Why a financial plan? What does a “proper” financial plan cover?

Dealing with personal finances fills the hearts of many with anxiety and apprehension. Why is it that anything beyond an annual budget can feel like such a challenge? It may be the inherent complexity. It may be that the rules of the game are constantly in flux – pension and tax law never stands still for long. It may be the never-ending nature of earning and spending that makes things feel like a long grind.

This post introduces nine steps that will help you on the journey from anxiety to taking control of your financial future. These are the nine key parts of a “proper” financial plan.

1) Get super clear about where you are, and where you are going

Think about what is truly important to you. No plan is of any use without an end point, so the first question you have to ask yourself is: when I look into the future, what do I see being important in my life? Thinking about the aspects of life that matter to you now will help you envisage the kind of future you want.

This takes on several layers, often guided by a high level vision, ‘financial independence by 55’ for example. You then break this down further into goals and objectives. Your financial plan is shaped around these goals and objectives, guided always by your vision for the future.

Similarly, you can’t plot a course from an unknown starting point, so get clear on where you are right now. What do you own and what do you owe? What do you earn and what do you spend?

2) The crystal ball has been drastically improved upon, we can now dynamically forecast the future

Despite the many uncertainties that lay ahead, the action of plotting a path from now into your future is extremely valuable. Putting down a marker for significant milestones, school fees for example, means that psychologically you have taken a massive step in the right direction.

Big ideas can be seen evolving and coming to fruition, or big adjustments that need to be made to reach your goals show up. Being able to visualise the outcomes of various decisions can lift a great deal of stress about making trade-offs. This is very helpful when your current self is essentially negotiating with your future self. A deep concept, but one that is going on in your head whether you are conscious of it or not.

The tools for undertaking such an exercise often start with the humble spreadsheet, but these days it is possible to come up with bespoke planning that brings life to the most complex scenarios.

3) Review. Re-evaluate. Revise. Repeat.

Regular re-evaluation of your financial plan is crucial to securing long-term success. No budget or plan remains valid for long – life is happening too fast and with too many moving parts coming at us. Diarising to regularly review your plans is an extremely simple, but effective, way to stay on track. What’s more romantic on date night than throwing financial planning into the mix? Okay, that’s maybe not for everyone, but having an annual standing ‘meeting’ with your spouse could make a lot of sense.

Test everything. Question everything. Make the necessary adjustments and then get on with your life, secure in the knowledge that by next year, everything will have changed, but that you are on top of things.

4) Sensibly mitigate your life and financial risks

What risks? What is risk, really? Risk is often misunderstood and characterised as something exclusively bad, or to be avoided. Generically, risk is the probability (high or low) of a given outcome (good or bad) occurring at some point in the future (near or far) and the impact of the outcome (large or small).

Phew!

In order to construct a secure financial plan, you need to understand the risks of everyday life, particularly those relating to your employment, lifestyle choices and health. Having diligently compiled an inventory of all these risks, you will need an explicit action plan that mitigates risk where sensible to do so.

Having an up to date will is an example of mitigation; so is having a suitable emergency fund of safe and available cash.

5) What about high impact events, even with low probability?

This is the proverbial “hit by a bus” question. Low probability means the chances of a big impact negative event are small, but bad things do happen all day, every day, so what do you do about them?

From the inventory of risks, it will be clear what the main priorities should be. For young singles and retirees with adult children, insurance against these big events is often not necessary, but for families it can make a huge difference if adequate protection is in place. Most people cover their house, contents, vehicle and travel. Many professionals have other cover provided by their employer. Know what you have and seek out what you need.

6) Risky investments, anyone?

Equally as important for you to consider is your approach to financial risk. Understanding the extent of the risks you are willing to take with your money has a significant impact on your investment strategy. Your attitude to risk is determined by factors such as your age, current financial situation and long-term goals.

Modern behavioural finance is helping our understanding and developing measures for assessing how we behave under stressful conditions to allow for greater nuance.

Carry out a full analysis of the financial risks you are currently taking in order to proactively embrace the investment process and identify levels of risk that are suitable for different elements of your financial portfolio.

7) What do we invest in?

Many people get this part of the plan backwards. They start out seeking returns and base their selections on dubious recommendations, short-term past performance or what they think their friends are doing. Who hasn’t had a cryptocurrency tip recently? The correct place to start is actually by asking: what level of returns deliver a successful outcome? What does my pension need to achieve for me to retire at 55? In a great many cases, it is not the returns that have the biggest impact on the success of a plan, but the behaviour. Are you sticking to the plan? Are you making the maximum contributions you can afford in the early years to allow the magic of compounding to work for you?

8) Okay – but which fund do I invest in and who do I trust?

This really comes down to doing the work. Most professionals are capable of doing some basic due diligence on the counterparties of an investment and are comfortable going with big names. This is not always the best, but can feel safe.

Fund ratings and financial press recommendations are usually well intentioned, but are rarely tailored to your requirements so care needs to be taken to ensure that you are getting the context right.

Always seek ideas about investments from independent sources who are not conflicted. Unbelievably high returns are often just that – unbelievable.

9) Optimise for maximising growth

The UK has a deep and sophisticated financial services industry that means most investors can access all the investment products they will ever need. The trick is to do it tax efficiently and cheaply. This is about keeping on top of your allowances for ISA and pension investment, but also utilising all available reliefs in your tax return for things like dividends, savings income and capital gains. Optimising is also about getting the risk level right for different investments that have different purposes and time-frames.

Finally, the high cost attached to many financial innovations that attract sophisticated investors just don’t deliver value for money most of the time. If you are serious about investing for your future, you need to keep costs and taxes to a minimum, and risk to an appropriate level, to deliver your desired outcome.

That is the framework for a “proper” financial plan. There are many nuances and complexities which mean that hiring a good financial adviser can create huge value. If all this seems like a lot of work, it is. That could also be a good reason to hire a domain expert to guide you and support you on your journey.

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