When asking a new client what financial planning is, I am usually met with a blank stare. It’s a vague term accompanied by many stereotypes. However in markets like the US and the UK, financial planning has become a fee-based profession. When you engage a financial planner you’re essentially paying money to save money. But does it work? What do financial planners do? And, as more people embrace DIY investing, is it worth hiring one?

Business woman standing against the windows

The first thing to note is that financial planning is a multi-disciplinary profession. There’s more than one way to measure planners’ value. They are investment managers, tax advisers, life planners and councilors – all rolled into one with a focus on your personal financial well-being. Through this integrated offering they add value in two principal areas – tax planning and investment management. Here’s how.

Tax planning

Domestic and cross border tax planning is one of the most complicated tasks imaginable, and where financial planners really prove their worth. The tax environment in most developed countries is subject to a greater rate of change now than ever before. Tax incentives are being used, removed and re-applied in different forms. Anti-avoidance legislation is increasingly complex as common reporting standards between countries interact with domestic legislation. The most significant tax savings we generate for clients is through the avoidance of tax errors. Retail investors need to pay heed to a stark truth: you don’t know what you don’t know. Making significant financial decisions without the input of a qualified adviser can result in unforeseen tax bills.

Investment management – four essential building blocks

The second main area financial planners add value is investment management. Some would argue that in an era of low cost index trackers people don’t need planners to run portfolios. However the cost of the fund is only part of the cost of the total solution. Once again, this isn’t a world you should enter without knowing what you’re doing:

1. Wrapper selection

What form does the fund take? (Pension? Offshore or onshore investment bond? Corporate wrap?) Each wrapper changes the tax treatment of the money going in, the money going out and the tax treatment of the growth. Wrappers also vary in the access they provide to the cash. Financial planning is the process of understanding how to use a range of different wrappers to create tax efficiency against an evolving set of personal circumstances. The issues to focus on in the accumulation phase are considerably different to the draw down phase. 

2. Choosing a custodian or platform

The funds you buy must be held in safekeeping by a custodian. If you buy them directly from the fund manager you will pay a very high entry charge that is avoidable if you retain a financial planner. This is because fund managers don’t want to deal with retail clients directly.

3. Asset Allocation

Next, investors need to consider portfolio construction. This explains 90% of the investment returns you achieve so you need to get it right. Asset allocation is the allocation of your investment pot toward different asset classes like equities, bonds, property, alternatives etc. Clients with self-managed portfolios are often too influenced by the financial press: this means they end up holding an asset allocation that is incompatible with their actual risk profile or capacity for loss. A good grounding in economic history helps to wash off the effects of the daily information soak. Experience and clear goals are needed to build a long-term investment plan.

4. Choose your strategy – active or passive or both?

Here we choose the method by which we access the exposure to the different asset classes. There are a bewildering array of strategies and fund designs which can be divided largely into two camps – actively managed collectives vs passively managed collectives. Active managers rely on their skill to try to pick winning stocks and generally hold smaller holdings of stocks or instruments. Passive managers put their trust in the market, and buy the equity or bond market by its composition (i.e. market capitalisation in equities and bond issuance by bond markets). A third option called Smart Beta is becoming popular. These are passive funds which modify the composition of the market in ways that are proven by academia to boost returns without resorting to the expensive business of stock selection. Our research (and that of academics) suggests that active fund managers’ performance (relative to the market, passives and smart beta) are very influenced by changes in fund size and overall market volatility. The case for passive investments in bond markets is also less clear than it is in equity markets.

Once you have decided which areas of your portfolio will be active and which passive you need to build your asset allocation for the various short, medium or long term investments you have. Which areas of your portfolio should be allocated to equities, bonds, property, and alternative investments? Within each of those areas there are sub-sectors that require an allocation decision. The asset allocation needs to be matched to both the risk appetite and the capacity for loss. The problem that many retail investors face here is that although many people have an idea of their own risk appetite, very few grasp their capacity for loss.

This requires an independent perspective. Experienced financial advisers have seen too many cases of clients losing more money than they could afford. We are trained sceptics weathered by the changeable nature of financial markets and long term effects of short term losses. We think of personal finance in the context of lifetimes. It’s very hard to take that helicopter view of one’s own situation.

The above journey through the layers of financial planning has hopefully demonstrated the value of having your own financial planner. No matter how tempting it is to cut corners, a trusted relationship with a financial adviser is both cost effective and valuable for the peace of mind it offers.

For more information on the topics covered in this post, or for any other wealth-related queries, you can contact us on +44 (0) 20 7759 7519 or email our wealth team.

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