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Andrew Silton: Wise advice for those in need of a financial plan

“The One Page Financial Plan: A Simple Way to be Smart About your Money” by Carl Richards.
“The One Page Financial Plan: A Simple Way to be Smart About your Money” by Carl Richards.

I’ll bet you fall into one of two camps. A small number of you have a detailed financial plan that projects your income, expenses and investments over the course of the next thirty or forty years. The rest of you don’t have a financial plan and are either unsure of how to develop a financial plan or afraid that the results will show a gaping chasm in your financial future. In this week’s column, I’m hoping to make those of you who fall into the latter camp feel a little better.

On the other hand, I’m going to make those of you with raft of spreadsheets and projections feel somewhat uncomfortable. Along the way, I will be urging you to read “The One-Page Financial Plan: A Simple Way to be Smart About your Money” by Carl Richards. About a year ago, I provided you with a suggested reading list. Richards new book belongs on that list.

If you have a detailed financial plan, it undoubtedly contains some very precise looking numbers. It might even give you a range of possible outcomes based on different market scenarios. While your financial plan is certainly better than not having one, it is actually just a wild guess about the future. Does anyone really know what his or her compensation is going to be in 10 years? Is anyone sure that they’ll always be gainfully employed throughout their careers? Can anyone confidently predict what college will really cost in two decades?

The truth is we don’t know the answer to any of these or other critical questions that underpin most financial plans. Thus, those of you with detailed financial plans probably have a false sense of security because no one can come close to modeling the future.

Richards provides a sensible framework for developing a useful financial plan without filling in hundreds of cells in a spreadsheet. However, his greatest contribution to financial planning is a simple question that dominates the first part of his book. It’s a question you need to answer before you can even contemplate developing a financial plan: “Why is money important to you?” Unless you are a hedge fund or private equity manager, money is a means to an end, not an end unto itself. Many money managers make money in order to make more money. However, for the rest of us money is important because it can be spent and/or stored in order to purchase goods and services. The problem is that we haven’t thought about what is important to us. We’re just spending money on stuff and hopefully setting a bit aside for college education or retirement.

Thus, the first step in developing a financial plan is actually not about numbers; it is about values. If you spend some time thinking about why money is important to you, you’ll be forced to think about what is important in your and your family’s life. Moreover, as Richards points out, you may discover that you and your spouse have different ideas about what is important.

For several years I taught investments at the Kenan-Flagler School of Business at UNC-Chapel Hill. The course required students to develop a financial plan. Every semester, a number of students reported that the exercise had led to some surprisingly difficult conversations with their spouses. It turned out that one spouse really wanted to have more time to be with the children, while the other one wanted to acquire a second home in the mountains. They also had different ideas about what retirement might eventually look like. The exercise of answering the “why” question will force you to identify your goals, prioritize them, and confront the trade-offs.

Establishing priorities

This is not an exercise to be conducted casually over a dinner or at the end of a busy day. It may require as little as an hour’s time or a series of conversations with the people important in your life. In the end, your priorities should easily fit on a three-by-five index card. Richards recommends writing down your goals and priorities with a Sharpie, so you can’t file the card with dozens of hard-to-read items. He also suggests that some of us will be better off having a third-party facilitate the conversation.

Once you have established your priorities, you can actually proceed to the planning process. Fortunately, planning doesn’t require specialized software or advanced mathematics. While there’s nothing wrong with these tools, most of the necessary math can be done with a pencil and paper, especially once you realize that any calculation about the future is a guess. In fact, the remainder of Richards’ book is a practical guide to answering the financial questions.

To build a financial plan, you will have to estimate how much it will cost to realize your priorities. Whether it’s a private education, annual vacation, or a first or second home, you are going to have to take a stab at guessing the cost of your goals. This is where a good financial planner can be extremely helpful.

Next, you must have a basic understanding of your budget. How much do you make and where is the money going? This is the most detailed part of the exercise and one aspect of planning that you can control. By figuring out what you actually spend, you can get a good idea of whether your spending is aligned with your priorities and start to build up savings. As I’ve written in the past, it is savings that allows us to build wealth rather than earning some fantastic return based on a few hot stock picks.

Most of us aren’t going to found a multi-billion dollar company or win the lottery, so we have no choice but to budget, prioritize, and save.

The right questions

Once you’ve figured out how much you are saving or need to save, you can finally start to worry about the investment part of the equation, and again the good news is that it isn’t complicated, at least in the world inhabited by Richards and this columnist. As detailed in “The One Page Financial Plan,” some combination of three or four low-cost index funds can provide you with all the returns and diversification you’ll ever need.

To be clear, Richards is not a proponent of do-it-yourself investing. He is, after all, a certified financial planner with a stable of clients. What he is suggesting is that financial planning is about asking the right questions, avoiding too many numbers, and resisting the temptation to jump into complicated financial products. Unfortunately, the financial planning and investment community tend to invert the planning process. They are all too eager to whip up a binder full of statistics and quickly get your money invested in all sorts of financial products laden with hidden fees.

There’s one more nice feature of Richards’ book. It’s short. In just 224 pages, “The One-Page Financial Plan” covers all the key topics, including a series of simple doodles illustrating the main points. As with any useful treatise, I recommend reading it twice. The first time, you’ll just want to cruise through it to merely find out what the book is about. It won’t take long because there’s no technical jargon in this volume. Then after a few weeks, pick it up again and slowly begin to apply the book’s lessons. If nothing else, you’ll feel better because Mr. Richard gets you to focus on the things that are important and in your control, while convincing you to stop worrying about the things you can’t control.

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