17 Nov Personal financial plan: the greed vs fear equation
Good financial planners will help you to balance the greed vs fear equation.
During times of market uncertainty a solid personal financial plan stands you in good stead. Many investors make the cardinal error of panic selling when emotions of fear and greed take over as we are barraged incessantly by diverging investment information that robs us of peace of mind and sleep.
Even the most astute investors like Warren Buffet warn of the dangers of emotions in the investment process. By taking time to understand investment principles and constructing a sound financial planning strategy, many of these pitfalls can be avoided.
Where to start with your personal financial plan
When developing a personal financial plan it is important to first define your own objectives, such as when you want to retire and how much monthly income, in today’s rands, you would like to have during retirement.
Gather as much financial information as you can and value your current investments. It is then possible to calculate how much additional capital will be required at retirement.
Various factors must be assessed at this stage, including how long you intend to invest and different tax implications. Adding complexity will be the analysis of how high the investment return needs to be to provide that ‘pot of gold’. At this stage your required investment strategy will become clearer.
What to invest in – balancing a personal financial plan
Investment markets are quite complicated, even for those with a higher than average IQ. Simply put, there are really only four things in which you can invest your money: shares, bonds, property and cash. Sure, you can invest in paintings or sculptures but these are speculative assets.
The decision to invest in shares, bonds, property or cash is known as the asset allocation decision. Most investors close to retiring need to grow their capital at a rate above inflation net of tax and should ideally be spreading their investments between the various asset classes.
Equities do provide inflation-beating returns, but they also carry the greatest capital risk. Cash and bonds are considered lower risk investments, but are at the cost of lower returns.
Retirees would typically wish to have most of their funds invested conservatively in defensive assets with most in cash and bonds. However, few can afford this luxury. They usually need some exposure to the inflation-beating returns equities provide.
They also need to consider that interest earned from conservative investments is taxable. This can further erode the capital.
Taking into account the risk and returns particular to each asset class, you must allocate funds between the asset classes according to your needs and cash flow. The construction of your investment portfolio is something which should be done with an investment expert as the decision will certainly have far-reaching consequences.
Investors frequently make investment decisions according to what they feel comfortable investing in rather than what they need as an investment return. If you are by nature a risk-averse person you will probably choose a more conservative portfolio, while an aggressive investor may choose a more aggressive portfolio only later to possibly fall into the classic trap of panic and selling.
Personal financial plan example
Let’s illustrate the importance of a correctly structured investment portfolio. Let’s assume a 45-year old investor has R4 million and continues to invest 15%, of her R600,000 annual salary until age 65. She requires a net pension of R300,000 p.a. If she only invests in cash her funds will be depleted by age 75. If she achieves a real return (i.e. above inflation) of 2% per annum those funds extend until age 84. However, with a real return of 4% per annum, the funds extend until age 99.
Investors still accumulating funds for retirement have time to grow their wealth. They can afford to be more aggressive in their approach and can have more exposure to equities and property and less to bonds and cash.
Be cautious – one cannot simply be categorised into low-, medium- and high-risk investors. This was the way things worked in the past, to most retirees’ peril.
Financial planning is the process which tailors a personal financial plan particular to your unique circumstances and focuses on what you need rather than what you want. You can then invest accordingly.
During times of investment uncertainty a framework like the one above is essential to reliably generate inflation-beating returns and completing an annual review is time well spent.
If you feel you need assistance then consult a fee-based CERTIFIED FINANCIAL PLANNER® to help you understand and plan a more certain financial future. Ask for a referral or visit the Financial Planning Institute’s website at www.fpi.co.za.
Debbie Netto-Jonker CFP® is the founder of Netto Financial Services and was Financial Planner of the Year in 2001 .