There
are certain elements common to all kinds
of financial planning whether it involves
running a business, running our own lives
or running the country. The difference
is only in the detail of the application
not in the basic ideas. Here we'll go
through these basic building blocks and,
in other primers, we'll see how they apply.
Firstly,
we must recognise just how important being
in control of our finances is. Nobody
in their prime wants to be doing their
accounts or thinking about money for the
pure fun of it. The reason we do it is
not because we want to make ourselves
feel miserable us but, in fact, the reverse.
Knowing
what we're doing with our money, where
it's going, whether or not we're spending
it wisely, actually liberates us rather
than constrains us. It means that we're
in control. It means we're aware of problems
before they hit us and it means we can
take action before it's too late.
More
and more we're being asked to take responsibility
and control of our own lives, in an ever
more complicated, demanding and fast changing
world. We're expected to think about education
costs, housing costs, health costs, pension
costs and a host of other things over
a time span that covers pretty well the
whole of our adult lives. And we're likely
to have to do this in an environment where
the career we start out on is unlikely
to be the one we finish up with. So how
do we go about it?
Money
is a scarce resource
Except
for, possibly, a very small number of
people on this planet just about every
person or organisation can lay claim to
having more ideas for what they can spend
money on than they actually have money
to spend. So what are we supposed to do
about that? Where does this lead us? Well,
it leads us into various possibilities.
Many
years ago, one of my very first work colleagues
when confronting his wife with the fact
that they needed to economise was told,
in no uncertain terms, "The economies
will come from you earning more!" So that
is one solution, increase the income side
of the equation and more will be available
for spending. That is not always possible
in the short term but can be done. For
example, we may take a second job while
saving for a deposit on a property. We
may look at our investments and make them
more productive.
Other
possibilities will be to review our level
of expenditure and possibly to cut back,
or to decide on priorities or to review
the timing of our spending and phase the
items in as we can afford them. So how
do we do this?
Objectives
The
value of planning and of developing objectives
in a rational and logical way cannot be
over-emphasised. There'll be short term
objectives, like living a comfortable
and enjoyable life and saving for holidays,
there'll be medium term objectives like
buying a house and supporting our children
and their education, and there'll be very
long term objectives like building up
a pension pot for our retirement including
thinking about how long we want to work
for and what kind of lifestyle we want
to enjoy. All of these should be thought
about and given priorities and placed
in the context of the careers or businesses
that we're trying to build up.
At
this stage of our planning we may not
be able to put precise numbers on many
of the items but we can at least be thinking
about them and thinking when they are
going to figure in our calculations, and
their significance. We're at the beginning
of a long journey and we're merely trying
to decide where we'd like to get to.
Options
and Choices
Once
we've got our objectives clear in our
minds we can start to think about the
options we have. There may be various
ways of reaching our ultimate goals. Or
we may not be able to do everything, certainly
not all at once, and so we have some choices
to make. But at least now we're trying
to stay in control of the situation rather
than running haphazardly in all directions.
For
some things we may think that we have
very little in the way of options but
it's surprising how few this really is.
What we do need is a way of evaluating
one alternative course of action from
another and being able to choose, that
is make a decision, sometimes rational
sometimes less so.
Choices
and decisions
In
financial decision making many kinds of
techniques have been developed to help
us make decisions but they all boil down
to the one question.
"Do
the benefits of doing a particular thing
outweigh the costs of doing it?" In other
words, "Is it worth it?"
If
the benefits are going to outweigh the
costs then we go ahead with the decision.
If not, then we reject the option or we
try to find ways to achieve the benefits
but at a lower cost. The problem lies
in identifying the benefits and the costs
and most of the time we will not be able
to quantify either of these very precisely.
That, in itself, doesn't matter; our conclusion
could be very subjective, as long as we're
trying to think through the situation.
In
analytical terms a decision is a choice
between two alternatives. So whenever
you have to make a decision, that is ask
yourself "Shall I do this?" you must ask
yourself the next part of the question,
"Rather than what?" Then you will find
that the issues fall neatly into place.
Example
1
"Would
you like a new dishwasher?"
"Yes
please"
Try
again
"Rather
than what?"
"A
romantic weekend away?"
Example
2
"Would
you like to spend £74 going on
a 3 hour speed awareness course?"
"No
thanks."
Wrong
answer! Try again.
"Rather
than what?"
"Rather
than a conviction, a £60 fine
and 3 points on your licence."
"Yes
please."
Planning
We're
now in a position to put together some
financial plans. There'll be different
kinds of plans. There'll be long term
plans that at this stage can only be directional
and will not be very detailed in financial
terms. There'll also be detailed budgets
dealing with only short term horizons,
maybe the year ahead, and these we'll
spend a lot of time thinking about and
preparing.
It
may be that when we have put together
our plan or our budget it simply doesn't
work. Perhaps we're planning to spend
more money than we've got, in which case
we'll have to review matters and see what
can be done. The Chancellor has to do
this, big business has to do this and
individual households have to this. And
the remedies are similar in all cases.
We could look to increase our income,
we could look to reduce or re-phase our
expenditure, we could borrow or we could
sell some assets. We must review and adjust
our plans until they make financial sense.
Operation,
Control and Evaluation
Once
we have a plan we can now start working
to it knowing that we have thought about
it carefully and, if we follow it, we
should end up achieving our goals and
being in a sound financial state. We need
to check against it regularly, possibly
monthly in the case of a budget, when
we receive our bank statements and credit
card bills, and see if we're meeting our
financial targets. If all is going to
plan then we can continue on our way.
If not, and we're overspent, then we'll
have to find ways of getting back on track.
Risk
Any
form of forecasting and planning involves
trying to see into the future and so is
inherently risky. Furthermore, there'll
be risks associated with the kinds of
ventures which we undertake or the kinds
of investments which we put our money
into. Prudent financial planning, therefore,
involves considering some of these risks
and trying to minimise the impact they
may have or, at least being aware of the
consequences if they take place. There
may be risks associated with the certainty
or otherwise of our jobs. There may be
risks associated with unexpected inflation,
or price rises or interest changes. There
may be risks associated with the possibility
of ill health or bad weather.
Whatever
they are, if we're to plan for a smooth
ride then we should take them into account.
Some things we may choose to formally
insure against. In other cases it may
be best not to live life right up to the
limit but to have a contingency or a bit
of slack built into our financial plans
so that we can absorb at least some of
the smaller shocks without being thrown
off course.
