Economics is the strategic backdrop to financial planning.
Economics is the study of systems that provide methods to allocate scarce resources. Communism allocates by government fiat, capitalism by ability to exchange something of value. There are variations between.
Financial planning is a specific instance of allocating scarce resources and none of the macro systems matches exactly. Personal or micro economics is easier and there is a way to think about it. It is still about allocating scarce resources.
First Fundamental. Know the purpose of allocating your money. What are you trying to accomplish? How much of that? When? Who will be involved? Where? What other choices are there?
Second Fundamental. Discover or estimate the resources to allocate? What others can you reasonably expect to have? Future income, inheritance, lottery win. If you allocate differently now can you increase the resources you will have in future? Maybe more education. Maybe pay debt before investing.
Third Fundamental. How will time affect the plan? Waiting to start means more capital will be needed. Being able to extend the end point makes it easier. Discover what could limit the time and have a way to deal with it. Life insurance for example.
Fourth Fundamental. Understand that debt drags. Investing in debt reduction is, for most people, a high yield and very conservative investment.
Fifth Fundamental. Understand investing. It is a time machine with growth features. It takes money from now to the future and reconstitutes it for use then.
Do not make the mistake of treating investing and stock trading as equivalent. They are based upon different principles. Investing is about participating in a business that adds wealth, while trading is about guessing how other people will value a particular stock.
Sixth Fundamental. Understand how compound interest works for you. Use the rule of 72 to discover how long it takes money to double at a given rate. For example at 8% money doubles every nine years. In 36 years it will double four times. BUT, it doubles just three times in 27 years. The last double makes as much money as all the doubles before it. Start early.
Seventh Fundamental. Discover the financial tools that will make your task easier and cheaper. No point reinventing the wheel. People have been doing this for a long time.
Financial planning is merely organized common sense. You already know the fundamentals. It is about moving money around in time. It is like getting paid on Friday and allocating the money over the days until the next pay day. Only the time scale differs.
Sometimes people need help to keep them on track, to help with tools and to put things into the proper order. Consider a financial advisor who can assist you.
Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.
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