What is Financial Planning?
When people contact me to ask for financial advice they have often come to a solution themselves; “I need a pension” for example.
While this is not necessarily incorrect it is like starting a journey before you now where you are going.
How much should you be contributing and for how long? How should you be investing? It is difficult to answer these questions without having an idea of what you are trying to achieve.
A common management phrase is ‘start with the end in mind” and with financial planning it is certainly logical.
-Why do you need a pension?
-What are you looking to achieve?
-Have you thought about the life you want to live now and in the future?
-What are your financial circumstances currently?
By answering these questions first you can piece together the route map of your future to determine (amongst other things) what your pension needs look like.
The former world heavy weight boxing champion George Foreman has been quoted with saying “The question is not at what age do I want to retire but at what income” It is this focus on an objective that allows us to build a financial plan that will ensure we achieve what it is we want in life when we want it.
Financial planning, therefore, can be seen as a process in which we start with describing in as much detail as possible what we want to achieve; the acronym SMART is a common reference point here (that is, any objective should be Specific, Measurable, Achievable, Realistic and Time framed).
Objectives that aren’t SMART are easily left unrealised as it is difficult to determine how and when they will be accomplished.
Once our objectives are set the necessary steps can be put in place to ensure we meet our goals. The steps required will vary depending upon the goal but some basic principles should be followed.
1. Clear Debts – They erode wealth
2. Manage Risks – Death & Disability
3. Be Tax Efficient – Use allowances first
4. Decide on a Funding Strategy – Make it a habit
5. Decide how much investment risk is appropriate – Too much or too little render goals futile
6. Review – Goals will go off course if Financial Plans are not regularly reviewed.
One’s needs should be attended to first because they are likely to be more numerous and have the greater influence on one’s immediate life.
Examples of needs would be to have sufficient disposable income to cover day to day costs or ensuring loved ones are financially secure on death, disability or redundancy.
Once the Needs segment is taken care of one can consider one life’s goals; the age you want to retire or the house you want to live in. The financial plan can then be constructed to focus on these goals.
Finally, the pinnacle of the financial planning triangle is one’s dreams. All of us dream about what we wish to accomplish with our lives and while they may vary in their nature it is unlikely they will be realised without a structured financial plan.
Financial independence is the ability to live off assets and income that is self generating and so does not require any other individual or any institution to provide it; i.e. as salary or fee income.
It is a goal for many and one would hope that in retirement it is likely but without suitable planning it is easy to walk into a retirement that is spent penny pinching because no plan was put into place and the cost of retirement (exaggerated by inflation) was not accounted for.
In his book, The Number, American author Lee Eisenberg explains how everyone will have their own personal number. That is the unique personal wealth that will ensure financial independence for life. It is unique because everyone’s lifestyles will differ and therefore the rate of capital erosion by expenditure will vary.
One important variable is how early in one’s life financial independence can occur. Some people live to work and so can spend longer doing what they enjoy and earn over a prolonged period of time. Others may want to stop work as soon as possible and therefore need to build up a larger net worth sooner.
The diagram below maps the relationship between age and accumulated net worth that can determine at what point financial independence is possible. If expenditure is greater than income in retirement net worth will be eroded such that an unfortunate individual may be forced to reduce their lifestyle to avoid poverty in old age.
If you would like to understand more about Financial Planning or to have your own personalised Financial Plan produced please email us at hello@icl-ifa.co.uk or call us on 01483 274566.
