Q: I know people who have a set financial plan and those who don't, preferring to figure this out as they go along. Who's right?
A: Your friends with specific plans are on the right road – provided that these plans are realistic and well thought-out.
Not only do many people not have a financial plan, many of them don't understand what such a plan should involve. One way to deal with this is to engage a qualified financial planner. Whether you take this route or go it alone, a financial plan should be the answer to issues raised by key questions about your future, including:
- When will you have enough assets to retire, and how long will these assets last? Will you outlive your retirement resources?
- What will be your income streams during retirement? What's the best strategy to timing the beginning of your Social Security benefits and what will your total monthly figure be? Do you have any pensions? What will be your withdrawals from your investment portfolio?
- What will your standard of living be during retirement? How much will you need for this, and do these figures account for likely inflation? What kind of spending items would be included in a retirement budget? Does this budget include costs for health care and for long-term care if you or your spouse needs it? Do you have long-term care insurance now to take care of this, or are you planning to self-insure?
These questions underscore the need for a sound, comprehensive financial plan. A solid financial plan is like a blueprint for a house. If your design is well thought-out and the construction of the resulting house is well executed, you'll have a structure that assures a secure financial future and retirement.
Financial plans should be undertaken with your time horizon, individual risk tolerance and life goals – educating children, vacations, retirement and, if necessary, caring for elderly parents – in mind. Plans should reflect investment vehicles and should state how much to invest in each and what the expected returns from each realistically will be. These vehicles most often should include low-cost, passively managed investments like index funds, which capture the returns of various indexes, such as the S&P 500. This is in stark contrast to active management, where over-paid investment managers speculate by trying – ultimately and usually unsuccessfully -- to pick winning stocks.
Plans should also spell out your asset allocation -- – spreading your investment dollars over different types of assets to achieve balance and manage risk. When one asset class, such as stocks, temporarily goes down in value, your bond holdings may help stabilize your portfolio. And to properly diversify your stock holdings, you also want to spread your money over different types and sizes of companies globally.
Some people think an asset allocation is something you can just set and forget, but that's not true. It's paramount that you strategically rebalance your portfolio as needed. If not, this lapse can significantly increase risk.
Your plan should also set down your methods of managing risks from the unforeseen. Insurance coverage for business, life, liability, health, home and auto should be inspected for cracks. Often, an umbrella general liability policy should be added for additional protection from lawsuits (for example, if someone gets hurt in your pool).
Above all, even with a great financial plan, you must have the commitment and discipline to stick to it by avoiding emotional, impulsive reactions to market changes. If you don't stick to your plan, it's of little value.
If all goes well and your plan enables you to meet life goals and fund a secure retirement, you'll also need to plan what to do with the assets you'll have left by doing some estate planning – preparing another blueprint, this time for how your accumulated wealth will be passed on to your heirs most efficiently.
Remember what Confucius said: "A man who does not plan long ahead will find trouble at his door."