For more than ten years following the financial crash, markets could do little wrong – and, when they did, they recovered quickly. There are a range of reasons for these quick recoveries, such as the artificially low interest rates in many economies and generally positive market sentiment.
There are, however, question marks around how long it will take markets to recover from the downturn of the past few years, caused by a myriad of world issues. Whilst market movements and recent news cycles can be troubling, a well-managed financial plan that focuses on an effective structure, coupled with good risk management, can help you manage your financial concerns.
One of the main benefits of a financial plan is the comfort of feeling your financial arrangements are set up to better weather any storm. But to feel in control of your finances rather feeling controlled by them you need to make sure a good plan is in place as early as possible to mitigate the short-term risks from market volatility.
So, how does this work and what should you expect from a good financial plan?
What does a good financial plan involve?
1. It helps you manage risk
With market movements being one thing we are unable to control or predict, it is important to understand risk and how this can affect our plans for the future. This makes perfect sense in theory – but how do we achieve this in practice?
In financial planning, risk is typically broken down into three main areas:
- Attitude to risk
Otherwise known as ‘risk appetite’, this describes the level of risk you are willing to take as an investor. It’s an emotional response to risk situations and we assess this through a combination of quantitative questions and qualitative discussions.
- Capacity for loss
A number-based assessment of your ability to sustain short-term investment losses whilst meeting your longer-term objectives.
- Time horizon
This relates to the length of time you expect to remain invested before accessing your wealth. Essentially, the longer your time horizon, the greater your ability to weather short-term volatility of returns.
If at the outset of arranging your finances, a clear assessment of these three areas is carried out, a financial plan and its component parts should be managed with these front and centre. Once you have a clear understanding of the amount of risk that can be taken, short-term volatility should not be hugely damaging to the long-term strategy.
However, if this assessment has not been done, the emotional and financial damage from unexpected losses could be potentially catastrophic.
2. It helps you make use of tax allowances
Alongside deciding the right mix of assets for your investments, a good financial plan will make the most of the various accounts available (also called “tax wrappers”) including:
- Pensions (including Self-Invested Personal Pensions)
- Individual Saving Accounts (ISAs)
- General Investment Accounts (GIAs)
- Offshore bonds (depending on your circumstances)
Pensions, ISAs, and offshore bonds all have various tax advantages. They also have different access constraints. Pensions, for example are a very long-term investment so can afford to hold a riskier basket of assets until you are close to retirement age. ISAs can be used for short-term or long-term savings and your reasons for saving will determine the time horizon and thus the appropriate risk profile for these accounts.
General Investment Accounts have limited tax allowances, and these are set to reduce in the coming years following the Autumn Statement. But they still play an important role if you want your savings to outstrip inflation.
3. It will be focused on risk-adjusted outcomes
Various studies have investigated the impact of sharp market declines at various stages in a client’s life, and the impact this can have on achieving their objectives.
It is a fact that a 20%, 30% or 50% drop in the value of investments requires subsequent returns of 25%, 43% and 100% respectively to get back to the same position. Therefore, very simplistically, the closer you are to needing to call on an asset, the lower the level of risk you can afford to take.
Gains required to make up for loss
This is why a good financial plan takes into consideration your appetite for risk and your investment time horizon. Even if you think you have a high tolerance for short-term losses, if you have a short time horizon it might be difficult to recover a 30% loss before you need to access your wealth. You should also bear in mind if you have a low risk tolerance and a long time horizon, your total returns are likely to be lower than those of someone with a higher risk appetite. Your losses in the bad years are not likely to be as deep but returns in the good years are also likely to be lower.
Everyone has unique circumstances. What matters is ensuring your wealth is organised to maximise the level of long-term potential return for the amount of risk you are happy to take. Focusing on others’ financial outcomes can lead to anxiety and whilst your friends might boast about the good times, their silence during the bad times should speak volumes.
Employing an Investment Manager to invest your wealth in line with your risk tolerance can increase your peace of mind. Especially if they have the freedom to adjust the investment mix to reduce potential risks and therefore losses. Short-term volatility, whilst noteworthy, should not be a source of stress and distress.
4. It helps you explore cash-flow modelling
That sounds fancy but it means we try to understand how you imagine your future mapping out. What are your dreams and aspirations, and when would you like to achieve them? For example, when do you plan to retire and what would you like your retirement to look like? Are you planning to buy a second home, maybe pay for school/university fees, a child’s wedding, a second honeymoon, a round-the-world cruise? Each of these events will have an associated cost.
Cash flow modelling is a way of visualising all these questions in a way that makes it easier to grasp your goals and how they might be attained. You can then explore what/if scenarios such as what if I retire earlier? Or later? Or decide to work part time? What happens if I cannot work for a long period of time?
Having established how much you'll need and when, the next question is: how do you aim to achieve this? Do you have any current savings and investments? How are these structured? How many workplace pensions have you been a member of? Do you have any personal pensions? How are they invested? Are the investment profiles appropriate for your objectives, time of life, and attitude to risk?
A good Financial Planner can help you find the answers to these questions and be more wealth confident. Request a call back and our experts can help you plan your finances and help you gain financial peace of mind.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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