Planning is essentially about knowing where you’re going and deciding on the steps you need to take to get there. Given we’re talking about financial planning, there’s likely to be some maths involved, but we’ll work through that together.
Everything You Need to KNOW
1. Life is a Journey, with Points of Interest Along the Way
There is usually a clear beginning to our financial journey, where we begin to take an interest in financial matters. And there is a logical end goal, which is usually retirement or financial independence. Then, there is the long middle.
That journey, for most of us, is a long one. But fortunately, it isn't like one of those American highways through the desert – a straight road with nothing on either side where you pass one other car every couple of hours. Life is more interesting than this, full of what we might call transitions or pivotal moments, where we have to assess where we’re going financially.
These might be a career change or promotion; a new relationship or a breakup; starting a family or losing a parent; receiving an inheritance or a bankruptcy. And there are also many less significant incidents, but which still require you to take stock of your finances.
2. On This Journey, Financial Products are not That Important
Notice that in describing your wealth-building journey above, not once did I talk about products. By products I mean insurance policies, pensions, ISAs, funds, trusts and wills, all of that stuff. While the financial services industry likes to place a great deal of store on those things, they are actually of minor significance in the grand scheme of things.
Whether or not you reach your desired end goal is actually a combination of mathematics, unknowable market machinations, behaviour and time. Whether or not you have 10% or 20% of your allocation in the UK equities has little or no bearing.
On many occasions in the history of my podcast, I have spent time explaining how products work and why one might be better than another in any given situation. I believe that this aspect of financial planning is very simple.
Folks in the Planning with Purpose phase of life will already have a pretty good handle on the practicalities of wealth building, so instead we need to deal with the larger factors at play. It really isn't it about whether you choose a pension or an ISA.
3. Establishing the Paradigm of a Timeline
We need to establish a paradigm of how to think about this journey so that we are all picturing things in the same way, so I need to introduce you to the concept of your timeline. There is an example timeline which you can download here, which will help you to visualise things in the same way that I do. I'm going to try to describe it clearly even if you don’t have it in front of you.
Imagine a simple two axis graph. Along the horizontal axis at the bottom is it time, measured in full years. When I am planning for client, I work in tax years and I suggest that you do too. When I am creating such a timeline for clients, I label each tax year with the age that the clients will attain in that tax year. I always extend the axis to their age 100, because I plan into retirement.
Up the vertical axis on the left, the scale is in pounds sterling and pence. Against this axis we will measure your expenses. The idea is that in each year, we need to understand what our expenses will be.
Obviously, that’s easy to work out for the current year, and maybe for next year, but further out than that, we’re in the realm of assumptions. I suggest you create your own personal timeline to do the same.
Along the bottom of the chart, on the timeline axis, there will be key points along the way. Maybe your daughter is five years old now, so in 13 years’ time, mark on the timeline when she’ll go to university. If you’re planning to buy a house in five years’ time, then mark that down.
These are life transitions, some of which we can prepare for, and others we don’t know about until they happen. Those unexpected life events can’t be plotted, but be aware that they may occur one day.
4. Agreeing Some Assumptions
As our timeline extends into the future, and we don’t know for sure what the future holds, we need to make some assumptions. Really, there are just a few that you need to bear in mind, and you can choose any figures you want.
Inflation: This is the key factor that works against you as things get more expensive each year. I set this to be 3%. You might also want to think about the inflation rate on your earnings. Does your salary go up by 3% each year, or less than that? If you have a rental property, how often do you put the rent up? To keep things simple, use the same inflation rate for everything.
Savings returns: The amount of interest you’ll get on money held in the bank. I set this to be 1%, which is a little ambitious really. Keep your assumptions low and realistic.
Investment/pension returns: This is the rate of return you’ll get on your money held in pensions and investments. I set this to be 5%, but it might be better to adjust this down to 4.5%.