What is a Personal Financial Plan?
There are three key elements to a personal financial plan: Financial goals, Budget & saving strategy, and Investment strategy.
Every journey requires a plan, without it you don’t know where you are going or how you are going to get there – or why? This is true if you are planning to sail around the world or save for a home.
I'll admit it upfront: I never had a written plan on my path to FIRE, and I made plenty of mistakes along the way. I budgeted and tracked my financial numbers and knew I was spending less than I earned, but I had no particular goals other than to enjoy life whilst having a good financial buffer.
If I started again today, knowing what I have documented in the proceeding posts, I would have thought more about What, Why, How, and When. I write this so maybe you can benefit from my mistakes without needing to make them all on your own.
Fail to plan, plan to fail
Sitting down and writing a financial plan will help to identify what you want to achieve and then detail how to get there. Making a plan is a way of increasing your chance of adherence and reducing your chance of self-sabotage. Writing a financial plan isn’t easy, how can we know our financial expectations for the next 10 years never mind the next 40. The solution is to keep it short and simple and recognize that it will have to change over time.
Mike Tyson famously said, "Everybody has a plan until they get punched in the mouth." This response was to a reporter's question regarding whether he was worried about Evander Holyfield and his fight plan. What Tyson said is similar to the old saying “no plan survives first contact with the enemy”, but does this mean that there is no need to plan? Absolutely not. Plans should be kept up to date and adapted to changes in reality.
The three key elements of a personal financial plan are: Financial goals, Budget & saving strategy, and Investment strategy.
Financial goals
These are just some basic questions to ask yourself to help establish your financial goals:
- What is your current financial situation?
- What are your financial goals - short/medium/long term?
- What emergency fund requirements do you have?
- What % of your income are you prepared to save?
- Where will you be allocating the money (Pension/LISA/ISA)?
- What are your target allocation and types of funds?
- How old do you want to be when you reach FI?
- How much money do you need to live comfortably?
- What reasons would you consider changing your financial plan?
Budget & saving strategy
The very first post on this website What is the 50/30/20 budget? covered the importance of having a written budget and savings strategy. Knowing exactly where your money is going: how you will split your income to cover essentials, non-essentials, and savings/investments. Save more than you spend, automate as many payments as possible and pay yourself first – this is the bedrock of your financial plan.
Investment strategy
Your investment strategy will detail the accounts and funds you will use, the level of risk you are prepared to take, and the balance of assets you will use. A sound asset allocation strategy ensures your investment portfolio is one you can hold without fear for the long term through market downturns.
It is incredibly powerful to go through the process of actually writing down a financial plan, particularly the investment strategy. Some investors have a game plan for investing ‘in their head’, but when times get tough and emotions start to interfere, the financial plan will help you to buy and hold, rebalance, and keep your head when all about you are losing theirs!
Your investment strategy will be a guiding light when the markets do something you aren't expecting. By not using a written plan, you are more likely to be short-term focused and chase near-term performance.
By working on a financial plan, you are helping ensure that you remain focused on achieving the right goals. Keep it simple, one or two A4 sheets at most so that you can refer to it and ‘keep it alive’. Writing it down, of course, is not the end of the process. It is important to regularly review, modify the plan as necessary, and continually check-in to make sure your actions are lining up with your plan.
Sample Plan
Current financial position: Conor leaves college with a £1,000 debt (Remember, a student loan is not a debt – it is a tax on future income) and no savings. He gets his first job paying £25,000 per annum. Happy Days!
What are Conor’s financial goals?:
- Budget to pay off the £1,000 loan then build an emergency fund.
- Maximise the employer contribution to the company pension.
- Start saving in a LISA for a new home in 5 years’ time.
- Budget for two holidays annually.
- Reach FI by age 55.
Monthly take home pay is £1,710. His budget and saving strategy uses the 50/30/20 rule and the monthly amounts are:
50% of income should cover fixed costs/essentials £855
30% of income covers none essentials £515
20% save/invest. Pay yourself first automatically £340
Conor’s budget spreadsheet shows that his fixed costs/essentials come to £880 per month (This includes budget for two holidays annually). He decides to take £25 from his none essentials pot leaving £490 to spend monthly on none essentials.
The £880 fixed costs/essentials are either paid by monthly direct debit from his current account or left in his current account to cover annual expenses (eg car insurance) – all except food and petrol.
The £490, along with his monthly amount budgeted for food and petrol (as these are day to day expenses), goes on to a contact card account to spend daily on none essentials.
Conor just has to ensure his contact card account stays in credit every month. Any underspend at the end of the month can move to savings to build up a seasonal buffer or for bigger annual spends. Then keep a check on fixed costs/essentials and none essentials to make sure they don’t ‘lifestyle creep’!
That leaves £340 per month to save and invest.
Conor’s employer provides a company pension and takes the contribution gross i.e. before tax. They also match Conor’s payment up to 5%. Conor is definitely taking advantage of this free money and will pay 5% of his gross income with the aim of increasing it later.
Conor pays 5% or £80 each month (£100 before tax) into his pension and the employer doubles this to a total of £200 per month! (By making the payment a % rather than £ value, the amount will increase as the salary increases over time. Good Move!). This could provide a pot of approx £200,000 by age 55, so will need to be reviewed upward at a later date when more income is available.
That leaves £260 per month.
For the first 4 months, he will use this to pay off his loan. Then for the following 4 months build an emergency fund in a high interest savings account.
Once this is accomplished, for the following 4 years and 4 months he will pay the £260 each month into a cash LISA to save for a house deposit (this is increased to £325 per month by the Government). This will provide a house deposit in 5 years’ time of £17,000 (This can also be considered part of the emergency fund as it can be accessed with a small financial penalty, if necessary). Conor will add to these monthly payments with any pay rises, bonuses, or additional savings to boost the value.
Once the goal of buying a house is achieved, this allocation will be moved to a stocks and shares LISA/ISA alongside a review of the amount of pension payment.
What is his investment strategy?
- Do not try to time the market.
- Buy and hold long-term.
- Contribute monthly by direct debit and stick to low-cost, global index funds.
- Let returns compound over time.
- Aim to reach FI by age 55, annual income amount TBC.
- Maintain a 100% Equity allocation and at age 45, change to 60% Equity / 40% Bonds.
- Rebalance annually. If asset allocations are off track by more than 5%, rebalance to get back on track.
- Account allocation; ISA/LISA/Pension.
Stick With The Plan!