The concept of personal financial planning is widespread in the West, particularly in the US and UK. Every day we see more and more interest in long-term planning of the financial future and fatigue from the brazen foisting of unnecessary products on clients in banks and investment companies. However, a simple question often arises - how necessary is a personal financial plan? Can't you just take the product that provides the highest return?
This is a plan for achieving your financial goals, based on your current financial situation and taking into account the real results of various investment instruments over the long term. In essence, this is your personal financial strategy that will lead you to your financial goals.
A short example:
You have a dream - to buy a house in Italy on the seashore. If you express it in monetary terms (for example, the cost of such a house today is 1 million euros) and decide on a deadline (say, by 2030), then this is already a financial goal.
Let's say you have about 1,000 euros left every month for investment and you have savings of 200,000 euros. Having assessed the historical return that you will be able to earn on such an investment horizon (for example, it will be 5-6% per annum), you can roughly estimate whether your expectations are realistic, and if not, what needs to be done to increase the likelihood of achieving the goal.
"Where to invest then?" - you can hear the voice of a novice investor. Only a Personal Financial Plan (hereinafter - PFP) can answer this question, which is quite individual for each person due to different goals and financial situations.
Despite the fact that the LFP is individual, several basic life scenarios can be distinguished from a financial point of view.
Te frst scenario is the poverty scenario. The basic scenario for most people and it is defined very simply - in it, income is equal to expenses. Why is this bad? Because at some point, income inevitably falls (quitting a job, closing a business, retiring, etc.), and in the absence of sufficient savings, very soon you will have to rely only on the state, which is not very generous. In the picture below, you can see how the cash flow becomes negative, and then the savings go into the negative.
The second scenario is much better (the comfort scenario). In this option, income exceeds expenses, the remaining money is invested and at the time of retirement there is capital sufficient for a comfortable existence. In the picture below, you can see that although the cash flow at some point becomes negative, the savings are enough for the rest of your life. In this scenario, as a rule, the heirs do not leave a large inheritance.
The third scenario is the most optimal. It is called the wealth scenario. During the period of active activity, capital accumulates, sufficient to live solely on interest, moreover, part of the interest is invested, which leads to a constant increase in total savings.
Like any long-term plans in such a volatile area as finance, LFP is never implemented absolutely precisely. Moreover, the slightest changes in the initial parameters included in the plan lead to quite serious adjustments to the final result.
However, despite this, we believe that financial planning is an extremely useful and necessary practice in achieving financial goals for the following reasons:
With the help of LFP, you can assess how realistic it is to achieve your goals.
Financial planning is a process. LFP must be regularly reviewed (we recommend annually) and the course adjusted, just like a ship or an airplane adjusts its course while moving.
Only on the basis of LFP can you choose those financial solutions that will be well suited to achieving your goals. Otherwise, you may encounter a situation where investments in a product with a high expected return have been made, the current result is negative and you need to wait a few more years for the desired result, but you need the money today and there is no way to wait.
By comparing LFP and what actually happened, you can assess your progress in achieving your financial goals. How close or far away have you gotten from them, and whether adjustments are required.
The only time you don't need a personal financial plan is when you have already achieved your financial goals, for example, you are already living on passive income.
See you soon, I will write an article on how to create a personal financial plan yourself.
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