Personal Financial Planning

Everyone needs to plan their personal finances. This should include short term planning as well as long term planning. Short term planning can be easily accomplished using an Annual Financial Plan that enables planning and tracking of income, expense and savings over one calendar year. It also includes doing a net worth which is a summary of your assets and liabilities at the start of the year and at the end of the year. Long term planning can be accomplished using a multi-year or Lifelong Financial Plan that enables planning and tracking of income, expense, savings, investments, assets and liabilities over many years or for life. MyFinancePlans personal financial planning spreadsheet templates are the best tools available for planning and tracking your finances. No other approach allows for ease of use, realism, accuracy and complete flexibility for your individual financial situation.

Sources of Income

An important aspect of personal fianncial planning is identifying and understanding your sources of income into the future and into retirement.  In your earlier years this likely includes employment income and/or business income.  In the years between retiring from work and collecting government pension this may include company pension and planned registered retirement plan withdrawals.  In your senior years this may also include government pension and seniors assistance.  For some there may also be inheritance.

It is important to determine when your income is expected to be the lowest and to plan to withdraw personal retirement plan amounts at that time to fill the income gap and to minimize tax.  If you plan to retire before you collect government pension then the period between may be the best time to withdraw part of your personal retirement plan as income, then reduce it when government pension kicks in.  That raises the question, when should I retire and when should I start collecting pension.  A personal financial plan based on MyFinancePlans can allow you to do "what if" scenarios and determine how much to save, what type of investments to hold and when to withdraw it.

Managing your Expenses

Managing your expenses means understanding what you spend your money on, making decisions about what to spend your money on and maintaining a balance called "Living within your means".  An budget plan or an annual financial plan will allow you to do plan, track and manage your expenses for the current year.  Once you have that you can then use that to project your expenses over future years and of course make adjustments based on what you know or presume about your future.  That goes into your lifelong financial plan.  But how would I expect my expenses to change as a result of life events such as getting married, having children, changing careers or retiring.  That depends on the event of course and only you can make those judgements.  For example, you may plan that when you retire your lifestyle and spending habits will continue as they always have.  That is a good assumption and starting point.  Then factor in other things such as that maybe the children have left home and the expense associated with them will reduce.  Or perhaps you expect quite the opposite, you presume a possible need to support adult children at home or elsewhere.  The point is managing your expenses is not just for now, it is for life, and you need a financial plan to do that.

Saving for the Future

Another important aspect of personal fianncial planning is saving for the future.  The types of savings may include real estate, personal assets and different types of saving/investing accounts.  Saving/investing accounts include bank chequing/saving accounts, guaranteed investment certificates or term deposits, and registered plans and investment accounts (stock/bond trading accounts).  Registered plans for Canadians include Registered Retirement Savings Plan (RRSP), Tax Free Savings Account (TFSA), and Registered Education Savings Plan (RESP).  Registered plans for Americans include Individual Retirement Account (IRA) and 401k account.

Types of Investments

There are so many different types of investments and investment products available today.  The main investment types to be familiar with are interest accounts, bonds, mutual funds, exchange traded funds (ETFs), and stocks.

Interest Accounts include savings accounts and guaranteed investment certificates (GICs) obtained generally at regular banks but also at online banks which pay higher interest.  You put your money in the account and you are paid interest on it.

Bonds are issued by companies and governments and are available from bond dealers such as banks and brokers.  When you buy a bond you are lending your money to the company or government for a fixed period of time and for a fixed return.

Stocks are offered by companies and are traded on the stock markets.  They are available from brokerages (e.g., online discount brokerage).  When you buy stocks you are buying an actual part of the company and as such you own a part of the company and all the associated risks and rewards.

Mutual Funds consist of a selection of stocks managed by a fund manager.  When you purchase a mutual fund you are indirectly purchasing a portion of the funds portfolio of stocks.  Mutual funds are available from banks and mutual fund companies or brokers.

Exchange Traded Funds (ETFs) are similar to mutual funds except they are traded on the stock exchange and typically have lower management fees because they contain a set index of stocks and therefore are not actively managed.

Low Fee Mutual Funds, a relatively new offering, are index mutual funds which offer low fees and returns comparable to ETFs, but with the convenience of a mutual fund.  An example of a low fee mutual fund is the TD e-series mutual funds.

Investment Return and Risk

Generally investments with greater potential returns will have greater potential risk associated with them.  The risk however is reduced for investments are held for a long time.  That is why short term investments should be held in low risk accounts while investments intended to be held for a long time can/should be considered for higher risk and return holdings  The following shows how different types of investments compare from a risk and return perspective over a period of at least 5 years.  What is right for you depends on your timeframe and your ability to stomach risk.

Investment Type Typical Return Return Range Typical Risk
Interest 2% 1% to 3% Zero
Bonds 3% 2% to 4% Low
Bond Mutual Funds 4% 0% to 6% Low
Balanced Mutual Funds 6% 0% to 10% Medium
Equity Mutual Funds 7% -4% to 12% Med/High
Exchange Traded Funds 8% -5% to 15% Med/High
Dividend Stocks 8% -8% to 20% Med/High
Growth Stocks 9% -15% to 25% High

Investment Diversification

Risk can be reduced through diversification thus allowing you to invest in higher return investments - well to a degree.  You can diversify by investing in different types of investments, across different geographies (countries) and over different points in time.

Risk can be reduced by spreading the investment over different types of investments that respond differently to different events.  For example, when interest rates rise, bond values tend to go down.  When there is a bull market (people with greed charging forward with investing) equity mutual funds rise while bond mutual funds go down.  When there is a bear market (people with fear retreating with investing) speculative stocks will fall further than dividend utility stocks.  You may choose, for example, to target having 25% in the safety of interest, 25% in bond mutual funds, 40% in dividend stocks and 10% in growth stocks.

Risk can be reduced by investing across different geographies.  That is because the markets around the world do not move up or down together. As an example a Canadian may invest 50% in Canada, 35% in US and 15% in International.  An American may invest 70% in US and 30% in International.

Risk can also be reduced by spreading your investment and withdrawals over different points in time, perhaps 2 or 3 times per year if you are doing it manually.  Or set up an automatic monthly purchase or withdrawal plan.

Whatever types of investments you choose, diversify as much as you can while keeping your portfolio of investments as simple and manageable as possible.

Taxes on Investment Returns

Different types of investments provide different types of returns which are taxed differently.  Interest earned is considered income and is taxed as regular income.  Each additional dollar of interest earned is taxed at your marginal tax rate.  Bond interest is also considered income and is taxed as regular income at your marginal tax rate.  Stocks can provide two types of return, capital gains realized when you sell the stock for more that you paid for it, and dividends paid to you on regular intervals (monthly, quarterly or anually) for owning (holding) the stocks.  Capital gains (depending on the country you live in) may be taxed at 50% of regular income.  Dividends are little more complicated but are often a very good deal depending on the country you live in and the country of the stock.  Dividends may be taxed at an effective rate below zero percent (for low income persons) to higher that of capital gains but less than that of regular income (for high income persons).  ETFs or mutual funds can provide capital gains and dividends.

However any investment held within a registered plan will be taxed according the rules of the plan, which means they can be taxed in a completely different way than if they were not in a registered plan.  For example for Canadians, all returns from RRSPs are taxed as income and taxed at the regular rate at the time of withdrawal, all returns from TFSAs are not taxed at all (ever), and returns from RESPs are taxed at the regular rate at the time of withdrawal.

Handling Taxes in Financial Planning

There are several ways to include the impact of taxes in your financial plan.

The first approach, which is used by the Basic edition of MyFinancePlans, is to use only after tax amounts in both the annual plan and lifelong plan.

The second approach, which is used in the Lite edition of MyFinancePlans, is to use before tax income as well as actual taxes in the annual plan, and use only after tax amounts in the lifelong plan.  This gives you greater acuracy on your annual plan for the current year.

The third approach, which is used in the Full edition of MyFinancePlans, is to use before tax income as well as actual taxes and deductions in the annual plan, and use before tax income and average taxes and deductions in the lifelong plan.  This allows you to better estimate and adjust the impact of taxes over the years.

The fourth approach is to include actual tax calculations for different types of income (employment, business, interest, dividends, capital gains, etc.) in the annual and lifelong plan.  I use this approach for myself in my own personal plans, and you could too if grow your expertise in your financial plan spreadsheets and your personal tax situation.

We recommend the following sites for increasing your understanding of taxes and they impact your personal financial planning.

For Canadians:

For Americans:

Using Spreadsheets

Spreadsheets are easy to use yet powerful and flexible.  That is why MyFinancePlans uses a spreadsheet template approach.  You only need to know the basics of using spreadsheets to use MyFinancePlans templates.

We recommend the following tutorial from Microsoft which covers the basics in a few minutes, but also goes further if you wish.

Microsoft Excel Training Poster

Microsoft Excel Training Website

Recommended Websites

These websites are recommended for information about personal financial planning and investing.

Google Finance    Yahoo Finance