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How to Define Your Financial Position

According to the CFP Board, the financial planning process can be broken down into a number of steps and areas.  It always starts with a conversation to define the relationship between advisor and client.  You need to be on the same page with your professional about the scope of what you hope to accomplish.  Later in the process are the fun things such as implementation and monitoring (stuff like picking appropriate investments or having review meetings where you get free Nespresso coffee).  Pretty early on, though, you should be working with your advisor to gather data—a lot of it.  What we’re trying to help you do here is to define your financial position.  So let’s take a look more in depth at that. 

First the math.Financial planning, if oversimplified, can be broken down into a giant math problem.  For example, if you were to focus just on retirement planning, you’d need to know or make guesses at a few variables.  How long will you live?  When will you retire?  What sort of rate of return do you expect you’ll see on your investments?  What about an average rate of inflation?  How much have you saved already?  How much do you have available to save today?  How much will you need to spend in your first year of retirement? 

Naturally, it gets quite a bit more complicated…. Typical free internet calculators don’t bother to take things into account other questions a good financial planner should be asking.  What you might pay in taxes?  What happens to your spouse’s Social Security payments if you pass away 12 years earlier than they do?  Do you have a family history of cancer, heart disease, or something like dementia?Have you addressed that appropriately?There are others too, but you still need the basic information we looked at above. 

Start by creating a budget if you don’t already have one.  We can send you a spreadsheet to work with if you like, but our clients have also had good luck using programs such as mint.com, Quicken, or even a legal pad and a pen.  Include estimates for things such as home repairs and furniture purchases.  You may not see these expenses every year but forgetting to include money for things like “the water heater going out” can lead to unexpected credit card purchases down the line. 

Next, look at your budget and try to identify what might get added or go away in the future.  For example, you might have a car payment today, but this may disappear before you retire.  Health insurance, on the other hand, may increase later on and you need to include the extra expense down the line. 

Your financial position now addresses your cash flow, and the next step is to look at your assets and liabilities.  You’re looking for a snapshot in time of what you have, what you owe, and the details of those items.  Address each account to identify the type (IRA, 401(k), bank savings account, etc) and what’s in it.  What is the account going to be used for?  What is the allocation of your investments (we’ll look to see whether it’s an appropriate allocation for your risk profile later)? 

For your liabilities (debts), it’s important to identify the interest rates you’re paying.  For mortgages, remember to separate the interest and principal part from things like property taxes (which will stay in your budget even after the mortgage payments stop).  You’ll want to identify when the debt will be paid off and a current balance.  Although not everyone has these, make sure to include debts to family or the IRS.Hiding things from your financial plan will only lead to a poor analysis. 

By now you should have a fairly good snapshot in time of what you have, what you owe on it, your ability to pay debts and save for the future, and a fair guess at what you might need to spend in the future.  Pat yourself on the back—you’ve already done more than most people.  Stay tuned, as a future article will try to decode what those fancy financial planning calculators are actually doing, and identify their limitations.  

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