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THE IMPORTANCE OF AN ANNUAL FINANCIAL CHECKUP
It's one of the six steps of the financial planning process.
But, oftentimes, it's the one step that gets overlooked. It's
the sixth step — the annual financial check-up.
The annual financial check-up is indeed the most important of
the financial planning steps. And yet, financial planners and
clients sometimes downplay its significance.
What is the annual review and why is it so important? In
short, the annual review is the opportunity to measure a
client's progress against their plan of action. It's also the
one time when planners and clients can examine the many changes
that typically occur any given 12-month period — the birth of a
child, the death of a loved one, the loss of a job, a major
purchase — and then readjust the client's financial plan,
charting a new course if need be or further affirming the
client's progress towards their personal financial goal
achievement.
Indeed, lives are seldom static and that's why financial
plans are not necessarily set-and-forget documents. But what
exactly should financial planners and clients examine in their
annual meetings? And when should they conduct their annual
meetings.
Typically, financial planners will collect a client's data,
prioritize their goals, examine their resources, make
recommendations, and implement a plan as part of the financial
planning process. In an annual review, the financial planner
will do much of the same and then some. They will first
typically examine a client's progress against the plan time
frames. This sort of monitoring benefits both planners and their
clients. Clients get an opportunity to step back from their busy
lives and review their goals and confirm that their priorities
remain the same. Planners have a chance to reconnect with their
clients to affirm their positive actions towards goal
achievement or to help refocus them so that they don't get too
far off track. And planners get a chance to enhance the
relationship and trust.
In some cases, planners and clients will want to establish a
regular appointment, meeting on an annual basis, and in some
cases on a quarterly or semi-annual basis. Typically, the
planner and client will review in these meetings short-term
goals, examining what if anything may have changed. In some
cases, the planner will make changes to a client's investment
portfolio in light of tactical or strategic asset allocation
models in place. In other cases, a planner will suggest changes
based on certain life events. The birth of a child or grandchild
may require a discussion about 529 plans. A divorce may require
changing beneficiary designations on retirement accounts and
life insurance policies.
In addition a planner may want to review with their clients
new research that has become available in the interim to either
confirm rationale or provide a basis to alter a client's
short-term or long-term strategies. For instance, new research
that shows the escalating costs of nursing homes or health care
in retirement wouldn't change the goal of "secure long-term
retirement," but it would change the strategy to achieve
that goal.
Besides reviewing family developments, planners would also
address in an annual review regulatory and other changes that
could affect adversely or positively a client's financial plan.
The new Medicare Part D plan or the introduction of the Roth
401(k) could prove useful to some clients. In other cases, the
annual review is a chance to review potential changes, changes
in the federal estate tax laws, for instance, and devise
possible plans of actions.
Planners and clients will often want to measure the
"performance" of the investment portfolio as part of
the annual review. Typically, performance should be measured
against several benchmarks, the most important of which is the
client's own personal goals. For instance, if the planner and
the client established that a portfolio should grow by 5 percent
per year before taxes then the performance should
be measured against that yard stick. To be sure, it's
important that portfolios be measured against standard
benchmarks. But only as a point of reference. Meeting personal
investment goals is far more important that over performing or
underperforming the Dow Jones industrial average. By and large,
it's imprudent for planners and clients to make wholesale
changes to a portfolio based solely on one quarter as well as
one year of performance.
In summary, annual reviews provide a chance for planners to
examine a client's long-term goals. These reviews can establish
whether the client is generally on course to meet their goals.
It's also a chance to review changes that have occurred and
begin to anticipate changes that may occur. It's a chance to
implement any new plan of action that has been developed in
light of changing goals or changing performance. And then last,
the annual review provides the perfect opportunity to establish
future review meetings.
One of the most important worksheets to review is a balance
sheet or net worth statement. If reaching all of the client's
goals will require a net worth of $1 million at some point in
the future, it is the balance sheet that will demonstrate
movement toward or away from that goal. It is a road map. When
going out of town, a map is almost always consulted before and
during the trip. Progress toward your ultimate destination is
noted by each passing town or landmark. It is easy to see when
you move off track and what corrections should be made to get
you back on the correct path in the least amount of time or
distance. The balance sheet measures your progress toward your
monetary goal in a finite manner. What the numbers show from
year-to-year are not as important as what they show after
several years looked at as a whole.
May 2006 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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