Financial objectives, goals and plans
You may have several financial objectives at any one time, such as to save £500 by the end of the month, or £5,000 for a luxury holiday, or £25,000 for a house deposit, or even to be a millionaire before the age of 40.
All of these are high-level objectives, setting out what you want to achieve and giving you a general direction of travel. They don’t say how you are going to do it.
Setting an overall objective is important on your journey to financial independence. As it’s a high-level statement, it doesn’t need to be detailed, in fact, it doesn’t even need to contain any specific figures at this stage.
“My objective is to be financially independent by the age of 50. This will require me to have an unearned income stream, equivalent to, or above, my total outgoings at that point in the future”.
This general statement is clear in its intent, even though we don’t yet know some of the key criteria, namely what our outgoings actually will be at that point in the future.
When you start out investing for the long term, and you don’t have any other relevant information to base your calculations on, it is acceptable to use an average to kick things off. So in this instance, we shall assume that the average cost of a month’s outgoings for a typical UK family is about £2,500.
Therefore, our initial annual income objective is £30,000 plus inflation.
Once we know our overarching objective, we can then start to plan the route to get there.
Proper financial planning starts with goal setting, including short, medium and long-term goals. These goals can be reviewed each year and adjusted as required.
Short term goals
Setting a budget
We talked about the importance of setting a budget here, and now it is time to put that into action. You simply cannot know where you are going financially until you know where you are right now.
Spend a couple of days looking through your last three months bank statements to establish average expenditure, including phone payments, cash payments, and anything else you can think of that doesn’t show up on your bank statement.
Then write down all the income you receive from any employment, allowances, businesses, savings, investments and anything else you regularly receive.
Finally, you must set out all your financial assets in one place, including any savings, investments or other cash-based items. I do not mean things like cars, bikes and paintings in this example.
Once you have all this information, you can then either populate a readymade budget found on-line or make your own. There are of course budget Apps that you could use, but you still need to populate the information to begin with.
Starting an emergency cash fund
An emergency cash fund is money you set aside, specifically to pay for unexpected expenses, which should prevent you from having to dip into any long term savings and investments.
Ideally, you want to aim for between three to six months of expenditure. You can get started with a £500 or £1,000 goal to kick off with, and then aim to build up the rest over the next 12 months, depending on how much spare cash you have.
The more emergency cash you have, the bigger the financial problems you can cope with, for example, a broken-down car, or unexpected unemployment.
Paying off credit cards
Once you have achieved a reasonable emergency cash fund and given yourself a decent financial safety net, then the next short term goal is to pay off any expensive credit card debt.
As mentioned several times before, you won’t be able to earn the same rate of return on your investments, as you are likely to be paying on your credit cards, so investing is not an effective use of your spare money until those debts are cleared.
A well-used strategy for paying off credit card debt is to list all your debts by interest rate from lowest to highest, then pay only the minimum on all but your highest-rate debt, aim to overpay that one as quickly as possible first.
Once that one is cleared, cut the card up and move onto the next highest rate, and so on, until you have paid off all your debt, and cut up all your credit cards.
Start your employer’s company pension scheme
Make sure you sign up to your employer’s pension scheme when it is offered to you. By not doing so, and “opting out”, means you are giving away free money, in the form of contributions from your employer, and tax relief from the Government.
Once you’ve created a budget, established an emergency cash fund, and paid off your credit card debt, it’s time to start working toward your mid-term financial goals.
These goals will continue the process of debt reduction, and begin the processes of your financial safety net through insurance, and financial freedom via investing.
Life insurance and critical illness insurance
Insurance for life and critical illness are essential safety nets if you have a spouse, partner, or children who depend on you for their income. The critical illness insurance is also worth considering for all employees or business owners, even if you don’t have any dependents yet.
Life insurance is comparatively inexpensive and well worth the price, for the peace of mind it can bring to the family. Critical illness cover will be more expensive, simply because you are far more likely to become critically ill than to die outright. Both insurances get more expensive the older you get.
TIP: You should check with your employer first, as you may already have these insurances provided by them for free.
Pay off any student debt
Student loans can be a major long term expense on many people’s monthly budgets. The interest rates are usually much lower than credit card debt, and also the loan doesn’t have to be paid back until you reach a certain level of income. However, having this debt outstanding is not useful when trying to build up an asset portfolio from spare cash, and so lowering, or removing those payments completely, will make it easier to save for your other goals.
Invest in a stocks and shares ISA
In a similar way to the cash ISA discussed here, a stocks and shares ISA, is simply a wrapper that allows you to build a portfolio of stocks and shares, bonds and other investment assets, free of tax.
Any gains will not be subject to capital gains tax, dividend and bond interest payments are tax-free, and any income you eventually drawdown from your accumulated pot, will also be tax-free. Another benefit of an ISA is that you don’t have to declare any ISA income on your self-assessment tax return (if you have one).
Starting to invest in a stocks and shares ISA, is an essential step on your road to financial freedom. There are ISAs now available for both adults and under 18’s with very generous annual allowances.
Long term goals
Pay off or reduce your mortgage
The largest long-term debt for many people is their mortgage, which could have a 25 – 30-year duration, and even more in some circumstances.
I am not suggesting paying it off in one go or paying it off before you start investing, as that would be some mountain to climb. I am though, suggesting that you consider tackling it, with a two-pronged approach. The first prong can be carried out immediately, and the second prong can be looked at once you are comfortable all your short, and medium-term goals are achieved or are on course to being achieved.
The first plan of attack is to make sure you have the absolute lowest interest rate available. It’s easy to check and compare rates online, and if you find a better deal that makes an overall saving after expenses, then move your mortgage and free up some extra cash.
The second plan of attack is to try and overpay your mortgage payment each month, by as much as you can reasonably afford. Even £50 per month can shave years off your repayments, and save thousands of Pounds of interest in the process.
The more you overpay, the more time and money you will save in the long run.
Even if you have fixed your mortgage with a provider for, two, three, five, or ten years, you should still be able to pay off up to 10% of your loan per year, penalty-free.
TIP: Overpaying your mortgage makes sense when your mortgage interest rate is higher than anything you could achieve through risk-free saving. But if your mortgage rate was only 1%, and you could earn 3%-4% safely elsewhere, then it would be more efficient to earn the higher interest on any spare cash, than to pay down the mortgage debt.
I was once in the position of being able to pay off my own mortgage entirely, after acquiring a lump sum of money. However, in a similar scenario to that noted in the “tip” above, it wasn’t cost-effective to do so at that particular time. My mortgage rate was only 1.29%, and I could generate a 5%-6% return, relatively safely through some other investments. So on this occasion, I didn’t pay off the debt, as it was financially more sensible to use the money elsewhere.
Invest in a personal pension
Yes, you are making contributions to your State pension by way of National Insurance contributions, and you are making contributions to your employer’s pension scheme each month, so why do you need another personal pension scheme or Self Invested Personal Pension (SIPP) as they are called?
Firstly, as we have already mentioned, the State pension scheme does not provide anywhere near enough income to live on, even if you have accumulated the maximum number of qualifying years. Therefore, additional income is required.
Secondly, the State pension for most people is a long way off, and it’s getting further away as time goes by. The age for drawing the State pension has increased from 65 to 66 and will continue to move to 67 and then 68. No doubt future Governments will continue to push the retirement age upwards, and who knows, it could reach 75 by the time you plan to retire.
Thirdly, the Government can and does change the pension rules on a regular basis. If the country is in a financial mess, or more of a financial mess than it is today in say, 20, 30 or 40 years’ time, then there simply may not be any State pension at all. It is sensible to assume and make plans for the possibility of not getting a State pension, and if you do, then consider it a bonus.
Fourthly, even your employer’s pension is most likely not going to provide for a very comfortable retirement. They are probably providing the scheme and associated contributions, on the bare minimum the current law permits, which is only a total contribution of 8% of qualifying earnings.
This is half the amount it should be, and when they say qualifying earnings, this doesn’t mean your whole salary, it just means the band that sits above the minimum level and below the maximum level of earnings. So be aware, you are not saving 8% on all your salary at all.
Check your payslip to see what is happening in practice.
Fifthly, you need to take control of your own financial future, by having your own pension scheme that stays with you, and is not attached, or associated with an employer, or dependant on the Government.
Sixthly, saving into a personal pension is very tax-efficient with upfront tax relief paid on most contributions. For example, if you pay in £100, tax relief of £25 is also paid in, so you have automatically made a 25% gain for doing nothing.
If you are or become a higher rate taxpayer, then you can recover a further £25 from your tax return.
As with an ISA, all gains and income within a pension grow tax-free for as long as you are accumulating your pot. Once you decide to retire, you can take 25% of your pot as tax-free cash, then the rest can be drawn as a taxable income, subject to any pension rules that apply at the time.
Continue investing in an ISA
You should also continue to invest in your stocks and shares ISA over the long term, as this is where you can generate a significant tax-free income in the future.
Personal pensions like SIPPs and ISAs are complementary to each other, it shouldn’t be a case of one or the other, it should be both.
They both have slightly different tax advantages and different benefits. One of the benefits of an ISA is that your money can be taken out at any time if there is an emergency that calls for it. With a pension, your money cannot be accessed until you reach a certain age.
You know your overall objective is, “to be financially independent by the age of 50”, you also know, your short, medium and long term goals as a means of getting there.
Now you need the financial plan of how you are going to achieve those goals.
Everybody’s financial plan is going to be different, as there are so many personal variables involved. The key thing is, to have how you are going to achieve your goals, and plan set out in writing. This way, it can’t be forgotten, or lost, or hidden out of the way. In fact, if you think you may be tempted to lose it or forget it, print it out and attach it to your wall.
As an example, (and remember your circumstances will be different), this could be a bullet point summary plan, of someone investing for their financial future. They will have already established their monthly free cash flow from their budget.
I will pay £1,000 into an instant access savings account to start my emergency cash fund.
I will then pay £250 per month into my emergency cash fund for 12 months to provide me with six months of emergency cash.
I will pay off an extra £100 per month on my credit card for the next six months, to clear my debt.
I will join my employer’s pension scheme as soon as I am offered one.
I will pay £300 per month into my stocks and shares ISA.
I will overpay my mortgage by £50 per month, saving me five years of payments and £10,000 of interest.
I will set up a SIPP pension, and pay in £200 per month to gain tax relief and benefit from the power of compound interest over the years and decades to come.
These are examples indicative of what an investor just starting out may plan for themselves.
As and when circumstances allow, more cash must be allocated to the required investments, for example, once you have topped up your emergency cash fund, and paid off your credit card debt, that doesn’t mean you should go and spend the extra free cash generated from achieving these goals, it means you can now reallocate some, if not all, of this free cash into another one of your goals.
As time progresses and you achieve more and more of your goals, you will notice you have more and more free cash to use for investing. This snowballing effect is when investing gets really interesting and exciting, as your investments will start generating as much cash by themselves, as you are putting in yourself.
By way of an example, the maximum you can put into an ISA is currently £20,000 per year, which is plenty for 99% of the population. Over time, some people have amassed ISA pots of £500,000 or more, which can mean, depending on the investments they have selected, the ISA is generating an income itself of over £20,000 per year.
If you managed to reach a £1m ISA pot, as several hundred people have already done so far, then you could expect a tax-free income of circa £40,000 per year, without having to do anything. That’s the same net income as someone earning a £55,000 salary, but without any of the work!
Your financial plan, which should include details about your cash flow, savings, debt, investments, insurance and all other elements of your financial position, is an ongoing process.
You should aim to review it once a year, to make sure everything is going to plan, and also review it following major financial changes such as a new job, promotions, receiving cash lump sums, marriage, divorce, children, redundancy etc.
This planning will help you build your nest egg, by using your financial literacy to build a portfolio of assets, to ensure you meet your future goals.
If you don’t think you can do the planning part yourself, and I certainly hope you can after reading this website, then there are plenty of on-line services that can help you do it, or alternatively, you could use a financial planning professional to guide you, although they will charge you a fee for this service of course.