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Financial planning fundamentals

Here’s what your financial plan should incorporate.

Whether you’re developing a financial plan for the first time or updating your plan to keep it aligned with your changed circumstances, keep in mind that financial planning is a holistic exercise that should cover all areas of your financial life. All components of a financial plan are inextricably linked which is why no aspect should be dealt with in isolation. Here’s what your plan should incorporate:

A snapshot

Most financial plans begin with a snapshot of where you are currently in terms of your personal finances, which should include a breakdown of your assets and liabilities, and an understanding of your net worth. It should also include a breakdown of your assets into their various classes such as fixed property, unit trusts, retirement funds, business interests, cash and offshore investments to determine if you are exposed to too much risk in any particular area. The snapshot should also include information regarding your earnings, together with any commissions, incentives or bonuses due to you as part of your employment, your tax bracket and status, and any inheritances or lump sums due to you. Your advisor will analyse your policy and investment information, including any contributions you are making towards your group pension or provident fund to gain full insight into these benefits and how they work. If you have business interests or shares in a business, your advisor will request valuations of these shares, together with information pertaining to any buy and sell agreements, business assurance or key person cover that you have in place.

Money management

Once you have a snapshot of your assets and liabilities, the next step is to analyse your day-to-day money management habits. Through this process, you should gain a clear understanding of how your net income is being used proportionately to service debt, cover your living expenses, pay for non-essential or luxury expenses, and invest for the long-term. A careful budgeting process will allow you to identify leaks in your expenditure, areas of over-expenditure, or raise potential alarm bells if your debt-to-income ratio is too high. Your budget will provide your advisor with a good gauge in terms of your affordability when it comes to recommending financial solutions and/or re-allocating certain expenditure for more effective purposes. For instance, you may be spending money on life cover that you no longer need and these premiums could be used as tax-deductible contributions towards a retirement annuity; or you may be over-contributing towards a retirement annuity whereas those over-contributions could be used more effectively to build up an emergency fund or save for a deposit on a home.

Goals and objectives

Objective-setting is the cornerstone of financial planning as all solutions recommended by your advisor will hinge on what it is you wish to achieve. As part of the goal-setting exercise, it is important to give thought to your short, medium and long-term goals, bearing in mind that your financial plan should remain pliable and adaptable as and when your circumstances change. For instance, if working abroad or emigration are realistic options for you, your plan should factor this into account and solutions should be structured with this in mind. If your medium-term goal is to save for a deposit on a property, your monthly savings should not all be locked into a compulsory investment. In the same vein, if your short-term goal is to set enough money aside for your teenager’s university fees in a few years’ time, your money should probably not be exposed to a high-risk portfolio.

Risk management plan

A comprehensive risk management plan is designed to ensure that you are adequately protected against future unforeseeable events while taking into account your affordability, health status and personal circumstances. Types of risk protection include life cover, capital disability and dread disease cover, income protection, medical aid and gap cover. Your advisor should prepare a full risk analysis which will demonstrate your financial position in the event of your death or disability, exposing any shortfalls or excesses that exist in your portfolio. In preparing this analysis, your advisor should take into account your personal life policies as well as any group cover that you have in place. The idea is to map your existing risk cover against your financial objectives and to address any areas where you remain financially exposed. This analysis should include a review of the beneficiary nominations on your various policies, as well as an assessment as to whether there have been any benefit or product enhancements since the inception of your policy that you may wish to take advantage of. If you have business interests, your advisor will analyse your business assurance cover to ensure that it is correctly structured and fully aligned with your buy and sell agreement.

Long-term investment strategy

While you may not have a clear picture of what your retirement will look like, it is always advisable to begin your long-term investment journey as soon as possible – even if it means contributing a small monthly amount and then increasing your contributions as and when affordability allows. As such, your long-term investment strategy should take into account your current levels of affordability, your goals for retirement – including your desired retirement age and assumed longevity, your travel goals, and any capital outflows that you envisage during your retirement years. Your advisor will analyse your current investment portfolio, taking into account your group retirement funding, local and offshore investment portfolios, cash or near-cash investments, tax-free savings accounts, investment properties, and any business interests that are earmarked to provide for retirement. The purpose of this exercise is to ensure that you are investing in the most tax-efficient manner and that your investment risk is aligned with your propensity to assume risk. It should also include analysis into the structure and diversification of your investment portfolio with recommendations as to how it can be optimally constructed to achieve your long-term goals. Your advisor should be able to prepare a number of retirement scenarios for you which include post-retirement cash flow modelling to ensure that you won’t run into liquidity problems in the long-term, while at the same time prioritising tax-efficiency.

Estate plan

As much as your financial plan should focus on building wealth, it also needs to include an estate plan that makes provision for the distribution of your wealth should you die, keeping in mind that tragedy can strike at any stage. Structuring an estate plan involves determining the liquidity in your estate in the event of death to ensure that your debts and all estate costs can be covered and that your dependants can be adequately provided for. If there is any liquidity shortfall in your estate, your advisor should be in a position to recommend solutions to increase your estate’s liquidity in the most tax-efficient way. Once again, your estate plan should be built around your stated objectives including how you wish to provide for your loved ones, whether you have any special needs dependants, any bequests you wish to make, or any assets you wish to preserve for the next generations. This may involve the setting up of testamentary or inter vivos trusts in order to ensure the safe custody of assets intended for your beneficiaries, making donations to loved ones while you are still alive, or including special bequests in terms of your will. That said, a well-constructed estate plan should be underpinned by a well-drafted will that is devoid of contradictions or confusions, and the two should be inextricably linked to give effect to your desired legacy.

ADVISOR PROFILE

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Crue Invest (Pty) Ltd

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