Saving and investing is something that people do because it’s inherently sensible. You choose an arbitrary figure, based on what you think you can afford, then invest it without any real consideration as to what you actually need to do to meet your financial goals. For a lot of people that process is good enough as it beats doing nothing, but for those who really want to understand their financial why and how, whilst getting the best out of their money and advisory relationship, cash flow modelling is the process that can be used to map out the road to financial freedom.
Financial freedom? Yes, I know, it sounds fluffy, and of course, everyone has a different perspective of what it is to them but broadly speaking:
Financial freedom is about having the financial resources, when needed, to give you the benefit of choice.
It means not being backed into the worst case option because of a lack of planning. Having no choice about how and when you retire, or your working hours later in life, or your ability to spend time with the family or your wish to go it alone in business can be crushing.
But having choice in the future requires planning, time, patience and sacrifice in the here and now. Most people think it’s too late to put in place an achievable plan or they just don’t have access to the planning tools that they need to help them make it work. But that’s where an advisers cash flow modelling tools can assist. Whether you’re 25 and have it all ahead of you or 85 and not sure whether you can afford to make gifts or leave a legacy, if I can show you how things might play out, then maybe you’d have all the assurance you need to make the financial changes to meet your goals.
Cash flow modelling is the simplification of complicated mathematical computations that can change the perspective of your finances from a bunch of misunderstood numbers into a clear picture of the future. It could allow you to act with confidence on matters such as what would happen to my finances if I retired early, what if I invested more, what if I invested less, what if I needed care in later life, what if I spent more time with the family now, what if I did take that job I always wanted on a lower income, and the list goes on.
Cash flow modelling uses computing power to consider all of your income sources, expenses, assets, liabilities, tax positions and financial goals, collectively projecting them forward using realistic growth rates and variables, such as inflation, to determine whether it’s affordable for you to meet the desired goal. And if there’s a shortfall, you can investigate a solution to help you get on track, such as saving more, spending less, delaying consumption or taking a different investment strategy. Still don’t get it? Well seeing is believing so let me show you a very basic example using ‘Plan with Voyant‘:
The Time Line
John and Jane are both aged fifty and with 15 years remaining until their intended retirement. So this is a very basic before and after retirement situation, although the timeline can be built out to incorporate all manner of planning situations such as the need for school fees, university plans, one-off payments such as a gift for a house deposit or wedding, the impact of stock market crashes, staggered retirements, long-term care fee’s and any other scenario of your thinking. The timeline is there to set out the planned sequence of events.
Detailed Cash Flow
Although John and Jane have a planned timeline for retirement they still have no idea whether it’s actually affordable. Like so many people, they just do not know what their current savings, investments and pension arrangements will produce for them in the future. And although forecasting should never be relied upon as a guaranteed solution, in consultation with their adviser, John and Jane’s initial financial details can be used to produce a starting cash flow model. By entering their financial details into the plan, and using realistic investment growth rates, inflation and other variables to forecast probable outcomes, the numbers can be interpreted into the chart below.
The chart shows that on an annual basis employed earnings prior to retirement (in blue) exceed current needs (the solid black line) and that in retirement from age 65 a combination of current savings, investments and pensions can be used to meet the expected retirement expenses, increasing each year by inflation. However, as can be seen, toward the end of their lifespans some red ‘shortfall’ columns appear, signifying that based on the current arrangements they would likely run out of money.
So, what can be done? Once John and Jane visualise the predicament, it’s clear that action must be taken if ‘financial freedom’ in retirement is to be achieved. Working with their adviser, explorations can be made into one or a combination of ‘what if’ solutions to treat the shortfall including the ability to save excess income now, retire later than initially intended, adjustment of the investment strategy, lowering of the expenditure expectations or even downsizing of the marital home at some point to release additional capital. These avenues and others can be assessed and shown by updating the plan and as can be seen in the chart below, after simply diverting some of their current excess employed income into a pension, the red shortfall in John and Jane’s plan can be avoided.
This is, of course, a very simplistic example of a cash flow plan and in real life, circumstances, emotions and goals tend to be much more complicated and subject to change. However, cash flow modelling can be just the jolt needed to get a financial plan started, with regular reviews updating the plan based on new information so that you stay on track.
Ultimately, cash flow modelling can help you make financial decisions with more conviction and understanding of why you’re saving and investing. The plans are not infallible and regular updates are required to make the best use of the system, but the planning possibilities are endless and it’s just a case of being open to exploring your ideas. Please do get in touch if you’d like to explore your own financial goals and choices.
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