The Art of Financial Planning

If you don't know where are you going, any road will take you there, the old proverb says. Having a financial plan means having your roadmap to financial success. In order for a plan to be successful you have to understand the comprehensive process of financial planning and you need to have a plan, to begin with. What's the point of doing any planning if you are not going to do anything about it?

Let's briefly examine the typical six steps of financial planning and some important issues for your consideration, in order to get yourself familiar with the process, and to get the most out of this life changing experience. Keep in mind that every financial plan should be custom made for each individual, and should address any specific needs and wishes by putting them in realistic and easy to understand perspective.

1. Establishing and defining the client-planner relationship

You should get clear explanation, in writing, from your planner about services to be provided, including defining responsibilities of the client and the planner. The compensation should be fully disclosed, how the planner will be paid and by whom. You should both discuss and agree on the time frame of your professional relationship and on decision making process.

2. Gathering client data, defining your goals and expectations

Be prepared to provide any information relevant to your financial position, and to go through a gathering process of interviews and questionnaires. Your personal and financial goals should be mutually defined, your time frame and risk tolerance should be addressed. Remember, garbage in, garbage out. If information you provide is garbage, expect the same quality of advice in return.

3. Analyze, evaluate and clarify your present financial position and identify any problem areas and opportunities

In order to address your present situation and determine what needs to be done to achieve your desired goals, the planner has to analyze your information in some details, based on the scope of services he was hired to provide. This might include, among other issues, your net worth and cash flow, capital needs, investments, retirement, estate and tax planning, risk management, group and government benefits, educational planning, charitable giving and any other need you might have.

4. Developing and presenting financial planning recommendations

Your financial plan should be custom designed to address all your specific goals and objectives, and should be explained and discussed with you. If necessary, the recommendations might be revised to make sure your concerns are fully addressed and acknowledged.

5. Implementing the financial planning recommendations

The planning now has to come to life, recommendations prioritized and implemented, either by the planner directly or with his/her help with other professionals (attorneys, accountants, investment and insurance brokers, and others).

6. Monitoring the financial planning recommendations

As you walk through life things tend to change. Your planned recommendations, accordingly, might need to be adjusted from time to time and your plan should be monitored and reviewed at least annually, or more frequently if needed. For you and your planner this is an excellent opportunity to make sure you are on the right track to your financial independence.

To better asses the value of financial planning when envisioning your future life in financial terms, it might be of helpful to remember the flowing important topics:

During our lifetimes we are going through three major stages relative to financial planning:

1. From the age of 25-55 we are toiling hard to create wealth during our working years;

2. From the age of 55-75, even though we are still working and saving, conservation of what has been already accumulated becomes the major priority;

3. From the age of 75-100 our wealth will eventually be distributed to our heirs and estate.

Life's major events often turn out to be major financial events, and financial planning can be of great help to have you prepared. Consider some of the following events in life and significant financial implications they represent:

Getting married and buying your first home in your twenties;

Having children and buying recreational property in your thirties;

Job loss and going through divorce in your forties;

Disability and aging parents in your fifties.

Children in university and children getting married in your fifties;

Retirement and serious illness in your sixties;

Premature death and death of a spouse seventies;

Outliving your money in your eights.

There is no magic formula to investment success. If you learn from the following most common mistakes, you too will be on the road to financial independence:

1. Failing to have a financial plan;

2. Procrastinating;

3. Failing to diversify;

4. Ignoring the impact of taxes;

5. Ignoring the impact of inflation;

6. Not staying invested in the market;

7. Not paying yourself first;

8. Not seeking professional financial advice;

9. Not protecting your earning power;

10. Taking unnecessary risks.

Studies in Canada and the US have shown that investors who use services of financial advisor achieve superior returns on their portfolios, in comparisson to those who do not receive outside professional advice. Don't try to outsmart everyone else and do it yourself. Surround yourself with qualified individuals, delegate responsibilities and let the professionals do it for you.

You will earn an incredible amount of money during your 40-year working life.

If you earn $30,000 per year from age 25 until age 65, with annual salary increases of 2.50% you will earn a total of $2,022,077.

If you pay yourself 10.00% of your salary ($3,000 in year 1) at the beginning of each year, and invest it in Tax-Deferred Growth Plan (taxed only after funds are withdrawn from the plan as income) or, even better, in Tax-Sheltered Plan (tax free growth and tax free income) for a period of 40 years, you will have an additional $1,873,264 in your retirement fund at the age 65, assuming a rate of return of 10.00%.

This retirement fund will provide you with an annual income of $187,326 (before tax) at the same 10.00% rate of return.

If you earn $30,000 per year from age 25 until age 65, with annual salary increases of 2.50% you will earn a total of $2,022,077.

If you pay yourself 10.00% of your salary ($3,000 in year 1) at the beginning of each year, and invest it in Tax-Deferred Growth Plan (taxed only after funds are withdrawn from the plan as income) or, even better, in Tax-Sheltered Plan (tax free growth and tax free income) for a period of 40 years, you will have an additional $1,873,264 in your retirement fund at the age 65, assuming a rate of return of 10.00%.

This retirement fund will provide you with an annual income of $187,326 (before tax) at the same 10.00% rate of return.

Every dollar you owe in your credit card balances, personal and car loans and mortgages is a dollar you are not investing.

If you are paying 15.00% in loan interest that is not tax deductible, you will have to earn 25.00% from a fully taxable investment, such as Bond Instrument, just to mach the return from paying down the loan, given your marginal tax rate of 40.00%.

Pay off non-deductible debt as soon as possible to free your money to work for you, not for your creditors.

This table shows how much you need to earn on a fully taxable investment just to match the return from paying down a loan.

For example, you will have to earn 13.30% on an investment (at the 40.00% tax bracket) to match the return from paying down an 8.00% loan.

You should always take taxes and inflation into account when looking at the real rates of return of an investment, to ensure that you are staying ahead.

This table shows what you really earn on an investment, after subtracting inflation and taxes.

For example, you will only earn 2.80% on an investment with a nominal rate of return of 8.00% after subtracting 2.50% for inflation and 3.20% for taxes (8.00% return x 40.00% tax rate = 3.20%).

What rate of return do you need to earn just to break even after taking inflation and income taxes into account?

If inflation is 3.00% and your marginal tax rate is 50.00%, then you need 6.00% just to break even.

You should make sure all your investments are doing more than just breaking even.

This table shows how much you need to earn on a fully taxable investment just to break even after taking inflation and taxes into account.

For example, you will have to earn 5.00% on an investment to break even if you are in the 40.00% tax bracket and inflation is running at 3.00%.

The power of compounding (interest earned on interest) can be really dramatic. You wind up with much more the longer you let your investment grow. So, start investing early and let compounding work its magic. The table shows the value of an investment growing at 10.00% per year, over various time periods.

In this example, we have single deposit of $10,000, plus annual deposits of $3,000, made at the beginning of the year, indexed at 2.00%.

This table shows the future value of an investment at various rates of return, growing over four different time periods. The higher the rate of return and the longer the time period, the greater the effect of compounding on the future value of the investment.

In this example, we have single deposit of $10,000, plus annual deposits of $3,000, made at the beginning of the year, indexed at 2.00%.

How long will it take to double your money?

To find out, just divide 72 by the rate of return of your investment. For example, if your investment earns a rate of return of 10.00% per year, you will double your money in 7.2 years.

72 : 10.00% = 7.2 Years

Earning a higher rate of return can have a dramatic impact on the future value of your investments. For example, an investment earning 8.00% will grow to $162,226 after 25 years, while one earning 10.00% will grow to $234,766.

Just a 2.00% difference in the rate of return results in additional growth of $72,540 after 25 years.

In this example we have single deposit of $10,000, plus annual deposits of $1,000, made at the beginning of the year, indexed at 2.00%.

This table shows how much you need to invest annually to reach a goal of $500,000, at various rates of return and over different time periods.

The cost of delaying an investment program can be very dramatic. An investment earning 10.00% will grow to $234,766 after 25 years.

If you wait 5 years before starting this investment, it will only grow to $139,346.

Just a 5 year difference in starting the investment program results in $95,420 growth loss.

This example is based on single deposit of $10,000, plus annual deposits of $1,000, made at the beginning of the year, indexed at 2.00%.

The above graph shows the single deposit amount you need to invest at 10.00% to reach an investment goal of $100,000 in 25 years.

If you start now, you only need to invest $9,230 as a single deposit.

If you wait 5 years, you will need to invest $14,864, as a single deposit, to reach the same goal.

If you wait 10 years, you will need to invest $23,939, and if you wait 15 years, you will need even more, $38,554.

Don't delay - start your investment program today.