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The process of financial planning uncovers far more about a client's situation than a normal investment onboarding process ever could.Pekic/iStockPhoto / Getty Images

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The number of advisors offering financial planning either directly or through a specialized team at their dealer continues to grow. That’s the good news. The bad news is that there’s an inherent problem with when financial plans are delivered in the client relationship, as the vast majority are produced only after the investment or other solutions are implemented.

When a doctor performs surgery before taking the time to diagnose the patient’s condition properly, that’s known as malpractice. Yet, in the financial services industry, it’s the norm to onboard a new client’s investments with as little as basic know-your-client data and a Fund Facts page.

If the scope of engagement is one of simply investing the client’s money, then there’s an argument to be made that this is “sufficient.” But if financial planning is included in engagement, then this order makes little sense.

A diligently composed comprehensive financial plan involves a deep dive into both the quantitative realities and goals, but also the larger qualitative aspects of who the client is. Once completed, the process leaves the advisor with a deep understanding of the client’s financial circumstances as well as who they are as people.

The process of financial planning is also incredibly important to the successful implementation of a client’s portfolio as it uncovers far more about their situation than a normal investment onboarding process ever could.

These potential discoveries can arguably be broken down into four key areas: goals-based investing, optimization, human capital, and philosophical.

The purpose of goals-based investing and optimization

Different goals have unique timelines and diverse pools of capital need to reflect that, or the entire portfolio needs to account for these in aggregate.

Yes, basic questions about “what is this money for” can be asked, but only through the completion of a comprehensive financial plan can other aspects of goals – such its progress, probability of success, and the capacity of assets to take on risk without failing to reach the goal – be answered.

In fact, the only true test of measuring an investor’s risk capacity, a requirement for advisors under the client-focused reforms, is to stress test their ability to meet planning goals within the context of at least a rudimentary goals-based financial plan.

Comprehensive financial plans with stress tests like market corrections and Monte Carlo simulations are arguably the most comprehensive way of determining a client’s capacity for risk.

Meanwhile, clients often come with sub-optimal allocations of capital among different account types such as failing to fund registered retirement savings plans and tax-free savings accounts to the optimal amount. Or holding debt, while investing more than enough in taxable assets out of a preference not to pay off one with the other. They fail to realize that if they paid off the debt, borrowed that money again, and invested the proceeds, it would make the interest tax-deductible.

All of that can be discovered and corrected in a financial plan.

The role of human capital and philosophical

Human capital, defined loosely as the present value of the investor’s future earnings, also bears consideration in the design of a client’s portfolio. Particular attention needs to be paid to the volatility of the investor’s earnings.

This concept is detailed clearly in Moshe Milevsky’s book Are You a Stock or a Bond: Identify Your Own Human Capital for a Secure Financial Future. Some people’s careers have highly secure and stable earnings, which are bond-like in nature, while others have more volatile earnings, which are more stock-like in nature.

The present value of future earnings and their volatility should be factored into any portfolio recommendation and, again, speak to a client’s risk capacity.

Furthermore, polls are coming out constantly showing investors care about responsible investing but their advisors have not asked them about it. Yet, most advisors claim they have had this conversation.

Clearly, there is a disconnect here, and that’s likely a sign of other disconnects that could affect portfolio recommendations. These preferences could be uncovered in a comprehensive financial planning process.

Reviewing all of this after the investment recommendations have been made is a sure way of increasing the probability that the initial advice advisors gave was wrong.

The issue with ‘free’ financial planning

Another problem with the way financial plans are provided is that they’re often offered as “free” on the condition advisors get to manage the clients’ assets.

Yet, financial plans are not free. Calling them free is about as honest as an airline telling you the snacks are “complimentary” when you fly with that company.

There is a small, but growing, group of advisors in Canada who are reversing this paradigm. They’re putting the horse before the cart and creating financial plans as the first step. In the U.S., it’s a far more common phenomenon, and all make sure they are compensated adequately for their work by charging for the financial plan.

Yes, in a world of fee sensitivity, people are charging upfront fees for what others are giving away for “free.” Why? Because when clients are told that creating a financial planning first makes sense, they get it.

After all, when you go for a surgical consult, do you want to go with the doctor who reviews all your health data or the one who pulls out their scalpel as soon as you walk in?

Jason Pereira is a partner and senior financial consultant at Woodgate Financial Inc., a financial planning firm under the IPC Securities Corp. umbrella in Toronto, and president of the Financial Planning Association of Canada.

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