financial plan

Wealth and Living a Rich Life

It would seem that popular society, in its current state, places a high value on material wealth. This can be seen all over mainstream news channels, reality television shows and neighborhoods across the United States. Such a great importance is placed on material wealth, that the perception of wealth has become a priority over, and became confused with, living a great life.

Any individual’s stance on this issue is none of my concern, as I do not intend to project my ideals and beliefs on anyone. However, I do think that certain behaviors, as described below, affect the long-term prosperity of individuals and families. I would like to convey the financial impacts of these decisions and how they can affect your financial plan.

Living a Rich Life

It is my personal opinion that a rich life is one full of challenging experiences, adventures and hard work. These elements of a great life can be accomplished with or without large sums of money. While money can provide the freedom and time to live a rich life, it really doesn’t help much beyond that.

Living a great life is more of a matter of attitude than financial resources. Those that set and complete realistic and achievable goals, enjoy the satisfaction of accomplishment. It is when we being to compare ourselves to others, when we lose our sense of value and self-worth.

If you feel as though you need to change your life in order to feel happier, then I suggest making a list of your life’s goals and objectives. List the things that you want to accomplish and what’s important to you. This exercise should help you begin to design a satisfying life. In addition this exercise will provide a foundation to prioritize your financial resources in-order to life the life you want.

The Costs of Perceived Wealth

The expenses accumulated while maintaining the perception of wealth undermines every conceivable attempt to accumulate real wealth (both in a material and quality of life sense). This spending behavior eventually creates a financial situation that is very difficult to turn-around, leading to the potential of a unfulfilling life.

Making short-term financial decisions without understanding (or completely disregarding) the financial impacts over the long-term plagues most of our decision-making processes. This is not only evident in individuals and families, but also corporations and budget appropriators in Congress. Making the least savvy financial decisions on a regular will eventually erode the rich life you could’ve had, no matter how small the amount.

Making Financial Sacrifices

More often than not, small and usually short-term, sacrifices are required to enable long-term success. This is true if you would like to improve your athletic performance, grades at school or financial future.

While making financial sacrifices will most likely reduce your ability to maximize the perception of wealth or success in the short-term, in a few years you will be much better off than you would’ve been. This is the largest benefit of creating and implementing a financial plan; living a fulfilling and rich life.

Financial wealth is not a measure of a rich or successful life. A great life is lived through the accumulation of rewarding experiences, helping those around you and hard work. Despite it’s popularity in mainstream culture, having money is different from being happy.

Financial Planning Assumptions - Part 2

As mentioned in Financial Planning Assumptions - Part 1, in-order to create a financial plan you will need to rely on a variety of assumptions. These assumptions will be required to forecast and estimate your future financial situation. In addition to estimating investment rates of return and inflation, you will also need to estimate the following assumptions for inclusion in your comprehensive financial plan.

Assuming Life Expectancy

A financial plan should include a lifelong cash flow forecast. This will ensure that you understand about how much money you will need though all phases of your life. The best case scenario is that you will have enough money to live comfortably in your golden years. To ensure that you do not run out of money during retirement, you will have to use an estimate of your life expectancy in your cash flow analysis.

Two of the most common methods of estimating life expectancy includes using an actuarial life table and planning to 100 years old. Using an actuarial table provides an estimated life span based on year of birth. The U.S. Social Security Administration provides actuarial tables on their website.

Despite the mathematical savvy of the actuarial table, I prefer to estimate all life spans to 100 years of age. This method reduces the risk of running out of money in retirement.

Retirement Planning Assumptions

Looking into the future, it is difficult to determine what your life and career will look like at certain date or age. Due to this difficulty, you will need to make a few assumptions concerning your eventual retirement.

The assumptions that you will need to place in your retirement plan include: date of retirement, income needs during retirement, amount of monthly Social Security benefit and the value of your investment accounts upon retirement.

Your anticipated date of retirement is highly contingent on your cash flow needs and preferred lifestyle. In the absence of any additional data, estimating a retirement age of 62 - 67 is appropriate. Your income needs during retirement can be estimated by creating a budget or using a few common rules of thumb.

Many of us will rely on Social Security benefits for a portion of our retirement income. This amount will have to be assumed due to the probability that Congress will lower these benefits in the future. To estimate these benefits at retirement I like to use the models on the Social Security Administration's website. Finally, you should take a look at your investment plan and forecast the value of your portfolio at your retirement age.

Guessing Future Tax Rates

The last major assumption you will have to incorporate into your financial plan concerns tax rates. Tax rates are as difficult to estimate as Social Security benefits due to the politics that influence them. This is why I rather refer to tax rate forecasting as "guessing".

There are three main tax rates that influences the outcome of your financial plan. These rates includes taxes on income (salary), capital gains (investments) and estates (property transfers).

Due to the uncertainty of these rates, many financial analysts keep them constant (place current rates into the financial plan) when estimating future cash flow. However for a robust comprehensive financial plan, I recommend performing a "what-if" analysis to see how a change in rates effects your long-term financial success.

When developing a financial plan you will be required to include a few assumptions into your analysis. These assumptions can have a significant impact the outcome of your plan, thus your best effort should go into their accuracy.

Financial Planning Assumptions - Part 1

A financial plan, as with every other planning and analysis document, requires the use of assumptions. In contrast to facts, assumptions are uncertain and can change over time. Real life events can significantly change planning assumptions; which in-turn can have a large impact on the implementation of a financial plan and your way of life.

Choosing the wrong assumptions can lead to a financial plan that is unattainable, thus not meeting your goals and expectations. There are a variety of methods that can be used to determine the best assumption to use in your financial plan, however I suggest using historical data or commonly accepted rules of thumb.

Inflation Rate Assumptions

Overtime the cost of goods sold within an economy will change due to the forces of supply and demand. More often than not prices rise, at least in a healthy economy. The rise of prices overtime is the effect of inflation.

Inflation will eventually affect both your income and expenses. Historically many economists, financial planners and analysts assumed an annual inflation rate of 3% for use in a simple model. This assumption was based on historical data and government economic policies.

Complex financial plans include a few different inflation assumptions to cover the changes of prices in different sectors in the economy. In example, healthcare and education costs usually rise faster than the general economy at an average of 5% annually.

Investment Rates of Return

In a financial plan, the accomplishment of your future goals and objectives is highly contingent on the growth of your portfolio. To estimate the growth of your investments overtime you will need to estimate a rate of return.

Rates of return vary significantly among investment vehicles. This is due to the varying levels of risk associated with each type of investment. Investments with higher risk demand a higher reward and the inverse is true with investments with lower risks.

The assumed rates of returns for various stock investments should be derived from historical prices. It was once assumed that the entire stock market would return approximately 10% a year, however recently this figure has been lowered. In my analyses I like to use an average annual rate of return of 6-8%.

More often than not, projected bond rates can be calculated using historical prices, however you can also choose to use current rates in your financial plan. When looking for a quick assumption for bond yields, you can choose to incorporate 2-6% into your financial plan.

Please keep in mind that the assumptions mentioned here are extremely rough and are meant to be used as a rule of thumb. Assumptions differ from facts, as they can change rapidly. Every financial situation is different, thus the assumptions in your plan should be tailored to your specific situation.

A Few Benefits of Financial Planning

Personal finance affects most of Earth’s population. However many of us do not understand the benefits of financial planning. Creating a financial plan will help you with a wide variety of financial and non-financial aspects of your life.

A common misconception of financial planning is that only the wealthy need a financial plan. This couldn’t be further from the truth, in all actually I personally believe that we, non-wealthy people, need a financial plan more than those with huge portfolios. This is primarily due to the fact that having a well designed and properly implemented financial plan can enable us to improve our life through increases in our financial resources.

Understanding What’s Important to You

One of the first steps in the financial planning process is to clearly list your goals and objectives. When going through the mental process of determining your life’s goals and objectives, you will quickly discover what’s important to you and your family. This understanding can have a huge impact on your self confidence and attitude.

In addition to defining your goals and objectives, creating a financial plan will provide you with the direction and clarity required to make sound financial decisions. When you have a clear understanding of what you want and where you want to go, you will gain more control of a seemingly chaotic world.

Improving Your Standard of Living

An obvious benefit of creating a financial plan is the eventual increase of one’s material wealth. However, keep in mind that it is the effect of increased wealth that is most important. To many, an increase in wealth is accompanied by an increase of freedom and independence from the restriction of finite resources. Increases in financial resources enables you to live the life that you want without having to take on the burden of debt.

Improving your standard of living begins with the prioritization of expenses. To accomplish this the financial expenses that provide you the most value should have a high priority and expenses with a low priority should be reduced or eliminated.

When cutting expenses, you will subsequently increase your free cash flow. This additional cash should then be placed into your savings and investment accounts. Overtime, this increase in material wealth will provide the resources that you need to live the life that you want.

Protecting Your Property and Financial Assets

An often overlooked benefit of financial planning is the protection of property and financial assets. Many see financial plans as a way to increase material wealth, versus protecting what they already have. A comprehensive financial plan includes risk management and insurance to ensure life’s unexpected events have little impact on your family’s finances.

A comprehensive financial plan will also include an estate plan, which will help protect your assets from entering probate. This ensures that your estate's beneficiaries receive the property that is intended for them with minimal Government involvement, or in other words headache.

There are many financial and non-financial benefits of financial planning. Creating and implementing a financial plan will help you increase your standard of living, protect your property and provide focus and direction in your life.

Financial Management Words of Wisdom

A financial plan, whether for an individual, family or organization is a unique document. Despite this fact, there are financial management words of wisdom that hold true for everyone regardless of their financial situation. These financial management strategies can, and should, be integrated into every financial plan. When integrating the following financial management strategies into your financial plan, I have no doubt that you will be able to increase your personal cash flow and increase your long-term standard of living.

“Create a Financial Plan”- Creating a financial plan is the first step towards accomplishing your personal finance goals and objectives. Without a plan, you are more likely to lose sight of your financial goals and what you have to do to accomplish them. This severely limits your ability to achieve financial freedom.

“Spend Less Than What You Make”- Accomplishing your financial goals and objectives takes positive cash flow to be used for paying down debt and growing personal wealth through various investment vehicles. We have more control over how much we spend then how much we make, thus you need to keep an eye on your monthly cash outflows.

“Maximize Tax Efficient Investments”- When implementing a financial plan, there is nothing worse than throwing your hard earned money away. When you choose to pay more taxes than you are required to, you are essentially doing just that. The easiest way to become more tax efficient is to maximize your 401(k) and Traditional IRA contributions.

“Don’t Invest, or Bet, Anything You are Not Willing to Lose”- There is risk in virtually every market and every type of investment. Even though asset allocation can help reduce these risks, your nest egg can still lose a majority of its value in a relatively short period of time. Ensure that you have enough cash to cover financial emergencies.

“There’s an Difference Between a Want and a Need”- Emotions are a necessary element in the human condition, however not your financial plan. Understanding the difference between what you need to buy and what you want to buy is an extremely important distinction. Reducing your spending on what you want to buy is an great way to save a little more money every month.

“Automate Your Financial Management Strategy”- Taking the emotion and tempting spending decisions out of your everyday financial decisions is an excellent way to save more money. You can use tools such as online banking, direct deposit and automatic allocation to painlessly automate your financial management strategy.

“The More Things You Own, The More Things Own You”- Having lots of stuff does not make you richer, its actually quite the opposite. Due to the additional costs of storing, operating and sustaining excess property you will probably end up paying more money than you originally expected. This reduces the amount of money that you can save and invest, crippling your long-term financial growth.

Despite the fact that every financial plan is different, there are a few common financial management words of wisdom that hold true, despite your financial situation.