A basic financial plan

by Admin
Updated: June 23, 2018

A basic financial plan that focuses on income will maximize your financial freedom

A basic financial plan that provides a guaranteed minimum return might be all the plan you need. Even so, there is no low-maintenance investment that is completely safe so it’s important to pay attention to what’s being done with your money. If you’re not yet very wealthy or you’re ambitious, you’ll want to build-in realistic possibilities of significant short-term gains.

The standard goal of a basic financial plan is to obtain a passive income sufficient to support the lifestyle you desire at some point in the future, i.e. enough money to enjoy life without having to work. This is valid regardless of your current level of wealth.

The standard approach

Work backwards like this:

  1. Decide on a minimum income.
  2. Calculate the size of the fund needed to generate the minimum income using reasonable rate of return, e.g. $50,000 per year would require $1 million if an interest rate of 5% per year can be achieved.
  3. Calculate the activity per paycheck, something like: Over x years, with compound interest of y% per year, save $z per month (the calculation is heavily dependent on assumptions).

You can leverage your contributions by taking maximum advantage of government and employer incentives, but essentially it’s a matter of saving hard over a long period of time.

Problems with the standard approach

  1. The minimum income is often calculated based on current value and does not take account of inflation ($50k in 30 years will not buy what it does now).
  2. The “reasonable rate of return” can easily be over-estimated.
  3. Living off your capital at a fixed rate will see your income and your capital lose value against inflation.
  4. The regular saving amount of $z is usually depressingly large for even a modest future income.
  5. If you are lowly paid, you won’t be able to save enough for a comfortable retirement (this also applies if you are fully invested in self-employment, a start-up or struggling business etc.).
  6. No provision has been made for fees.
  7. Smaller funds sometimes disappear.
  8. Many funds are accessible as assets.
  9. Apart from contributing more money ($z), there’s nothing you can do to increase the value of your savings.
  10. You should have started 20 years ago.

Despite these, most people should take advantage of the standard approach if they can. Over 10+ years, an S&P 500 index fund in a 401(k) is the standard by which other investment vehicles should be judged.

The disconnect

I’ve seen too many people spend their best years working a job they didn’t enjoy to put money into investments they didn’t understand and end up disappointed with the results.

On the other hand, the idea that embracing risk is how you get rich is also flawed because by definition risk means you could use everything. I’ve seen that happen too.

The solution is simple in principle: Spread your risk.

Including risk

There is only one type of risk that fits into a basic financial plan and that is taking a risk on yourself. Specifically, I’m referring to bootstrapping a side business: Start something for next to no money - so it doesn’t impact any savings plan you’re working on - and make a profit by adding & selling value.

For example, if you start something for less than $100 and make $500, you’ve made more than 500%! If it fails or you decide to quit, you’ve lost less than $100.

Either way, you’ll learn business fundamentals in a visceral way you cannot get from theory alone and it will make you a much more savvy investor when it comes to buying stakes in other businesses.

More info

A better than average guides to financial planning basics are at goodfinancialcents.com and wealth-steps.com.

A nice video course is available at societyofgrownups.com.

A short intro to side business, “The Side Hustle: Why You Should Have One” is at smartasset.com.

Internal links

Compound interest and inflation Bootstrapping a business Financial freedom All articles
Agree? Disagree? Questions? Answers?
Please post a comment...
Log in