We’re told over the course of our entire lives about the importance of saving to reach other goals, especially when it comes to retirement. Most people agree that having a financial plan is important to provide clarity.
Unfortunately most people have never had a properly prepared financial plan. For those who have a plan, few stick to it over time – especially during the down-turn we’ve all witnessed lately.
Most plans require you to gather both personal and financial information. Your financial planner is able to input this information and generate a variety of documents ranging from a simple concept to a comprehensive financial plan.
The information you gather is mostly concrete and is based on actual amounts as of a certain date. As well, you will have to make some projections as to the level of income you would like at retirement. Your financial planner will also establish various assumptions or estimates (inflation rates, life expectancy, investment returns).
The best part of a financial plan is the list of savings required to meet your goal. As an example, a typical financial plan may recommend that a couple each maximize RRSP contributions and save $500 per month in non-registered savings. These savings are required whether we are experiencing good times or bad.
Unfortunately when markets decline, many people stop investing. This often has a bigger long-term impact on your financial situation then for someone who continues to save. By continuing to invest during difficult times people are essentially dollar cost averaging. By dollar cost averaging we mean that some investments are purchased at higher amounts and others are purchased at lower amounts.
Rather than stopping the amount you save, consider saving more. By saving more, at any time, you increase your chances of reaching your goals.
After a financial plan is prepared, it is important to update your financial planner with details of any significant changes in your life. Significant changes may include family death, marriage, birth of child, inheritance, sale or purchase of a property, significant raise, job loss or health issues.
A typical financial plan may have an investment return assumption of 7 per cent annually. It would be unrealistic for returns to be exactly 7 per cent each year. On average, over time this is what is used as an estimate. When investment returns are significantly different – that is a one-year deviation of 20 per cent or more – we recommend updating the financial plan.
When returns are greater than expectations then three things can be discussed. Consideration should be given to shifting the investment portfolio more conservative as the required returns are now lower. Another discussion point would be lowering the required amount of periodic savings. The last item to discuss is the possibility of either retiring younger or having more funds available at retirement.
When returns are lower than expected it is important to assess how this will impact your financial situation. For some people it may involve saving a little more or working a little longer. We would prefer these two options rather than encouraging people to take more investment risk.
For younger people, a negative year in the markets has minimal impact to long-term financial plans. The older a person is, the more the stock market may have an impact on your financial situation. This is the reason why a person’s investments should shift towards fixed income (bonds, GICs, term deposits) the older one becomes.
The best part about a financial plan is that it provides some clarity relating to savings and long-term goals. The conclusion after a significant decline or increase in the stock market is a change in the required periodic savings. The most important component to long-term success is to continue saving during all market conditions.