Let’s say your boss assigns you a task. How would you go about accomplishing it? Would you:
Now let’s say your goal is to buy a house, or to send your kids to college, or to retire comfortably. How would you go about accomplishing these? Let’s face it. Most of us tend to go with option 2.
This is where financial planning makes a difference. “financial planning” may sound like something for rich people with a lot of money or for big-time stock and bond investors … but it’s not. Financial planning is about life. It is about determining your goals and figuring out how to use the financial resources you have to reach them.
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A personal financial plan is a strategy for how you will spend, save, and invest your money today and into the future. The plan describes your current financial status, your financial goals, when you want to achieve them, and the steps needed to do so.
Just as there are systematic steps for planning a task, there are systematic steps to putting your financial house in order. Financial planning is not something you are born with; it’s something you can train to do and do well.
From the simplest to the most complex financial planning, it all begins with building a household net worth statement and a cash flow statement. The former is a comprehensive snapshot of what you own and what you owe; the latter is a simple spreadsheet that lists your income from all sources and your expenses. To get started, pull out your earnings statements (W-2’s), your bank statements, credit card bills, mortgage papers, worksheets, your tax return, credit report, everything that has anything to do with your assets, debts, income, and spending. Pull out your computer, or some paper, and prepare the two worksheets using the information that you have gathered.
A Statement of Financial Position, as it is technically called, or a Balance Sheet, as it is commonly referred to, is a statement of your net worth. To produce one, begin by listing your assets (property you own) by name in the first column of a worksheet and the market value of each asset you’ve listed in the second column of a worksheet. Lists of assets typically include your primary residence, bank accounts, work-place plan accounts, like your 401(k)-plan account, IRA accounts, both traditional and Roth, annuities, the cash value of any life insurance policies you own and any business interests and rental property. Next, list your liabilities (money that you owe on the property you own and to creditors) by name and the total amount you owe to each creditor in the first and second columns below your assets. Here you would list the mortgage on your primary residence along with the outstanding balance, any loans or credit card debt and any other money you owe. Add your assets, add your liabilities then subtract the total of the latter (liabilities) from the former (assets) to arrive at your net worth. This is the statement that you should be managing your personal financial “house” too.
Building wealth is building net worth.
An Income Statement is a statement of your cash flow. To prepare one, begin by listing your sources of income and the amount of money you earn from each source for the year in the first two columns of a worksheet and add up your income. Next, list each of your expenses by name and then the amount (annual) of each expense in the same two columns below your income columns. Income tax is a typical household’s biggest expense and should be included. Add up your annual expenses. Subtract the total of the latter, your total expenses, from the former, your total income, and you have your net cash flow. It will either be positive or negative.
Thrift is the key to building wealth. You should strive to put yourself in a position where you’re spending less money than you earn, so you have money to commit to achieving your goals. Money to save and to invest.
Find a nice quiet place, sit down with a cup of coffee or tea, and think. Think about where you are in life. Are you further than you expected you might be at this point, or do you feel behind? Upon what were those expectations based? What life events are coming your way? Now look at the information you’ve gathered with a critical eye. Is your net worth positive? Do you have too much debt, or the wrong kind of debt? Does your net worth statement exhibit financial wisdom to date? How does your income compare to your spending? What are you spending your money on? Are you saving enough? Would becoming more financially disciplined today put you in a stronger financial position tomorrow?
This exercise can become emotionally charged. Stive to emerge from it dispassionately. This will enable you to objectively determine the next steps required to move forward.
Next, think about where you want your life to go… short term, say one to five years, and long term, say from six years to forever. Then think about what you would like to achieve with your money. Your financial goals. Typical goals may include paying for college for someone, buying a new home, or maybe it’s time for that vacation home you’ve always wanted. Do you want to travel – to take one special trip and/or put together a recurring travel fund, or maybe you would like to purchase a sailboat, a motor home and, of course, the big one; to be able to retire comfortably without compromise and worry. Whatever it is, go for it and make it a goal. Now, write your goals down – that makes them more real. Be specific in terms of what you want and by when. “I want to buy a house” or “I want to be rich” are not goals, they are daydreams. “I want to save $100,000 as a down payment for a house in 8 years” is a goal. Goals should be specific, measurable, attainable, realistic, and time bound. Having done all the aforementioned “heavy lifting” you will be well on the way to taking control of your financial future!
Although this work is best done with the help of a Certified Financial Planner Professional, as is really all financial planning, it is not difficult if you’re willing to make an investment of your time. Determining the cost of something you plan to consume in the future, how much you need to save monthly or annually between now and then, factoring in the time you have and assuming some rate of return on your money is referred to as “capital needs analysis” in financial parlance. Begin by studying capital needs analysis, learning the relevant time value of money concepts and formulas and searching for, and exploring, the relevant financial calculators that are available online and at your disposal.
Next, perform the calculations necessary to determine how much money that you will need to save to achieve each goal. Financial calculations involve assumptions, like the number of years you have to reach the goal, inflation and how much money you are starting with. Be aware that most financial calculations are very sensitive to even small changes in the assumptions involved. Having done these calculations for each of your goals, you will have determined the amount of money you’ll need to commit to each of them, the frequency of the deposits and the required rate of return on your money needed to reach each of them.
Next, create a table that outlines both your savings allocated to each goal and the savings required annually to meet each of them. This will help you determine whether your goals are realistic and help you prioritize them. Most of us will not have the resources to fund all that we hope for.
Take your analysis of where you are, compare it to your goals describing where you want to go, and figure out how to get from point A to point B. Create a new spending plan that embodies better spending and savings habits. Determine the size of your protective reserve. Choose insurance products. Decide which credit cards or loans to keep and which to pay off. All three of the aforementioned should be considered high priorities.
Stack rank your financial goals and objectives in order of their importance and tackle them one by one starting at the top of the list. Revise or reprioritize your goals if they are unrealistic or you are unlikely to be able to accomplish them all.
One of the greatest challenges with financial planning is its expansive breadth. It’s one of the reasons that an ongoing, dynamic approach to financial planning succeeds and one-time comprehensive financial planning fails – because fifty-page plans with a dozen or more recommendations often erect an unintentional impediment to implementation because of their heft. Financial planning is a process, not a product, so your financial house remains properly ordered through control, ongoing effort, and attention.
Consider engaging and/or getting a second opinion of your plan from a CFP® professional and if you don’t feel that you have the time, interest, knowledge, or skills to manage your own investments, find and hire a professional.
You must protect yourself and your family from a dramatic decrease in your standard of living. Thus, you must immunize yourself and your family from personal risk: the devastating impact of not being able to meet your essential cash needs. It is critical to keep enough easily accessible money on hand to cover your essential spending needs (food, rent or mortgage, insurance premiums, etc.). No one knows what could happen tomorrow – a broken refrigerator, a job loss, a hurricane, losing your business or getting a divorce. A protective reserve could be the difference between whether the emergency is a just a financial headache, inconvenience, temporary set-back, or a major financial crisis.
If you get sick, suffer an accident, suffer property damage, or die, you (or your survivors) may take a bad, or perhaps catastrophic financial hit. The right insurance can soften the blow – health, disability, auto, homeowners’ or renters’ and life insurance are some of the kinds of insurances that are available to you. That is a lot, so decide which kind of insurance policies are essential for you to protect yourself and your family. Remember, if you’re single and have no kids, you need to ask yourself, do I really need life insurance, and who needs the benefit of my life insurance? If you are married and have a young family, you and your spouse need to have life insurance policies.
Freeing yourself of credit card debt should be a top priority. Know what you owe. List all your debts. Include in the list the name of the lender, the outstanding balance, the interest rate, the monthly payment and whether the interest is tax deductible (like mortgage interest). How big a chunk of your income goes to debt payments – too much? Now work to reduce your debt – usually it is best to start with the highest-interest-rate credit card debt. While you’re at it, you should also consider getting a free copy of your credit report (annualcreditreport.com) and check it for errors.
Paying off your debts is one of the best investments you can make.
Goal based investing involves aligning a goal with an investment account or set of accounts and, in turn, an asset allocation model and portfolio of investments designed to generate the rate of return necessary to achieve the goal. If, for example, one of your goals is to put our child through college you might align a 529 plan (college savings plan) to this goal or if your goal is to build wealth for retirement, then you might align your 401(k) plan account at work, your IRA accounts and, say, a brokerage account that you have been socking away some money into your retirement goal.
Instead of focusing on making the most money you can in the markets (more volatility than you may be able to withstand) or trying to beat the market (which studies have shown that even highly skilled, experienced investors are unlikely to do), goal-based investing allows you to tailor your approach to achieving each goal and to easily measure your progress toward achieving each of them. You will succeed if you save as prescribed and earn the required rate of return on the investments in the account or accounts dedicated to each of your goals.
Investing without purpose is akin to taking a road-trip without a destination and the aid of a roadmap. You may not end up where you intended.
Contrary to the way most people see it, successful investing is about time in the financial markets not timing them and leveraging the power of compound interest. That is… earning interest on interest over time. The power of compounding is striking. If, for example, you can earn 7.5% on average annually on your investments over a 10-year period, the amount of money you deposited initially will about have doubled in value without you having added any more money to the account!
It’s probably best to delegate investment management to a competent, experienced Investment Advisor Representative (IAR). Yes, a pretty-precise term. IAR’s are the only financial advisors that have a fiduciary duty to their clients under law. As such, they must always act in their client’s best interest and are obligated to fully disclose any conflicts or potential conflicts of interest to their clients. They can be found working for Registered Investment Advisory firms (RIA’s). Engage and work with no one other than an IAR. Plain and simple. Successful investing is by no means easy. Developing the skills necessary for success takes time and experience. Competent advisors have degrees in economics, business, and finance. Most have advanced degrees and industry certifications. Their philosophy, process and approach should, ideally, be driven by academic research and be evidence based. Most importantly, they should understand how an investor’s behavior often gets in the way of their success and be able to help them avoid making poor decisions and mistakes.
Should you decide to take investment management on yourself, you should be aware of four generally accepted pillars of successful investing. They are asset allocation, diversification and indexing and periodic re-balancing.
Asset allocation is the process of dividing the money in your account between different asset categories (classes), such as stocks, bonds, and cash, based on the required rate of return necessary to achieve your goal, your risk tolerance and how much time you have until you need the money. The objective is to generate the necessary return while controlling and minimizing volatility.
Diversification is the process of spreading your investments across different industries and companies within an industry. By diversifying your investments, you can potentially benefit from growth in different industries and companies while limiting your exposure to the poor performance of any one industry sector or business. The aim is to reduce the risk of loss. Remember businesses do sometimes fail and take their investor’s money with them.
Indexing is a passive investment strategy that involves tracking the performance of a market index such as the MSCI All Country World index, the S&P 500 index, or the Bloomberg US Aggregate Bond index. Instead of trying to pick individual stocks or bonds, an investor simply buys a low-cost index fund, or funds that hold a basket of stocks or bonds, etc. that mirrors the performance of a particular index.
Lastly, portfolio rebalancing is the process of realigning the weights of the asset classes in a portfolio to maintain the desired risk and return profile. This involves selling some of your outperforming assets and buying more of your underperforming ones. The goal of rebalancing is to ensure that the performance of the account or accounts stay on track with the goal, and to avoid overexposure to anyone asset class or sector.
Stuff happens. Often unexpectedly. At a minimum, put together a document that identifies the essential information that your heirs will need to know should something happen to you and pinpoint where it, and everything listed in the document, can be found. List important information such as the location of your safe deposit box (and the keys). Describe the nature and the location of personal papers, insurance policies, legal documents, financial documents, deeds, and titles.
List the names of important people and their contact information, such as your employer, attorney, financial planning professional, insurance agent and accountant and all the financial institutions that you have a business relationship with, the type of account held at each and the account number. Above all, talk with your spouse, partner, and children about your wishes.
Verify the beneficiaries on your insurance policies, annuities, and Individual Retirement Accounts. Make sure that should something happen to you, the proceeds and accounts will end up in the hands that you intend them to end up in. Work with an estate planning attorney to have key estate planning documents drawn up. While you’re at it, you may want to consider buying a burial insurance policy. It can sometimes take time to administer an estate and transfer property (money) to heirs.
The documents you should have include:
A Will or Trust – makes sure the right people get your property when you are gone.
General Durable Powers of Attorney – appoints someone to take care of your finances and legal matters when you can’t.
Health Care Power of Attorney – names someone to look after your medical care when you can’t.
A Healthcare Directive (Living Will) – declares what life-saving measures can be taken should you become incapacitated.
HIPPA authorization form – allows for the sharing of medical information with someone.
As you follow your plan, keep an eye on changing circumstances, and make adjustments as needed. A new job may let you boost your savings rate. An unexpected crisis may force you to push back some goals. Changing family circumstances may create new goals or make old goals irrelevant. And, especially, check to see if unnoticed or previously unrecorded bad habits are pulling you off course. This is a time to be completely honest with yourself and your financial habits. Mistakes don’t break your plan. In fact, financial planning is an exercise in mistake management.
Measure your progress in achieving each of your goals by comparing the required rate of return necessary to achieve each of them with the average annual rate of return on the account or accounts that are aligned with each of them. Your actual return will likely vary from your required rate of return each year, but over time should be tracking it. Compare the appropriate market benchmarks for each account or set of accounts to the account or accounts that are aligned with each of your goals to determine the tracking error from market returns. Review each of the investments in every account to determine if the investment is contributing to or detracting from your success. If necessary, make adjustments to the overarching asset allocation model designed to target the required rate of return and changes to the associated investment line-up.
It is often the unknown that causes stress. Clarity, and planning bring comfort. Do yourself a favor and make the time to think about where you would like to go, draw up a plan, put it in writing and work it. You’ll be happy you did.
There is so much more that goes into financial planning than any one-size-fits all formula can tell you. On the contrary, to fully understand you and your families’ unique needs requires a deep dive into your financial situation, family history, values and goals and the help of a financial planner and investment management professional.
At Meridian Wealth Management, we can help you build a financial plan. A plan that covers everything necessary, and more, to put you on a path to success in achieving your financial goals and the things that are important to you in life.
Definitions:
The MSCI ACWI (All Country World Index) is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. The index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. The S&P 500 Index focuses on the large-cap segment of the market; however, since it includes a significant portion of the total value of the market, it also represents the market. The Bloomberg US Agg Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).
Disclosures:
All information provided in this publication is for informational and educational purposes only, and in no way is any of the content contained herein to be construed as financial, investment, or legal advice or instruction. Meridian Wealth Management, LLC. does not guarantee the quality, accuracy, completeness, or timelines of the information in this publication. While efforts are made to verify the information provided, the information should not be assumed to be error free. Information in the publication may have been provided by third parties and has not necessarily been verified by Meridian Wealth Management, LLC. And does not assume any liability for the information contained herein, be it direct, indirect, consequential, special, or exemplary, or other damages whatsoever and howsoever caused, arising out of or in connection with the use of this publication or in reliance on the information, including any personal or pecuniary loss, whether the action is in contract, tort (including negligence) or other tortious action.
Meridian Wealth Management, LLC, dba Meridian Wealth Management is a Registered Investment Advisor in the State of Washington and certain other states. The advisor may not transact business in states where it is not appropriately registered, excluded or exempted for registration. Individualized responses to persons that involve either the effecting of transactions in securities, or the rendering of personalized investment advice for compensation will not be made without registration or exemption.
