When most people hear the term “financial planning”, they automatically assume it has something to do with saving and investing. While saving and investing are integral components of financial planning, they represent only one part of the equation. As we shall see, there are other factors that need to be considered when developing your personal financial plan.
A sound financial plan is based around four major elements, known as the four pillars: cash flow, risk, debt, and asset management. If any one of these pillars is weak, a person’s financial well-being may be in jeopardy. Cash flow is vital to the success of any financial plan. As we go through life, we expect to establish cash flow through some form of income and accumulate wealth to some degree. Income allows us to cover our needs food, shelter and other basic necessities of life. Extra income over and above that required for necessities is referred to as discretionary income, and is either spent or saved. Discretionary spending is money used for optional items such as big screen TVs, vacations, or any number of other life-enhancing products and services. It is your lifestyle. Controlling discretionary spending is crucial to your savings and investment plan.
Risk management is the area of financial planning that protects us from catastrophic financial loss in the case of adverse events. We typically purchase insurance products to protect us from the threats that are most likely to affect us at our particular stage of life and with our particular mix of assets. For example, property and liability insurance cover us against damage to our house, car, and their occupants. Health and dental coverage, including travel insurance, are common forms of cost containment from the high price of health care. Life and disability insurance protect us in the event of death or disability. In recent years, the need to cover the cost of a critical illness or a stay in a long-term care facility have become popular components of risk management. There are many ways to protect our income, and each person’s risk profile is different. This makes risk management an area that requires careful consideration and a critical eye to ensure that you are properly protected against the risks that are most relevant to you and your family.
Debt management is control over your loans to banks and other lenders. Debts come in many forms; some examples are personal loans for things like a car, and mortgages for your real estate. Other sources of debt stem from the use of credit cards and lines of credit. This is an area where many people have difficulty. These days, it is very easy to apply for and obtain a loan or credit card. The trick is to have a plan in place to pay it off. You also want to be mindful of the interest rate to make sure you are receiving the best and most attractive interest cost and terms for repayment.
Managing assets of discretionary income is often the first thing people think about when they want to develop a financial plan. In its simplest form, asset management is management of discretionary income. What you do with the money you have left over after you have paid for the necessities of life can either be saved or spent. We already discussed how discretionary spending determines your lifestyle. What about the saving component? A sound financial plan establish both short- and long-term savings goals. Set up different accounts that can meet both objectives. A short-term savings account allows you to deposit money and then withdraw it when needed. It tends to pay the least interest but it is safe and secure. It is ideal for saving for such things as an annual vacation. This approach allows you to pay for your “extras” without relying on a loan or credit card debt. Long-term objectives, such as retirement or education funding, should be met with long-term investment vehicles, such as RRSPs and RESPs. Retirement savings allow you to maintain your desired lifestyle once you have removed yourself from work and no longer receive an income. Generally we expect to receive a higher rate of return from long-term investment strategies.
When you are building your personal financial plan, be sure to consider all four pillars, and aim to remain flexible in the face of unexpected contingencies. It’s not easy, and professional advice can be very helpful. Building a strong financial foundation is an important step towards realizing your dreams and goals, and will go a long way towards reducing the worry that so often surrounds financial matters.
Rick Sutherland has been a resident of OOS since 1985 and has been a regular contributor to OSCAR since 1991. The foregoing is for general information purposes and is the opinion of the writer. This information is not intended to provide personal advice including, without limitation, investment, financial, legal, accounting or tax advice. Please call or write to Rick Sutherland CLU, CFP, FDS, R.F.P., to discuss your particular circumstances or suggest a topic for future articles at 613-798-2421 or E-mail email@example.com. Mutual Funds provided through FundEX Investments Inc.