Why You Need a Financial Plan Before Investing - Behavioral Finance Chapter 14
Chapter 14 of Behavioral Finance and Investor Types by Michael M. Pompian takes a step back from psychology and biases. Instead it asks a very basic question: do you actually have a plan? Not an investment strategy. Not a stock pick. A plan. Because financial planning and investing are not the same thing, and a lot of people confuse the two.
Financial Planning Is Not Investing
Here’s the thing. The previous chapter was about asset allocation. This chapter is about the step that should come before that. Financial planning is the roadmap. Asset allocation is just one piece of executing it.
A financial plan covers everything. Retirement savings. Kids’ college funds. Insurance. Budgeting. Career decisions. Estate planning. It’s the big picture. And Pompian’s point is simple: if you skip the plan and jump straight into picking stocks or funds, you’re building a house without a foundation.
As Pompian puts it with the old saying: “He who fails to plan, plans to fail.”
What Does a Financial Plan Actually Do?
Pompian breaks it down into three things.
First, it figures out where you are right now. What you own (assets) versus what you owe (liabilities). Pretty basic stuff but you’d be surprised how many people have never written this down.
Second, it spells out where you want to be. Your actual goals. Not vague stuff like “I want to be comfortable.” Specific targets. How much for retirement, by when. How much for the kids’ school, by when.
Third, it maps out how to get from point A to point B.
And here’s the problem most people don’t think about. Every financial decision you make affects every other one. Pay down the mortgage faster? That money isn’t going into college savings. Fund your kid’s education aggressively? That might push back your retirement date. A good plan shows you these trade-offs so you’re not blindsided.
The Six Steps of Working with a Planner
Pompian outlines six steps that the Certified Financial Planning Board recommends. They’re straightforward.
- Define the relationship. Agree on fees, responsibilities, and how long you’ll work together.
- Gather your data and set goals. The planner collects all your financial information, and you both talk about goals, timelines, and risk tolerance.
- Analyze your current situation. The planner looks at your assets, debts, cash flow, insurance, investments, and taxes.
- Develop recommendations. The planner presents a strategy. You review it, ask questions, push back where needed.
- Implement the plan. You both agree on how to execute. This might involve coordinating with lawyers, accountants, or other specialists.
- Monitor and update. Quarterly reviews. Adjustments when life changes.
Nothing groundbreaking here. But the value is in actually following the process instead of winging it.
What Makes a CFP Different
Not all financial planners are equal. The Certified Financial Planner designation is the gold standard, and Pompian spends a good chunk of the chapter explaining why.
To get a CFP, you need a bachelor’s degree, you have to complete coursework covering nearly 100 subtopics (taxes, insurance, estate planning, investments, retirement, the whole thing), and then you sit for a 10-hour exam. After passing, you need three years of full-time work experience in financial planning. Plus a background check. Plus ongoing ethics and continuing education requirements.
So when someone has CFP after their name, it means something. They’ve been tested and vetted pretty thoroughly.
The Fiduciary Problem
This is the part of the chapter that should make you pay attention. Pompian explains the difference between a fiduciary standard and a suitability standard.
A fiduciary is legally required to put your interests first. Period.
A suitability standard just means the advisor has to believe the product is “appropriate” for your situation. That’s a much lower bar. The product could be appropriate for you and pay the advisor a fat commission. Both things can be true at the same time.
Pompian quotes consumer advocate Barbara Roper: “Many investors do not realize that their trusted financial ‘advisor’ may be nothing more than a salesman.” That’s blunt but accurate.
Three types of professionals are always fiduciaries: attorneys, CPAs, and Registered Investment Advisors. Stockbrokers and insurance agents? Not necessarily. They can legally put their firm’s interests ahead of yours.
So here’s what Pompian says to ask any advisor before hiring them. Are you a fiduciary, and will you put that in writing? Do you have any conflicts of interest? How exactly do you get paid?
You Might Not Need a Planner, But You Need a Plan
Pompian is honest that not everyone needs to hire a planner. If you’re a do-it-yourself type, there are free resources and software tools. But even DIY people benefit from the discipline of budgeting and tracking spending. Life throws financial potholes at everyone. Market crashes, job losses, medical bills, car breakdowns. You can’t avoid them all, but a plan helps you absorb the hits.
His final list of tips is practical. Start now, don’t wait until you’re older or richer. Set measurable goals, not vague wishes. Understand that financial planning is more than just retirement planning. Don’t expect unrealistic returns. And review the plan regularly because life changes.
The bottom line from this chapter is simple. Before you worry about which stocks to buy or how to allocate your portfolio, step back and make a plan. Know where you stand, know where you’re going, and map out how to get there. Everything else follows from that.
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