Here we are at session number 36 , and we’re going to be talking about the Four Steps to Financial Freedom. The longer I do the job I do, I realise more and more that financial planning is essentially a very simple process. Sure, there are some complexities involved along the way, but the fundamental steps are much the same for everyone, no matter your financial starting point.

I had the idea for this session listening back to another podcast called Common Sense Money which is produced by my friend Chris Daems of Principal Financial Solutions. Back at the IFP Conference at the beginning of October, Chris asked myself and four other advisers to conduct a round-robin discussion about various financial planning matters -it was fun!

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Introduction

In the podcast with Chris Daems I mentioned earlier, and in quite a few situations since I have quoted a four-step financial planning path which is the distillation of the way to be financially secure and to get rich slowly. It is the only way which is guaranteed to work. There are plenty of ways to accelerate the journey, but whether you get to the goal of being financially free sooner or later, the point is you WILL get there.

So this session will cover the four steps to financial freedom and, as ever, some practical advice as to what to DO to get started.

Are you ready? Let’s crack on…

Everything you need to KNOW

Step One – Spend less than you earn

Ah, drat. You mean this takes effort? Yup, sure does. And this is the biggest challenge for so many people, myself included.

The biggest change in mindset for me was to understand that budgeting should be done in advance not arrears. In other words, you have to tell your money where you want it to go, not just know where it  has gone. For years I could tell you exactly how much we had spent in a given month on food, fuel and clothes, but only after it had been spent, which of course is too late to do anything about it. I thought I was being very organised, but nope, I was just good at reconciling a bank account.

Budgeting is just a different word for planning. You don’t plan a holiday after you have taken it. Imagine getting on a random plane to an unknown destination and then just seeing how you got along and hoping you can get a flight back in a couple of weeks. Actually, for some of you listening that probably sounds ideal. But when I’m on holiday I don’t want to have to think, I just want to get on with relaxing.

A budget sets a plan for the coming month. You’ll probably have to review it during the month as something is bound to come up that you weren’t expecting, but do the work at the beginning of the month and it’ll serve you very well.

I found a couple of great quotes about budgeting. The first is from Joe Biden, the current Vice President of the US:

“Don't tell me what you value, show me your budget, and I'll tell you what you value.”

I love this. It’s absolutely right. What you decide to spend your money on says a lot about you. You could say that this is a paraphrase of the words of Jesus in Matthew’s gospel:

“Where your treasure is, there your heart will be also.”

The other quote is from American author Sinclair Lewis:

“It isn’t what you earn, but how you spend it that fixes your class”

That’s genius. Whether or not you do well or poorly in life isn’t so much to do with the income you receive, but how you spend what you do receive.

So spend less than you earn. It’s the foundation for everything and its importance cannot be overstated.

Step Two – Invest the rest wisely

Assuming step one is under control and you have some spare money each month, you need to determine what to do with the excess. When I say that these four steps are a distillation of the financial planning process, that’s never truer than this step. Four words – invest the rest wisely – attempt to cover everything that goes into investing for your future. That one word – wisely – is very subjective too and my view of that may well be different from yours.

So for instance, the actual choice of what you buy in terms of investments can be influenced by many variables. Maybe you have an ethical conscience and want to make sure that you are not investing in anything to do with arms, tobacco, alcohol, or whatever.

Or maybe you feel very strongly about passive investing over active investing or vice versa (I’ll be having a session dedicated to this pretty soon).

Or maybe, you’re so risk averse that you will only invest in deposit accounts offered by high street banks.

Everyone is different and your decisions about how you invest will have a massive impact on your investing success. Planning is only possible within the constraints of your own investing preferences. Now my hope is to educate my clients and my listeners so that they are open to investment options that they might not otherwise think about. Education is the antidote to ignorance and education sets you free.

Timescale is another factor. I’ve often said you should invest with an end in mind. When is that end along your timeline? The timescale between now and then is a major factor in getting your investing right

Personal constraints, risk, timescale these are just three of the factors that determine the ‘right’ investment strategy for you. It might not be right for me, but I’m not you!

Step Three – Use your tax allowances

The investment strategy we talked about just now, the one unique to you, will be implemented using a variety of different asset classes. But they will be held, in turn, within a variety of different tax-wrappers. Wrappers, plans, boxes – I’ve used these terms to describe what I’m talking about, but these are things like ISAs, Pensions, Investment Bonds and General Investment Accounts, all of which are differentiated by the different tax rules attached to each one.

So the things that make a pension a pension, are the tax relief you get when you pay obey in, the restriction on access until age 55 and then the ability only to take 25% of the fund as a lump sum. Also the way the investments are taxed within the pension, and what happens on death before retirement and after.

Tax breaks are given to encourage us to save. The government knows that what they lose in tax, say on pension tax relief, they will save in the future not having to pay out pension credit to those people. If they are there to encourage us to save, then we really should use them.

There are quite a few tax breaks that are obvious and should be used by most people – we’ll come to those in the what you have to DO section in a minute or two, but for now let me just say that for the vast majority of us, we don’t need complex offshore tax planning costing thousands of pounds to set up and which are so complex they’re just bound to irritate HMRC. Nope, most of us just need to make the best use of the ordinary, everyday allowances which when added together can make a huge difference to our wealth over time.

Step Four – Insure against the worst case scenario

All this talk of investing for the future is meaningless unless you or your loved ones are going to be around to get the benefit of it one day. Becoming wealthy over time entails sacrifice now for future benefits, but there is no point making those sacrifices if one out-of-left-field incident can derail the whole thing.

If you’re saving and investing for your future out of income, what happens if that income disappears? Premature death, illness, inability to work or redundancy can scupper your plans in the blink of an eye. The only way to ensure that your future plans can continue no matter what, is to insure against the worst.

Let’s use me as an example. I am working hard to build up Jacksons with my colleagues into a powerful business which will secure the future for my family and I. Jo doesn’t work but runs the home incredibly well so that I can have the time to put long hours into Jacksons, and into MeaningfulMoney and my other site, Advisertech. All these things are the platform which will support my family’s future financial wellbeing.

Now if I cross the road without looking tomorrow and am hit by a bus (if that actually happens by the way, how ironic would that be?!) so that I am either killed, or left a quadriplegic, what impact will that have on my family’s future?

Well, I won’t be able to work again anytime soon, so I’ll need some kind of payout that will replace my income either as a big lump sum, or as a recurring income payment that’ll pay the bills going forward and enable us to keep saving. I’ll probably want to have the mortgage paid off too, and provide some extra money in case we need to move to a bungalow or otherwise modify the house.

If I’m dead, then Jo will need an immediately accessible financial cushion to give her the space to rebuild her life (or throw a great big party!) without worrying about money.

You get the idea – you pay insurance hoping you’re never going to need it, but if the worst case scenario happens, then you’ll be glad you’ve got it.

OK, rant over – I know that you know this stuff, but if you get these four steps in place, you’re pretty much guaranteed to be successful financially. And they’re not that difficult to master, with the possible exception of the first one, spending less than you earn. That takes hard work and sacrifice. But nothing worth having is easy right?

So with those words ringing in your ears, what do you have to do to win at each of these steps?

Everything you need to DO 

1 – Spend less than you earn

Yeah, that’s it. Just do it.

I know it’s not easy, I know that life gets in the way some times but there are things you can do to help yourself there.

The first is to have an emergency fund. Start small, say £1,000 and then pay off your debt. This might take a while, but you haven’t a chance of feathering your own next if you’re still feathering someone else’s with interest payments on debt. I don’t include your mortgage in this, unless the mortgage is crippling you.

The only way to spend less than you earn is to PLAN. Budgeting is a froward-thinking process, not a backward thinking one. Sit down at the beginning of the month and plan where your money I going to go. Do this with your spouse or partner if you have one. If you work as a team you’re more likely to be successful.

Getting out of debt is covered in detail in session number 4 and budgeting in session number 3. I get more comments about these two sessions than any of the others. Given that they are session 3 and 4 I’m worried I may have peaked too soon! Listen to those sessions and put the clear action steps into, er, action.

Rinse and repeat. Do it every single month so that spending less than you earn becomes a habit, a part of you.

2 – Invest the rest wisely

Like I said before ‘investing the rest wisely’ is a pretty broad cover for a pretty detailed project. As always, I do recommend seeking advice from a competent adviser though I see portfolios put together by incompetent advisers all the time. You can take the following steps to help your adviser or to give yourself a good start (I’ll be covering how to build a DIY portfolio in a future session)

• Determine your timescale. You may have multiple timescales, more like a timeline with steps along the way, maybe you want to pay off your mortgage in 15 years, but in that time you also need money to put your kids through university. These are all steps along the timeline.
• Determine your risk tolerance. There are doubtless risk questionnaires online that will try to put you onto a scale of 1-10 for how much risk you’re prepared to take. But these questionnaires are only part of the story. Unless you have real numbers in your mind, risk is an abstract subject. So you might be willing to accept 10% fluctuation in the value of your investments. But If I say to you that you gave me £100,000 to invest and I’ve lost £10,000 of your money, how angry are you going to be? Can you cope with that kind of fluctuation, or more, on your way to financial success?
• Lay out your investment parameters. Do you have strong feelings about investing one way or another? I had a prospective client once who got very wound up about investing in anything French. Seriously. He wanted me to build him a portfolio which avoided France at all costs. Even threatened that he might formally complain if he subsequently found out that a penny of his money had found its way onto Gallic shores. We did not end up working together. No chance of an entente cordiale between us because let's face t, he was a pillock. I make light of his unusual leanings, but your leanings are important to you and it’s important that you vocalise them when planning your investments.

These three factors will directly influence your choice of investment direction. Again this is too big as subject to cover here, look out for an in-depth session in the near future. Or you can just seek advice or click the ‘Work with Pete’ button at the top of the website 😉

3 – Use your tax wrappers

For most of us there are two main tax wrappers that matter, Pensions and ISAs. These are the essential building blocks for successful investing. There are others of course. It may be that an Enterprise Investment Scheme or Venture Capital Trust might suit you, but definitely seek advice on these, they’re tricky.

Assuming you have an emergency fund of 3-6 months income in an accessible bank account, your next port of call for savings is an ISA. These are accessible, usually and come in two flavours, Cash ISAs and Stocks & Shares ISAs.

Cash ISAs are simply tax free bank accounts – the interest is paid to you without tax taken off. But even though this is the case, they are not a place to hold money long term. Regular listeners know what I’m going to say next:

Cash is NOT an investment – say it with me – Cash is NOT an investment. Bank accounts are places to hold your emergency fund and other money you might need in the short term. Cash ISAs are perfectly good for this. Any money you don’t need in the next few years as far as you can tell, should be invested and the best place for that is in a Stocks & Shares ISA.

As I speak you can invest £11,520 into a S&S ISA each tax year, or £960 per month, which should do for most people’s savings purposes.

As far as pensions are concerned, if there is a scheme at work and your employer will pay into it for you just join it. Don’t ask questions, just do it! If not, then you should consider taking out a personal pension and contributing into that alongside your ISA So if you have, say £250 per month you can put away, I’d consider £100 into the pension and £150 into an ISA so you’re building up both pots as you go. At some point, you’ll crank up the funding into your pension, but if you’re just starting out, bias things in favour of an ISA for now. That way the bulk of your savings will remain accessible in the short-ish term.

Remember, the Pension and the ISA are just wrappers, and the choice of underlying investment is what will really determine how your money grows.

I talk much more about pensions in session 13 and about wrappers, platforms and funds in session 11.

4 – Take out insurance

Insurance is one of those things that I can think of about 14 million things I’d rather spend money on. But the peace of mind that comes from having a robust insurance portfolio is priceless, and even beats the pleasure of buying a new iMac.

The key with insurance is to get what you need and not more than you need. Also, avoid insurance which has an investment element to it. What you’re after is straightforward term life insurance which covers you for a fixed period of time.

Take some time to add up the financial implications of death, and make sure you take into account any benefits from, say, a works pension or group life scheme. You would want all debts paid off on death as a minimum, plus some money to provide a cushion for those left behind to come to terms with their loss and rebuild their lives.

You should also consider what happens if you are diagnosed with something nasty but which doesn’t kill you. I’m thinking cancer, great attack, stroke or paralysis. These are called Critical Illnesses and you can insure against those too. Again, think through the financial implications of you suddenly not being able to work for a couple of years. Can you imagine the stress of trying to beat cancer while worrying about being repossessed? How much better either to pay off your mortgage in this situation or have five years mortgage payments in the bank so you can forget about that and concentrate on getting better.

Finally, consider what you would do if you couldn’t work but it wasn’t something severe that could be covered with critical illness insurance. Maybe you seriously injure your back, have to wait for surgery and it takes 18 months to recover. Factor in how long your boss will pay you for in this situation. Is it two weeks or a year? Insurance to cover this is called income protection insurance and pays a regular tax-free income until either you get better, or you each the end of the policy term.

Life cover, critical illness cover and income protection cover. Consider all three and listen to session 7 for more detail on this essential part of your planning.

Summary

Is it really possible to distill the complexities of financial planning into these four simple steps? Well, probably not satisfactorily, but for most of us, getting these things right is all that is required. The rest is just detail. But as simple as it is, it takes discipline and rigour, two words which today’s ‘I deserve it’ generation don’t like very much. Accept the fact that unless you man-up and take responsibility for your future, no-one else will. And then go out and do it.

This week’s reviews

A couple of five star reviews this week taking the total number of ratings to 50 and written reviews to 41. WestCornwall says:

“Very clear and informative. This subject of death is so easy to skirt around but really needs to be addressed by everybody who cares for those left behind.”

I guess this refers to session 34 where I talked to Dennis Hall about the financial and emotional impact of death. I’m glad it was helpful, and I wonder if I know the person who left that review. The name WestCornwall suggests I might… The next is from Silvo:

“Useful info well presented.pete comes across as a likeable, informative and motivational host. Keep up the good work and much appreciated. Thank you”

Thank you Silvo who I now know to be really called Phil! I’m glad it’s a helpful show for you. I’ve just blasted through another record week with over 1800 downloads, which is just staggering. Thanks so much for your support. Please, if it is helpful do leave me a review on iTunes which helps keep the show front and centre. Just go to meaningfulmoney.tv/iTunes

News

Aside from the record week above the only other thing to say is that I’ll be moving out of my house in the next couple of weeks, and into temporary accommodation. Which means that soon this podcast may be coming to you from my office rather than my garage; we’ll see. It may even be necessary for me to skip a week, but I hope not. I’m busting a gut trying to get ahead so I can avoid that if possible.

Outro

That's it for this session of the MM podcast, I hope it was helpful. Did I miss anything? Do you have any questions? If so, please leave them in the comments section below.

I hope you enjoyed this session. Next time I’m going to be taking a look at some different investment platforms that you can use to invest money without an adviser.

If you have any questions about this, go to meaningfulmoney.tv/feedback and leave a voicemail

Thanks for listening – I'll talk to you next time