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Introduction to Financial Planning Virtual Class 1 of 3

Introduction to Financial Planning Virtual Class 1 of 3. Financial Planning Process, Time Value of Money and CFP Board Code of Ethics. Financial Planning Process. Gives direction to your financial decisions.

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Introduction to Financial Planning Virtual Class 1 of 3

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  1. Introduction to Financial PlanningVirtual Class 1 of 3 Financial Planning Process, Time Value of Money and CFP Board Code of Ethics Introduction to Financial Planning: Session 1 of 3

  2. Financial Planning Process • Gives direction to your financial decisions. • Helps assess the short, medium, and long-term effects of every financial decision on your life goals. • A lifelong process called “life-cycle planning” Introduction to Financial Planning: Session 1 of 3

  3. The Spokes of a Wheel • Time Value of Money and economic environment • Insurance planning • Investment planning • Income tax planning • Retirement planning, and • Estate planning When the rubber meets the road, are all the spokes in place? Introduction to Financial Planning: Session 1 of 3

  4. What Drives the Financial Plan? • Each person has his/her own unique facts and circumstances. • One size does not fit all. Determine each person’s wants and needs to assess if reasonable and attainable. • Understand the issues. Seek expert advice when applicable. • There is no “right” answer or solution, only “good,” “better,” and “best.” Provide alternatives. Introduction to Financial Planning: Session 1 of 3

  5. Is a Guitar Just a Guitar? • 1959 Gibson Sunburst Les Paul Standard • 1952 Gibson Gold Top Les Paul Standard • 1952 Fender Telecaster • 1957 Fender Stratocaster • 1927 Gibson L-5 • 1938 D’Angelico New Yorker • 1960 Gibson ES-335 • 1955 Gretsch White Falcon • 1944 Martin D28 Introduction to Financial Planning: Session 1 of 3

  6. The Financial Planning Process • Establishing Client-Planner Relationship • Gathering Data; Determining Goals and Expectations • Determining Client's Financial Status • Developing and Presenting the Financial Plan • Implementing the Financial Plan • Monitoring the Financial Plan Introduction to Financial Planning: Session 1 of 3

  7. Time Value of Money White keys on top row of the HP-12C • n = Compounding periods • i = Interest rate per compounding period • PV = Present value • PMT = Annuity • FV = Future value Introduction to Financial Planning: Session 1 of 3

  8. Uneven Cash Flows • CHS – used to input cash flows received as a positive number and cash flows paid as negative • g CFo – represents a cash flow at time zero • g CFj – represents a cash flow after time zero • g Nj – used for repeating the same cash flow Introduction to Financial Planning: Session 1 of 3

  9. Time Value of Money (TVM) • Helpful to understand the math in computing TMV problems, but not necessary. Know how to use the HP-12C! • Can compute any variable when the other variables are given. • In practical situations, the preferred application is not to calculate an exact answer, but to determine if a goal can be met (e.g., saving for retirement in 30 years, using an i of 8%, is not realistic). Introduction to Financial Planning: Session 1 of 3

  10. Present Value Definition: What a sum of money to be received sometime in the future is worth in today’s dollars, based on a specific discount rate. Introduction to Financial Planning: Session 1 of 3

  11. Poll Question #1 If a 1959 Les Paul Guitar is worth $350,000 today, assuming a 15% rate of return calculated annually over 50 years, what was the guitar initially worth in 1959? • $203 • $323 • $528 • $989 Q&A in 2 slides Introduction to Financial Planning: Session 1 of 3

  12. Poll Question #1 If a 1959 Les Paul Guitar is worth $350,000 today, assuming a 15% rate of return calculated annually over 50 years, what was the guitar initially worth in 1959? • $203 • $323 • $528 • $989 The correct answer is $322.98 or $323. Note, your display may show a negative number! Keystrokes are: n = 50; i =15; FV = $350,000 Q&A in 2 slides Introduction to Financial Planning: Session 1 of 3

  13. Future Value Definition: The future amount to which $1 today will increase, based on a defined interest rate and period of time. Q&A Next Slide Introduction to Financial Planning: Session 1 of 3

  14. Poll Question #2 Assuming the same 15% annual return, what will the $350,000 Les Paul Standard guitar be worth 50 years from today, in the year 2059? • $323 • $604,070 • $379,280,105 • $604,069,873 Q & A Introduction to Financial Planning: Session 1 of 3

  15. Poll Question #2 Assuming the same 15% annual return, what will the $350,000 Les Paul Standard guitar be worth 50 years from today, in the year 2059? • $323 • $604,070 • $379,280,105 • $604,069,873 The correct answer is $379,280,105. The keystrokes are: n = 50; i = 15; PV = ($350,000) Q & A Introduction to Financial Planning: Session 1 of 3

  16. Communicating TMV Results • When setting a goal, most laymen will have a better grasp of present value than future value. • For example, it is easier to explain to clients that a monthly savings of $1,475 is needed over the next 30 years than telling them they need $3,000,000 for retirement, using a 9.5% rate of return compounded monthly. Introduction to Financial Planning: Session 1 of 3

  17. Ordinary Annuity and Annuity Due • A systematic payment occurring at the beginning of each compounding period is an annuity due; however, it is an ordinary annuity when the annuity occurs at the end of each compounding period. (Use PMT key) • g BEG – Annuity due (starts now) • g END – Ordinary annuity (starts at the end of each period) Introduction to Financial Planning: Session 1 of 3

  18. Annuity Due Year 0 Year 2 Year 3 Year 4 Year 1 $100 $100 $0 $100 $100 Ordinary Annuity Year 0 Year 2 Year 3 Year 4 Year 1 $100 $100 $100 $0 $100 Introduction to Financial Planning: Session 1 of 3

  19. When to Use • The g BEG will display “BEGIN” • Used for cash outflows for college funding, retirement funding, gifting, and insurance premium payments. • Used for cash inflows received from Social Security benefits, pensions, retirement planning, and disability payments. Introduction to Financial Planning: Session 1 of 3

  20. Poll Question #3 Assuming you have $750,000 saved at retirement, what would the monthly annuity payment be, assuming a 30-year period and a 5.25% rate of return? • $4,123.49 • $4,141.53 • $47,684.28 • $50,187.70 Introduction to Financial Planning: Session 1 of 3

  21. Poll Question #3 Assuming you have $750,000 saved at retirement, what would the monthly annuity payment be, assuming a 30-year period and a 5.25% rate of return? • $4,123.49 • $4,141.53 • $47,684.28 • $50,187.70 The correct answer is $4,123.49. When receiving payments in retirement you assume they begin at the beginning of each period (an annuity due). The keystrokes are: n = 360 (30 x 12 or “g” “n”); i = .4375 (5.25 / 12 or “g” “I”); PV = ($750,000); g BEG for the annuity due function. Introduction to Financial Planning: Session 1 of 3

  22. Annuity Concepts Due to the passage of time: • The funding of a future value will be smaller for annuity due than an ordinary annuity (which is why you start funding goals today)! • The payment received from an annuity due will be smaller than an ordinary annuity. Introduction to Financial Planning: Session 1 of 3

  23. Net Present Value (NPV) • NPV is used to evaluate the cash flows associated with capital projects and capital expenditures. • The method discounts the future cash flows at an appropriate discount rate and allows the present value of the inflows to be compounded to the present values of outflows. Introduction to Financial Planning: Session 1 of 3

  24. (Continued) NPV • Use time lines to schedule cash flows. • Don’t forget to enter the discount rate for “i” (usually an annual rate). • Use the g CFo, g CFj, and g Nj keys for inputting information. • Calculate the result using f NPV. Introduction to Financial Planning: Session 1 of 3

  25. (Continued) NPV What does the result tell us? • If the answer is positive, then undertake the investment. The actual “i” > the required “i.” • If the answer is negative, do not undertake the investment. The actual “i” < the required “i.” • If the answer is zero, then undertake the investment. The actual “i” = required “i.” Introduction to Financial Planning: Session 1 of 3

  26. Poll Question #4 Assume you pay $100 for a stock which provides the following cash flows at the end of each year: • Year 1 = $5 • Year 2 = $6 • Year 3 = $7 • At the end of Year 3, you sell it for $110. Ignoring taxes, would you purchase this stock, assuming your required return is 8.25%? • ($4.63) • $1.98 • $195.37 • $201.98 Hint Next Screen Introduction to Financial Planning: Session 1 of 3

  27. Cash Flow Year 0 Year 2 Year 3 Year 1 $6 Dividend Received $7+$110=$117 Dividend Received + Sale of Stock ($100) Original Cash Outlay $5 Dividend Received Q&A in 2 slides Introduction to Financial Planning: Session 1 of 3

  28. Poll Question #4 Assume you pay $100 for a stock which provides the following cash flows at the end of each year (write these down): • Year 1 = $5 • Year 2 = $6 • Year 3 = $7 • At the end of Year 3, you sell it for $110. Ignoring taxes, would you purchase this stock, assuming your required return is 8.25%? • ($4.63) • $1.98 • $195.37 • $201.98 The correct answer is $1.98. The keystrokes are on the next screen. Q&A Next Slide Introduction to Financial Planning: Session 1 of 3

  29. Cash Flow Year 0 Year 2 Year 3 Year 1 $6 Dividend Received $7+$110=$117 Dividend Received + Sale of Stock ($100) Original Cash Outlay $5 Dividend Received Keystrokes: 100 CHS g CF o 5gCF j 6gCF j The Calculator Returns: 1.9756 117gCF j 8.25 if NPV Q & A Introduction to Financial Planning: Session 1 of 3

  30. Internal Rate of Return (IRR) • The method discounts the future cash flows at an appropriate method used to determine the exact discount rate to equalize cash inflows and outflows of a specific investment or project. • Allows the financial planner to compare computed rate to required rate of return. • The IRR calculation assumes the reinvestment rate is the IRR. Introduction to Financial Planning: Session 1 of 3

  31. Poll Question #5 (using same facts as #4) Assume you pay $100 for a stock which provides the following cash flows at the end of each year: • Year 1 = $5 • Year 2 = $6 • Year 3 = $7 • At the end of Year 3, you sell it for $110. Ignoring taxes, what is the internal rate of return (IRR)? • 6.87% • 7.26% • 9.00% • Not Enough Info Hint Next Screen Introduction to Financial Planning: Session 1 of 3

  32. Cash Flow Year 0 Year 2 Year 3 Year 1 $6 Dividend Received $7+$110=$117 Dividend Received + Sale of Stock ($100) Original Cash Outlay $5 Dividend Received Introduction to Financial Planning: Session 1 of 3

  33. Poll Question #5 (using same facts as #4) Assume you pay $100 for a stock which provides the following cash flows at the end of each year: • Year 1 = $5 • Year 2 = $6 • Year 3 = $7 • At the end of Year 3, you sell it for $110. Ignoring taxes, what is the internal rate of return (IRR)? • 6.87% • 7.26% • 9.00% • Not Enough Info The correct answer is 9.00%. The keystrokes are on the next page. Introduction to Financial Planning: Session 1 of 3

  34. Cash Flow Year 0 Year 2 Year 3 Year 1 $6 Dividend Received $7+$110=$117 Dividend Received + Sale of Stock ($100) Original Cash Outlay $5 Dividend Received Keystrokes: 100 CHS g CF o 5gCF j 6gCF j The Calculator Returns: 8.9934 117gCF j f IRR Introduction to Financial Planning: Session 1 of 3

  35. NPV vs. IRR • The NPV is considered a superior model to IRR when comparing investment projects of unequal lives. Why? Because investing at the required rate of return is more reasonable than at the IRR. • With changes of more than two inflows/outflows in an investment project, there is only one NPV, but multiple IRRs. Introduction to Financial Planning: Session 1 of 3

  36. Poll Question #6 Assume a client’s required rate of return is 6.75%. Starting today, the following cash flows are needed in retirement: • $20,000 for Years 0 – 5 • $35,000 for Years 6 – 10 What is the net present value (NPV) of this cash flow stream? • $186,775 • $199,382 • $206,775 • Not Enough Info Hint Next Screen Introduction to Financial Planning: Session 1 of 3

  37. Cash Flow Year 0 1 2 3 4 5 6 7 8 9 10 $20,000 $20,000 $35,000 Annual Cash Flow Annual Cash Flow Introduction to Financial Planning: Session 1 of 3

  38. Poll Question #6 Assume a client’s required rate of return is 6.75%. Starting today, the following cash flows are needed in retirement: • $20,000 for Years 0 – 5 • $35,000 for Years 6 – 10 What is the net present value (NPV) of this cash flow stream? • $186,775 • $199,382 • $206,775 • Not Enough Info The correct answer is $206,775. The keystrokes are on the next page. Introduction to Financial Planning: Session 1 of 3

  39. Cash Flow Year 0 1 2 3 4 5 6 7 8 9 10 $20,000 $20,000 $35,000 Annual Cash Flow Annual Cash Flow Keystrokes: 20,000 g CF o 20,000 g CF j 5gN j 35,000 g CF j The Calculator Returns: 206,775.65 5gN j 6.75 i f NPV Introduction to Financial Planning: Session 1 of 3

  40. Template Modeling TVM calculations using the math formulas can be integrated into template format. For example, assume a client presents you with a fact pattern and you need to create an accept or reject proposal. See NPV Excel worksheet. Introduction to Financial Planning: Session 1 of 3

  41. Serial Payments Definition: a payment that increases at a constant rate (usually inflation) on an annual basis. • Some investors are more comfortable increasing payments or deposits on an annual basis since they expect an increase in salary or wages with which to make increasing payments. • Examples include investment deposits, life insurance premiums, educational needs, and retirement needs. Q&A In 2 slides Introduction to Financial Planning: Session 1 of 3

  42. Serial Payment Example What is the present value of $100 in today's dollars in three years, assuming inflation at an 3.5% rate and that the annual average after-tax rate investment is 9%, computed as a yearly compound rate? Q&A Next Slide Introduction to Financial Planning: Session 1 of 3

  43. (Continued) Serial Payment Example • Let’s go to the Internet and see a blog posting I created on December 18, 2007, for the solution. http://online-financial-planning.blogspot.com Q & A Introduction to Financial Planning: Session 1 of 3

  44. CFP Board's Code of Ethics and Professional Responsibility and Disciplinary Rules and Procedures • The Board’s Standards of Professional Conduct are found at: http://www.cfp.net/Downloads/2009Standards.pdf • Provided in a 47-page booklet. Introduction to Financial Planning: Session 1 of 3

  45. The 7 Principles ICan Obtain the CFPDesignation! • Integrity • Competence • Objectivity • Confidentiality • Fairness • Professionalism • Diligence Introduction to Financial Planning: Session 1 of 3

  46. CFP Board’s Standards of Professional Conduct • Memorizing section numbers and other references not necessary. • Know the essence of the principles and standards and how to apply the rules. For example, it’s important to know that a certificant shall not borrow money from a client. This is Section 3.6 of the Rules of Conduct. Introduction to Financial Planning: Session 1 of 3

  47. Practice Makes Perfect • With a little practice, you will master the time value of money and cash flow questions. • Don’t panic. Print out the poll questions; through repetition you will master the keystrokes! Introduction to Financial Planning: Session 1 of 3

  48. Rules of Conduct • Be aware of all six sections. • Violations of the Rules of Conduct may subject a certificant or registrant to discipline! • Rules are designed to protect the public. • Rules are binding on all certificants. Introduction to Financial Planning: Session 1 of 3

  49. Rules of Conduct – Section 1 Defining the relationship with the prospective client or client: • Defining goals, needs and objectives, • Gathering and providing appropriate data, • Examining the result of the current course of action without changes, • The formulation of any recommended actions, • Implementation responsibilities, and • Monitoring responsibilities. Introduction to Financial Planning: Session 1 of 3

  50. Rules of Conduct – Section 1 If the services include financial planning or material elements of the financial planning process, the certificant or the certificant’s employer shall enter into a written agreement governing the financial planning services (“Agreement”). Introduction to Financial Planning: Session 1 of 3

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