In the previous post, we looked at financial planning and everything you need to know about it. This time, we'll look at what you need to do.
Everything you Need to DO
1. Map out Your Own Timeline
If you’re in the Planning with Purpose life stage, you’re probably OK to run the timeline up to your desired retirement or preferably, financial independence (FI) age. As you approach that point, then you’ll need to extend the timeline into retirement, but don’t try to think too far ahead.
Along the bottom of the chart, on the timeline axis, there will be key points along the way, as we mentioned earlier. Dream ahead a little – what would you like to include on your life’s timeline? Major holidays? Mini-retirements? A cruise? A dream car purchase?
Try to populate your timeline with some events or transitions that you can foresee – you may be planning for a promotion or career change, rather than waiting for these to happen. Being prepared will help with your planning.
The big one needs to be FI, or retirement. Where would you like this to be on your timeline? It won’t be a complete picture, but this is going to be a living, breathing plan so you can always update it. I suggest you do this as part of your annual review.
2. Total Your Expenses
This part is a little less fun. You need to spend some time identifying your expenses so that we can add them to each year. Remember that the first step to financial success is to spend less than you earn. You should be consciously looking for ways to either spend less or earn more, in order to free up money to save for the future.
Start with the current year. What are your basic living expenses? Mortgage/rent, household costs, food, travel. No luxuries, no gym memberships, only the stuff you would need to pay in order to survive. On top of this you can add those extras, striking a clear divide between required and desired expenses.
Finally, give some thought to one-off or short-term costs. These might be linked to events like your daughter’s university career. Maybe you’ll give her £500 per month for nine months of the year for four years. That’s 500 x 9 = £4,500, for each of the four years she’ll be there.
Or maybe you want to spend £30,000 on a camper van the year you hit your FI. We’re now linking expenditure amounts to timeline events, which is great. However, we do have a problem…
3. Factor in Inflation
We can only think in today’s money. Sure, inflation won’t make much of a difference over a year or two, but if you’re working out what £500 per month will be in 13 years’ time when your daughter is going to university, then that’s not a sum most of us can do in our heads.
Today’s money is the only money that makes any sense. Ask anyone who bought a house in the 1970s and they’ll tell you a story or two about inflation. Today’s numbers are crazy in comparison. Fortunately, the maths isn’t complex.
To work out an inflation factor you might need a scientific calculator, or an Excel sheet. I’ve created a simple calculator which anyone can use within Google sheets. It’s free, too, which is excellent. The formula is simple:
1 + the rate of inflation, to the power of the number of years
If your inflation rate is three percent, you add 1 to get 1.03. 7% inflation would be 1.07 etc. Then to work out the inflation factor over 13 years, you multiply 1.03 by itself 13 times.
To put it another way, that’s 1.03 to the power of 13. You’ll find that figure is 1.468 – that’s your inflation factor. Multiply today’s money by your inflation factor – so £500, inflated by 3% for 13 years is £500 x 1.468 which equals £734.
So when your 5-year-old daughter goes to university in 13 years’ time, you won’t be sending her £500 per month, you’ll be sending her £734 per month. You’re going to need to do this maths for every expense you have, and for every year in your plan.
If your basic living expenses are £1,500 per month, that’s £18,000 per year, this year. If we assume inflation at 3%, next year it’s going to be £18,000 x 1.03, which gives £18,540. The year after that it’ll be £18,000 x1.03^2.
4. Add in Your Income(s)
In exactly the same way, we’re going to need to factor in our income in each year. I suggest that you use net income for this, unless you want to also do the income tax calculations. If your net income is £2,700 per month, that’s £32,400 per year net in the current year. Then you’ll need to apply the inflation factor for each year in the plan.
If your income is likely to step up due to a promotion or pay rise then factor this in too. If someone on the next grade up from you is on £50,000 a year gross, then you need to first work out the net pay and then apply an inflation factor if you expect that promotion in, say, five years’ time. You can use this calculator to help you.
Maybe you’re planning a career break, or a reduction in your hours for a period of time, perhaps to see your kids into primary school. Look at your timeline and ask yourself what your income will be in each year. If you’re thinking of going to three days per week in five years, then work out three-fifths of your current take-home pay and inflate it five years into the future.
5. Note the Difference
Now, in each year, at least while you are still working, there should be an excess of income over expenditure. This excess is the money we’re going to save over time to meet our financial goals. We’ll apply the growth rates we’re assuming in our plan and try to work out what those savings will add up to in future.