How to create your own financial plan

Here's a summary

By Vishal Teckchandani

Creating a financial plan helps you put in writing the grand vision of how much money you need to live your life the way you want, and identify what you need to do in order to get there.

When you have a financial plan, it is easier to make decisions about your wealth, make changes and stay on track to meet your goals. Think of it like a compass to keep you on your path to financial independence.

But many of us may think that making our own financial plan involves seeking financial advice. The good news is that doesn’t need to the case, according to InvestSMART Chairman and renowned money expert Paul Clitheroe.

“Every Australian and every citizen of the planet can do most of this work themselves,” he says.

Clitheroe recently spoke to nabtrade’s Director, SMSF & Investor Behaviour, Gemma Dale, about the four steps you can take to create your own financial plan. You can watch the interview or read a summary of the steps below to learn more.

Step 1 – Determine your incomings

It’s critical to know how much money you earn. And not just your gross salary but the actual after-tax income that hits your bank account, according to Clitheroe.

“What’s coming in? Let’s get that sorted, that’ll take five minutes,” he says.

After figuring that out, Clitheroe urges individuals to not run for the hills and create a budget underpinned on austerity as this approach usually fails.

People write down a budget “deciding that we are now going to live like a Buddhist monk, so we’ll live in a cave and grow our own vegetables and we’re going to save 80% of our salary,” he says.

Hold off on the budget until you’ve worked out steps two and three to uncover the full extent of your financial situation and goals.

Step 2 – Determine your outgoings

“The truth is what are you spending?” This involves identifying all of your living costs including:

• Mortgage and/or rent payments
• Utilities, internet and phone bills
• Insurance premiums
• Grocery bills
• Medical expenses
• Entertainment spending
• Car running costs

And so on.

While this seems straight forward, Clitheroe notes that too many individuals understate the true extent of their spending and this leads to a doomed financial plan.

“You’ll probably put down car running costs at $20 per week for fuel. Well no – wrong answer. We find that the cost of running your typical mid-sized, relatively inexpensive car is probably close to $300 per week” after factors such as registration fees, depreciation and provisioning for work such as tyre changes are taken into account, Clitheroe says.

The key message here is to be brutally honest with you much you’re really spending.

He says after figuring out the “horrible truth”, you’ll hopefully start to get a clearer picture of why you’re not making as much progress as you’d like towards your goals.

“The pain you are going to go through to get this right is that you will be proud of yourself once you get over the depression [of realising your true spending pattern],” Clitheroe says.

Step 3 – Define financial independence

After determining your incomings and outgoings, you’re now in a position to think about your future goals, and that shouldn’t necessarily mean retirement at age 65.

“The world’s changed. The idea that ‘I’m 65, I get a gold medal and I retire’ – forget it. Let’s dump the word retirement, please don’t ever use the word retirement again,” he says.

Instead, individuals should aspire to 'financial independence’. In other words, what would it cost you to live and do the things you want to do each year? For example, this could include eating well, playing golf, sailing or being a grey nomad. Put an annual cost against it (i.e. will it cost you $50,000 or $100,000 to live the way you want?).

“That gives you a target inside of your super fund,” he says. “Financial independence is whether you’re 18, 25, 35 or 62, I don’t care. The fact you’ve got a plan gives you a high chance of success.”

After you’ve come up with a cost, Clitheroe says a golden principle he abides by is the ‘rule of 17’, which involves multiplying the amount you want by 17. This means someone who wants $100,000 in annual income requires $1.7 million in assets, as an example.

“This will give you the chance to have a conversation about how to get to that target to achieve financial independence,” he says.

Step 4 – Create a budget and an investment plan

Once the above three steps are complete, it’s time to make a budget.

“So we’ve now got this situation where really we’ve got a terrific plan. It doesn’t sound like we’ve done much, but we’ve identified ‘how much am I earning? How much am I spending? My goal is this’.” he says.

Based on this, you can start to control your finances and determine what to stop doing or sacrifice in order to save more, and Clitheroe suggests individuals to look at redirecting surplus income towards investing.

While this may involve sacrificing some of your lifestyle today, it will set you up for financial independence tomorrow.

“It’s a simple trade off. What do we not do today to give us that goal, or do we do more travel today but we’re not independent till our late 60s?” he asks, as an example.

He notes that while many people fear investing, buying quality assets over the long-term has produced better returns than cash (or putting money under the mattress).

“The issue for me is that if we go back over 1000s of years of history, supply and demand is surprisingly accurate. Australia’s population will be around 35 to 37 million people in about 27 years time,” he says.

This means that over time, property prices and rents should increase and businesses will sell more products.

“I’ve done this for my 40-odd years of investing: I just buy property that is well located and I buy shares of companies doing sensible things,” he says.

“And in particular I recognise that the Australian share market is only 2% of the world so for decades now I’ve held probably more than most people do in international shares. Not because I’m smart, not because it’s tricky, it just makes sense to me to participate in global growth.”

In investing, he stresses the key is to diversify and to recognise that investment markets move in cycles, which means asset prices will move down as well as up. And in times when markets are tough, investors should stick to their long-term plan rather than selling into fear and panic.

“My house in 1990 in a big city fell in value by about 30% when interest rates hit 18.5%. Now three years later it had recovered that amount. Did it really matter? It only mattered if I got forced out of the market and I was forced to sell into a downturn,” he says.

After undertaking these steps, you may still feel you need help with some areas of your financial situation, in which case a financial planner could be the person to see. As Clitheroe points out, you’ve done most of the hard work of identifying your goals and clarifying your situation, so your financial planner can spend their time helping you with more sophisticated strategies to grow and protect your wealth.

Wrap-up and final tips from Paul Clitheroe

Rule 1: Determine your incomings

Rule 2: Determine your outgoings, but be realistic about your expenses

Rule 3: Define financial independence

Rule 4: Create a budget and an investment plan

• You are in control of your finances
• Consider the annual income you require for your lifestyle goals rather than a lump sum amount
• Follow the ‘rule of 17’
• Drive the cheapest car you can afford
• Sacrifice now for earlier financial independence
• When creating an investment portfolio, diversification between asset classes is key
• “Just do something” – make a careful decision but don’t wait 10 years to start investing 
• Stick to your long term plan during difficult market conditions

This content was produced in conjunction with our content partner InvestSMART. Visit their website for more information about their research and share recommendations.