Personal Finance: 3
Creating Your Financial Plan
Financial goals are the basis of personal financial planning. I can almost hear your thoughts. "I have goals: family security, educate the kids, a comfortable retirement, and being faithful along the way." Great, but my first question back to you is how much does each goal cost?
Next I could ask how you are planning to meet each goal? Do you have other goals that will require diversion of assets? Do you have a budget to manage your monthly income and generate savings for investment? Congratulations if you are comfortable with each answer. Few people obtain their potential without specific goals, a working budget, and a financial plan. As General Saint used to say, "Hope is not a method" (Butch Saint CINCUSAEUR circa 1990).
A great many people are working hard to save and invest, but do not have a plan, or at least not one sufficiently specific to assess progress. I’ve counseled a number of people who were on track to meet their goals, but didn’t actually know it and had anxiety about it. Some people are spending more than they can afford without compromising their goals, but they don’t know it. Both groups are uneasy because there is something in us which says, "I need to be responsible, to save, and to invest." That means having, and following, a plan.
A plan starts with specific goals and clear priorities, then allows you to set savings and rate-of-return requirements. How do you do this? There are a number of options, but only three good ones: learn enough to do it yourself, get help, or use an appropriate combination of both.
What about professional financial planners? I don’t have any statistics, but anecdotal data suggest a few problems. Hundreds of people have told me they don’t have much confidence in plans prepared by "advisors" who are also sales people, paid commissions by certain investment companies for enlisting investors.
However, few people go to independent (fee-only) planners. So most plans are prepared by people who have a bias either because they have an interest in selling a product or they are more informed about the particular products their firms sell. They may be honest and objective, but their solution may not fit your needs, or profit you as much as it profits their firms.
This article is interested only in teaching you "how to fish," so you will be skilled enough to access, accept, modify or reject outside advice. You are the steward appointed by our Lord and you are responsible for planning for your family. It is my prayer that you add whatever this article can teach you to your investment data base, that you seek Christian counsel and that you pray. I’m sure your plan will be pleasing to the Lord.
Your plan should bring your specific goals into balance with risk/return/time. Sounds reasonable enough, but only your goals and time can be easily quantified. There is no actual risk/return ratio, so you will have to make a number of judgments. The last article focused on your priorities and philosophy. In this and the following articles we will show you how to build on that foundation. "Commit to the Lord whatever you do, and your plans will succeed" (Proverbs 16:3).
Goals are the "pacing items" of financial plans.
Many financial institutions have work sheets to help lay out goals. USAA uses a simple chart that helps you see the requirements in specific quantities of dollars at specific times. (The USAA Foundation. Starting Out: Positioning Yourself Financially pg. 5) (USAA Educational Foundation has many such excellent pamphlets: 800 531 8722.)
You can enter simple dollar amounts or for more accuracy, do Time Value of Money (TVM) calculations as discussed in article two.
Another format (below) could show amounts increasing (highlighted) for each goal as earlier goals are met or as pay raises (2004, 06, 08, 10) are added. (This system is also often used by debt reduction planners. It would then include a column for interest rates to help decide which debts to pay off fastest.) Any way you do it, goals need to be viewed over the continuum of your planning horizons.
Goals can be short, intermediate, or long term. They should be based on your financial philosophy or concept (see example family plan below) and need to be measured in specific dollar amounts. ". . . will he not first sit down and estimate the cost to see if he has enough money to complete it" (Luke 14:28). For example, you believe in education, so sending the children to good colleges is a high priority, but you have set limits on total college costs so that these expenses do not threaten other priorities such as tithing, support of missions, and a set retirement point. It is very important to do this thinking, and realize that you can modify it as your world view evolves, and as opportunities present themselves.
I want to introduce you now to an example family and share their investment plan. The Stewards are both twenty-eight years old with children six and four years of age. She is a stay-at-home mom while he is a captain (03) with six years of service (YOS). His base pay (Jan 01) is $43,876.80 plus BAS and BAH. They have $350,000 in life insurance and $56,000 in savings. (The Lincoln Rule of what the average family should have in savings: decade of age X age X 1000, or 2 X 28 X 1000.) In my seminars, I have to pause while people figure out how they compare.
There are many ways to visualize or chart your needs over time. Requirements grow with the birth of children, peak during their college years and reach an option point based on retirement decisions. Other major financial decisions float in the future along with common major expenses that could be charted to include homes, weddings, vehicles, vacations, or second homes. These "other" major decisions could be included, or they could be left in a pot that ultimately depends on the growth of the regular budget and savings plans.
The Stewards have prayed and decided on their major priorities and where to accept risk. "Many are the plans in a man’s heart, but it is the Lord’s purpose that prevails" (Proverbs 19:21). A number of firms, including Army and Air Force Mutual Aid Association have systems to determine family security needs. Using such a system, CAPT Steward has determined that he needs $500,000 for family security. Going to the College Board of NY website, he determines the four-year cost of the average public university to be $76,574 and $82,920 for his children (Present Value, the amount he needs today to grow @ 8%, is $68,677). There are many ways to do this–I chose 2015 as a point at which all money is available, used 4% inflation in school cost from 00-01, and 6% rate of return.
He does not plan to buy a house during his service, (but he’ll have savings to allow it if necessary). He will save for automobiles with dedicated mutual money markets, and wants to have great flexibility at a 30-year retirement point. For planning purposes, he assumes that an 0-6 salary over 26 YOS would give him that flexibility so he establishes an objective of having investments to replace the difference between his final active and initial retirement pay.
NOTE: This is a very reasonable approach, but fewer than 5 out of every 100 of my contemporaries have been able to retire without seeking some type of regular employment.
Captain Steward wants to be able to go into ministry or community work with his wife and not need much, if any, salary. To do this, he figures the difference between active and retired pay to be $82,980 in 2025 or $12,243 in PV (Present Value @ 8% and 24 years). Therefore–now stay with me, the principle needed to generate $12,243 a year is $153,045 @ 8% return.
To summarize, he needs $500K for security on an ongoing basis, $68,677 PV for college, and $153,045 PV for retirement savings. We won’t compute the cost of other major expenses, but he realizes the value of buying good cars for 8-12 years, staying in quarters when possible, and maintaining these financial priorities despite the consumerism of our society. He also plans to add all longevity and half of each promotion pay raise to his saving and investment program. Yes, this is a challenging concept. Lets see what it looks like.
Family Security is provided by income, investments and insurance (including survivor programs). If he lives to retirement eligibility he’ll have SBP (Survivor Benefits Plan) plus their investments. If they need more security, they will select ten-, fifteen-, or twenty-year-level term life insurance to cheaply cover any risk they do not want to assume. While on duty he carries the max $250K SGLI and has opted for an additional term policy. They could cover the $94K of risk with more term life insurance, but opt to accept that risk and focus on filling it with investments. (This is for illustration: I would actually counsel this young family to carry $100-200K additional term life insurance.)
Many people insure non wage-earning spouses and that may make sense. A basic rule of insurance is to only insure against risk you cannot accept. Her early death would not cause loss of income, but would generate child care costs. A couple of years ago he selected a $100K fifteen-year-level term policy which covers her until the youngest child is seventeen years old. He doesn’t think he needs more than about twelve years’ coverage, but he can cancel if that holds true. (This is cheap flexibility). If they had planned on her returning to work to help fund college, he might have taken 200K for twenty years. Again, the basic rule, "Only insure against risk you cannot afford."
Insurance and investments can both provide for the family’s future financial security, but it is important to note that investments are the more desirable and more flexible option. If our example father lives, then insurance is not an option (not available) to meet college costs or help in retirement. The good news is that as he lives and earns, he continues to invest and those investments grow to meet the family’s future financial needs. He sees term insurance as an excellent vehicle to cover short-term risk without the expense of whole life (cash value insurance). He accepts that there is no "investment component" as the cash value insurance sales force always reminds us. He plans on actual investments (vice whole life insurance) to give him future return. As a contingency, he could cover future periods of vulnerability (such as under-funded college accounts) when the family would need his full income, with five- to ten-year term policies.
College costs are based on the College Board of NY AY2000-01 national average costs ($11,115 public and $24,801 private) inflated into the future at 4%. Always use the most reasonable cost estimate you can find, such as home state or "family school." You don’t have to be exact, nor do you have to reach your goal. Ask anyone who has partially financed college from family income–the more you have set aside the easier those years will be. Captain Steward used 2015 as the target year and thus needs to invest $604 per month assuming a six-percent return and no tax to reach that goal.
His desire for college tuition is to try to save the entire amount. Since saving $604 a month is too limiting, he’s allocated $10K of the existing family savings towards his goal and upped his desired rate of return to 8%. This reduces to $322 the amount he needs to save per month. He could accept coming up short of the total amount desired, since he knows that during the last two years of the second child’s college he could pay most costs from the family budget.
In general, financial planners warn middle class Americans to not reduce retirement savings during the middle-age years to pay for tuition; if necessary, let kids work or borrow money. Kids learn about overall family responsibilities and more willingly accept responsibility when they carry part of the load! Still, much of the middle class digs into family assets for college and pays a price in retirement options.
Retirement is the most difficult to plan for because most of us have trouble envisioning our situation that far into the future and none of us know what we might be called to do then or between now and then. My experience working with close to a thousand lieutenant colonels at about 20 years of service (at AWC where promotion and 3 or more years of service are almost certain) is that few have any concept of what they will need or how they will provide for those needs. Not surprisingly, several years later many colonels, at their retirement points, are still uncertain. Most need to work fulltime after retirement to support current lifestyles or to make up for past ones. These officers, once trained in personal finance, almost uniformly respond, "Great stuff, why didn’t I get this when I was a captain?"
In my view, everyone, and especially Christians, should plan for flexibility. There are retired officers who have a heart for ministry, but aren’t making themselves available to heed the call because of financial obligations. I know many real servants who would be wonderful in ministry, but cannot make enough to satisfy their material needs and, like the rich man in Luke (18:22,23) they cannot bear to, ". . . Sell everything you have and give to the poor . . ."; instead they ". . . become very sad . . ." I can’t tell you how many people at 30 years take another "PCS" they may not want because of need for a job. "Diligent hands will rule, but laziness ends in slave labor" (Prov. 12:24). I never counsel making money for its own sake, but rather to give you life, employment, and service options. Having flexibility is a very responsible thing and a way to be available to heed His call!
The Steward budget looks like this:
Note: They work hard to live on this budget because they appreciate the long-term value of having options and flexibility. He has some frustrations, realizing that short -term savings won’t let them pay for a new car in 5 years, but he plans to put pay raises from the over 8 & 10 years of service points and half of promotion to major into short-term savings. Still he knows he has the flexibility to borrow from long-term savings, or if rates stay at current low levels, finance the car. Captain Steward doesn’t completely rule out debt, but takes all the biblical admonitions seriously, and will ensure it never "enslaves" his family. Month-by-month, they occasionally go over their spending limits in several categories, but save in others. They can accept that, knowing that a budget must fit their lifestyle to be workable and help reach long-term priorities. Short-term saving (mutual money market) is listed last as they use this as their flexibility—still, since it is their car savings account, they try to fund it and repay it if they have to borrow.
Budget categories are listed in order of priority. The first optional allocation is $333 per month to fund their Roth IRA’s at the current $2000 maximum each. At age 59 they can draw on these tax-free funds to support retirement options. That is a big hunk of their savings, but virtually all financial advisors say the IRA is where the first dollars of saving should go. Because they are hard to touch, grow without tax and grow for long periods of time, they often become our greatest financial asset other than military retirement.
After providing for essentials, they allocate $200 per month to long-term savings. This fund provides great flexibility. If they never dip into it and never add more, it could grow to $241K. They expect to have to dip into it and could use it for home down payments, or higher-than-expected college costs, or an auto purchase. They also expect to add more to long-term savings as they move into the higher field grade ranks. So there is no specific goal for long-term savings but they do want it to do well. Last but not least, they can gift (Larry Burkett’s chart) from this fund for special ministries they become convicted about.
Finally, Short Term savings is the only investment not funded by allotment or direct deposit from their bank account. As indicated in the budget note, it is envisioned as a true savings account with a new car as the goal, but it also provides the flexibility to cover unexpected real life demands. While they don’t have a projected goal, it could well be worth $16,000 in 5 years giving them some options for an auto, gifting, or other purposes.
This chart summarizes their plans and helps them visualize how they reach their goals.
If they earn their fairly conservative rates of return listed, their family financial plan will give them the options they desire. They reach college goals, and even if it costs more, they have long-term savings to help out. They fall just short of retirement goals, but will be close enough to make decisions free of financial pressure.
They recognize that things change and at their age, they do not have a high degree of certainty about the future. For these reasons, they have two savings accounts to provide critical flexibility. They expect to identify other goals and therefore adjust existing goals. They recognize that jobs and promotions are not certain, therefore they try hard to do the best they can now. As mentioned earlier, he wants to put longevity and half of promotion pay raises into short-term savings. That leaves them both annual raises and half of his promotion pay increases to keep up with cost of living or divert to new priorities.
Is this a good plan? They have a detailed and livable budget. They have prayed about their philosophy and values and then established specific goals. They have allocated funds to each priority based on reasonable projected rates of return. Still, despite all those smart things, they need flexibility. I think their two savings plans and their pay raises plan provide excellent opportunities to adjust when necessary and change and stay on task. Their plan has them on track to achieve financial independence. More important, they are being faithful and their priorities are reflected in their lifestyle. "The plans of the diligent lead to profit as surely as haste leads to poverty" (Prov. 21:5).
I hope you are asking the obvious question: "Why these rates of return and what investments do they have?" The following two articles will look at appropriate investments for the phases of life and at the actual investing process. They’re important articles, but not as critical as having an initial plan and a workable budget. Without these, investors acting randomly and reacting to external economic forces rarely reach the level of resources that a prayerfully considered plan will likely provide.
Butch Saint: General Crosbie E. Saint, CINCUSAEUR circa 1990
The USAA Foundation, "Starting Out: Positioning Yourself Financially" Copyright USAA 1992 800 531 8722