It is impossible for anyone to be good at any skill until they know what it is for.
After postponing the task for 50 years, I am taking guitar lessons. My teacher must be inadequate because I have been doing it now for 4 weeks and I still cannot play any Stevie Ray Vaughan material. I’ll give it another week or two.
What I have learned though, is that if I had never heard guitar music I would be unable to learn how to play it. There would be no purpose to it.
The “What’s it for?” question.
So it is with financial planning. Both clients and advisors must have a clear idea about the answer to the question, “What is financial planning for?”
Each person will have a slightly different collection of ideas or emphasis or priority. People cannot see the whole picture from their own viewing point, thus the need for explanation. Once they see the bigger idea, decisions become obvious.
Here are some ideas to begin the discussion.
Financial planning is a process.
It aims to efficiently, or possibly conveniently, allocate wealth that you possess or that you will earn into three time spaces.
- Today. Lifestyle. Consumption.
- Yesterday. (Debts and other obligations, like children’s education, to which you are committed)
- Tomorrow. Retirement, flexibility, opportunity or estate issues. Some would put education funds here and that is okay.
The purpose is clear with money you already possess. It is not as clear with money you are earning week to week. That money tend to fall into three categories too.
- Now Money. Earn it today, spend it today
- Them money. The money you lose to the government for taxes, maybe union dues, maybe some other costs of earnings, like unemployment insurance.
- Then money, being anything you earn today and either spent in the past or will spend in the future. Mortgage payments are a past expense resulting from buying your home. Pension deductions at source and savings are future spending.
Debt and investment are a kind of time machine that moves money from one time space to another.
Financial planning is about balancing the past, the present and the future. What you consume is available to neither the past nor the future. What you save is unavailable for lifestyle. Both the present self and the future self must be happy with the outcome. Rate of return and time to completion are important aspects.
For most young people earning middle class income, “Now” money is 45% to 50% of total income. As income goes higher the “Them” share tends to grow and lifestyle becomes less than 45%. It is not easy to change lifestyle, so choose one carefully. A common breakdown is 45% “Now,” 30% “Them” 25% “Then” with the big share of then being the past.
Clients are willing to let someone modify how the them and then categories work. They do not usually pay day to day attention and unless lifestyle is affected, they may not even notice them. Advisors can productively provide techniques and products to manage these.
The first stage of planning under this model is to get control of time.
- Insure future earnings.
- Hold a safety fund for the ups and downs of now.
- Have a will and powers of attorney.
- Have a budget to rationalize lifestyle spending so that there is adequate wealth to deal with the past and to provide for the future.
- Have a longer term plan that creates both priorities and incentives.
Most people are not productive until they see the reasoning. Help them see it and provide useful products and techniques to make it work.
People who are planful tend to be more successful. The whole thing is just organized common sense with an arithmetic component.
Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: firstname.lastname@example.org