Glossary of Financial Planning Process Terms
Understanding financial planning terminology enables productive conversations with advisors and informed decision-making throughout the planning process. This glossary covers essential terms used in comprehensive financial planning.
A
Asset Allocation: The distribution of investments across different asset classes such as stocks, bonds, and cash. Asset allocation is determined by goals, time horizon, and risk tolerance.
AUM (Assets Under Management): The total market value of investments that a financial advisor or firm manages on behalf of clients. AUM-based fees are calculated as a percentage of this amount.
B
Beneficiary: A person or entity designated to receive assets from an account, insurance policy, or trust upon the owner's death. Primary beneficiaries receive assets first; contingent beneficiaries receive assets if primary beneficiaries are unavailable.
Bucket Strategy: An approach to retirement income that divides assets into separate "buckets" based on when funds will be needed—typically short-term (1-2 years), medium-term (3-10 years), and long-term (10+ years).
C
Cash Flow: The movement of money into and out of a household over a specific period. Positive cash flow occurs when income exceeds expenses; negative cash flow indicates spending exceeds income.
CFP (Certified Financial Planner): A professional certification awarded to financial planners who complete education requirements, pass a comprehensive examination, meet experience requirements, and adhere to ethical standards.
Contingent Liability: A potential financial obligation that may arise depending on the outcome of a future event, such as a personal guarantee on a business loan.
D
Discovery: The initial phase of the financial planning process where an advisor gathers comprehensive information about a client's financial situation, goals, values, and concerns through interviews and document review.
Discretionary Expense: A non-essential expenditure that can be reduced or eliminated if necessary, such as entertainment, dining out, or vacations. Contrasts with fixed or essential expenses.
E
Estate Plan: A set of legal documents and strategies that specify how assets will be managed during incapacity and distributed after death, including wills, trusts, powers of attorney, and healthcare directives.
F
Fee-Only: A compensation model where financial advisors receive payment exclusively from client fees, not from commissions on product sales. This structure is designed to minimize conflicts of interest.
Fiduciary: A person or organization legally obligated to act in the best interest of another party. Financial advisors operating as fiduciaries must prioritize client interests above their own.
Flat Fee: A fixed dollar amount charged for financial planning services, regardless of assets managed or time spent. May be charged as a one-time fee or ongoing annual fee.
Financial Plan: A comprehensive document that analyzes current financial position, defines goals, and outlines strategies for achieving those goals across multiple areas including investments, taxes, insurance, retirement, and estate planning.
G
Goal-Based Planning: An approach to financial planning that organizes strategies around specific objectives rather than general wealth accumulation, linking each investment or savings strategy to a defined purpose.
H
Human Capital: The present value of an individual's future earnings potential, based on career, skills, and remaining working years. Younger workers typically have high human capital relative to financial capital.
I
Implementation: The phase of financial planning where recommended strategies are put into action, including opening accounts, purchasing insurance, executing investment trades, and establishing estate documents.
Investment Policy Statement (IPS): A written document that establishes investment objectives, risk tolerance, asset allocation targets, and guidelines for managing a portfolio. Serves as a governance framework for investment decisions.
L
Liquidity: The ease with which an asset can be converted to cash without significant loss of value. Checking accounts are highly liquid; real estate and business interests have low liquidity.
M
Monitoring: The ongoing phase of financial planning where progress toward goals is tracked, performance is measured, and adjustments are made as circumstances change.
Monte Carlo Simulation: A statistical technique that runs thousands of possible market scenarios to estimate the probability of achieving a financial goal, commonly used in retirement planning to assess portfolio sustainability.
N
Net Worth: Total assets minus total liabilities, representing overall financial position at a specific point in time. Also called net wealth or balance sheet position.
P
Power of Attorney: A legal document authorizing another person (the agent) to act on your behalf in financial or legal matters. A durable power of attorney remains effective if you become incapacitated.
R
Rebalancing: The process of realigning portfolio allocations back to target percentages by buying or selling assets. Rebalancing maintains intended risk levels and may be performed on a calendar schedule or when allocations drift beyond set thresholds.
Retainer: A recurring fee paid to a financial advisor for ongoing access to planning services, typically charged monthly or quarterly regardless of specific services rendered.
Risk Capacity: The objective ability to absorb financial losses based on factors such as income stability, time horizon, and liquid assets. Differs from risk tolerance, which is psychological.
Risk Tolerance: The degree of variability in investment returns that an individual is psychologically willing to accept. Assessed through questionnaires and discussions about comfort with potential losses.
S
SMART Goals: Goals structured to be Specific, Measurable, Achievable, Relevant, and Time-bound. This framework transforms vague aspirations into actionable objectives.
Sequence of Returns Risk: The danger that poor investment returns early in retirement will deplete a portfolio faster than average returns would suggest, due to the combination of losses and withdrawals.
T
Tax-Advantaged Account: An account offering tax benefits for saving toward specific purposes, such as retirement accounts (401(k), IRA), health savings accounts (HSA), or education savings accounts (529 plans).
Time Horizon: The expected number of years until funds will be needed for a specific goal. Longer time horizons generally support higher-risk investment strategies.
W
Withdrawal Rate: The percentage of a portfolio taken as income annually, typically in retirement. The "4% rule" suggests withdrawing 4% initially, then adjusting for inflation each subsequent year.
Additional Terms by Category
Planning Process Terms:
- Discovery, Implementation, Monitoring
Professional Terms:
- CFP, Fiduciary, AUM, Flat Fee, Retainer, Fee-Only
Goal and Risk Terms:
- SMART Goals, Risk Tolerance, Risk Capacity, Time Horizon
Investment Terms:
- Asset Allocation, IPS, Rebalancing, Monte Carlo Simulation
Legal and Estate Terms:
- Beneficiary, Power of Attorney, Estate Plan
Financial Position Terms:
- Net Worth, Cash Flow, Liquidity