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Financial Planning

Viewed from a distance, personal financial planning may appear complicated and overwhelming.  It may appear so unwieldy that folks delay tackling this issue because they do not know exactly where to start or how to go about it. The fact is that someone, or something, is going to do our financial planning; the choice we have is to choose who or what.  We can choose to do it ourselves, seek professional help, or allow the vagaries of daily life to do it for us.  Though it appears that most choose the latter and don't really know where they are going until they get there, I propose that the first two options are much better.  So, I want to take a look at how personal financial planning is logically approached.

First we need to understand that a viable financial plan is never set in stone.  Much about life cannot really be planned, especially our financial lives that often depend not only on the general economy, but also on the whimsical turns that fate occasionally throws our way.  Thus plans have to be flexible and allow for the unexpected, both the good and not so good. So, when we speak of a financial plan, we are really talking about a map that depicts a road we hope to take but also realize that there may be some detours from time to time.  So, with that proviso, let's take a look at the various areas that a good financial plan will cover.

A personal, or family financial plan will cover six basic areas:

1) Budgeting

2) Insurance

3) Taxes

4) Investments

5) Retirement Planning

6) Estate Planning

Budgeting comes first because until a family has an understanding of where their money is going, and how much can reasonably be expected to be left after their fixed expenses each month, they don't really know what they can, or cannot do with their money.  So, they must first determine how much money comes in each month, what their fixed expenses are, and then determine where their discretionary money is going.  This will give them a pretty good idea of what their cash flow looks like and, in the process, reveal what kind of options they may have for the rest of their financial plan. Until this step is taken, the rest of the financial planning process is on hold.

As I mentioned in a previous article, every good financial plan begins with a discussion about insurance.  Just some of the topics to be covered here will include home, auto, life, disability, loss of license (for us pilots), and long term care.  If you are a small business owner you know that many other areas from liability to key man insurance may also come into play.  Insurance may also be a factor in planning how a family business may transfer from one generation to the next.  Insurance products can be complex, but they can also be flexible and fill many needs.  A good insurance agent is worth his commission.

Tax planning has become more and more important as our tax code has become more complex.  The complexity of the US tax code should be an embarrassment to every elected federal official.  We live under a tax code with which neither the Secretary of the Treasury nor the Chairman of the House Ways and Means Committee that writes the tax laws were able to legally comply.  But until our Congress comes to it senses and moves to simplify our tax code, we have to live with it as it is.  Due in part to its complexity, it offers those who do a bit of planning the opportunity to minimize their tax bills.  This touches every other aspect of our financial plan.  How we invest our money, buy insurance, and prepare for our retirement impact our tax bills.  How we are paid at work and withdraw money from our retirement accounts affect our tax bills.  And ultimately, how we prepare to pass on our estates affects our tax bills.  Being aware of the impact of taxes and planning to minimize them where appropriate, can have a very significant impact on one's net worth if done over a lifetime.  So you see, tax planning is a very important part of any financial plan, and with the complexity of today's tax code, the help of a qualified tax specialist is usually needed.

Personal investing and retirement planning actually go hand in hand because the primary reason many of us struggle with investing is the aim to prepare for our eventual retirement.  Thus, once we have a reasonable emergency fund (six months expenses) in place in a stable account such as a bank savings account or money market fund with a large reputable mutual fund company, we can begin our investment/retirement savings plan in earnest.  If our cash flow permits only contributing to a 401k at work, then the simple answer is that is what we should do.  If we have extra funds after fully funding our 401k up to the point where we capture any matching funds from our employer, we can then look to diversify our investments in other accounts, a Roth IRA first and foremost, followed by traditional IRAs.  If funds are then still available, we can invest in taxable accounts such as CDs, individual stocks, or well diversified equity mutual funds.  As our investable funds grow, we should look to diversify further with investments in commodities, real estate, international equities, and bonds.  Again, a great many mutual funds and exchange traded funds are suitable vehicles for these types of investments.  We should always look for funds with the lowest expenses for expenses will figure prominently in our investment success over the course of an investing lifetime. Thus, non-managed, low fee index funds are suggested by many reputable investment gurus.  We also need to be aware of and carefully plan how our investments are allocated between equities, cash, and bonds.  Generally speaking the younger a person is, the greater will be his allocation to equities.  An individual in his 20s or 30s will probably have up to 80% of his portfolio in domestic or foreign equities.  As one nears retirement age, his allocation should become more conservative and favor more cash and bonds.  At retirement I believe that one's portfolio should hold no more than 50% equities.  This is a complex issue, and is being debated in many financial circles.  Much relies on the individual investor's risk tolerance, and there is no "right" answer for everyone.  Again, a good financial counsellor can help the individual find his "right" answer.

Finally, we come to estate planning, perhaps the most complicated financial planning issue and the one with which the average investor has the least experience.  The estate tax is currently being debated in Congress and is doubtless going to change over the course of the next few years.  I believe that the estate tax will be increasing as Congress looks to finance our huge and growing federal deficit, and this is a tax that primarily affects those families with more assets and who can ostensibly better afford it.  Nevertheless, many families will still be able to minimize this tax bite with a bit of prior planning with the help of an estate attorney.  There are a number of trusts and other vehicles that a family can use, if, and a big IF, they plan ahead.  These steps must be taken will before the death of the estate holder.  The mistake that many have made is to wait too long to make estate plans (note famous Nashvillian Steve McNair.)  Regardless of their financial picture, everyone should have a will for a variety of good reasons.  Likewise, every young family should have plans in place to insure that their children are cared for as they would choose if something were to happen to the parents.  No estate is as precious as children; thus their future should not be left to chance.

If one is truly wealthy like Warren Buffet or Bill Gates, they can afford accountants and lawyers on full-time retainer to see to their financial planning.  For the rest of us peons, we need to take the time to educate ourselves a bit and/or seek the help of others.  A good, fee-only financial planner, one with whom you feel comfortable, is well worth their fee.  They will ask questions and encourage you to consider issues that you may not even recognize you need to consider.  They can also suggest ways to deal with these various issues.  But however you approach the topic, just remember that someone or something is going to do financial planning for you.  You get to choose who or what.  Make it a good decision.


Fly/Drive Safely

11 October, 2009

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