This should be an easy question to answer: Do you have a financial plan? Yes or no?
OK, that was actually something of a trick question, even if it seemed straightforward.
There’s actually confusion about what constitutes a financial plan. Is it a budget? A projection of investment returns? A list of securities to buy? A spreadsheet loaded up with all manner of financial forecasts?
I’ve seen each of those described as a financial plan, and in every case, it’s a mistake.
A budget is a good starting point for many. But it’s just one component of a plan, and it’s not even necessary for every plan. If you have a good handle on your spending, and it’s clear you’re not spending more than you’re bringing in, then your financial planner may not even ask you to do a budget.
But if you believe you’re spending $60,000 a year, yet your income is $100,000, it’s worth a deep dive to see where that additional $40,000 is going. Sure, a chunk of that is for taxes. But generally, in a situation like that, there is excess spending that is unaccounted for.
How about a projection of your investment returns? That’s a component of a comprehensive plan, done by an adviser with a fiduciary duty to his or her clients, but it’s tricky for a do-it-yourselfer to get it right.
How do you know whether you have the right mix of investments, tailored for your time horizon, risk tolerance and financial goals? How do you know whether you are using low-cost investments that are not taking a big chunk from your return? How can you be sure to correctly model the expected return from each of your investments and from the overall allocation?
Those questions lead into another variation of a “financial plan.” It’s not uncommon for investors, and even some advisers, to believe that a list of securities constitutes a financial plan. Just as with a budget, the securities are one piece of the plan but not the plan itself.
Here’s a good way to think about it: The plan is your roadmap to ongoing financial success. It incorporates many elements of your financial life, including insurance, your legacy, charitable giving, real estate, ongoing cash flow and income, inflation, taxes and, yes, your stock-and-bond investments.
The biggest consideration when developing a financial plan is: Can you meet your goals? At its most basic, that means not running out of money before you die. To determine that, you’ll need to evaluate the factors listed above, focusing your attention on elements unique to your situation.
For example, do you have rental properties? Are they cash-flow positive or a drag on your finances? Do you want to continue being a landlord or are you ready to cash out? Is travel important to you? How much do you want to allot for that? Do you want to give financial gifts to your family while you are still living? Does your retirement income put you in a high tax bracket? What can you do to offset that? Do you have numerous 401(k)s and Individual Retirement Accounts, and you’re confused about taking the required withdrawals at age 70½? Should you look into a Roth conversion, which has the potential to reduce your tax burden in retirement, if done correctly? When should you take Social Security?
While these concerns, and many others, are the foundation of a comprehensive plan, the investments are simply the building blocks. You need a vehicle to help achieve your goals. In retirement, you no longer have income from a job or a business, so you need to derive income from other sources, such as a pension, Social Security and your investments.
All of these components go into the overall roadmap for your lifelong financial wellness. With many of today’s retirees living longer than previous generations, it’s unwise to leave major financial decisions to chance or to gamble on aggressive investing as a way to generate income.
Kate Stalter, founder of the independent firm Better Money Decisions, helps people throughout Northern New Mexico invest and plan for retirement. Reach her at email@example.com.