May 15, 2016

In our Cytonn Weekly #15, 2015, we focused on Savings and Investments and elaborated why individuals should strive to save and suggested steps to effectively create a savings plan. We highlighted the six steps on how and why to save and finally, suggested several saving options and products. This week, we continue to expound on the same subject, looking at the wider process of financial planning, with focus on the stages of making a financial plan.

Financial planning is defined as a the process of a comprehensive evaluation of an individual's current income and future financial state by using currently known variables to predict future income, asset values and withdrawal plans. Before establishing a financial plan, one should consider their current circumstances based on age, income and level of risk tolerance. These factors have led to the broad classification of investors into three phases:

• Accumulation phase. It constitutes the young population of ages 18- 30. Their net worth is low and restricts them to low-priced investments. Nevertheless, they have a high-risk tolerance because of their long-term investment lifespan. A loss incurred can be recovered in the next investment cycle.
• Consolidation Phase. It encompasses the middle age income earners of ages 30-55. At this stage, net worth of individuals is relatively high since they are not burdened by payment of school loans like those in the previous stage. They can afford a range of investment commodities. However, their risk tolerance is lower than that of individuals in the accumulation phase. They seek out ventures that would not imbalance their accumulated capital while still investing to offset inflationary rates.
• Spending/ Gifting Phase. Most people at this stage are retired and are of ages 55 and beyond. Their source of income is majorly from the investments held. They have a low-risk tolerance and prefer little to no risk investments.

It is critical to evaluate these three phases before launching a financial map. Once the appropriate classification is identified, one should be able to determine the personal optimal plan. After this evaluation, we describe the process of creating financial planning;

1. Setting long term goals

The thought of long-term financial stability appeals to most, if not, all individuals. Some would argue that the daily “hustle” is an attempt to attain the said prosperity. Like every other journey, the single step in this instance begins with setting effective goals: long term. There are various factors that drive people to outline their financial priorities. The need can be fueled by a shift in individual characteristics. In most cases, an example is given of a Double Income No Kids (DINK) couple whose status quo changes to a family with children. Such instances prompt the need for a solid financial plan.

2. Knowing the investment options

The achievement of long-term financial safety involves undertaking various investment projects that would not only build wealth but also secure it. There are numerous investment options available that appeal to different classes of investors. The myriad of possibilities can leave an individual confused about the ideal product. In determining the appropriate investment option, one should consider:

• The rate of return to be obtained. A rational investor seeks out a venture that would provide maximum return for a given level of risk
• The cost of the investment. Research shows that one should harbour the same sentiments in purchasing an investment as they do in buying groceries. The price of the good is a key element. Over time, the returns received should exceed the cost of the investment
• Liquidity needs and time horizon for investment. The liquidity varies from one asset to another. An individual must evaluate the target for the investment chosen and the length of time they for which they require illiquid assets
• The regulatory and legal constraints placed on the venture. Awareness of the tax treatments that the selected investment options are subject to assists one in evaluating their long-standing returns.

3. Saving for retirement

The mention of long-term brings to mind retirement benefits. People aspire to have a comfortable living that can sustain them throughout their old age. The most common schemes are the defined benefit and the defined contribution options. They both include separate enticing packages that can fit into personal financial plans. Preparation for retirement can include:

• Understanding the retirement goals. This is mandatory since it helps an individual to determine the optimal course of action in achieving the long term goals
• Putting up funds in conjunction with the employer’s contributions. The higher the income in retirement funds, the easier it is to attain long-term financial stability
• Never withdrawing funds before maturity. A long term investment gives a higher return than one that is short term. Constant withdrawal of funds not only depreciates the income, but can also be subject to stringent tax laws in some countries.

4. Preparing for unexpected events

The occurrence of an emergency can pose an obstacle in the race to attaining personal financial security. Unexpected events can cause a financial dip from which it would be difficult to recover. Despite their rare nature, plenty of funds are dispensed to restore the situation to normal. This has necessitated the need for emergency funds. A financial plan should include a proportion of wealth that is readily accessible. Moreover, an emergency fund should be distinguished from other accounts. Undertaking withdrawals from various funds to counter unexpected events disintegrates the long-term financial map.

In conclusion, every individual should seek a personal financial advisor to assist them develop personal financial plan in order to achieve personal financial security, which is important for our respective well-being.