IF YOU ASKED everyday Americans to define a financial plan, chances are they’ll talk about investment strategy. And for many people who call themselves financial advisors, that’s what a financial plan amounts to.
But a real plan is so much more than that.
To be sure, investment strategy will form part of a financial plan. But a strategy that isn’t moored to each individual’s goals, risk tolerance, financial situation, family circumstances and values isn’t really a strategy at all. It is more likely just a product that’s being sold off the shelf.
A real financial plan—as drawn up and constantly reviewed by a good financial planner—is really a living and breathing creation that begins with each person’s goals and aspirations, and then works back from there. The goals determine the strategy, not vice versa.
Another identifying feature of a bona fide plan is there isn’t just one goal or one strategy. Most people will have a long-term goal, such as generating sufficient income in retirement. But they will also have medium-term goals, like funding the children’s education, paying off the mortgage or helping with the care of elderly parents. On top of that, they’ll have short-term goals, like next year’s vacation. Each goal will come with its own strategy.
Then there’s the fact that your life rarely moves in straight lines and smooth roads. Recent events provide a stark reminder that the unexpected and unplanned can force us to rethink even the most locked-in goals. This means that managing risk will be a pivotal element of any plan worth its salt: Cash needs in a crisis will be part of the mix, as will life and disability insurance. What will happen to your estate after you’re gone has to be considered as well.
Furthermore, a good plan will take account of the day-to-day as well as the long term. A planner will assess your current financial situation, including regular incomings and outgoings, and how best to manage your assets and liabilities—what you own and what you owe.
The investment part of the strategy—the part that most people believe constitutes a financial plan—isn’t as straightforward as you might think, either. Markets are unpredictable, as we’ve seen recently. A planner needs to balance the need for strategies that maximize your chances of reaching your goals with those that you can actually live with.
You need your money to grow, of course. But you also need a shock absorber in your portfolio to help you deal with the inevitable downtimes. And you need sufficient cash as a buffer when unexpected events occur in your life or in the financial markets. These considerations, along with your time horizon, all influence how your assets are allocated to stocks, bonds, real estate and cash.
Complicating matters further is that nothing stays the same. When stock markets have a strong year, you can find yourself with a portfolio that’s riskier than you bargained for. A planner will rebalance at regular intervals to keep you on track, selling assets that have gone up in price and buying those that have gone down.
The bottom line: A financial plan serves a wide range of functions. It connects your short-term, medium-term and long-term aspirations to different strategies. It takes account not only of those goals, but also of your preparedness to live with the inevitable volatility involved in getting you there.
A financial plan, therefore, is not a static document, but an organic one. It changes as your life and circumstances evolve. Careers change, children come along, education costs increase, children leave home, health challenges arrive, families merge, retirement looms. A financial plan may start out as one thing, but it frequently evolves in style and content as our life story evolves. In some ways, it’s never finished.
Of course, no single plan can ever prepare you for everything that occurs in your life. But the plan is there to help you better prepare, to give you leeway when unexpected change comes along, to give you comfort and to make explicit the choices that you have. When it comes down to it, a great financial plan is really a great life plan.
Robin Powell is an award-winning journalist. He’s a campaigner for positive change in global investing, advocating for better investor education and greater transparency. Robin is the editor of The Evidence-Based Investor, which is where a version of this article first appeared. Regis Media owns the copyright to the above article, which can’t be republished without permission. Robin’s previous articles include The Good Advisor, No Need for Prophets and Death by Lifestyle. Follow Robin on Twitter @RobinJPowell.