By failing to prepare, you are preparing to fail

Benjamin Franklin once said, “By failing to prepare, you are preparing to fail” and from my opinion this is a motto that should be embraced in all aspects of life. However the saying is particularly apt when emphasising the importance of an appropriate financial plan.

And yet, despite our tendency to meticulously plan for events, holidays, home renovations, and even the weekly grocery shopping, many of us navigate significant life stages without a plan in place to manage and finance these transitions. Consequently, people are often finding themselves wondering why the retirement they had always envisaged didn’t come to fruition. Failure to prepare.

What is a financial plan?

A financial plan is a personalised strategy designed to help you achieve your future financial goals and objectives. It serves as a roadmap, guiding you through different life stages by carefully planning, budgeting and saving for each phase and the potential financial liabilities that may arise with each.

Cashflow forecasting

A crucial component of a financial plan is cashflow forecasting. This involves using specialised software to project an individual’s future inflows and outflows over the course of their lifetime. By integrating this data with assumptions based on long-term averages for life expectancy, inflation, investment growth, and potential taxes, we can effectively demonstrate the feasibility of achieving a client’s future aspirations through strategic planning.

Budgeting

A natural tendency is to spend more as our earnings increase over time. While it’s important that we enjoy our hard-earned income, it’s equally crucial that we live within our means and budget for the now and the future.

Effective budgeting starts by understanding more about our regular spending habits, and this can be done by dividing our spending into the following key categories:

1. Fixed vs. variable expenses:
   1. Fixed expenses: regular and recurring costs that don’t change much from month to month, such as rent/mortgage,
   2. Variable expenses: fluctuating expenses each month, like groceries, utilities, entertainment, and dining out.
2. Essential vs. non-essential expenses:
   1. Essential expenses: Necessary for your basic needs, such as housing, food, transport, and healthcare.
   2. Non-essential expenses: This is more about lifestyle choices, such as hobbies, subscriptions, and luxury items.

Once we have a better understanding of your annual expenditure, we can establish a strategy to reallocate some ‘surplus income’ towards saving and investing that will help achieve the goals you have set.

Saving and investing

A financial plan is often the difference between aimlessly investing for capital growth (that everybody’s aim, isn’t it?) and investing with the purpose of achieving a future objective. A well-engineered financial plan will involve more than investing for maximum capital growth; instead it should include a strategy for the distribution of wealth to take advantage of the various tax wrappers (or structures) available such as pensions, ISAs, general investment accounts, and offshore bonds. Diversification and tax efficiency are crucial when investing and each of the aforementioned wrappers have different access constraints and tax advantages. The goal of a good structural financial plan is to consider diversification of overall wealth and ultimately aim to have funds in the right wrappers, taking the appropriate level of risk to support the desired lifestyle (or investment objective) at the right time.

Risk

With market movements being one thing that we are unable to control or predict, before investing it is important to understand the associated risks. This concept is sound in theory, but how do we implement it in practice? When it comes to financial planning, risk is typically divided into three main areas:

• Attitude to risk
• Capacity for loss
• Time horizon

Attitude to risk is evaluated through detailed questioning and discussions with the client. Capacity for loss is a numerical assessment of a client’s actual ability to endure losses on liquid assets while still meeting their objectives. Time horizon refers to the duration an investment or portfolio is expected to be held before being accessed. Essentially, the longer the time horizon, the greater the ability to withstand short-term volatility.

In practice, this allows for varying levels of investment risk from one asset to the next depending on the access constraints and tax treatment of each asset in isolation. For example, a pension will probably have a far longer time horizon, than funds allocated towards paying school fees. It can therefore be managed with a higher-risk approach as the pension time horizon will be able to withstand short-term volatility.

If carried out correctly, then, you should feel comfortable withstanding sharp market downturns without feeling the need to make knee jerk reactions and selling investments at an unfavourable time. One of the main benefits of a financial plan is the comfort of knowing your arrangements are set up to weather the storm, allowing your lifestyle to continue unaffected.

While in theory this seems straightforward, it’s human nature to react to sharp market downturns with the desire to sell investments, to ‘stop the rot’. It is our job as financial planners to remind you, particularly when there has been a volatile event, or even a bear market, that it’s time in the market, not timing the market, that delivers long-term returns. The success of a financial plan will hingeon remaining calm and staying on course even when the going gets tough, rather than reacting to our natural emotions and this all starts with the assessment and explanation of risk from the outset.

Cash

The significance of maintaining an adequate cash reserve cannot be overstated. Beyond ensuring funds are available to meet upcoming liabilities, it is equally crucial to have readily accessible emergency cash to cover unforeseen expenses that may arise. We typically recommend holding a rainy-day fund equivalent to 6-12 months of annual expenditure. By maintaining this cash reserve, you are less likely to need to liquidate investments during unfavourable market conditions to meet unexpected expenses.

Adaptability

Everyone on this planet possesses unique characteristics and will encounter distinct needs at various stages of their lives. Consequently, a financial plan cannot be a ‘one-sizefits-all’ solution, it should be regularly updated to adapt to the evolving requirements of the client and thus, an ongoing financial planning relationship is often the basis to successfully ‘preparing for each stage of life’.

Some of the key stages that a financial plan will usually focus on are:

• Retirement planning: Saving enough capital towards life after work, so that you can maintain your desired lifestyle in retirement. Using cashflow we can identify the level of saving required between now and retirement to help achieve that desired retirement. It’s important to note that small, regular savings now can be just as impactful as larger savings closer to retirement, thanks to the benefits of ‘time in the market’ and compounded growth.
• Estate planning: Planning for the distribution of your assets after your passing, including creating a will, lifetime gifting, setting up trusts and so on, inheritance tax is the most significant of UK taxes at 40%, however, with early consideration and proper planning it is one of the taxes that can moste asily be mitigated.

However, the most common mistake amongst most people is leaving it to late to prepare for each these stages of life, thereby preparing to fail.