CHAPTER 19

1. CHAPTER 19 Statement of Advice Construction

2. OVERVIEW • A well produced SOA provides clear evidence of the value of advice. • The first step is to engage with the client to collect data and analyse it. • The SOA must be developed in a logical and compliant manner. • The advice must relate to client goals, needs and expectations. • Recommendations must be clear, specific and fully justified. • Appropriate disclosures, disclaimers and warnings must be included. • Communications must be clear, concise and appropriate for each particular client.

3. Principles of Preparing Advice • Effective data collection and client discussions mean that advisers can show they have a basis for advice. • Standardised risk tolerance assessment and matching of recommendations to the client’s risk tolerance will lower the business risk of having unhappy and litigious clients.

4. Principles of Preparing Advice • Plans and strategies should be kept as simple as possible within the requirement to meet the client’s goals, if possible. Complexity should only be added if a simple plan will not achieve the client’s goals. • Where a client is provided with full information regarding strategies and recommendations, the client can make his or her own decisions about what actions to take. This is called informed consent. It shifts the final decision making from the financial adviser to the client. The client is then responsible for the outcomes.

5. Principles of Preparing Advice • In this chapter, we will use the term financial adviser to encompass both authorised representatives and employee representatives. • The Financial Services Reform Act 2001 (Cth) introduced the requirement to provide clients with a Statement of Advice (SOA). A full SOA will exceed the requirements at law for a Statement of Advice. We will use the abbreviation SOA to denote a full Statement of Advice.

6. Steps in the Financial Planning Process In Chapter 2 we considered the steps necessary to construct a comprehensive SOA. They were: • Step 1 — Collect and assess the financial data of the client. • Step 2 — Determine the objectives and goals of the client. • Step 3 — Identify any financial problems that may exist. • Step 4 — Prepare a written plan which contains alternatives and recommendations. • Step 5 — Implement the agreed written plan. • Step 6 — Review the plan.

7. Step 1 — Collect Client Data • Clients will be a diverse group, with different backgrounds, experiences, resources, concerns and goals: each will present a unique challenge. It is both a legal requirement and common sense for the financial adviser to be aware of the client’s specific circumstances.

8. Life cycle Each life stage presents differing issues and problems. There are a number of identified life stages: • savings versus consumption phase — generally younger people, trying to get established, new jobs, wanting cars, saving for home, enjoying life; • early family formation — young families, both partners may be working, issues with mortgage payments, child care, school fees, need for insurance, trying to stretch their budgets;

9. wealth accumulation phase — the mortgage is not taking up so much of their income, they are earning higher salaries, balancing work and leisure, assisting their children, creating personal wealth and saving for their retirement; • approaching retirement — generally associated with people in their early fifties up to age 65 — people seeking to maximise their retirement savings so that they can comfortably fund their retirement income needs; • post-retirement — managing income needs to ensure a lifelong comfortable retirement.

10. Quantitative data The information in this category includes: • financial data – this includes the client’s individual income and expenditure statement as well as a personal balance sheet; • personal information as to age and investment time horizons; and • financial objectives — the client provides details as to the level of future income required in order to maintain his or her desired lifestyle.

11. Assessed Data The information in this category includes: • Risk Tolerance Assessment • Financial Literacy Assessment

12. Qualitative data The information in this category includes: • goals and objectives; • issues and concerns; and • preconceptions as to the client’s needs in retirement.

13. Steps 2 and 3: Determine the Client’s Objectives and Goals and Identify any Financial Issues • The financial adviser has to work with the client to determine his or her goals and objectives both for the short term and long term. It is important to determine if the goals and objectives are attainable given the client’s current and expected financial resources.

14. If, after analysis, some goals are unattainable or not obtainable within the time frame the client has set, then the financial adviser must work with the client to determine trade-offs and prioritise the goals. • Clients may have unstated goals, which the financial adviser may have trouble uncovering. These can only be identified through extensive questioning of the client and sometimes only through observation of the client’s body language and facial reactions when questioned or when certain issues are discussed.

15. The financial adviser will have to seek: • points of clarification; • assurance and verification that the data has been interpreted correctly; and • discussion regarding clashing objectives. Generally speaking, clients will have to consider: • saving more and spending less – saving smarter and more tax effectively; • working longer – postponing planned early retirement; • accepting a lower income in retirement; or • accepting a higher level of investment risk seeking higher levels of return.

16. Assumptions • The financial adviser will have to make certain assumptions in order to develop the strategy and recommendations for the client. • The financial adviser must ensure that the client understands the need for these assumptions and how they will impact the advice being given. • These assumptions need to cover personal events in the future, ongoing receipt of current income levels, and continuation of good health. • They also need to include assumptions about the behaviours of markets, regulations, inflation etc. • These assumptions will need to be tested at each annual review.

17. Step 4: The preparation of a written plan Most SOAs are written with a standardised format. To start they have: • a personalised and complying covering letter; • a standardised and complying cover page; • an Executive Summary that provides the client with a general understanding of the actions recommended and a summary of expected outcomes; and • a Table of Contents that clearly outlines the structure of the SOA.

18. Covering Letter • The covering letter should use professional but not necessarily formal language. The language you use for this letter, as in the rest of the written plan, should be clear and concise and readily understandable to the client. • The covering letter should: • be written on letterhead with contact information (address, telephone number, email etc) • include the name of the licensee and its licence number and ABN; and • be signed by the financial adviser, stating that he or she is an Authorised Representative (or Representative)of the Licensed Dealer.

19. Covering Letter • This letter should invite the client to contact the financial adviser if any of the information is incorrect or if the client requires clarification of any of the issues or recommendations. • It also needs to warn the client that decisions regarding implementation of the SOA must be made within 30 days. After that, it may need to be reviewed to ensure that any changes over that time will not affect the recommendations that have been made. • It is also important to get the client to understand the need for annual reviews.

20. Cover Page All SOAs require a cover page that provides the following information: • that it is a Statement of Advice; • the name of the plan recipient; • the date that the plan becomes effective; • the name and contact details of the financial adviser who provided the plan; • the name and contact details of the licensee who authorised the SOA;

21. Cover Page • a statement that the plan is private and confidential; and • a warning box that reminds the client that this is an important document, that it should be read carefully and in full, that if the client has any questions the client should speak with the financial adviser, and any information required about cooling off periods.

22. Executive Summary • The Executive Summary should be no more than two pages in length and in bullet point form. • The Executive Summary sets out the key personal details of the client, so the client can see that the financial advisor has understood his or her position. • The second section summarises the client’s goals and objectives, in his or her terms, so the client can see that the financial advisor understands what is wanted from the SOA and the planning process.

23. Executive Summary • The next section needs to state each main recommendation, who is to act, how much money is involved, where the money is to come from. • The final section, after providing a warning in relation to projections, needs to state the expected outcomes from each investment portfolio, including retirement savings, and confirm likely goal achievement, including adequate retirement income past the client’s life expectancy.

24. Table of Contents • This page clearly outlines the structure of the plan and can be used in future to locate specific sections of the plan. • Make sure all pages are numbered, even those in appendices. • Keep to major headings so that the plan does not seem to be overly complex.

25. Body The body of the SOA usually has six distinct parts: • the basis for advice: client details, assumptions, discussion of risk tolerance and asset allocation and, potentially, a source of funds and a use of funds table; • the recommendations, their justification, their impact on the client’s cash flow and net worth, and a cost-benefit and risk analysis; • an implementation schedule; • disclosures and disclaimers; • client sign-off (Authority to Proceed); and • appendix (including product disclosure statements).

26. The Basis for Advice • This section provides the information upon which the financial adviser has based his or her advice. If this section is not completed fully and then used to make recommendations, the advice provided will be inappropriate. This section must have: • a clear and concise restatement of all of the pertinent client information; • an estimated cash flow for the current financial year that identifies any excess savings capacity which the client can use to fund goal achievement;

27. The Basis for Advice • a chart showing the client’s assets and liabilities; • an analysis of the client’s current investments (including superannuation); • a full discussion of the client’s personal risk tolerance, what asset allocation he or she would prefer to hold and what benchmark asset allocation the client will need to accept if he or she is going to achieve stated goals; • a list/discussion of all personal and financial assumptions; • a discussion of the client’s concerns and issues that may impede goal achievement; and • a source and use of funds chart if it will clarify the client’s situation and the funds available for investing.

28. Cash flow, assets and liabilities • The core of every SOA is a statement and analysis of the client’s current cash flow which sets out his or her income and expenditure and indicates available cash after all expenditures have been met. The financial adviser can then use that cash flow to meet the client’s goals and create future wealth. • The financial adviser needs to ensure that the client has an emergency fund set aside to meet any unexpected needs for immediate cash. • An assets and liabilities table can provide a significant amount of information. The financial adviser should be able to see what the client owns, any debt, when the debt is expected to be paid, what cash the client has and what other investments are held. With this knowledge, the financial adviser can move to reduce debt, recommend sale of non-performing assets and, hopefully, free up funds for investment.

29. Risk tolerance assessment • The analysis of current investments should include a full discussion of the client’s personal risk tolerance, asset allocation preference and what benchmark asset allocation the client will need to accept to achieve his or her goals. • The result of the client’s risk tolerance should be a preferred asset allocation, based on the level of growth assets the client is comfortable with.

30. Assumptions It will be necessary for the financial adviser to make assumptions about the future and state these assumptions early in the plan. The financial adviser should ensure that the client reviews this section and understands the impact of these assumptions on the advice being provided.

31. Concerns and issues There will be specific concerns that the client will voice, questions they will ask and attitudes or financial situations which will impede goal achievement. It is important to summarise and settle these concerns and issues in writing within the SOA before beginning work on specific recommendations.

32. Source and Use of Funds Chart Sometimes it is necessary to move clients’ funds around in order to clear up debt, sell non-performing assets and identify funds available for investing. Where there are a number of cash movements, a Source and Use of Funds Chart will help illustrate these movements.

33. The RecommendationsStatement of Strategy The client needs to see a clear statement of the strategy behind the recommendations. The strategy must be flexible enough to deal with the likely changes of circumstances that most clients experience and be supported by recommendations which are detailed and specific to a client’s individual needs.

34. Risk Management and Insurance Cover Most financial advisers do not discuss insurance issues sufficiently with their clients. This discussion is essential, as appropriate and affordable risk cover can help to ensure that the client’s goals can be achieved, given that unforeseen events may cause financial loss. A full review, including estimated cover requirements, must be completed even if the client will be referred to a specialist for specific product advice.

35. Risk Management and Insurance Cover The discussion should include strategies for coping with: • the death of the client(s) and loss of financial stability for their dependants; • accidents causing permanent and total disablement to the client(s) or a dependant; • loss of the ability to earn an income due to illness or accident; • the costs associated with a traumatic illness; and • the need for private hospital cover.

36. Risk Management Strategies It is important to discuss strategies for risk management, such as: • avoidance or elimination of the risk (often not possible); • management and control – possible to some extent; can lower insurance premiums; • self-insurance; and • transfer of the risk.

37. Risk Management Strategies The process of assessment should be: • assessment of risks; • non-insurance solutions; • attribution of a dollar cost to the loss; • the offset of existing cover or savings; • determination of cover levels required; • matching product features to needs; • development of a full insurance plan for each individual and the family as a whole (where relevant); and • disclosure of indicative premium costs and their inclusion in cash flow.

38. Estate Planning • Most clients are uncomfortable discussing death, Wills and disposal of their wealth. • However, it is important to point out to clients the importance of having a written structure (a Will) to back up their wishes on the transference of their wealth. • While the adviser is not a legal practitioner, it is the adviser’s responsibility to discuss these matters with the client and prepare the client for a visit to an appropriate legal professional. • Such discussion should revolve around issues such as Wills, beneficiaries, trust mechanisms to preserve assets, insurances and other taxation structures, as well as Powers of Attorney.

39. Taxation • While no strategy should be recommended simply for tax reduction purposes, a financial adviser must thoroughly understand the tax implications of the recommended strategy and product selected. Advisers should seek to recommend tax-effective outcomes consistent with the client’s ability to accept legislative risk. • Wherever a discussion of taxation occurs, the financial adviser must clearly inform the client that he or she is not a tax adviser.

40. Investment Recommendations Investment recommendations first need to be generic and should move from the most tax-effective (usually superannuation) to the least tax effective (usually managed funds). Each recommendation must be referenced to the client’s risk tolerance asset allocation or the asset allocation agreed to by the client.

41. Investment Recommendations • Within the investment strategy, it is important to consider the most appropriate investment vehicles (tax structures), for example: • holding assets personally (direct investments); • unit trusts; • insurance bonds; • superannuation-based investments; and • retirement and non-retirement income streams. • For most clients, investment recommendations will be a mix of all of the above.

42. Superannuation, Retirement Planning and Social Security Issues • In relation to retirement planning, there are both financial and emotional considerations. • It is the role of the adviser to look at the client holistically and view retirement first as a lifestyle choice. • Retirement financial security and wealth preservation usually involves the best use of superannuation balances and possible social security benefits. • This section of the plan should also take into consideration such issues as changes in the ability to make additional contributions to superannuation and the changes to taxation and social security assessments.

43. Specific Product Recommendations • After the generic discussion on strategies, specific products must be recommended. It is necessary to clearly identify the characteristics of each product, the product provider and how the product matches the client’s risk profile and financial needs. • Each and every product should be fully justified, and a risk-benefit analysis completed so that the client can fully understand the risks that he or she may be taking and the benefits that he or she should be able to expect.

44. Post-Implementation Cash Flow • The client must be able to see that they can afford to implement the recommendations. • A post-implementation cash flow will show the client that he or she still has enough money to manage daily living requirements, even after implementing the recommendations. • It is important to include indicative costs for additional insurance and the cost of legal work and periodic reviews.

45. Fees and Commissions The regulatory environment and best practice require that a financial adviser disclose all fees and commissions to the client in dollar and percentage terms, including any pecuniary interest the adviser may have in any of the products recommended.

46. Fees and Commissions A financial adviser must disclose in writing: any remuneration including fees, commissions or any other pecuniary or non-pecuniary interests that are either direct or indirect in relation to the plan presented to the client or any other financial services (including any fees in dollar and percentage terms for the placement of investments (entry and exit fees) as well as the costs of review);

47. Fees and Commissions • any other benefit that might influence the recommendation of a particular investment (often called soft commissions, for example, a paid overseas holiday provided by a fund manager); • any benefit a third party might receive in relation to the recommendations being made; and • any other costs to be borne by the client.

48. Disclosure of Capacity The financial adviser reminds the client what areas of financial advice he or she may provide and the types of products and services he or she can offer.

49. Disclaimers • Disclaimers act as a warning as to how the information provided in the plan can be used and that it is specific to the client and not for general use. • The disclaimer points out to the client upon what the client can rely. • Disclaimers are used to avoid possible legal action by making the client aware of the scope of the advice.

50. Monitor and Review Process • This needs to be personalised for the specific client. • The client needs to see why it is so important for his or her goal achievement to undertake an annual review. • The client needs to know what the annual review process will be, what will be discussed, and the cost, even if it is only a statement that the cost of the annual review will be covered by trailing commissions from the investments made.