A worry free financial future: Part 1 — How to create your financial plan

Posted at 08:34h in Financial planning, Goals by Carolyn Gowen

“If you fail to plan, you are planning to fail!”

Benjamin Franklin

Seriously, what would it be like to stop feeling stressed about your financial future? How would it feel to know that the financial decisions you make on a daily, weekly, monthly, annual basis are going to help you to get closer to achieving your life goals? Wouldn’t that be wonderful?

If only there were a way…

Well, doing nothing certainly isn’t the answer.

Fortunately, the solution is not complicated. There are a few simple steps which everyone can take to feel more confident about their financial future and it all starts with your financial plan.

Everyone needs a financial plan

 Whilst it may be true that not everyone needs a financial planner, it is the case that almost everyone would benefit from having a financial plan. If you need some guidance on how to create your own financial plan, you can download our Guide to Financial Planning, free of charge, from our website.

Here, in brief, are the steps you need to take.

Step 1: Define and quantify your goals

What is it you are working towards each day? Think about your longer-term goals, such as:

  • When do you want paid work to become optional?
  • What sort of lifestyle will you want to support at that point?

Then think about your shorter-term goals — do you want to pay for your children’s (or grandchildren’s) education? Plan for a special holiday to mark a milestone event? Buy a bigger house? Or downsize?

Step 2: Create your lifetime cashflow

Once you know what your financial goals are, you can start to build your lifetime cashflow. This is going to be the roadmap you will use from here on in, so it’s worth spending time on this stage, no matter how much you hate dealing with paperwork or, perhaps, confronting your pathological hatred of numbers and spreadsheets. You might want to enlist the help of a financial planner at this point. Alternatively, you might feel your situation is straightforward enough to manage on your own (in which case, you might find this tool to be useful). Your lifetime cashflow should be able to tell you:

  • Most importantly, whether, based on the assumptions you are making, you will run out of money before you run out of life and
  • The rate of return you need to achieve on your invested assets to meet the cost of your goals

Looking good so far?

Hopefully, at this stage, and if you’ve used the Voyant software linked to above, you’ve got a lovely blue chart which indicates that, based on the assumptions used, your plan works. If that’s the case, great. If not and your resources look as though they might be insufficient, you’ve some more work to do; either way, you need to do the next step first.

Step 3: Determine your attitude to risk

Whether your plan works or not at this stage, before you start thinking about your investment portfolio you need to determine your risk profile. Don’t even think about skipping this step if you want to give yourself the best chance of having a rewarding investment experience. It will be £30 well spent and could end up saving you thousands if it helps to stop you taking more risk than you can handle.

The risk test linked to above is a psychometric risk testing software and whilst other forms of risk testing software are available, we believe this format is one of the most rigorous, and is the software we use for all of our clients.

Psychometric risk testing will give you great insight into what level of risk you can tolerate emotionally, and will help you to stay the course in the years ahead. Do bear in mind though that this should not be used in isolation. There is more to determining a suitable portfolio than how much risk you are comfortable with taking.

How well does your emotional tolerance for risk match the risk needed to meet the cost of your goals?

Once you know what level of risk you can cope with, i.e. the proportion of stockmarket (known as equity-based) investments you would be comfortable holding in your investment portfolio, you can compare how the expected returns from a portfolio with that level of riskier assets stack up against the rate of return you require from it to meet the cost of your goals (which your lifetime cashflow will have calculated for you).

Don’t worry if you don’t know what to assume for the expected returns — if you use the Voyant software linked to above, Voyant has done this for you. We’ve also programmed assumptions for future inflation, increases in your expenditure, and earnings growth to make life a little easier for you.

At this stage, if there is a mismatch (for example you can cope emotionally with a portfolio 50% invested in riskier assets but to meet the cost of your goals you need the returns which could be expected from a portfolio invested 80% in such assets), you need to have a rethink. You can’t change your emotional tolerance to risk — that’s a psychological trait — so you will need to modify your goals and/or your current behaviour. This might mean doing one, or a combination, of the following:

  • Spend less;
  • Earn more;
  • Work longer and/or
  • Downsize or liquidate your property or some other asset (a business, for example) to release capital at some point.

The beauty of the Voyant software is that it will let you model different scenarios so you can see the effects of doing any of the above immediately on the screen.

As part of this process you should also model your situation in the event of the death or long term illness of either you or your partner, to determine whether there is sufficient protection in place should such an event occur.

If your plan didn’t work back at Step 2 then modify your goals until you eliminate any deficits (red bars if you are using Voyant). Once you get to that point you should have determined:

  • How long you need to work;
  • How much you need to earn while you are working;
  • How much you need to save and
  • What level of expenditure you will be able to afford when you cease paid work.

Step 4: Create your action plan

Your plan is worth nothing if, once you’ve created it, you stick it away in a drawer and do nothing, so now you know what needs to be done to achieve your goals, draw up an action plan — who does what, by when — and then DO WHAT IT SAYS.

You’ll be glad to know that most of the boring stuff is now behind you, although there might be some additional admin tasks you need to deal with (Are your wills up to date to ensure that your estate is distributed as you wish? Do you have powers of attorney in place to allow your affairs to be managed if you are unable to do so?). You should also now know:

  • The resources you have available (existing savings plus any surplus cashflow) to invest towards meeting the costs of your goals and
  • The basic asset allocation (i.e. the split between equities and fixed income) that you

a) can cope with emotionally and
 b) has an expected return commensurate with the return you need to meet the cost of your goals.

NOW you can now think about your investment approach. This might come as a surprise to many, as the general modus operandi is to invest surplus funds without considering what it is you are trying to achieve — other than increasing your net worth. Wouldn’t knowing exactly WHY you own the assets you choose to own be useful? To know the job of every element of your portfolio? In my experience, people make much better financial decisions when they know their ‘Why’.

“A clear vision, backed by definite plans, gives you a tremendous feeling of confidence and personal power.”

Brian Tracy, author

In Part 2, I’ll look at how to construct a robust investment portfolio to support your financial plan.

Warm regards


Originally published at thefinancialbodyguard.co.uk on October 16, 2017.