Everyone avoids wealth planning because itâ€™s so complicated. Even figuring out how much money you need at retirement is a hassle. Youâ€™ve heard or maybe read about â€œsimpleâ€ online calculators that will spit out a number that you can use as a savings goal. But, what do you do with that number? Many calculators obscure how much money you need to save every month and, even when they do tell you how much to save, itâ€™s based on interest rate and inflation assumptions you donâ€™t really know to be true. Hereâ€™s how to sort it all out and make sense of it.
Be Comfortable With Some Uncertainty
There is going to be a fair amount of uncertainty in your financial plan. Most people want hard and fast answers. And, many wealth planners will try to give you hard and fast answers. Unfortunately, reality just doesnâ€™t work that way.
Interest rates are notoriously difficult to predict, inflation is only going to be known by the central bank, and technology makes it difficult to know what company profits will be like going forward. So, while your advisor might tell you to expect an average of 6 or 7 percent per annum, this could mean that your compound annual growth rate fluctuates between 4 and 8 percent.
Confused? Youâ€™re not alone. The reason average rate of return doesnâ€™t correlate with true dollars-and-cents in your investment account is because your advisor often quotes average returns and not the compound annual growth rate, or CAGR. Thereâ€™s a huge difference between the two.
Average returns paint an optimistic view of your investments, often minimising losses and highlighting gains, while the CAGR smooths out volatility in individual years to provide you with a more accurate picture of investment performance over time.
Cover Your Assets
No one likes talking about insurance, but itâ€™s the cornerstone of all good wealth plans. Making sure your assets are covered requires assessing your exposure to financial loss and then insuring those assets to protect yourself and your family.
So, for example, if you have $100,000 in debts, you would want at least $100,000 in life insurance. You will also probably want to look into umbrella insurance to cover a multitude of risks ranging from property and casualty to excess personal liability.
You will also want to set up a will and trust for your heirs so that there is no confusion about what happens when you die An insurance agent is needed for the insurance policies, but youâ€™ll need to draw up legal documents with an estate planning lawyer.
Balance Your Portfolio
A good mix of stocks and bonds, usually in the form of mutual funds, can be a good way to diversify your investment holdings. Some individuals use cash value life insurance as the cornerstone of their financial plan, while others hold cash in a bank account.
Regardless of how you decide to allocate your funds, or which products you choose, you will want at least some liquidity. Some experts believe 30 percent of your total holdings in cash is sufficient.
Itâ€™s hard to think long-term when you have bills due this month. But, wealth planning is all about the long-term. Making a commitment to saving is one of the hardest things to do. Start forming the habit by thinking about it as a necessary expense. Over time, this â€œexpenseâ€ will become habitualised and youâ€™ll start viewing it in a more balanced way – that you have both expenses and savings.
Start Saving Now
Youâ€™ve probably heard this advice before, but, what you might have heard or read is that you need to start saving at least 10 percent of your income. For a lot of people in their 30s and 40s, this figure probably needs to be more like 40 or 50 percent of their income, assuming very conservative rates of return in the market.
That sounds like a lot, and it is. Itâ€™s almost unfathomable to most people. And yet, this is usually what is required if youâ€™ve got little or no savings at all. The sooner you save, the better. An individual just starting out, at age 20, may only need to save 10 to 15 percent of his or her take-home pay. But, every decade of life pushes that savings requirement higher.
Matthew Everingham is a retired financial advisor. When he has time, he likes to research the field and share it with others by posting online. Look for his enlightening and helpful articles on many websites and blogs today.