A good financial plan

My husband and I enjoy taking long day hikes in the forest. Compared to the modern life of handling distractions and juggling obligations in 30-minute increments, the act of doing nothing but walking for an entire day is so simple yet attractive. You are never bored in the process- there are birds to look for, trees to gaze on, conversations to be had, and PB&J sandwiches to devour. Plus the logistics are easy- you can do any of the above whenever you want. The day passes with a sense of fulfillment, even though we seem to have accomplished a lot less than in a normal day.

It occurs to me in one of our recent hikes that sometimes we make our lives more complicated than it should be, and it reflects in our financial decisions. Propelled by a sense of urgency and insecurity that are so common in modern society, we keep looking for the next thing that may help improve our financial security, but always wonder if we are doing enough. Eventually we lose sight of what is really important; instead we chase after the next investment that would give us higher return, the next loan that could help turn our lives around, and the next sale that supposed to save us money but make us overspend.

A good financial plan should change all of that. It returns the simplicity into our lives and makes every financial decision clear with a purpose. Whether you are working with a professional financial adviser or planning on your own, you should have a financial plan that includes the following elements:

#1: Clearly defined goals

What are the things you want to achieve in life? Everyone has different sets of goals. One may want to live in the same house for twenty years; the other may want to travel like a nomad around the world. Some may want to try to stop working as soon as possible; others may value the routine in a job over leisure mornings. Whatever your ideal life is, be honest to yourself and to your spouse. Ask yourself, “If the doctor told you that you only have 3 more months to live, what would you regret not doing?”

The more important part, however, is to translate this dream world into clear and simple terms that are achievable. For example, “traveling around the world full-time” could mean:

Save $2 million dollars by age 40 to travel around the world on a $50k USD a year budget

Or

Find employment that allows travelling around the world for work until age 50 by 2016, and save enough to retire permanently in South East Asia on a $20k USD a year budget

The more clearly defined the goals are, the easier it is for you to find ways to achieve your goals.

#2: Simple policies to achieve your goals

What do you need to do to achieve your goals? Once you have your goals on paper, all of your financial decisions have meaning. You are no longer saving or budgeting out of habit or fear, but for specific purpose. You also don’t need to feel guilty about treating yourself to nice restaurants or buying expensive items, as long as you are following the policies set out to achieve your goals.

A policy should be a simple action item that you follow. For example, to achieve the first goal mentioned in #1, you may have a policy of:

Maximize 401(k) and IRA contributions, plus contribute $50k in taxable account, each year and invest in a balanced mutual fund.

It is so simple that it can be completed in one sentence. The rule is that if you are chatting with your best friend and he/she asks you what you are doing to get yourself closer to achieving your goal, you can explain in one to two sentences.

#3: Realistic assumptions behind the policies

Of course, you need to make sure these policies are doable policies can help you achieve your goals. This requires you to adopt realistic assumptions in your analysis, whether it’s from an Excel spreadsheet or from the back of a restaurant napkin.

Let’s say that you have written down the goal and policy from #2, but you are currently working in a job with $50k annual salary without employer benefits or room for promotion. Without any analysis, we can say for sure you are not meeting the goal unless there is a drastic change in your financial circumstance. However, if you are making $200k a year with stock options in the next IPO star, it is possible that the policy will allow you to meet that goal, but you still need to make some return assumptions if you are investing the money in the market.

Using the most baseline assumption, $2 million dollar should sustain $50k spending for 40 years, if the investment makes a return that at least beats inflation. But what if you live to be 100 years old? That means you need to take on more risk to increase your return. But how much more risk should you take, and what kind of return will it give you? These are the questions you need to think about when you build your policies.

Drafting a financial plan for one goal sounds easy enough, but most people have multiple goals. In the end, the most challenging part is allocating your limited resources toward multiple goals, while managing the uncertainties that may alter your life’s path. Nevertheless, a good financial plan should simplify your life, not make it more complicated. You still need to take actions according to the plan, but it will be enjoyable long hike in the woods, where everything falls into place.