Plan for Tomorrow, Act Today

Looking into the future just might impact your view of today. Thinking about and planning for the future can have a strong impact on our spending, saving and investing behaviour.

Imagine getting paid your entire lifetime's salary on day one. Let's say you are 20 years old and you have arrived on day one of your first job. It's not a bad job and it pays pretty well, say $50,000 a year.

The boss is a nice guy and he really believes in you. He wants you to work for his company for the next 40 years, and has decided to pay you your entire 40 years salary on day one as a show of good faith.

So he hands you a cheque for two million dollars.? you think about it for three seconds and you decide to accept. The deal is done. This is all you're ever going to earn, not a penny more and not a penny less.

So what do you do now? Go out and party?

Once you get over that first partying impulse, the reality of the situation would begin to dawn on you. You would probably start thinking about how to make sure that the two million dollars actually does last you for the rest of your life, even if you live to be 80 or 90. And how you're going to pay for all of life's essentials along the way, including somewhere to live, and maybe raising a family, and still have some left over for your old age.

And then, if you are an intelligent person, you will realise that if you invest a proportion of the money sensibly, it could be earning you more money, helping you to afford more of the things you want out of life, with enough left over to support yourself when you retire.

It all makes sense so far doesn't it? But here's the thing. You will probably earn two million dollars or more over your lifetime. The difference is that it will be paid to you in dribs and drabs every month instead of as a lump sum.

The big question remains the same though, whether you are working for a wage or in your own business: how do you make sure that the money you earn in your lifetime will stretch to cover all the things you need and want over the years, and still finance your life when you stop working?

The big question: spend or save?

Every day of your life is full of trade-offs between spending and saving.

We must spend money, not just to live, but also to have a decent quality of life, and what we spend is gone forever. By contrast, what we save can be invested well or badly, depending on how we invest it. So how do we know what to spend and what to save and invest? And what to invest it in?

The only way to work that out is to know what you want out of life financially. In other words, to have a financial goal and a plan to get you there.

A famous Yale University survey asked graduates if they had ever written down a financial plan. Only 3% had. Twenty years later, they quizzed the same graduates about their financial worth. The 3% who had taken the trouble to write down a plan were richer than the other 97% put together.

There are three reasons why having a financial plan can give you a much better chance of getting what you want out of life.

First, the plan is personal. It's all about you. The things that are important to you. What you want to do with your life.

Second, the plan gives you a goal or goals, something to save and invest for. A reason not to spend the money, but to make it work for you instead.

Third, a plan doesn't just define a goal that is important to you, it sets out a practical path to achieve it.

A financial plan and a diet plan have quite a lot in common. If you just starve yourself and cut out all the foods you like, you soon feel bored and unhappy at missing out on so many everyday pleasures, and fall off the diet wagon. Within a short while you weigh more than you did when you started.

A sensible diet plan, on the other hand, helps you save kilojoules without starving, gives you weight loss goals that can be measured, and sets an ultimate objective - a long term ideal weight. No wonder it is more successful!

Know thyself

Once you've written down your goals, a lot depends on you.

Circumstances such as your age, your income and how much money you owe or have saved are all important. (If you were 20 and had $2,000,000 you might be happier to take on the potentially higher returns and greater risks of the share market. If you were 58 and set to retire in two years, your attitude might be much more conservative).

But it isn't just a matter of how old you are and how much you have. It's also a matter of what is in your head. Attitudes to risk often depend on the kind of people we are. A risk averse person could be 20 years old and cautious.

The important thing to note is that you don't have to take risks to make money. Not with time and compound interest on your side.

For example, just imagine you were 20 years old and had invested $2,000 a year for 10 years in a bank guaranteed fixed deposit earning 8% per year.

When you were 30, you decided to start a family, so stopped saving, but you left the money in the fixed deposit with the interest re-invested. By the time you were 65, your total investment of $20,000 would have compounded to $428,378 (before tax).

On the other hand, accepting more risk can offer the potential of much higher returns. Investing in property is far less certain than fixed interest. Home and unit prices go up and down, tenants bring income, but also expenses. In spite of this, if you had saved $2,000 and used it as a down payment on a residential investment property in Sydney in 1970 for $14,006 (median price), it would have been be worth $520,300 in 2006 (median price), and the tenants would have paid off the mortgage.

Obviously, property has historically appreciated faster than fixed deposit investments, but that doesn't necessarily make it a better investment for you. That depends on your time frame, your available assets, your cash flow, knowledge and tolerance to risk.

In other words, it all depends on what financial plan you are committed to.

Not an easy do-it-yourself option

"Planning is the process of preparing a set of decisions for action in the future, directed at achieving goals by preferable means."
Y. Dror

There are two things that make do-it-yourself financial planning difficult. One is that it is almost impossible to look at ourselves objectively. The other is the sheer complexity of the investment market.

A good financial planner will spend a lot of time understanding you and your long term needs. (Most of us are so tied up with the decision making that carries us from month to month or year to year, we find it hard to make decisions that will affect us 10, 20 or 30 years into the future).

And once you've agreed on your financial goals, your time frame and the resources you are prepared to commit, a good planner will make the decision easier for you by only presenting those investment options that are relevant to your plan.

As a result, you are always in control, and always making informed investment decisions, no matter how time-poor you are.

Finally, a good financial planner will review your plan with you at least once a year. There is no such thing as a 'set it and forget it? financial plan. Your goals, needs, state of health and family commitments could change from year to year, and if they do, your financial plan must respond.

"We teach children to save their money. As an attempt to counteract thoughtless and selfish expenditure, that has value. But it is not positive; it does not lead the child into the safe and useful avenues of self-expression or self-expenditure. To teach a child to invest and use is better than to teach him to save."
Henry Ford

One of the questions a financial planner might ask you is what you would do if you were paid your whole life's salary on day one instead of receiving in drabs and drabs over 40 to 50 years.

The answer could change the rest of your life.