Financial planning is not an activity exclusively for the wealthy; it is a useful tool for everyone, no matter what their level of wealth or what stage of their lives they are at. It helps people to ensure that they and their loved ones are financially protected against life events as well as providing security and assisting people to achieve their goals. Those who have their finances under control will have less stress and be better prepared when faced with financial issues. They will also be more likely to achieve their goals than those who simply bumble through from one pay day to the next.
Budget
The first step to financial planning is to understand your budget. This is simple to do. Simply identify the net income into your household every month. This may be in the form of pay from your employer and/or any income from savings or investments you may already have. The next step is to divide your expenditure into two groups, that expenditure that you must make every month (fixed expenditure) and that expenditure which you choose to make each month (discretionary expenditure). Fixed expenditure will include items like rent or mortgage payments, utility bills, essential food shopping etc… Discretionary expenditure will likely include theatre trips, luxury food, socialising costs etc…
By subtracting your fixed expenditure from your total income, you will identify the amount of money you have each month for spending on items that you choose to spend on rather than have to spend. Once you are clear about your level of discretionary spend each month you can decide on how much of that discretionary you are prepared to set aside for you and your families future and achieving your financial goals. You can then divide that amount between the main categories of financial planning which are protecting against life events, planning for your retirement and saving/investing for future needs or desires.
Protection
Depending on your circumstances, it is likely that you will have a number of protection needs which may include one or more of the following.
Protection against the financial consequences of
a) death or long term illness
b) loss of income (maybe due to redundancy)
c) theft of or damage to property
The common way to provide protection against these types of events is to purchase insurance. There are a great many providers of insurance policies and you should shop around to identify which provide the cover which most closely matches your needs at the best price. If this sounds daunting, there are many helpful comparison web-sites and brochures to help. If you find working through all the information too difficult or tiresome, you can contact a qualified financial adviser to do this for you. The financial advisers are often paid by the insurance companies and their advice to you will be free.
Retirement planning
People are living longer lives than ever before and it has never been more important to ensure that you have provided for an income in retirement. There are a range of pension arrangements into which you can enter and this is often achieved with input from an employer who will contribute to building a pension fund.
There are two main types of pension arrangement, defined benefit schemes and defined contribution schemes. Defined benefit schemes guarantee you a set income in retirement in exchange for a monthly payment while working. These schemes are becoming harder to find as they place a financial burden on the provider which in times of economic downturn, providers struggle to meet. They are often the best schemes for employees as they can be certain about the level of their retirement income.
The more common defined contribution schemes require a regular contribution but do not guarantee a set income in retirement. Instead, retirement income will depend on the investment performance of the pension fund and the level of annuity (a financial product which provides a regular income on payment of a lump sum) the pension fund that has been accrued can purchase. This is useful for providers as their liability is limited to the fund that has accrued, but it leaves the prospective pensioner with uncertainty about income level in retirement.
Whichever type of scheme that you have access to, it is important to plan for an income in retirement. The alternative is to rely on State benefits which are not generous and will almost certainly result in a noticeable drop in living standards.
Savings and investments
There are two good reasons to save and invest for the future. One is to deal with unexpected financial demands, such as needing to buy a new appliance when one breaks. The second is to plan for achieving your goals and dreams, such as being able to fund college education for children, celebrating a significant event, going on holiday or buying an expensive item such as a car.
If you plan for these events, this will mean you are prepared when they occur rather than perhaps having to take out a loan and pay interest to the loan provider. Often, by planning in advance for known timescales (like a special holiday to celebrate your 40th birthday in five years time) you can achieve a better return on your savings and investments by buying fixed term financial products.
For most people, saving an emergency fund for unexpected events is the first priority. Financial advisers usually suggest building up savings of about three month’s salary in an easy access account before saving for other purposes.
The benefits of planning your finances in this way are probably obvious. You will have provided protection against adverse life events, ensured you can live a comfortable retirement and also you will be in a position to achieve your dream purchases. Often though, people have insufficient income to do all these things at once. People will have to prioritise their needs and address them in order of priority. For most people the priorities will be to address protection needs first, followed by retirement planning and then savings and investments.