A few weeks ago I wrote
a blog about the one thing that stops most people from making the most of their financial opportunities including making regular investments.
It was my thesis that a lack of context is the main cause. Having a long-term plan provides you with the context required to make mistake-free financial decisions. It is difficult to work out what investments to make (and when) if you don’t know where you are heading and how your will get there.
A financial plan will give you sufficient context in which to measure your financial decisions against.
We follow three distinct steps to develop and implement a financial plan for our clients. We have refined this process over many decades and have found this disciplined and logical approach helps develop very efficient evidence-based plans.
Step 1: Develop a high-level strategy
Determine your future cash flow and net worth
The first step is to build a financial model. A financial model will forecast your future income and expenses and therefore, how much cash flow you have to allocate towards investing. It should also forecast your assets and liabilities i.e. net worth.
The purpose of a financial model is to do two things.
Firstly, to measure whether your chosen strategy will work i.e., achieve your goals. For example, if you plan to invest in 2 properties and maximise super contributions, will that be enough to generate $100k p.a. of income (after-tax) that you require in retirement?
The second purpose of a financial model is to compare strategies to eliminate inferior ones and pick the one that has the highest probability of working i.e., the one that generates the highest returns for the lowest risk.
Financial modelling is part-art, part-science. The science bit is the Excel skills and technical knowledge required to build financial models. The art is knowing what strategies work best in various situations, which can only be acquired with many years/decades of experience. Realistically, most people won’t have the skill and experience to complete their own financial modelling.
Mixture of asset classes
Most people would be well served by investing in a mixture of asset classes including super, residential property, share market investments and so forth. The financial modelling exercise will help you determine optimum mixture of asset classes that suits your goals, risk profile and financial position.
Level of gearing
Whether you will borrow money to invest and if so, to what extent is a major strategic consideration. A financial model will assist with determining the right level of gearing. It is important you consider whether you will have enough cash flow to service debt. But even more important is to determine to what extent you need to repay debt before you retire. It is prudent to not take high levels of debt into retirement so you must have a debt retirement strategy.
Of course, a strategy is only useful if it can be implemented, so you will need to consider your present and future borrowing capacity i.e., how much will the banks lend you.
Ownership structures
Once you have determined the mixture of asset classes that you will invest in and how much gearing you will adopt, you can then determine the best investment ownership structures. Considerations include income tax payable over your lifetime, land tax (for property), CGT if your strategy includes selling, current and projected cash flow, borrowing capacity and asset protection.
Retain high-level focus
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Important
This podcast provides general information about finance, tax and credit. It doesn't take into account your specific objectives, financial situation or needs, so you need to assess whether it's relevant to your circumstances before acting on it. If you're not sure, speak to a licensed, trustworthy professional.
