Financial planning practice

Introduction to the financial planning process

Typically, prospective clients may require advice on a range of issues which could include one or more of the following:

Investing lump sums or regular amounts

Retirement and pension planning

Estate and inheritance tax planning

Mortgages

Financial protection such as life or health insurance.

Financial advisers and financial planners may use very different approaches when dealing with such clients. While both may complete comprehensive fact finds to determine a client’s financial circumstances, they may use this information in different ways.

Financial advice tends to be a transactional process where the financial adviser recommends one or more financial products to meet a specific objective or problem. As financial advice involves financial products, it is generally seen to be a regulated activity.

Financial planning is a holistic process. The financial planner will look at a client’s existing and anticipated future resources and agree the client’s needs and objectives. The financial planner may also identify other problems or issues that the client may have, and, possibly, not be aware of. These issues and problems may, themselves, become needs or objectives after the client has discussed them with the financial planner.

The result of the financial planning process is the financial plan that sets out how the financial planner feels the existing and anticipated future resources can best be used to meet these needs and objectives. In some cases, this can mean that no additional financial products are required and that a rearrangement of the client’s assets may be all that is required to meet that client’s needs and objectives. In other cases, additional financial products may be required. Financial planning can, therefore, incorporate financial advice.

The financial planner will then seek the client’s agreement to the proposed actions in the financial plan before they can be implemented. This may mean that the financial plan needs adjusting before the client is happy with the recommendations and is ready to implement them. It is important that the client sees the financial plan as their plan, so that they take ownershi...

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...e limited or more rarely execution only, this course treats the financial planning process as one providing an overall financial plan to the client, based on a full and clear picture of their situation.

Why pay a financial planner for advice?

There are a number of reasons why it makes sense for a client to engage a financial planner to deal with these issues, but in particular:

Knowledge : most people outside the industry lack the necessary knowledge to effectively deal with many financial issues. For example, how many are familiar with the rules on pension input periods and the annual allowance, or are even aware that such rules exist? How many clients understand the differences between the myriad of investment products and providers available or understand the risks involved? Armed with this information and knowledge of the relevant markets, financial planners can help clients make much better financial decisions and plans.

Time and confidence : even where a client has the knowledge and skill required, they may lack the time and/ or confidence to deal with their financial affairs or may simply prefer to pay an expert to do the hard work instead.

Self -discipline : effective financial planning often requires discipline, such as budgeting, paying off debt or starting to save for retirement. Left entirely to our own devices we are all apt to put these things off for too long, making it very difficult in the end to realise our goals. A financial planner can help clients put these disciplines in place.

 

Identifying objectives and priorities : sometimes people aren’t clear about their own objectives and priorities until they have talked it through with someone. A financial planner should know what questions to ask and be skilled in helping clients establish what their goals really are.

Test your knowledge questions

In many of the sections we include a "test your knowledge question" on an area covered in the section. You can type in your answer in the space provided and then click on the view button to check your answer.

 

Test your knowledge question

What should financial planners confirm to clients when providing limited advice?

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There are several different stages involved in the financial planning process, from the initial client meeting to analysing their situation, putting together and implementing a plan and then managing that plan over the years. Traditionally, many financial planners have struggled to articulate what it is they do and the many different aspects involved, with definitions and perceptions of what financial planning entails differing widely. Prospective clients may often be confused about what they will actually be paying for and may also be worried about the standard of financial planning they might receive.

The International Organisation for Standardization (ISO) has produced a best practice standard (numbered 22222) for financial planners, which aims to tackle this lack of clarity by providing an internationally agreed benchmark for financial planning. This standard specifies the ethical behaviour, competences and experiences required of a personal financial planner and lays out a model six step financial planning process for planners to follow.

By adopting the ISO 22222...

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...a and determining goals and expectations

Analysing and evaluating the client's financial status

Developing and presenting the financial plan

Implementing the financial planning recommendations

Monitoring the financial plan and the financial planning relationship

The CFP’s six-step process, used for the Diploma in Financial Planning, is slightly different. The six steps are:

Gathering data

Agreeing goals, objectives and priorities

Analysing and processing information

Producing a written financial plan with recommendations on how to meet stated goals and objectives

Implementing the financial plan

Reviewing progress and modifying the plan, as necessary, to take account of changing circumstances

You can see from the above that the 2 processes are very similar.

The stages in the following sections are based on the ISO 22222 six-step process, but are equally applicable to the CFP’s process.

 

What is the name of the international best practice standard for financial planning?

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Establishing and defining the client and personal financial planner relationship

At the start of any client engagement the financial planner should provide the client with details in writing about the scope and costs of the service being offered.

The following information must be given before any services are provided (before a fact find is even completed):

Name and address of the firm and contact details necessary for communication

Methods of communication to be used between the firm and the client

The firm’s regulatory status (authorised and regulated by the FCA)

Whether the firm is acting as an appointed representative or as a tied agent of an authorised firm

The firm’s status – independent, focused independent or restricted (explaiing the nature of the restriction)

Details of the services to be provided

Details of how the firm is paid

Details of loans and ownership

How to complain

Coverage by the Financial Services Compensation Scheme

Summary of the firm’s conflicts of interest policy

Once the planner and client have decided to enter into a professional relationship together, the planner should then provide the client with written terms of engagement or ‘client agreement’, to include the planner’s qualifications and experience, and details of how they conform to ISO 22222, plus:

Basis of remuneration – Example: an initial fee of 3% of funds invested and an ongoing advice charge of 0.5% of the value of your investments/pensions under management/administration

Services to be delivered and timeframes – Example: quarterly portfolio valuations/rebalancing or annual reviews

Commencement and duration of the agreement – Example: this agreement is on an annual basis

Type and frequency of contact – Example: six-monthly face to face meetings at the location of your choice

Investment objectives and restrictions

Withdrawal rights

Confidentiality provisions – Example: your personal information may be disclosed to third parties on a confidential basis and in accordance with Data Protection legislation

Any known conflicts of interest – Example: Wizard Financial Planning has an interest in and receives payments from Wizard Investments Ltd, which is the Author...

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... range of financial instruments. Such a firm needs to:

Market itself in a way that is intended only to attract clients with a preference for those categories or range of financial instruments

Require clients to indicate that they are only interested in investing in the specified category or range of financial instruments and

Prior to the provision of the service, ensure that its service is appropriate for each new client on the basis that its business model matches the client’s needs and objectives, and the range of financial instruments that are suitable for the client. Where this is not the case, the firm shall not provide such a service to the client

A firm that provides independent advice in respect of a relatively narrow market should not hold itself out as acting independently in a broader sense. The firm is not required to conduct a detailed fact find, but is required to gather relevant information to make sure it provided a suitable recommendation within the specific scope. The firm also needs to outline the level of service to ensure the client understood they are not receiving full advice.

Restricted advice

Restricted advice is essentially any advice which does not qualify as independent advice. The planner must detail the nature of the restriction, which could differ dramatically from a firm that chooses not to provide advice on structured products to a firm that provides advice on investments from one provider only. It is possible for firms to offer both independent and restricted advice, however it must be made very clear to the client which type of advice they are to receive. Some firms adopt separate trading names, one for their independent advice offering and one for the restricted, in order to avoid confusion.

Regardless of the planner’s status in this regard, the financial planning process should remain the same for both independent and restricted advisers. Firms can also offer what is known as ‘Basic Advice’, which is a simplified form of advice based on pre-scripted questions and stakeholder products. This course, however, is not concerned with the process for basic advice.

Through what main methods might basic client information be gathered at the start of the engagement process?

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Financial planners will sometimes face potential or actual conflicts of interest during the course of business. Some may easily be dealt with whilst others may result in the planner being unable to advise the client in one or more area(s). An example of a conflict of interest is where the planner could make a gain (or avoid a loss) at the expense of a client or where the interests of one or more clients are favoured over another’s.

Conflicts are most likely to arise between the interests of:

Different clients : examples – advising both employer and employee(s) of the same company, advising different members of th...

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...eseeable harm’. Effective ways to try and mitigate potential conflicts of interest include:

Avoiding remuneration structures where sales ‘targets’ could lead to inappropriate advice

Restrictions on gifts and hospitality from third parties

'Chinese Walls' between different areas of the business

Financial planners should always bring conflicts of interest, both actual and perceived, to their client’s attention.

 

As part of which FCA principle are financial planning firms expected to have systems in place to deal with conflicts of interest?

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The way that financial planners could charge for their services changed with the introduction of the Retail Distribution Review (RDR) on 1 January 2013. Prior to the RDR, the cost of advice on pensions and investments was often covered by commissions, which in some cases led to inappropriate products being sold where higher levels of commission were on offer.

The RDR banned commission on pensions and investments, although this is still the main method of adviser remuneration for mortgages and pure financial protection policies. The idea behind banning commission was to make adviser charges more transparent and to increase consumer confidence in the advice process.

A fee for advice on pensions and investments must now be agreed in advance, which can either be paid directly by the client or facilitated by the recommended product provider. In the latter case the adviser charge is simply deducted from the money sent to the provider and paid to the planner, with the remaining funds invested.

There are four main methods of charging for advice:

1. Value Based charging

This style of charging is based on charging a certain percentage of the funds to be invested as an ‘implementation fee’. Typically, this charge is tiered, based on the amount being invested. For example, an initial adviser charge of 3% of investments up to £150,000, 2% up to £500,000, then 1% for higher amounts. Where ongoing advice is also being provided for regular reviews and other services on this basis, this would usually be expressed as a percentage of the fund value at the time of the charge, such as 0.5% per annum.

In truth, value based charging is not too different from the old pre-RDR commission system, where the standard charge may often have been 3% initial commission + 0.5% trail commission, reduced for higher amounts. The major difference is that, under the old commission system, all of the money sent to the provider could be invested, with the adviser’s initial commission being paid for by an additional charge levied to the client’s plan over a period of say 5 or 6 years instead.

This option almost always worked out to be a more expensive route for the client and usually involved an exit penalty should they cash in their investment before these charges had all been taken. This practice is now no longer possible for new investments.

Advantages

Both clients and financial planners may be more used to and comfortable with this style of charging, with it being similar to many pre-RDR commission structures

Simple to calculate

The charges for ongoing advice will automatically rise where the value of the portfolio increases and vice versa where the value decreases. This makes it almost a ‘performance related’ charge.

Disadvantages

Where market conditions deteriorate and the portfolio drops in value significantly, the value based charge may not be sufficient to cover any ongoing work involved

Charges may simply be aligned to the pre-RDR commission basis and may not reflect the actual work involved. This could lead to either over or undercharging the client

Not an option unless there...

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...tasks, particularly those that are compliance-related, and may question the time involved or even having to pay for them at all. They may also be afraid that some tasks were being carried out solely to generate fees

More administration involved, for example recording everyone’s time, generating and chasing invoices.

3. Fixed Fees

Fixed fees are most often used for specific kinds of work, for example lifetime cashflow modelling, ad hoc valuations or producing certain kinds of reports. They are usually based on an estimate of the number of hours involved but provide the client with more peace of mind than an hourly rate as the total is known beforehand. The financial planner will also know in advance how much they will receive for the work involved and can budget accordingly. Generally speaking, fixed fees are likely to be used where the time involved is fairly predictable.

Advantages

Planner is protected against drops in income caused by falling markets

No suspicion of extra time being spent solely to generate fees

Predictability for both client and financial planner.

Disadvantages

Danger of over or undercharging the client where the time required varies considerably from the time expected

Charges more likely to need increasing each year in line with inflation

More difficult to establish appropriate charges

Fixed charges may seem more ‘random’ to the client.

4. Commission (for pure protection policies or ‘legacy trail commission’)

Payment by commission is still an option for advice on pure protection policies, such as critical illness, income protection or life insurance with no investment content. Financial planners may also continue, for the time being, to receive legacy trail commission, which is commission being paid on investment or pension products arranged prior to the RDR. Most changes made to such products however would trigger the rules on ‘disturbance’, which would lead to trail commission being turned off and a new adviser charging agreement being required in line with RDR rules.

Disturbance will not however occur in the case of:

Discretionary fund manager fund switches

Automatic portfolio rebalancing or fund switching (agreed pre-RDR)

Indexation related premium increases (agreed pre-RDR)

Re-registration of funds to another platform/manager (with no further changes)

Non advised fund switches or reinvestment of distributions/dividends.

Advantages

Simpler for both client and adviser

Client may feel that they are not paying anything for the advice (although in reality they are).

Disadvantages

Less transparent

Suspicion of commission bias, i.e. products being recommended because they offer higher commissions

Existing pensions and investments may deliberately remain unchanged to avoid triggering disturbance rules

Where protection products are cancelled in the early years, commission may be reclaimed by the provider on a pro rata basis leading to a loss of income for the financial planner.

What four methods of charging for advice might a financial planner offer?

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As we have learned in this opening chapter, the financial planner has a number of responsibilities at the beginning of the financial planning process,...

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... the six step process - gathering client data and determining goals and expectations. From this step, the ISO 22222 and CFP processes are aligned.

This revision test (opens in a new window)...

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...est will be added to your CPD certificate.