Thinking about financial planning is natural when you face life’s transitions, but transitions themselves are also a natural deterrent for planning. Having talked to many people who are interested in financial planning, one of the most common question I’ve got is, “Should I wait to make a financial plan until… (when I start that new job, when my baby is born, when we move to the new location, when I finalize my house purchase, etc.)?” People have reservations about making a financial plan when they know something is going to change soon in the future, and inevitably we want to wait until we get to that ideal “stable” place before we commit to something that will map out our financial life for the long-term.
I personally, likely many globally mobile young professionals, have failed victim to this kind of mindset. It is difficult to plan for the future when you don’t know where you will end up in two or three years, maybe to places with different cost of living, employment opportunities, and availability of quality schools. Facing all these variability in our lives, it is easy for us to leave planning for the long-term in the back burner and only focus on the near future.
But does a stable life really exist? Or are changes just a constant in life that we all need to plan for?
Think about it. Starting from graduation in college, we are constantly in transitions- changing multiple jobs to get to the position you want, moving to be closer to your significant others, going to graduate school, getting married, buying a family home, having children, moving to better school district for children, developing a second career, etc. And these are just the good parts, not counting the divorce, loss of family members, job insecurity, or unexpected health issues.
Our life is made up of transitions. We should have a financial plan that mimics life- continuously evolving and adaptable to changes. Instead of waiting for the stable period of life that will never arrive, you should have a plan in place that prepares you for the changes that will surely come one day.
How do you make a “fluid” financial plan like this? I suggest following the steps below:
#1: Establish a Baseline
First and foremost, you can only control what you know. Therefore it is important for you to be able to dissect your current financial picture and identify all the moving parts. Some parts will be fairly stable, while others will change when you face a new transition. Knowing the “baseline” help you prepare for the “shock” that a transition will bring to your finances, both immediately and for the long-term.
The best way to do this is simply going through the financial planning process, either based on your current financial situation, or according to a scenario that is achievable and allow you to meet your goals with certain probability. (To learn what my ideal financial plan look like, read my previous post: A Good Financial Plan.)
Once you establish a baseline scenario, you should be able to easily identify the various components of your finances and how likely you are going to meeting your saving goals. An example of these building blocks is illustrated below.
#2: Create policies for better times
When we face transitions, the most acute change is the level of our disposable income. If it remains the same or more, it’s fairly easy to add to your baseline. All you need to decide is how to allocate the additional resources, either to spend, save more, or pay down debt. A forward looking plan will include some policies on this front. For example, a policy can read like:
“I will save 50% of the future after-tax income increase for down payment on a bigger house.”
“I will contribute 5% more in 401(k) when I receive the student loan repayment award to pay off my student loan balance.”
Putting these types of policies in place in advance is also a great way to help you make sure you save for the long-term. (Read my related post: Save more tomorrow.)
#3: Stress-test your saving goals
What happens then if we will have less disposable income after the transition? While our immediate reaction is to find out where we can cut back, ultimately the real important step is to find out how that impact our saving pattern.
Stress-testing your saving goals simply mean that if you have to decrease your savings for certain goals by 5%, 10%, or even 50%, in a short or long period of time, how does the likelihood of meeting your individual goals change? These different scenarios serve as guidelines for what you have to do when the transition actually hits- cutting some other expenses, saving a little less in the short-term, or looking for other income source. The analysis can also play into the decision of whether you want to take the leap for transition, such as starting your own business.
A fluid financial plan not only keeps you grounded with what you can control, but more importantly prepares you for the inevitable changes coming to your life. It also reduces the need to constantly modify your plan, and decreases the feeling of not really sure where you stand when you make a transition. Of course there will be circumstances that require changes to the original plan. That is why engaging in the help of financial planning professionals periodically is also important.
So I say the changes on the horizon are no excuse for avoiding planning; it’s really the reason why you need planning. What do you think?