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- The Financial Plan, cont.
Compile and Analyze the Data
– Has all relevant data been analyzed?
– Have you given that data the depth of analysis it merits?
– Have SWOT, sensitivity and scenario analysis been
considered?
The evaluation process is the heart of planning
integration in practice.
The household is faced with many choices as to how to
prorate its limited resources.
The financial plan is the response.
It specifies what the household intends to do with its
current and future resources.
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- The Financial Plan, cont.
Operating parts of the financial plan:
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- The Financial Plan, cont.
The household resource problem can be viewed as a
series of integrated capital expenditure decisions.
Each part of the financial plan competes for capital.
The household has to decide which capital
expenditures to fund and in what amounts.
Importantly, the plan looks at these decisions not only
as current ones but as those that will take place over
the entire life cycle.
The following slide provides a visual portrayal of the
planning process.
12
- The Financial Plan, cont.
Life cycle source and use of cash:
13
- SWOT Analysis
SWOT analysis represents an appraisal of all the major
factors that can enhance or detract from the outlook for
goal achievement.
SWOT: Strengths, Weaknesses, Opportunities,
Threats.
– Strengths and weaknesses are part of the internal household
analysis.
– Opportunities and threats are identified through an
examination of the external environment.
SWOT analysis provides an overall assessment of the
household’s situation.
14
- SWOT Analysis, cont.
The external environment has an impact on the
household.
It includes political, legal, tax, social, economic, and
technological variables closer to home as well as the
industry you work in.
Opportunities could arise from new regulations that
result in a decline in income tax rates.
Threats could incorporate:
– The distinct possibility of higher energy prices, which could
result in a decline in your discretionary outlays.
– A movement toward larger houses, which could make your
modest sized home less valuable.
– Involvement in an industry with declining prospects.
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- SWOT Analysis, cont.
SWOT analysis is intended to uncover new information
and form a realistic appraisal for the planning future.
It can also lead to changes in projections or practices.
Our first choice is to overcome our threats by changing
our practices.
Yet we cannot deal with all threats directly nor do we
want to.
– For example, if we have a job that is lucrative and enjoyable
but it is in a highly risky industry, we may counter the threat by
accumulating extra savings in case our income drops or we
are laid off.
We compare the SWOT assessment with our goals
and plans. We may then provide for contingencies by
16 taking additional risk management steps.
- SWOT Analysis, cont.
SWOT analysis by planning area:
17
- SWOT Analysis, cont.
18
- Sensitivity Analysis
Sensitivity analysis is identifying those factors that
could significantly alter anticipated planning results.
– It may be performed as part of SWOT analysis or as a stand-
alone supporting analysis.
– Sensitivity analysis is sometimes more quantitatively based
than SWOT.
Perhaps the most popular form of this type of analysis
is Monte Carlo simulation.
– Monte Carlo isolates some key planning variables such as
investment return and inflation and assesses how these affect
planning outcomes.
19
- Scenario Analysis
Scenario analysis observes the effect of changes in
multiple variables or in one variable that influences
many situations.
– Its stress on creating an overall changed environment
distinguishes it from one-variable scenario analysis.
– For example, our projections of financial and other asset
returns may be based on historical returns and the
continuation of a normal economic environment.
– We may want to look at the impact of an alternative scenario.
– Given that scenario, our ability to save will be altered and we
may have to consider the possibility of a temporary work
layoff.
– In the event of such an economic outcome, the result could be
a higher level of liquid savings to be drawn down.
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