In drawing up a financial plan, the goal is to ensure that over a lifetime your income exceeds your spending. But life brings many changes – you have to keep working at it.
Most of us do not have the time, skills or even interest to become a financial expert. Nevertheless, we do need to take responsibility for our financial choices. Financial literacy requires that we know enough to be confident purchasers of financial products. The next few columns will provide a framework for financial planning, to help in understanding and judging the claims of advertisers and advisors as you make the choices that will most contribute to your quality of life.
The goal of financial planning is to make sure income exceeds expenditure. Whether for an individual or a business, failure to do so leads to debt, bankruptcy and ruin. There is an old joke that the three secrets for a successful business are: location, location, and location. While a prime location helps many businesses, the real three secrets are: cash flow, cash flow and cash flow. The first objective of financial planning is to ensure that your cash flow is positive.
Complications set in
The simple framework to be offered here is static. It only describes one point in time. But we live in a dynamic world. Once you introduce time to the equation, and changes to income and expenditures that occur over time, financial planning becomes more complicated. Maintaining a positive cash flow over time requires continuing effort.
Start with income. In the early years, income tends to be inadequate for a person’s needs. The struggling student needs to find income from family, loans and part time work. The student sets priorities for his or her needs, first to cover tuition and books. These expenditures are a form of investment intended to lead to a career and better income. At the same time the student minimizes expenses by sharing accommodation, eating a lot of Kraft dinner and only drinking the cheapest draft beer at the student pub. (Hey, a social life is a “need” too!)
After graduation and landing the first job, the young worker begins a career with steadily rising income that allows for additional expenditures encompassing a spouse, home, children and keeping up with the Joneses. Eventually, it’s possible to cut back on making income and pursue “other activities” – previously known as retirement. There may be declining income from earnings but if this individual has planned well there will be new income from wealth that ranges from pension plans to investment dividends.
On the expenditure side, no matter how frugal a person is in the early years, there may still be a gap between income and expenditure that is made up by debt. The trick to successful financial planning is to ensure that some of the rising income in the earning years goes to debt management to restore the cash flow balance over time. Not spending all your rising income on “wants” will be the key financial habit that will keep you successful through life.
Another positive habit is foresight. Begin saving as early as you can. This will first ensure that life’s emergencies do not bankrupt you. Early investments will grow through the magic of compounding. Then, just when you are getting financial planning under control, new needs arise. You get married, have kids (and they are expensive!), buy a house. Foresight and forbearance will be important in maintaining the savings habit.
Say you do maintain a positive cash flow, even in those highest expenditure need years. The reward in your 55-plus years will be much reduced expenditures, with the mortgage paid off, kids gone, solid pension credits and a well-diversified RRSP portfolio. But before you splurge your cash surplus on forgone wants, note that financial planning now really gets important. This may be your last crack at some serious compounding so that wealth can supplement the income you no longer earn 9 to 5.
Cover your debts
That is the framework. Keep cash flow positive. If you need to invest in education or your own business, make sure your financial plan provides for later surpluses to cover any earlier deficits. Know the risks to your income and manage them to keep on track. Here is where the right insurance products can help.
Then track your progress, monthly, quarterly, annually – and be prepared to make adjustments as plans rarely work out exactly as expected.
The final reward for effective financial planning is the opportunity for estate planning, to ensure the wealth you leave behind continues to serve the people and interests that you care about.
In the coming months we will look into related topics like paying down debt, minimizing taxes, critical illness, retirement. Even if you (like me) have not been the most effective financial planner you might have been, it is never too late to start.
Fred Petrie, MLI Insurance, provides financial planning for families and independent businesses.He can be reached at 204-885-3438 or cellular 204-298-2900 or email firstname.lastname@example.org.