I learned everything I know about money from my dad. Even though he had little formal education, he understood how money works, how to get it and how to make it grow. One moment stands out in my memory: it was a Sunday afternoon when I had just turned 12. Dad took his tan leather briefcase down from the top shelf of his bedroom closet, pulled out his notebook and preceded to show me how to create what I now know was his personal financial plan.
That afternoon, at our kitchen table, he showed me how saving can earn you money through compounded interest, and how owing money can bury you in debt. His message? If you have a financial plan, you have choices—and having choices and setting goals is what leading a successful and satisfying life is all about.
My dad’s personal financial plan was his road map, helping him navigate to his dreams. And the roads to those dreams were built on details. For instance, dad always knew exactly what his take-home pay was, how much the family spent every week on groceries and gas, and how much he needed to save each month to pay off his mortgage in 10 years—his main financial focus when I was growing up.
His plan wasn’t just about counting pennies though, it also allowed him to plan for luxuries—and pay for them in cash. That’s why there was a special column in his plan for $50 in weekly savings towards a family trip to Italy. He had a system he believed in, and made sure the household finances were managed effectively.
These days, most people I know don’t have a financial plan. We spend a lot of time planning for other aspects of our lives, such as our careers, marriages and having kids, but many of us fail to build a plan to achieve our financial goals.
If you would like to stop wondering about whether you’ll ever realize your financial goals, and build a plan to actually reach them, I can help. Read on and I’ll not only show you how to build a proper financial plan, I’ll take you through each step, complete with worksheets and a blank financial plan template that you can fill in at the end. Follow my simple instructions and in no time at all, you’ll have the peace of mind that comes with a professional-quality personal financial plan—without having to pay a financial planner a dime.
1. Talk to your spouse
Most couples never talk to each other about their financial goals. If you’re in a relationship, before you roll up your sleeves and dig into the numbers, talk to your spouse about what you want to accomplish. “Have a brief conversation about goals, values, and what kind of lifestyle you want,” says Karin Mizgala, chief executive officer of Money Coaches Canada, a national network of fee-only financial experts based in Vancouver. “That’s key to a good start.”
Action step #1: Click here to find 10 worksheets in the “MoneySense financial plan kit.” There is a PDF version of each worksheet that you can download and print out if you want to fill in the sheets with a pencil or pen. There is also a Microsoft Word version you can fill out on your computer. Print out “Worksheet 1-Prioritize your goals” for this step. You and your spouse should fill this sheet out separately, then compare the results when you’re done.
2. Figure out where you’re at
Before you start worrying about where you want to go, you first have to figure out where you are now. In this step you’ll create a net worth statement, which is essentially an honest measure of your current wealth. You do this by tallying up the value of what you own (your assets) and what you owe (your liabilities). When you subtract your liabilities from your assets, you get a number that represents your net worth. Your net worth statement is an important tool that charts your financial progress over the years. For instance, if your net worth is going down, you’re eroding your wealth and making it harder to achieve your goals. If it’s increasing, you’re on your way to getting richer and achieving your financial goals.
Action step #2: Determine your net worth. Print out “Worksheet 2-Gather your documents.” It’s a checklist to help you pull together what you’ll need before you start, including bank statements, credit card statements, and life insurance polices.
Once you have all your documents in front of you, you’re ready to fill out “Worksheet 3-Your net worth statement.” First list the values of all of your assets, including your home, your cars, your cash and investments. Then list your liabilities, including credit card debts, your mortgage and any other outstanding loans. Tally both your assets and your liabilities and transfer those amounts to the following section, your simplified net worth statement.
Finally, subtract your liabilities from your assets to discover your true net worth. This shorter net worth statement gives a clear snapshot of exactly where you stand today.
3. Track your spending
The key to building a strong financial plan for the future is to understand how much you spend and save right now. This is called tracking your cash flow, and it can give you a sense of control and confidence that makes it easier to make financial changes in your life.
Personally, I’ve kept a small journal tracking my spending for years because it helps me modify my behaviour if my spending gets out of control. It’s not always easy, but it works.
“The part most people dread is taking a really close look at their expenses,” says Mizgala. “But don’t put it off. Successfully managing cash flow is your key to financial control. It will give you an awareness that has more long-term value than anything you can invest in, buy or sell.”
The point of the exercise is to find out whether you finish each year with a cash surplus or a cash deficit. This number will tell you a lot about your general financial shape. A surplus means you’re living within your means, while a deficit shows you’re spending more than you make. If you have a deficit, you will have to cut your expenses (or increase your income) to achieve any financial goals.
What do most people find after doing this exercise? “They’re shocked,” says Mizgala. “It’s a very revealing exercise, mainly because if you have a family with two spouses with debit and credit cards, it’s hard to really see the complete financial picture unless you write it down. This awareness allows you to set up a system for the household.”
Action step #3: Record your cash flow. Fill out “Worksheet 4-Your spending and savings.” It shows what money is coming in (wages, interest, government benefits) and what’s flowing out (rent, debt payments, utility bills). Fill in all your monthly expenses in column 1 and your annual expenses in column 2. (You can leave column 3, the estimate for your future spending in retirement for a later date.)
Tally up your expenses in both columns and subtract them from total net income on both a monthly and yearly basis. The result is your cash flow deficit or surplus.
A good way to approach this exercise is to start with your regular monthly after-tax income and subtract the bills that don’t change month to month, such as rent or mortgage payments. If you don’t know the exact numbers, put in averages for things like groceries, gas or children’s activities. Then add in expenses that only come up a few times a year, such as travel, car repairs and gym fees. Estimate a total for these and divide it by 12, and put that figure in the monthly column of your worksheet. You may not pay the bills in 12 monthly installments but imagine you are setting money aside each month so that you have the total amount when the bill comes due.
4. Adjust your spending
Look closer. Are your expenses higher than your income? If so, you’re living beyond your means. You’ll need to adjust your expenses accordingly so you don’t go further into debt.
This step is not about punishing yourself or laying blame. If you’d rather eat out four times a week than buy a cottage in 10 years, that’s your choice. But you owe it to yourself to be honest about what you’re doing so you’re not wondering why you can’t reach your financial goals.
If you decide to cut back, there are some less painful ways of doing it. Consider renegotiating your mortgage to a lower rate or cutting out one major expense completely. A close friend of mine cut the $5,000 annual family vacation and substituted a couple of long weekends of camping instead. It saves his family $4,000 annually.
If you have a cash surplus, congratulations. You can start allocating money to meet your goals right away.
Action step #4: Compare your spending to your goals. Take a second look at “Worksheet 1-Prioritize your goals” and “Worksheet 4-Your spending and savings.” The idea here is to look at how well your current spending habits mesh with your goals. If you have a cash flow deficit you won’t be able to meet your goals, so you’ll have to see if you can free up cash by cutting back your spending in areas that are less important to you.
For instance, if you have a $5,000 a year deficit on Worksheet 4 and one of your goals is to go on a $4,000 family vacation to Britain in four years, you need to figure out a way to cut $6,000 a year from your spending. You could try using only one car and taking public transit to work. Such a cut could save you $6,000 a year in vehicle costs, allowing you to both balance your budget and reach your travel goal.
5. Set your life goals
Financial goals don’t just happen. You make them happen. This step requires you to assess where you want to be five, 10 and 20 years from now and answer some big questions, such as where you want to live in retirement and when you want to stop working.
One tip is to visualize what your life will be like 10 years from now if you do everything right. The truth is when they picture their future lives, very few people see themselves in a $10-million house in Hawaii. Most people’s goals are more realistic, such as keeping up their current standard of living in retirement (with maybe a few upgrades), preventing any financial disasters, and having the freedom to do the things they love, such as spending more time with friends and family.
“Think of what type of life you want in the future and how you are going to organize your life right now to get it,” says Mizgala. “Your job is to structure your finances so you can achieve your vision.”
Action step #5: Set your top three goals. Fill in “Worksheet 5-Your life and financial goals” and “Worksheet 6-Your top three goals.” If your are in a relationship, sit down with your partner and examine what your goals are and how they fit in with your spending and saving patterns. On Worksheet 5, list each of your top four or five goals and assign a dollar value to each, as well as a time frame for achieving the goal.
Now, compare how closely your goals align with those of your partner. In Worksheet 6, list the three most important goals that you both agree on, in order of priority, in column 1.
6. Develop a strategy
Once you know where you’re going, you need a plan to get there. The usual route is to spend less than you earn and invest the surplus in such a way that you can get where you want to go.
One word of caution—if you’ve identified your goals but you’re in debt, you probably should address that debt before you start investing for the future. “Even when people are not overspending and have debts that carry reasonable interest rates, I encourage them to work aggressively at paying those debts down,” says Norbert Schlenker, founder of Libra Investment Management in Salt Spring Island, B.C. “Don’t even think about investing before your debts are all gone.”
Action step #6: Chart a path to your goals. Go back to “Worksheet 6-Your top three goals” and in column 2, note any obstacles to achieving each goal. Then, in column 3, write down the action steps that you and your spouse have both agreed on to make that goal a reality. For instance, when you tally up the costs of your top three goals, you may find that you need an extra $65,000 in five years to meet those goals. The main obstacle may be that your household income is low because one partner works only part-time. That partner may decide to work full-time in order to earn extra money. The key is to develop strategies and appropriate timelines to make your goals materialize.
7. Review your insurance
If you work full time, much of your insurance may be provided by your employer’s group plan. But is it enough? If you feel confident enough to do some basic calculations yourself you can find out.
Many workplace benefit plans include disability insurance, but if yours doesn’t, get enough to replace at least 60% of your after-tax income.
Then look at your life insurance needs. The general rule of thumb is to get enough life insurance to cover 10 times your income if you have kids under 10 years old (five times your income if you have kids over 10), plus the amount needed to pay off your debt. So if you make $50,000 a year, you have $250,000 outstanding on your mortgage, and two kids under 10, you will need $750,000 in term life insurance. Go to www.term.ca for quotes.
At this point, it may make sense to have an agent review all your insurance policies—disability, life, auto and home—to make sure your coverage is adequate. But be careful. “Do not be oversold on insurance by an industry that is famous for doing exactly that,” says Schlenker. “Pay attention to fees, especially with life insurance. If you need more life insurance, chances are renewable term is the right product for you. You want plain vanilla coverage for a plain vanilla problem—your kids going hungry because you can’t work.”
Action step #7: Review your coverage. There’s no worksheet for this step, but you should still take some time to carefully review all of your insurance coverage. If you don’t have group coverage through work, you probably have private insurance policies for medical, dental, life and disability insurance. Consult an independent insurance agent for a quick review. If you need extra coverage, make a note of it so you can include that in your final financial plan.
8. Slash your taxes
Most tax planning is relatively simple. You’re probably doing a lot of things right already. For instance, if you own your home and use RRSPs, Registered Education Savings Plans (RESPs), and Tax-Free Savings Accounts (TFSAs), you’re already taking advantage of the best tax shelters out there.
To reduce the taxes you pay on your investment portfolio returns it helps to understand that the income tax system treats the various sources of investment income differently. Interest on bonds and foreign dividends is taxed at your full marginal tax rate, Canadian dividends are taxed at rates about one-third lower, and capital gains at half the full rate. So there are advantages to holding investments that generate capital gains and Canadian dividends outside of your RRSP and TFSA if you’re tight on contribution room.
Action step #8: Consider calling a tax accountant. Again, there’s no worksheet for this step. But a few basic principles apply. For those with low to moderate incomes, paying off debt—including the mortgage—is the best tax-planning you can do. That’s because you don’t pay taxes on the capital gains on your home and there’s no tax on the return you get for getting out of debt. If, however, you’re in a higher tax bracket—earning $85,000 a year or more—it may be worth paying for a couple of hours of an accountant’s time to see what mix of investment options—RRSPs, RESPs and TFSAs—is right for you tax-wise. Have these suggestions handy for your final plan.
9. Create an investing policy
Every professional financial plan includes an Investment Policy Statement (IPS) that recommends how a portfolio should be invested. It puts in writing the rules that will make you a more disciplined investor. Having an IPS helps you to stick with your plan and keeps you from changing course when the market gets volatile.
A typical investment policy might specify that your portfolio should always maintain a ratio of 60% stocks to 40% fixed-income investments. This ratio is determined by your time horizon and risk tolerance. The longer your time horizon and the greater your tolerance for risk, the higher the equity portion of your portfolio. As you near retirement and need the security of more stable income from your investments, the portfolio mix will usually tilt towards bonds.
An IPS also states the expected annual returns for your portfolio—typically 5% to 6% per year—over a very long time period, such as 20 years or more. Your IPS might also note the volatility you should expect for a given portfolio. For instance, it could say that you should expect the portfolio to suffer a 10% drop in the short term at least once a decade.
Action step #9: Determine which investments are right for you. Fill in “Worksheet 7-How are you currently invested?” and “Worksheet 8-Which investments are right for you?” On Worksheet 7, itemize every investment you own today—including cash, fixed-income products and equity holdings.
Worksheet 8 will help you assess how much you need to save monthly, when you’ll need the money, and what your risk tolerance is. The results will allow you to zero in on how you should invest in future to meet your goals.
If you have trouble with this section, you can always leave it for now. Once your financial plan is complete, you can consult a fee-only adviser to help you build an investment strategy that’s right for you.
10. Write up a will
Every adult who owns assets and has a spouse or children should have a will. An accurate and up-to-date will is the only way to ensure your assets will be distributed the way you want them to be. If you don’t have one, you’re letting the laws in the province you live in make those decisions for you. And if you hold the belief that your spouse will automatically inherit everything—you’re wrong. In most parts of Canada children trump partners. Without a will your husband or wife will get a predetermined amount of your assets—the rest goes to the kids.
Action step #10: Create or update your will. If you have an updated will it should be filed with your financial plan. If you don’t have one, hire a lawyer to draw one up for you. Visit www.lawyerlocate.ca and search for lawyers in your area who specialize in wills and estates.
11. Create your final plan
A typical financial plan has five main parts. The first outlines where you stand right now, that’s your current situation. The second contains your top financial goals, or where you want to go. The third is a simple net worth statement. The fourth lists the steps you must take to achieve your goals. It includes your income and expenses, an overview of your insurance, a section on retirement planning, and a section on estate planning. Finally, the fifth section—usually a separate document—is your Investment Policy Statement, which lays out how your portfolio is to be invested.
To get a better feel for what your financial plan might look like, let’s take a look at a plan that has already been created by a fictional couple, Patty and Walter Berglund. The Berglunds are a 34-year-old couple living in Halifax. They have two daughters, Debra and Marie, ages 5 and 2. Their household income is $110,000 and after all expenses have been paid, they have $20,000 in cash left over each year.
Their plan lists their top five goals—to pay down $20,000 in consumer debt, save $5,000 for a family trip to Disney World in two years, pay off their $150,000 mortgage in 15 years, save $60,000 in RESPs for their daughters’ post-secondary education and finally, to retire comfortably at age 60.
This is followed by a basic statement of their assets and liabilities that shows a net worth of $82,000. The couple’s projected income and expenses show a $20,000 annual cash surplus. That money is earmarked for their goals in the following way: In the first year the entire $20,000 surplus will go towards paying down the debt. In year two, $5,000 will go towards the big family Disney World trip, $5,000 towards an extra payment on their mortgage, $5,000 to the RESPs and $5,000 to a spousal RRSP for Patty. The couple agrees to continue using the annual surplus in this way each year until their goals change.
After consulting with an insurance agent, the Berglunds agreed that their group plans with their employer are mostly adequate but they decided to increase Walter’s insurance coverage by $300,000. In the section on retirement planning, the couple made some assumptions: that Walter remains employed as a physiotherapist and stays in the hospital’s defined benefit pension plan until age 60, and that Patty continues working part time earning $30,000 a year as a social worker. Walter will start saving $5,000 annually in a spousal RRSP for Patty once their consumer debt is paid off (excluding the mortgage). If they do this, the couple should have more than enough to cover their retirement expenses adequately. Their wills and power of attorneys are all in order.
The second document, the Investment Policy Statement (IPS), outlines the Berglunds’ investment plan. They have an average tolerance for risk and don’t require regular income from the portfolio right now. So a balanced 60% equity, 40% fixed income mix suits them fine. The couple wants a well-diversified portfolio at minimal expense. Thus, their policy states that low-cost index funds or exchange-traded funds are to be used wherever possible.
Their IPS also states that once a year the Berglunds will review their portfolio and rebalance to bring the asset allocation back to their pre-determined target mix of 60% equity and 40% fixed income. It also states clearly that sudden market price movements are not grounds for revision. This will help stop the Berglunds from making impulsive investment decisions out of fear or greed.
Action step #11: Create your financial plan. Open “Worksheet 9-Your financial plan” and gather together all of the worksheets you have already filled out. Worksheet 9 is a blank financial plan with all the sections already labeled for you. At this point, all you are really doing is taking information from the completed worksheets and putting it all together to form your plan. Before you proceed, it may help to review the sample plan for Patty and Walter Berglund at the end of Worksheet 9.
Now fill out “Worksheet 10-Your investment policy statement.” Again, refer to Patty and Walter Berglund’s Investment Policy Statement at the bottom of this worksheet for guidance. Write a brief summary of your current status, and under Objectives and Constraints write down your risk tolerance, time horizon, any taxation strategies you plan to use, and the amount of time you wish to spend managing your portfolio—in many cases, minimal.
Under Investment Strategy Guidelines, write an outline of how your investments will be allocated, according to asset class. The next three headings—Security Guidelines, Location Guidelines and Risk Control, Monitoring and Review are fairly generic and are already filled in for you.
Phew, it’s done! You now have a financial plan for the rest of your life. From this point on, as your goals change, modifications to your basic plan will be straightforward.
Of course you still have to follow your plan. But you’ll probably find that the process of putting it together has already changed some of your beliefs about how your money should be spent and invested, so changing your financial behaviour may not be as hard as you think.
To make sure you stay on track, you should take the time to review your plan at least once a year, and update it as necessary. It’s also a good idea to pull it out whenever you run into a big financial or life event, such as a market crash, marriage or job change. “It’s a tool to support you through life,” says Mizgala. “Money and household finances won’t be as scary when you break it down into these manageable bits. If you truly commit, it will be a huge boon to your emotional and financial well-being.”