II. Financial Planning Modules

In this section, I walk you through the basic steps to put together a financial plan.  You start by specifying your goals.  You then develop good insight into your financial life, including your current net worth (assets – debts) and your budget (income – expenses).  I provide links to freely-available, on-line tools and resources that may help you in this undertaking.  I also offer my perspectives on the merits of hiring a financial planner/adviser.

Financial planning is an application of basic math used across the entire investment field—present and future value calculations.  For an individual, this math is put to use to figure out this general question: given I will need a certain amount of dollars ($d’s) in a certain amount of years (y years) for a certain life event (college, retirement) and I have this amount of savings today ($c savings), how much do I need to save each month/year ($f savings) to hit that goal, based on an expected return (r) my current ($c) and future ($f) savings will make along the way?

As you can see from this formulation, the most important elements you will therefore need to input during a planning session are:

  1. Specifying your financial goals—retirement most importantly—and the time frame for each
  2. Identifying your assets and liabilities, with the difference being your net worth, which is the current amount of net savings you have to put to use toward your goals
  3. Setting your budget: income – expenses = savings, which is the amount you can put each month/year toward your goals

Notice that there is flexibility in this exercise, both initially and as the plan unfolds.  You can:

  • add or drop goals, depending on their importance, and/or change the time frames to achieve them
  • increase or decrease your savings, as your circumstances allow

A critical variable is of course, the expected return (r) on your savings.  This will depend on how you invest your savings—the mix of stocks, bonds, cash and other investments you make, which is known as asset allocation.  Note the word “expected” in front of return.  It is a forecast.  And even if this forecast is well-informed by historical returns, it remains uncertain.  As I’ve said, a critical goal of this website is to provide you insight into an investment approach that maximizes the likelihood of success.  But, as you can see from the word “likelihood”, this is a probabilistic statement.  I believe the investment approach I suggest maximizes predictability, but uncertainty remains.  You will always have much more control over setting your financial goals and their timings and adhering to a budget to achieve your desired savings levels.

With this background, here are some links to on-line calculators that can help you out in a planning exercise.  I’m going to point you to financial calculators available on the website of a firm called CalcXML, which is in the business of developing and offering on-line financial calculators.  Financial services firms, for a fee, pay to embed CalcXML’s calculators on their websites as a way to help current clients and attract new ones.  I suggest you go directly to the source.  If you do some web searches, you can find a wide range of free, on-line calculators and similar tools by other providers.

Without doubt, good financial planning starts and ends with budgeting.  If you do not save sufficiently, no goal is achievable.  A budgeting exercise provides the clarity and discipline to set and achieve savings objectives.  It helps you live your life, in terms of both earnings and spending patterns, in a realistic manner.  Here’s a calculator to help you figure out your current budget: http://calcxml.com/do/bud09.  And here’s one to help you think about how your budget (and net savings) may change in the future: http://calcxml.com/do/bud09.

Another key data point to figure out at the start is your current net worth, which you can do here: http://calcxml.com/do/bud07.  Notice that your net worth includes both real assets (your home(s) and other tangible assets) and financial assets (stocks, bonds, cash, etc.).  It is your financial assets which will be put to work toward your financial goals, but it is important to think about all your assets in a goals context.  For example, it is common for families to “downsize” their homes after children have left the nest; in this case, the equity proceeds from the home sale (net of mortgage repayment and smaller home purchase) contributes into the financial asset bucket.

A word here on retirement, as it tends to be most people’s most important goal.  It also can be the most complex, because it has two stages—saving and investing phase to build wealth up to the retirement date and then drawing down wealth over the retirement years.  This naturally raises questions of how much will I spend in retirement (compared to what I spend today) and how long will I live.  You will see on CalcXML a line-up of retirement-related calculators.  Here’s one that helps you think about how much you may spend in retirement: http://www.calcxml.com/do/ret01. (Notice there are other calculators at CalcXML specific to other life events like college and home ownership.)

A shortcoming of free on-line calculators like the ones to which I’ve provided links is that they are “one offs.”  They help you at a point in time, so you have to keep redoing them.  With the internet, there are now ongoing free services, especially ones that help you in the area of budgeting, which again is the most critical foundation piece in formulating and sticking with a plan.  The most popular is probably mint.com, which is owned by Inuit (the same company that provides TurboTax).  It allows you to link your accounts (bank accounts, credit cards), which makes inputting your data much easier in terms of an initial budgeting exercise and allows you to stay on top of it real-time on an ongoing basis.  There are alternatives to mint.com, which you can explore in this article from Forbes.

Another shortcoming of these calculators and even services like mint.com is a lack of integration in thinking about an overall plan.  In a plan, there are many moving parts, and a change in one impacts all the others.  Examples of such linkages include changes to a certain goal, changes in savings (due to job changes or unforeseen expenditures or windfalls), changes in expected returns and on and on.  There are a number of providers of integrated, sophisticated planning software packages used by professional financial planners and investment advisers.  These are fully-integrated, holistic applications, where a change in one area automatically ripples through to other areas.  You can see all the implications of this change and think about adjustments you need to make.  The software typically has very user-friendly, intuitive interfaces that provide you with web-based, real-time snapshots into your entire financial picture.

If you are not a hard-core DIYer, I suggest looking into engaging a financial planner and/or investment adviser.  (Note that financial planners do exactly what the name suggests; they help formulate and monitor a financial plan based on your unique financial goals and circumstances, typically for a fixed fee or at an hourly rate.  Financial/investment advisers often do the same sort of financial planning work, but then do the implementation of the plan with an investment portfolio; they typically charge a percentage of assets they manage for you or a fixed annual fee.)  They provide specialized expertise you may lack.  They make use of and provide you access to these state-of-the-art financial planning applications, which provides the greatest ongoing insight into your financial picture.

I, in fact, believe in the value of independent, capable financial advisers even for very sophisticated investors.  You can think about it how you might think about personal trainers.  Even if you know the exercises yourself, the trainer adds great value in the motivation, support and discipline she provides.  One of the on-line personal finance providers mentioned in the Forbes article as an alternative to mint.com is Personal Capital.  Its business model is to put individual investors in touch with financial advisors.  If you are looking for an adviser, hopefully this website helps you understand the type of philosophy and approach she should bring.  Above all, make sure any financial provider is a fiduciary, which means he or she must put your interest first.  Independent advisers must register with the SEC or the state in which they operate as a Registered Investment Advisor (RIA).  RIAs, by law, adhere to a fiduciary standard.  If you are going to use an adviser, use an RIA.

Quick and Dirty versus Full Monty approaches to planning

A word on how to think about any financial planning exercise.   When financial service providers advertise with catch phrases like “what’s your number?”, they are sending the wrong message.  In reality, they should emphasize the imprecise nature of planning figures.  Planning is of course by its nature forward looking, and, as always, the future is uncertain.  We must all remember that forecasts in a plan are estimates.  For example, with retirement planning, the uncertainty begins with the basic fact that we have no clue how long we’ll live in retirement.  And the estimation only grows from there with every forecasting detail introduced.  However, while we must not forget the imprecise nature of planning, we also must underscore the great usefulness of the process.  Here’s why.

In the section Diversification without Complication, I used the metaphor of a Viking ship, and I’ll use it here in another way.  When the Viking captain set out from Scandinavia to raid, he only needed to know to head southwest, into the setting sun.  On route, he likely had to alter course based on the wind and weather that turned up.  Eventually, he spied land and headed that way.  Then he could make out a specific village looking rich in the distance, and he trimmed the boat more finely with the steering oar.  He then pointed the ship to a safe beachhead when he could make one out.  And finally he steered the ship up onto the sand into a perfect berth between two big rocks.  When investing for long-term goals, retirement in particular, you just want to get started, generally heading in the right direction.  You will adapt your plans based on what comes your way in life.  As the journey progresses, your objectives will become more clear.  The closer you get to retirement, the more you can and will refine your plan.

So, if you’re young and/or have no clue what your life will look like in five years, let alone retirement, a high-level approach, what I call the “quick and dirty”, is likely sufficient and in fact most suitable.  What really matters is that you start setting aside whatever you can now, just to get yourself in the habit of doing so.  And, of course, the earlier you start, the more impactful is The Power of Compounding.

If you are older and/or more advanced in your retirement thinking, your plan can include much more clarity and detail.  And it is beneficial to do so, as improved accuracy likely translates into improved security.  I call this approach the “full monty.”

Financial planners/advisers and the planning applications they use should be able to accommodate as little or as much detail in keeping with your unique situation.