What is Financial Planning
The Three Areas of Financial Planning
Ok, you won’t find this in any textbook, but here are the three areas as I see them (with greater detail below):
- Protect What You Have – It makes sense to me that we must protect what we already have before we look to the future.
- Know Where It Goes – Since we spend money nearly every day, it’s important to know how much we are spending and what we are spending it on.
- Make It Grow – Of course, investments are an integral part of Financial Planning, but you can see they are not nearly as important as some might have you believe.
Protect What You Have
Understanding the protections we have for our assets and making sure they are structured appropriately seems to make common sense. No bank would last very long without locking the vault and no family will likely become financially successful if they aren’t protecting what they have.
There are two primary tools we use to protect what we have: insurance and estate planning.
When I say “insurance,” I mean all kinds of insurance and, more importantly, I mean to address all kinds of risk.
So, this includes your auto and homeowner’s insurance. Your umbrella policy which protects you against lawsuits and other forms of liability. Perhaps you serve on some boards that have created personal exposure to lawsuit, or maybe you are part of your HOA.
Whatever the potential cause for liability, we want to know and understand the risks we are taking so we may consider buying insurance to cover those risks. Note, I am not saying you should always buy insurance to cover everything. I am only saying that you should know and understand all the risks you are taking – as much as this is possible to do!
Life insurance is also important – but only if we have other people in our lives who depend on our income.
This is most usually your spouse or your kids, of course. And notice we are saying they depend on your income. If they depend on your assets, they most probably are the heirs to your assets, so life insurance may not be necessary.
Estate planning does something different: it allows you to make decisions at times when you otherwise wouldn’t be able to.
This includes determining what and how your kids will inherit your wealth. Who will raise them if you’re gone.
It also includes whether you wish to be kept on a ventilator.
Through the standard package of estate planning documents, you can make these decisions today in a clear and legally enforceable manner.
Know Where It Goes
This is the scary one.
No one likes to look at their spending! We live in a very expensive place and the cost of just existing here is very high and makes us uncomfortable to see.
But that is exactly the reason that knowing your spending is so important. If you know that you normally spend $4000 per year on clothing, and this year you have already spent that amount, you will be forced to think through your next purchase with more intention.
In other words, you will begin to weigh the actual value of your purchase vs. the cost.
Once you’ve done this for a short while, it will be liberating. No longer will you be spending $50 on lunch when that is not something you truly value.
So, how do we get there?
We must track our spending. This gives us, at a minimum, the price tag of our current lifestyle. If we get further into this process and assign categories to our spending, we gain even more knowledge and the end result is usually that we spend less while finding much greater joy in our spending.
From a more practical perspective, we have to know how much we spend each year if we are going to project out through 30 years of retirement to discover whether we will be ok. We cannot guess at our spending, because we will always guess too low.
We must track our spending to do financial planning right!
Make It Grow
This is our Investment Philosophy and Strategy.
First, we must have an Investment Philosophy to anchor our strategy. If we don’t, we will bounce from strategy to strategy, likely always choosing yesterday’s winners and experiencing them as tomorrow’s losers.
Realizing we cannot pick winners (and neither can anyone else) is the first step toward a coherent Investment Strategy.
The philosophy my clients and I have includes:
- Faith in the Future – This is the view that while sometimes things look pretty bleak in the world, they always seem to improve over time. In other words, you might say to yourself in these times “I can’t know exactly how things are going to turn out all right. I just know that things are going to turn out all right!”
- Patience – At the same time, we know that the world’s ups and downs can last for extended periods. You might say “I can’t know when it’s going to turn out all right. I just know that it’s going to turn out all right!”
- Discipline – Finally, we stick to strategies that have proven to work over long periods of time in history taking the view “I don’t care what’s working now. I care about what’s always worked, and I’m just going to keep doing what’s always worked!”
The Investment Strategy that comes from this includes an asset allocation that, historically, will get you where you want to go along with a widely diversified approach that includes rebalancing on a regular basis.
We must also be diligent about the investment vehicles we use as well as our service providers and overall structure.
It’s no small feat to manage a portfolio well, but the effort should not be directed at doing “what’s smart today” or even changing the portfolio very often.