An Overlooked but Essential Component of Your Financial Plan
Have you ever wondered why you can’t seem to save as much as you would like, even though you make great money? Or find yourself staring at the year-end tally, asking where all your money went? This can be the case even if you work with a financial advisor and have a long-range plan in place to secure your retirement income, because there is an essential element that is often overlooked in the financial planning process: cash flow planning.
A cash flow plan is different from a budget, which deducts expenses from income and plans how to spend the rest. A cash flow plan takes into account your income, assets and debts, as well as the number of years until your planned retirement. It allows you to see exactly where your money is going, creating an awareness of where money is being spent. This process is likely to reveal expenditures on things that are not really very important to you or your sense of well-being, and are in fact holding you back from reaching your true financial goals, which are very important to you. As always, knowledge is power and puts you in a position of control. You can determine exactly how much you can spend on things and experiences which are of value to you, while reining in spending in areas which make little difference to your enjoyment of life.
Cash flow planning is likely to reveal expenditures on things that are not really very important to you or your sense of well-being, and are in fact holding you back from reaching your true financial goals, which are very important to you.
A cash flow plan will also reveal the true extent of your indebtedness, and perhaps the need to restructure your debt load to reduce interest payments and timelines. Depending upon where you are in life, it can tell you if you can really afford that house while meeting the needs of your growing family, or how much you are going to need to maintain your lifestyle in retirement.
Full disclosure is necessary to complete a cash flow plan. Many people deal with their financial affairs in compartments, using the services of professionals in different disciplines, with the result that no one advisor has the full picture of your financial situation. Advice based on incomplete knowledge is obviously of limited value. It is also very common for people to be reticent about revealing aspects of their financial situation that they are embarrassed about. For example, your advisor may know about a mortgage but does he/she also know about the debts on various credit cards, lines of credit and so forth? These can have a substantially adverse effect on reaching your long-range financial goals.
To illustrate how dramatically it might change your financial outlook if all debts were factored into the equation, the Certified Cash Flow Specialist™ (a fairly new designation) uses the example of a couple in their mid-fifties who felt that they are well on their way to a debt free retirement in ten years. They had:
- $8,000 net average monthly income
- $200,000 of RRSP
- $450,000 managed by their bank in RRSPs and TFSA
- Mortgage: $80,000 (3 years left)
What they hadn’t taken into account was accumulated debt of $114,000 on various credit cards, lines of credit, and car loans. Their monthly payment on this debt was $1,314. Because they kept adding new debt, the timeline for paying it off was 32 years. This debt would obviously follow them into retirement, necessitating larger withdrawals than their current financial plan made provisions for. To solve the problem, the cash flow specialist restructured their debt so that they are now on track to be debt free in eight years and should save up to $120,000 in interest. They have also planned to save an additional $1,500 a month towards their retirement. The couple reports that these changes to their cash flow have not negatively impacted their lifestyle and that they feel they are getting more value from their money.
Whereas financial planning has a long-term horizon, cash flow planning makes use of shorter-term goals because it is easier for people to modify their spending behaviours related to a more immediate goal.
Controlling your spending is easier when you work with natural patterns of human behaviour rather than against them. As with dieting, it is more effective to focus on what you can have rather than what you can’t have. Looking at your cash flow plan through the lens of what you truly value is an effective way of managing your money. Streamlining the flow of money to those things and experiences that make a real contribution to your health and happiness feels good.
Incremental change is usually more sustainable than drastic ‘cold turkey’ measures. To that end, it’s easier to change your spending behaviour by setting a series of shorter-term goals that contribute to your long-term financial success.
Cash flow planning harnesses your financial power, ensuring that the money you are working so hard to earn is not squandered or misdirected. Rather, it puts you in control to spend your money in ways that reflect your values and priorities. The ultimate goal is peace of mind and a feeling of security and well-being.
Dale Berg is a Senior Financial Advisor with Assante Financial Management Ltd. providing wealth management services to principals of family-owned and privately held companies. The information mentioned in this article is for general information only. Please contact him to discuss your particular circumstances prior to acting on the information above.