If you would like to stop wondering about whether you’ll ever realize your financial goals, and build a plan to actually reach them, I can help. Read on and I’ll not only show you how to build a proper financial plan, I’ll take you through. Follow my simple instructions and in no time at all, you’ll have the peace of mind that comes with a professional-quality personal financial plan—without having to pay a financial planner a dime.
1. Talk to your spouse
Most couples never talk to each other about their financial goals. If you’re in a relationship, before you roll up your sleeves and dig into the numbers, talk to your spouse about what you want to accomplish. “Have a brief conversation about goals, values, and what kind of lifestyle you want, “That’s key to a good start.”
2. Figure out where you’re at
Before you start worrying about where you want to go, you first have to figure out where you are now. In this step you’ll create a net worth statement, which is essentially an honest measure of your current wealth. You do this by tallying up the value of what you own (your assets) and what you owe (your liabilities). When you subtract your liabilities from your assets, you get a number that represents your net worth. Your net worth statement is an important tool that charts your financial progress over the years. For instance, if your net worth is going down, you’re eroding your wealth and making it harder to achieve your goals. If it’s increasing, you’re on your way to getting richer and achieving your financial goals.
Finally, subtract your liabilities from your assets to discover your true net worth. This shorter net worth statement gives a clear snapshot of exactly where you stand today.
3. Track your spending
The key to building a strong financial plan for the future is to understand how much you spend and save right now. This is called tracking your cash flow, and it can give you a sense of control and confidence that makes it easier to make financial changes in your life.
Personally, I’ve kept a small journal tracking my spending for years because it helps me modify my behaviour if my spending gets out of control. It’s not always easy, but it works.
“The part most people dread is taking a really close look at their expenses, “But don’t put it off. Successfully managing cash flow is your key to financial control. It will give you an awareness that has more long-term value than anything you can invest in, buy or sell.”
The point of the exercise is to find out whether you finish each year with a cash surplus or a cash deficit. This number will tell you a lot about your general financial shape. A surplus means you’re living within your means, while a deficit shows you’re spending more than you make. If you have a deficit, you will have to cut your expenses (or increase your income) to achieve any financial goals.
What do most people find after doing this exercise? “They're astonished,” It’s a very revealing exercise, mainly because if you have a family with two spouses with debit and credit cards, it’s hard to really see the complete financial picture unless you write it down. This awareness allows you to set up a system for the household.”
A good way to approach this exercise is to start with your regular monthly after-tax income and subtract the bills that don’t change month to month, such as rent or mortgage payments. If you don’t know the exact numbers, put in averages for things like groceries, gas or children’s activities. Then add in expenses that only come up a few times a year, such as travel, car repairs and gym fees. Estimate a total for these and divide it by 12, and put that figure in the monthly column of your worksheet. You may not pay the bills in 12 monthly installments but imagine you are setting money aside each month so that you have the total amount when the bill comes due.
4. Adjust your spending
Look closer. Are your expenses higher than your income? If so, you’re living beyond your means. You’ll need to adjust your expenses accordingly so you don’t go further into debt.
This step is not about punishing yourself or laying blame. If you’d rather eat out four times a week than buy a cottage in 10 years, that’s your choice. But you owe it to yourself to be honest about what you’re doing so you’re not wondering why you can’t reach your financial goals.
If you decide to cut back, there are some less painful ways of doing it. Consider renegotiating your mortgage to a lower rate or cutting out one major expense completely.
If you have a cash surplus, congratulations. You can start allocating money to meet your goals right away.
The idea here is to look at how well your current spending habits mesh with your goals. If you have a cash flow deficit you won’t be able to meet your goals, so you’ll have to see if you can free up cash by cutting back your spending in areas that are less important to you.
For instance, if you have a N5,000 a year deficit on Worksheet and one of your goals is to go on a N4,000 family vacation to Calabar in four years, you need to figure out a way to cut N6,000 a year from your spending. You could try using only one car and taking public transit to work. Such a cut could save you N6,000 a year in vehicle costs, allowing you to both balance your budget and reach your travel goal.
5. Set your life goals
Financial goals don’t just happen. You make them happen. This step requires you to assess where you want to be five, 10 and 20 years from now and answer some big questions, such as where you want to live in retirement and when you want to stop working.
One tip is to visualize what your life will be like 10 years from now if you do everything right. The truth is when they picture their future lives, very few people see themselves in a N150-million house in Abuja. Most people’s goals are more realistic, such as keeping up their current standard of living in retirement (with maybe a few upgrades), preventing any financial disasters, and having the freedom to do the things they love, such as spending more time with friends and family.
“Think of what type of life you want in the future and how you are going to organize your life right now to get it. “Your job is to structure your finances so you can achieve your vision.”
6. Develop a strategy
Once you know where you’re going, you need a plan to get there. The usual route is to spend less than you earn and invest the surplus in such a way that you can get where you want to go.
One word of caution—if you’ve identified your goals but you’re in debt, you probably should address that debt before you start investing for the future. “Even when people are not overspending and have debts that carry reasonable interest rates, I encourage them to work aggressively at paying those debts down,” Don’t even think about investing before your debts are all gone.”
7. Review your insurance
If you work full time, much of your insurance may be provided by your employer’s group plan. But is it enough? If you feel confident enough to do some basic calculations yourself you can find out.
Many workplace benefit plans include disability insurance, but if yours doesn’t, get enough to replace at least 60% of your after-tax income.
Then look at your life insurance needs. The general rule of thumb is to get enough life insurance to cover 10 times your income if you have kids under 10 years old (five times your income if you have kids over 10), plus the amount needed to pay off your debt. So if you make N50,000 a year, you have N250,000 outstanding on your mortgage, and two kids under 10, you will need N750,000 in term life insurance. Go to www.leadway.com for quotes.
At this point, it may make sense to have an agent review all your insurance policies—disability, life, auto and home—to make sure your coverage is adequate. But be careful. “Do not be oversold on insurance by an industry that is famous for doing exactly that,” Pay attention to fees, especially with life insurance. If you need more life insurance, chances are renewable term is the right product for you. You want plain vanilla coverage for a plain vanilla problem—your kids going hungry because you can’t work.”
8. Create an investing policy
Every professional financial plan includes an Investment Policy Statement (IPS) that recommends how a portfolio should be invested. It puts in writing the rules that will make you a more disciplined investor. Having an IPS helps you to stick with your plan and keeps you from changing course when the market gets volatile.
A typical investment policy might specify that your portfolio should always maintain a ratio of 60% stocks to 40% fixed-income investments. This ratio is determined by your time horizon and risk tolerance. The longer your time horizon and the greater your tolerance for risk, the higher the equity portion of your portfolio. As you near retirement and need the security of more stable income from your investments, the portfolio mix will usually tilt towards bonds.
An IPS also states the expected annual returns for your portfolio—typically 5% to 6% per year—over a very long time period, such as 20 years or more. Your IPS might also note the volatility you should expect for a given portfolio. For instance, it could say that you should expect the portfolio to suffer a 10% drop in the short term at least once a decade.
If you have trouble with this section, you can always leave it for now. Once your financial plan is complete, you can consult a fee-only adviser to help you build an investment strategy that’s right for you.
9. Write up a will
Every adult who owns assets and has a spouse or children should have a will. An accurate and up-to-date will is the only way to ensure your assets will be distributed the way you want them to be. If you don’t have one, you’re letting the laws in the province you live in make those decisions for you. And if you hold the belief that your spouse will automatically inherit everything—you’re wrong. Without a will your husband or wife will get a predetermined amount of your assets—the rest goes to the kids.
Create or update your will. If you have an updated will it should be filed with your financial plan. If you don’t have one, hire a lawyer to draw one up for you. Visit www.nigeria-law.org and search for lawyers in your area who specialize in wills and estates.
10. Create your final plan
A typical financial plan has five main parts. The first outlines where you stand right now, that’s your current situation. The second contains your top financial goals, or where you want to go. The third is a simple net worth statement. The fourth lists the steps you must take to achieve your goals. It includes your income and expenses, an overview of your insurance, a section on retirement planning, and a section on estate planning. Finally, the fifth section—usually a separate document—is your Investment Policy Statement, which lays out how your portfolio is to be invested.
Under Investment Strategy Guidelines, write an outline of how your investments will be allocated, according to asset class. The next three headings—Security Guidelines, Location Guidelines and Risk Control, Monitoring and Review are fairly generic and are already filled in for you.
Phew, it’s done! You now have a financial plan for the rest of your life. From this point on, as your goals change, modifications to your basic plan will be straightforward.
Of course you still have to follow your plan. But you’ll probably find that the process of putting it together has already changed some of your beliefs about how your money should be spent and invested, so changing your financial behaviour may not be as hard as you think.
To make sure you stay on track, you should take the time to review your plan at least once a year, and update it as necessary. It’s also a good idea to pull it out whenever you run into a big financial or life event, such as a market crash, marriage or job change. “It’s a tool to support you through life,” Money and household finances won’t be as scary when you break it down into these manageable bits. If you truly commit, it will be a huge boon to your emotional and financial well-being.”
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