Developing a Financial Plan

Developing a Financial Plan

Any financial planning including retirement decision-making should be based upon the six steps of the financial planning process.

1. Identify and clarify the current situation

This first step involves data gathering and a review of quantitative information such as the investors total assets and liabilities which comprise the net worth statement, statement of income and expenses, life, disability and other insurance policies, important documents such as: tax returns, wills, powers of attorney, investment portfolio and transactions, shareholders agreements, employee benefit booklets, trust agreements, pension statements, and some basic family history such as name, age, marital status, employment history or details of a family business, details of the children's birth dates and other qualitative details.

Essentially this step summarizes where the client is today.

An individual's current situation is a result of the cumulative effects of all of the financial decisions and transactions that have occurred in the past up until the current time.

2. Identify goals and objectives

This step seeks to identify both financial and personal goals and objectives. After identification and listing, the goals and objectives need to be prioritized, to facilitate the allocation of the available resources to the most critical concerns. It is of primary importance that the financial goals are measurable, in order to track success and to provide feedback so that strategies can be fine-tuned.

Goals must be:

Specific. Otherwise, they are not goals, they are merely dreams. "I require $500,000 by my 65th birthday" is an example of a specific goal. "I want to be rich when I retire" is a dream not a goal.
Measurable. Financial goals are easily measurable since dollars and cents can be counted.
Attainable. Goals must be securable.
Realistic. In order for a goal to be achieved, it must be within the realm of reason. To accumulate $1 million by age 65, if one is currently age 64, and has no savings may be attainable by winning a lottery however; this is unrealistic. Conversely, for a 25-year-old to accumulate $1 million by age 65 through saving and investing is probably both attainable and realistic.
Time bound. All goals should be time bound in order to track progress towards the goals completion and to provide feedback. Corrections should be made in the action plan therefore maximizing the probability of success.

If goals are determined to be unattainable and/or unrealistic, the individual can:

reduce discretionary expenditures,
increase income,
choose more aggressive investments, with potentially higher investment returns,
increase the timeframe over which to obtain the goal, or
reduce the dollar value of the goal.

3. Analyze problems and opportunities

An analysis of the current situation will allow for the identification of additional opportunities that can be exploited in order to more efficiently accomplish the specified financial goals. Moreover, the situational analysis will help to identify problems that may be acting as obstacles or preventing the most efficient accomplishment of the identified objectives. Problems must be identified before solutions can be established.

It is in this stage of the financial planning process that the use of various mathematical tools is most powerful.

The answers to questions like "should I pay off my mortgage or contribute to my RRSP this year?" are not straightforward. The answer will depend upon each individual's situation, and the assumptions that the individual makes such as the interest rate, the rate of inflation, and the chosen investment vehicles. It is imperative that the economic assumptions upon which the financial plan will be based be set by the individual (with input from the financial adviser). It is therefore necessary that some basic understanding of the interrelationship of key economic information and investment performance be acquired in order to make educated or enlightened financial decisions.

4. Develop solutions

If sufficient analysis has been performed in the previous step of the process, the development of solutions is straightforward.

5. Implementation

This step involves putting the financial plan into action. An action plan should be created with appropriate strategies and tactics outlined in writing.

6. Monitor and review

The final step in the financial planning process is the ongoing monitoring that is required in order to fine-tune the financial plan and to ensure the successful attainment of the specified financial objectives. Regular reviews and updates allow any plan, which has gone off track to be quickly, set back "onto the rails".

Regular review allows for any changes in an individual's lifestyle or in the economic environment to be reassessed. Additionally, a review allows the opportunity to provide for any changes to strategies or tactics, which might be required.

The critical disciplines

There are six fundamental subject areas or critical disciplines which must be inter-woven into a plan for early retirement. The critical disciplines are the basic areas of knowledge upon which any financial plan must be based. These foundations are the essence of the plan. Each subject area overlaps another and weaves itself throughout the financial planning process.

1. Tax planning

Tax planning is important and is integrated throughout all of the disciplines. Tax will have a major impact upon an individual's goals and the accomplishment of those goals.

2. Cash and credit/debt management. Most individuals must use credit to build their net worth. This creates cash management concerns.

3. Retirement planning. It is never too early to commence retirement income planning. In fact, the earlier one starts to accumulate retirement funds, the easier the goal is to achieve in the end.

4. Investment planning. A major part of building a portfolio for net worth or creating retirement funds involves investment.

5. Insurance and risk management. The majority of individuals insure their homes and vehicles. Additionally, insuring ones life and protecting the continuity of the individual’s income stream is critical.

6. Estate planning. Estate planning includes providing for heirs and protecting loved ones through prudent estate pre-planning and the minimization of income taxes. Special concerns of family owned businesses involve succession planning and the desires and the abilities of the heirs to successfully assume control.

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