I’ve been in the investment business for over twenty years. In that time I have seen multitudes of financial plans. The plans are quite long, very detailed and often covered in a thin layer of dust.
Most financial plans are not worth the paper they are printed on. This has nothing to do with the planning software, the assumptions used for inflation or the products that are sold or bought to make the plan happen. The plan is not working because it got built backwards.
It’s unlikely that you would decide to build a house from the roof shingles down to the foundation. Yet this is exactly how we tend to approach financial planning.
When clients come in to see their planner, they often do not know quite what to expect. They are wrestling with a variety of competing needs. There may be aging parents to care for, kids to put through school, mortgages getting paid down and lots of bills to pay.
It’s easier for us, in the planning business, to ignore all this complexity. The best bet for a clean and easy plan is just to assume it all away.
The “assuming away” part comes in the form of one question and one answer. This particular question and answer will dictate the output of the plan, and also determine whether the plan has any real value to the client.
The question (from the financial planner) is “How much income will you need in retirement?” The answer from the client is (generally) “I don’t know I have never really given it much thought.”
This question and answer exchange is completely fair, but unless an awful lot of digging happens on everyone’s part, the plan ends up built backwards and useless.
The planner, faced with the client’s answer: “I don’t know, I have never really thought about it” will often make an assumption. This assumption for retirement income is usually something like 75% of your current expenses. The absence of a number from you means we stick our number into the planning software.
The number we just picked gets fed into the computer and out comes the plan. It has been calculated to two decimal places, it is completely accurate (using our assumptions), and it’s completely useless.
Why useless? Well, if you earn a lot of money and you assume 75% of current earnings, the plan might well tell you to save millions and you can only get there by putting aside twice your annual income every year.
The right place to start your plan is with what you spend today. What you spend and what you spend your money on are much harder numbers to come by. I have met hundreds of people in my career. I would say maybe five per cent know what they spend and where their money goes on a monthly basis.
If you would like to build a real plan, your spending today is the equivalent of starting to build your house at the foundation. These are the numbers that will make your plan relevant and allow you to strategize how you might handle retirement.
I have met people earning six figure incomes that spend thirty per cent more than they make. Does anyone really think a set of projections is going to help them retire well? I have met other people who are such diligent savers that they do not realize that they actually live quite modestly.
Chances are your financial planner cannot help you much until you know what you spend. Once you know what you spend you can see what expenses will stop when you retire and what expenses will keep going. If today you spend more than you make, strategies like borrowing money to make an RRSP contribution are just silly. Such a strategy just means the Visa bill won’t get paid. You need to start your plan by changing your spending habits.
The foundation of a real plan is in the present. My experience is that there are three things people want to do with their money in the present. People want to spend money on what is important to them, live within their means and spend less than they make. Knowing where your money is going today gives you the information you need to change your habits.
When you can get today’s spending to look like what you want, the future often seems to take care of itself.
Alan MacDonald is an investment advisor who helps high tech entrepreneurs make smart decisions about money. Contact Alan at Alan.Macdonald@RichardsonGMP.com
