The Benefits of Financial Planning and Financial Goals

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If someone asked you, what are your financial goals or what is your financial plan? Are you able to answer with an amount and a date and time frame? Can you break it down into years and months? Can you explain what it consists of, pension fund, provident fund, ETFs, RAs, property, local equities, foreign equities, bonds etc. If you can’t do all of this then you need financial goals and financial planning.

You more than likely have some of those financial planning instruments listed above but are they part of a plan. This was my experience for the first 20 years of my working life. I had all of the above and yet my net worth was less than zero. I knew that retirement was coming but I had no idea how much I needed and no idea how I was going to achieve it. It seemed so daunting and confusing. I don’t know what I was waiting for or how I thought I would solve this.

Have you done financial planning?

Any bit of investment advice that you read or get will ask you what your financial goals are and what is your financial plan. I could never answer these questions or maybe I just never took the time to think about it properly. It didn’t help that I was not good at asking for financial advice. I was very mistrusting as my experience in the past with financial advisors was that they just sold you policies.

The kinds of terms used are financial needs analysis, short, medium- and long-term financial goals, lifestyle goals, retirement structures and life goals. All this info you would need to know and then you do some fancy calculations and it tells you that you need so many millions of rands. It all sounds very complicated, but it doesn’t have to be. I needed to understand the basic principles and how and why financial planning was needed before I got it.

Why do you need a financial plan?

The day that you start working and get your first paycheck is one of the most exciting days of your life. It could be during school, after school or after your studies.  Either way from that day onwards you only have a choice of three options. Every month you will use your hard earned money by choosing one of these options.

So are you doing financial planning?

First option is that you spend more than you earn. In this situation you have to borrow money to pay for your needs and wants so you create debt. Basically you are a money Loser because you are wasting and losing money.

Second option is you spend all the money you earn. So effectively you do nothing, you owe nothing, but you don’t have assets either. So, you are a money Nobody. You think you are doing well but actually you are nowhere.

Last option is you spend less than you earn, and you invest the rest of the money. Now you have growing investments and you are building wealth. The confidence, sense of comfort and accumulating investments make you Wealthy.

Most people land up between Loser and Nobody either unaware or not knowing how to get out of it. The Wealthy on the other hand have a plan, they have an end goal in mind and a monthly and annual plan that will get them there. Not only do they have a plan to accumulate the wealth but they also have a plan to look after the wealth. Without this master plan and a view of what the end game to looks like, you will be lost or going backwards.

What are your financial goals?

When I used to get asked this question I had so many different answers. Everything from,

I don’t know
I want to retire by 50
I want to be debt free
I want to earn a fortune
I want to pay off my house
It is too complicated to know
It depends on how much I earn
I don’t know how to work it out
I don’t need a plan I am busy saving up

What made it more confusing was that I was always told that everyone has different goals so it depends on you, you must know what you want. This may be very true but is not helpful. So, let me simplify it.

You need money to survive and provide for yourself and your family. At some point in your life you will not want to or be able to earn money anymore. That means that from that point onwards you will need enough money invested to be able to live without working. You need to think about when you want this to be. You also need to think about what would happen if you needed it sooner.

“Every paycheck that you get that does not contribute to your financial goal is a lost opportunity for ever”

That is essentially what your most important financial goal is. It is the same for everyone, to be financially independent. Understand this, set it and pursue it first, then get more fancy with other goals. No matter what you do or who you are this goal will not go away.

What is a financial plan?

The financial plan is the how of achieving your financial goal. If you have got your head around your financial goal you need an actual date to achieve it and you must know how much money you will need. Once you compare your current situation to the end point being your financial goal you may have a small heart attack. Stay calm this is a normal reaction, it’s called a wakeup call. Just like that alarming ring in the middle of the night that jolts you awake.

You now need to figure out how can you make that target achievable. What do you need to change in your financial life?  Again, let’s keep it simple.

There are only 2 parts to this equation, your income and your expenses. You need to increase the gap between them, so decrease expenses and increase income. That gap that you create is the money that you use to achieve your financial goal.

Work out a plan of how you will use that money to move from your current situation to your financial goal. Essentially this plan will deal with settling debt and creating investments to accumulate the wealth. Work it out by month and by year. You can find templates online to help with this but it is best if you can learn and understand the calculations required. My next post will cover this in detail.

My financial goal

As the worst case, my goal was to make sure that I had enough money to retire. I actually wanted to be better than that. Inspired by the FIRE (financially independent retire early) concept I wanted financial freedom, enough money to retire as soon as possible. So my date was going to be dependent on how much I needed and how long it could take me to accumulate.

“Retirement date is dependent on you and how quickly you achieve your required net worth.”

To work out how much I needed I had to know what my expenses would be at the time of retirement, To do this properly you need to know what your current expenses are in detail. Then have a view of what they will look like when you retire. First big lesson, the lower your expenses, the less money you need to live and so the less you need to retire.

I worked out what my expenses would be if I was retired now. Then I adjusted this number for inflation to the relevant date that I had identified for retirement. This is a bit of a moving target because the longer you take the higher the retirement expense will be and so the higher the retirement amount. So you just have to go back and forth a bit to refine.

How to calculate your financial freedom number

The best way to calculate your financial independence amount is to use the 4% rule also called the rule of 300 or rule of 25. This rule says that your annual expenses at retirement must be less than 4% of your retirement amount. Or you can say that your retirement amount is 300 x your monthly expenses at retirement or 25 x your annual expenses at retirement. They all give the same number.

Other calculation methods make assumptions about your income required. I find this less accurate and misleading. The bottom line is that you will need enough money to cover your expenses in retirement plus any additional spending. So it is best to apply your mind to this and arrive at a reasonable estimate.

The way this rule works is that if you withdraw 4% or less from your retirement amount then your money will never run out. This is as good a number as you will ever get.  Lots of clever people have checked this and used this, there are many other resources on this. You can also compare this number with calculators available from some financial institutions. The results should be similar.

Eg retirement expenses R30 000pm or R360 000 pa
4% rule:                Retirement amount = R 360 000 * 100/4 = R 9 000 000
25 rule:                 Retirement amount = R 360 000 * 15 = R 9 000 000
300 rule:              Retirement amount = R30 000 * 300 = R 9 000 000

If you want to calculate your number then do the same calculation as I did or just check the table above. Look up your current monthly expenses on the left column. On the top column check how long until you retire. Where the two intersect is your retirement target number based on your current monthly expenses and how long until you want to retire.

Financial Planning

This final number is then your financial goal or target. If I wanted financial freedom and to be financially independent and not need a salary, I would need this amount of money.

Having this target allows you to also think about other financial goals along the way. Its not always possible to know everything at the start but I’m sure you have some things on your mind. Work those in and then any other that come later can be added.

In my next post I will explain how I put my financial plan together and what it looks like.

The benefits of doing your own financial planning

  1. It forces you to set your financial goals
  2. You understand your current spending and budget
  3. Calculating your retirement target and date creates urgency
  4. It identifies gaps in your financial literacy and financial situation
  5. You have a framework to make all future financial decisions in
  6. By tracking your progress you almost guarantee success.

You shouldn’t take any of this as advice, consult a professional financial advisor for that. This is merely what has worked for me and my experience, so what has your experience been?