What is financial planning? Good question. Do you want the laymen’s definition or the financial planning handbook’s version? How about I give you both, so the technical finance guys who stumble across this blog can’t burn me at the stake for not being accurate and people new to the term “financial planning” can actually understand it.
Let’s start with the definition from the South African Financial Planning Handbook. It reads as follows “Personal financial planning is the organization of an individual’s financial and personal data for the purposes of developing a strategic plan to constructively manage income, assets and liabilities to meet near and long-term objectives.” Wow! While 100% correct, it’s a bit of a mouthful. In simple laymen’s terms financial planning means having a personal plan in place to make money and a contingency plan (safety net) in place to reduce the risk of losing your hard earned bucks when life throws you an unexpected curve-ball. I will discuss a few of those unexpected curve balls in the next financial planning post. What you need to know is that making money and planning properly to protect it (in a nut-shell) is the name of the financial planning game.
However you define it, financial planning is important and everybody needs a money plan. This plan is going to differ from one person to the next because it means different things to different people but the fundamentals of the planning will remain the same and we are going to cover one of the core ideas in this blog post.
Any financial plan is going to cover two key areas. Creating wealth and protecting your money. It doesn’t matter what age you are, these are the basic fundamentals and as long as you remember the basics you can build your own plan around them. Sure financial planning can get a lot more technical than this and we will cover all the technical stuff in blog posts to follow but for now let’s stick with the idea of creating wealth. In the next blog post we will discuss how to protect your moeny, because a plan worth putting in motion requires a solid foundation.
Accumulating wealth (making money)
It doesn’t matter if you are saving for a deposit on your first home or if you have retired from a corporate company after 30 years of service, making money should part of any ones personal financial plan. We all work to cover our overheads (fixed monthly expenses) and spend some of our residual salary on the things that we enjoy. In my case it’s mountain biking and doing a little travelling. The rest of the cash we should be saving or investing in assets that appreciate in value to create wealth. Now this is where the actual “planning” part of your wealth creation strategy should start. What to do with your left over money each month?
In my opinion you need a couple of investment plans that should form part of your bigger financial plan. A short term investment plan, an emergency cash stash plan and a long term retirement plan. Any plan starts with an end goal in mind. That is what you always need to remember. Your wealth accumulation plan should be no different. Work out what you want then work backwards to find out how you can achieve the goal. Let’s start with the emergency cash stash plan. How often have you dipped into your wallet or handbag to pull out your credit card when a money emergency presents itself? Too often I would suspect. Why? “Because I can’t plan for the emergency”, I hear you say. Agreed, not every crisis that you are ever faced with can be planned for, but you can plan to have a little money stashed for an emergency.
How about a quick real life example? You have an unfortunate fender bender while racing home to make dinner after a Monday night spin class. The car gets assessed and you are in for a R4000 insurance excess. You either have the money to pay the excess or you don’t. If you had perhaps planned for this type of emergency and stashed some cash, you have it available. If you don’t, what are your options? Dive into the credit card to find the money (most likely scenario) or drive around with a banged up car (most unlikely scenario). You see, this is the basis of planning. It’s thinking ahead and making provisions for eventualities. At some stage or another you are going to be faced with a money emergency that you haven’t planned for, so you might as well start making some cash available for it now.
What is an example of a short to mid-term investment plan? Well, it could be saving for your kid’s education. Short or mid-term investment plans in my opinion would be considered to be any plan that has a 5 – 10 year horizon. Again what is important here is that you look at what you want to achieve and then set a plan in motion to work towards your goal. Let’s say that you are looking to save for your child’s varsity fees. The 3 year degree is likely to cost R50 000 and you have 5 years to put enough money away. How do you put in motion a short term investment plan? Firstly you need to look at the end goal. The goal is having enough money to pay for the fees in five years. What is the amount required and how long do I have to achieve it? In this instance it’s R50 000 that is the goal and five years the time horizon you have to achieve the goal. Start saving now so that you have the money available in five years to pay for the fees, or you will end up having to borrow the money in five years and start paying back a loan. Let’s assume that you have the money to start saving and want to plan ahead.
You will need R650 per month invested for five years and your investment would need to return 10% growth over the period in order to achieve a R50 000 maturity. What we have done now is quickly put in place a proposed short term financial plan to provide varsity money for your child. It is as easy as that.You see, a little planning goes a long way. Just remember than any plan worth putting in place is a plan worth revisiting because you need to make sure that you are on course. If you don’t put exactly R650 away each and every month and your investment doesn’t return 10% over the five year period the education plan is going to fall short.
What about long term wealth creation plans? I would consider settling your bond and planning for your retirement as critical long term investment plans. The same principle applies though. Decide on the end goal and work backwards to put in place your master plan. If you want to retire in 20 years and you need the equivalent of R30 000 per month in today’s monetary terms to live comfortably, then you need to work out how much money you are going to require in 20 years, then work backwards to determine how much you need to start saving today. Killing any debt is also a wealth creation plan. The sooner you have settled your debts (start with the smallest debt with the highest interest), the sooner your personal cash flow improves. That means having more money left over each and every month. More money left over means more cash available to invest.
Now that you know that creating wealth is a core component of any financial plan and a financial plan in the simplest terms is “planning to create money and then planning to protect it” you are on the right track. Let’s re-cap before I sign off and remember in my next financial planning post I will be discussing the second core principle of financial planning. “Putting measures in place to protect your accumulated wealth.”
How to create a wealth accumulation plan:
1) Step one – Have the end goal in mind
2) Step two – Set a timeline to achieve the goal
3) Step three – Set a plan in place to achieve the goal
4) Step four – Revisit the plan to make sure that you are on course.
Until next time
Brendan
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