A financial plan for an individual or couple is determined by one’s goals and priorities. Nonetheless, there are certain basics that make up any financial plan. In it, the plan includes:
- the client’s goals and objectives
- a summary and analysis of the client’s current financial situation; i.e., cash flow, net worth, savings/investment plans, insurance programs
- recommendations to achieve the stated goals
- an action plan to implement the recommendations
The priorities of the client will drive the emphasis of the financial plan. For example, debt managment may be highlighted if the client is seeking to improve household cash flow and eliminate consumer loans. Detailed estate planning tools would be the main component in a plan for clients who desire a tax efficient transfer of wealth to their heirs. And tax-efficient retirement income options would dominate a plan for clients ready to begin retirement.
A financial plan may be as unique as the individual for whom it was created. Even so, the basics of a financial plan form its foundation.
Until the 1970′s, Canadians looking for financial advice, would consult with their lawyers, accountants, bankers, insurance representatives or investment brokers. Then, there was no profession referred to as financial planning.
However, society grew more complex in the 1970′s. Canadians had to deal with increases to corporate and personal taxes, the oil embargo, high levels of unemployment and the occurrence of a new economic phenomenon, stagflation – a combination of high inflation and a stagnant economy (recession). For the first time, no one field was equipped to deal with all of these economic factors. Financial planning emerged as a distinct profession to deal with the complexities of a new economy.
At first, anyone could call themselves a financial planner and there were no standards for education, proficiency, or ethics. As the profession evolved, education and training became available, standards developed, and regulating bodies formed, most notably, the Financial Planners Standards Council, whose mandate is to “develop, enforce and promote the highest competency and ethical standards in financial planning as defined by CERTIFIED FINANCIAL PLANNER® (CFP®) professionals.”
Financial wellness is not unlike physical wellness in terms of maintenance and benefits. Consider the following analogies:
- to budget is to have control over our money flow
- to diet is to have control over our food intake
- a steady program of saving and investing can translate into high net worth
- a steady program of exercise can translate into physical fitness
- good financial habits can create wealth and financial independence
- a healthy lifestyle can create good health and physical independence
- working with a professional financial advisor can improve your financial results
- working with a medical professional can improve your fitness results
Although there are no guarantees in life, my experience has taught me that maintaining an awareness of our finances boosts confidence and self-esteem. In comparison, maintaining a healthy approach to diet and exercise also boosts confidence and self-esteem.
A program for financial wellness is a program of financial planning.
There is a concept in Economics known as opportunity cost, which is the benefit forgone when one alternative is chosen over another. For example, suppose we can either drive to work, or take the train. If we drive, we cannnot read the morning newspaper on the way to work. If we take the train, we cannot run errands during our lunch break.
Sometimes, opportunity cost can be measured in dollars, as in the following case, which also illustrates the power of compounding.
Al and Bob, both 25, begin working and earning identical salaries. Al begins an investment plan where he contributes $100 per month, and continues to do so for the next 10 years after which he stops. Bob waits the first 10 years, but begins his own plan to contribute $100 per month for the following 10 years. After 20 years, they have contributed $12,000 ($100 per month times 10 years), each to his own portfolio.
Al and Bob contributed to the exact same investment, which yielded 8 percent per year. At the end of 20 years, the value of Al’s portfolio has grown to $40,600. The value of Bob’s portfolio is $18,290.
The opportunity cost of Bob’s waiting is $22,000.
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Earlier this month, I read about the experience of a journalist who took a gene test because she wanted to know what medical conditions she may be predisposed to contracting in her lifetime. The argument she gave for taking the test is that if you know what you’re most at risk of contracting, then you can take steps to minimize the risk.
For me, the keyword is “know.”
From a financial planning viewpoint, risk management is essential. If a catastrophic event has the potential of causing financial ruin, then risk protection should be included in your plan.
For example, if illness or injury meant you could not work for several months or longer, how will you meet your expenses? Disability or critical illness insurance may provide the means to maintain your household. What if one spouse dies and leaves the surviving spouse with small children and a huge mortgage? Life insurance protection means that the family goals of your financial plan may still be achieved even in your absence.
It is worthwhile to learn what risks exist and where you are most vulnerable. Because, after all, if you know what and where the risks are, then you can take steps to minimize the risk.
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