Question

Many financial planners believe in the “life cycle approach” to preparing personal financial plans for their clients. This approach is based on the hypothesis that as people age, their objectives change along with their financial and personal circumstances, their investment knowledge and their risk tolerance.

REQUIRED

1. If the life cycle approach/hypothesis is correct, then why are financial planners required to spend so much time following the “know your client” rule when it comes to determining the client’s goals and objectives.
2. The life cycle approach was developed in the 1950’s by several North American and European economists. Explain why this approach may no longer be appropriate when preparing a financial plan for a client in Toronto in the year 2020.

Answer 1

a.

• The financial life cycle divides an individual’s life into three stages, each of which is characterized by different life events. Each stage also entails recommended changes in the focus of the individual’s financial planning:

  1. In stage 1, the focus is on building wealth.
  2. In stage 2, the focus shifts to the process of preserving and increasing the wealth that one has accumulated and continues to accumulate.
  3. In stage 3, the focus turns to the process of living on (and, if possible, continuing to grow) one’s saved wealth.
• According to the model of the financial life cycle, financial planning begins in the individual’s early twenties, the age at which most people choose a career—both the sort of work they want to do during their income-generating years and the kind of lifestyle they want to live in the process.

Life-cycle funds are asset-allocation funds in which the share of each asset class is automatically adjusted to lower risk as the desired retirement date approaches. For example, suppose that you invest in a life-cycle fund with a target retirement date of 2050 in 2020. At first, the fund will be aggressive. In 2020, the fund might hold 80% stocks and 20% bonds. Each year, there will be more bonds and fewer stocks in the fund. By 2035, you should be halfway to the retirement date. The fund would be 60% stocks and 40% bonds in 2035. Finally, the fund would reach 40% stocks and 60% bonds by the target retirement date of 2050.

Every Individual has different Obejectives, risks, existing wealth, etc. It is primary responsibility of Portfolio manager to understand these variables and understand the client. No single standard approach works for all clients. Thus it is important to spend sufficient time to know the client while determining the client’s goals and objectives.

b. SInce 1950, many investment planning tools have been formulated like Pension, etc. In 2020, many people have been building retirement corpus from the day they have started working. Also, they Job stability and Economic stability has improved. In short, entire dynamics of Investment objectives, risks, etc have changed. Hence, life cycle approach developed in the 1950’s may no longer be appropriate when preparing a financial plan for a client in Toronto in the year 2020.