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M1 Financial Planning

M1 Financial Planning

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Published by: api-3814557 on Oct 17, 2008
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his chapter is designed to provide the tax professional or other
financial advisor with an overview of important financial

planning and investment issues for people nearing or in retire- ment. Since clients often turn to their tax professional for advice on these matters, it is important for tax advisors to be aware of the important issues and questions.

Tax professionals have often been serving clients for several years and are therefore in a good position to understand a client\u2019s financial picture in an objective manner. It is important to become aware of potential problems before they become prob- lems\u2014rather than doing so after the fact.

The key issues are as follows:
sDoes the retiree have enough investment assets to provide the

desired retirement income (after considering other sources of retirement income, such as Social Security and company pen- sions)?

sWill the client, spending at current levels, outlive his or her
Financial Planning
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sIs the client\u2019s investment portfolio structured in a way that is
appropriate for his or her financial situation?
This chapter is designed to help the advisor approach these ques-

The first part of this chapter is a discussion of asset allocation and investment considerations relevant for those at or in retire- ment. If the reader desires detailed information on topics regard- ing investments and portfolio management, excellent sources are available (see Zvi Bodie, Alex Kane, and Alan J. Marcus,

Investments,second edition, Homewood/Boston: Irwin, 1993;
and John L. Maginn, CFA, and Donald L. Tuttle, CFA, eds.,
Managing Investment Portfolios,second edition, Charlottes-

ville: Association for Investment Management and Research, 1990). Considerations regarding insurance are reviewed. Finally, other sources of income, such as reverse mortgages, are consid- ered. For detailed information on financial planning topics, excellent sources are also available (see David M. Cordell, ed.,

Fundamentals of Financial Planning,third edition, Bryn Mawr,
PA: The American College, 1996).
Asset Allocation
The Importance of Asset Allocation

Asset allocation refers to the mixture of broad asset classes in an investor\u2019s portfolio. In a simplistic sense, one can think of asset allocation as the overall ratio of bonds versus stocks in the investor\u2019s portfolio. An aggressive, growth-oriented portfolio (designed for a younger investor saving for retirement) might contain as much as 80% stocks. Short-run safety of principal would be sacrificed for longer-term growth opportunities. On the other hand, someone in retirement, who needs his or her portfolio to provide significant levels of income on a relatively risk-free basis, would hold a greater percentage of bonds and other income-producing investments in his or her portfolio, per-

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Asset Allocation3
haps 80% or more in many cases. Stability of capital would be
much more important for such an investor.

Asset allocation has a tremendous impact on the risk and return characteristics of a portfolio. Studies have shown that about 90% of a portfolio\u2019s risk/return profile is determined by asset allocation, and only about 10% by the actual securities that were selected within the broad asset classes. Therefore, it is important to focus on the client\u2019s overall portfolio mix, and not necessarily on his or her individual security holdings.

Setting appropriate asset allocation guidelines requires a review of the client\u2019s investment objectives and constraints. A portfolio can then be designed to best meet these needs. These objectives and constraints are discussed in the next section.

Investor Objectives and Constraints
Return Requirements and Risk Tolerance

What are the client\u2019s objectives with regard to rate of return and risk tolerance? Obviously, all investors want high returns with- out taking risk, but the laws of economics usually prevail against such outcomes. Sadly, to achieve higher returns, investors must be prepared and willing to bear higher levels of risk. Perhaps the best place to start when examining an appropriate asset alloca- tion is the investor\u2019s risk tolerance. Is the client bothered by fluc- tuations in value of his or her portfolio? Has the client tended to focus on safe or insured investments in the past, or does he or she have experience with riskier investments? Some clients may have discovered equities fairly recently, and as a result may have unrealistic expectations regarding the risk of these investments. On the other hand, those who experienced the 1970s and the associated debacle in financial assets are aware of the downside risk of bonds and stocks.

What are the investor\u2019s return requirements? Consideration must be given to the client\u2019s level of wealth, other sources of retirement income, and goals regarding retirement lifestyle.

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