1. Essential Personal Finance
Chapter 4
Plan your future
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

2. Contents Introduction Why a plan is essential to success
Life stages, planning principles and practices
Key components of a financial plan
Values and goals
Current position
Gap analysis and ‘what if?’ scenarios
Financial planning policies
Strategy and action plan
Conclusions
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

3. Introduction Financial planning overview Life stages and events
Planning principles and practices
Key elements of a plan
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

4. Financial planning overview Life stages and events
Planning principles and practices
Key elements of a plan
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

5. What is financial planning?
‘The process of determining whether and how an
individual can meet life goals through the proper
management of financial resources.’
Source: cfp.net.
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

6. Financial planning process
Source: Financial Planning Standards Board Ltd. All rights reserved.
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

7. Why plan? ‘A goal without a plan is just a wish.’
Source: Antoine de Saint-Exupéry,
French writer (1900–1944).
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

8. Financial planning policies
Why plan?
Confidence
Clarity
Context
Measure progress
Written goals
Financial planning policies
Stay on track
Action plan
Spending discipline
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

9. Financial planning overview Life stages and events
Planning principles and practices
Key elements of a plan
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

10. Life stages Figure 4.1 Financial planning life stages
Source:
University of Wyoming Coperative Extension Service - The Life Cycle of Financial Planning.
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

11. How you see wealth Sources of money Labour Land/property Capital
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

12. How income maps to resources
Assets
Income
Expenses
Time
Skilled
Labour
Energy -
Intelligence
Experience
Knowledge
Degree
Extra bedroom
Rental space
French skills
Tutoring ability
Basement of stuff
Items for eBay
Figure 4.2 How income maps to resources
Source: Adapted from illustration in Sarah Newcomb (2016), Loaded: Money, Psychology, and How to Get Ahead Without Leaving Your Values Behind (Wiley: Hoboken).
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

13. Financial planning overview Life stages and events
Planning principles and practices
Key elements of a plan
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

14. Principles – The ’Rule of 72’*
Return 1% 2% 3% 4% 5% 6% 7%
Years 72 36 24 18 14 12 10
Table 4.1 Years to double your money at different rates of return
* The ‘Rule of 72’ is only a reasonable approximation
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

15. Principles – The ’Rule of 72’*
Time
5 years
10 years
15 years
20 years
25 years
Return
required
14% 7% 5% 4% 3%
Table 4.2 Rate of return to double your money over a specified time horizon
* The ‘Rule of 72’ is only a reasonable approximation
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

16. Principles – The ’Rule of 72’*
Inflation 1% 2% 3% 4% 5%
Years to halve capital 70 35 23 18 14
Table 4.4 How long it takes the buying power of your money to halve
* The ‘Rule of 72’ is only a reasonable approximation
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

17. Capital required to fund annual spending
Withdrawal rate a year
10,000
20,000
30,000
40,000
50,000 2%
500,000
1,000,000
1,500,000
2,000,000
2,500,000 3%
333,333
666,667
1,333,333
1,666,667 4%
250,000
750,000
1,250,000
Table 4.6 Capital required to meet different annual withdrawal amounts
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

18. Pound cost averaging
Legal & General UK Index: the benefits of pound cost averaging
Month
Price of units
No. of units purchased (monthly)
No. of units purchased (lump sum)
January
1.11
90.1
1081
February
March
1.10
April
1.14
87.7
May
1.12
89.3
June
July
1.02
98.04
August
0.91
109.9
September
0.92
108.7
October
0.82
122.0
November
0.86
116.3
December
Total Units
End Value
983.71
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

19. Planning practices
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

20. Financial planning overview Life stages and events
Planning principles and practices
Key elements of a plan
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

21. Key components of a financial plan
Figure 4.3 Key components of a financial plan
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

22. S SPECIFIC M MEASURABLE A R T ATTAINABLE RELEVANT TIMELY Goals
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

23. Financial statements INCOME STATEMENT Income Expenditure BALANCE SHEET
Assets
(Tomorrow)
Liabilities
(Yesterday)
Figure 4.4 Financial statements
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

24. Financial statements Cash reserves Debt Where am I today? Growth
Risk management
Figure 4.5 Four financial planning quadrants
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

25. Gap analysis and ‘what if?’ scenarios
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

26. Financial calculations
Basic calculations
Future value of current lump sum or known regular savings amount
Required present value of lump sum or regular savings amount to accumulate future amount
Impact of inflation and investment returns
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

27. Using rules of thumb - example
As %
of salary
Age
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

28. BERT
(Back of the Envelope Retirement Planning Tool)
A. Sum total amount of your invested assets (e.g. shares and bonds)
B. Percent of invested assets you might reasonably expect to withdraw each year (A x 3%)
C. Number of remaining years you expect to live
D. Total home equity - the value of your real estate (property)
E. Total amount you expect from any inheritance
F. The amount of state pension you expect
G. Expected annual pension or annuity benefits
H. Any remaining yearly income you expect, such as from part-time work, rental etc.
AVAILABLE PRE-TAX INCOME*
* (B + (D/C) + (E x 3%) + F + G + H) Estimate of potential income using highly simplified assumptions
Source:
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

29. (Back of the Envelope Retirement Planning Tool)
BERT
(Back of the Envelope Retirement Planning Tool)
A. Sum total amount of your invested assets (e.g. shares and bonds)
250,000
B. Percent of invested assets you might reasonably expect to withdraw each year (A x 3%)
7,500
C. Number of remaining years you expect to live 40
D. Total home equity - the value of your real estate (property)
300,000
E. Total amount you expect from any inheritance
250,000
F. The amount of state pension you expect
10,000
G. Expected annual pension or annuity benefits
5,000
H. Any remaining yearly income you expect, such as from part-time work, rental etc.
10,000
AVAILABLE PRE-TAX INCOME*
47,500
* (B + (D/C) + (E x 3%) + F + G + H) Estimate of potential income using highly simplified assumptions
Figure 4.6 Back of the Envelope Retirement Planning Tool
Source: © Copyright 2015 George Kinder and the Kinder Institute of Life Planning. All Rights Reserved. Used by permission of George Kinder and the Kinder Institute of Life Planning.
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

30. Simplified financial calculation - 1
Calculating monthly contribution required
to accumulate future capital amount
GOAL
£150,000 (in today’s terms)
Current amount £75,000
Now 5 9
Time in years
Round this up to 10
for approximation
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

31. Simplified financial calculation - 1
Assume expected real return of 3% p.a.
£75,000 (existing capital) x 1.3 [factor in Table 4.8] = £97,500
Capital shortfall is £52,500 (£150,000 - £97,500)
Monthly contribution to build 3% p.a. real = £400*
(£52,500/£1,000,000 x £7,300 [factor in Table 4.7])
* This is merely an approximation, with the monthly contribution required and time frame rounded up, to give a rough idea
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

32. Simplified financial calculations - 2
Calculating monthly contribution required to fund future annual income – 3% p.a. real return and 3% p.a. withdrawals
Target annual income goal
£20,000 in 20 years’ time
Capital to fund income
£20,000/0.03 = £667,0000
Monthly amount to build 3% p.a. real over 20 years
£3,100 p.m.
Monthly amount required to meet goal
£3,100 x (£667,000/£1m) = £2,070*
* Increasing by inflation each year
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

33. Financial planning policies
‘A decision rule that embodies client goals and values, with financial planning best practices in a form that allows for rapid decision-making in the face of changing external circumstances.’
Source: Yeske and Buie (2014, p.192).
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

34. Financial planning policy - example
I will only borrow to fund property purchase
I will only use a credit card for purchaser protection and where I can repay the balance immediately from income or savings
I will save 10 per cent of my net monthly salary
Monthly savings will be directed to an accessible savings account until I have accumulated (and maintained) a minimum of 6 months’ living expenses
I will join my employer’s retirement plan if this offers employer contributions, and I will contribute the maximum necessary to attract those employer contributions
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

35. Strategy and action plan – simple
Description
Target date
Current
Target
Action
Cash reserve
12 months
£12,000
£15,000
Save £250 p.m. in cash reserve
Annual expenditure (ex savings)
Now
£18,000
£20,000
Met from salary
Training course
6 months
£2,000
£3,000
Save £170 p.m. in cash reserve
Student debt
Ongoing
£22,000
Repay within 15 years
Payments taken from salary
Disability risk
No cover
Insurance to pay 50% of salary after 3 months
Apply for income protection policy
Tax management
None
To hold savings in tax-exempt a/c
Open account with bank
Estate planning
Simple will and pension nomination
Do online will
Sign pension nomination
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne

36. Conclusions
Creating a written financial plan increases the likelihood of achieving life goals, increases confidence and provides personal context for making key financial and life decisions
Life goals and planning needs for young people are usually simple, but often increase in complexity as they progress through life
There are a number of timeless planning practices (rules of the road) which we can follow to make better financial decisions
A financial plan can be simple or complex but will always be based on one’s personal goals, beliefs, priorities and circumstances
We can use simplified financial planning calculations to get a basic idea of the cost of funding life goals, bearing in mind that spurious accuracy is unlikely to improve financial decision making, especially for young people with very long time horizons
The planning assumptions we use (inflation, investment returns, taxes, etc.) can have a big impact on financial calculations
Financial planning policies can help us make faster and better financial decisions which are in tune with our values and beliefs
A financial plan needs to be followed by action and regular review
© 2017 Lien Luu, Jonquil Lowe, Jason Butler and Tony Byrne