Last week we looked at the basic steps in financial planning, this week we will discuss the first step in preparing a financial plan which is the identification of your financial goal, I list below some very common goals;
- Retirement; how to plan to have enough passive income to fund your lifestyle after active employment.
- Children’s Education; how to plan to fund your wards education expenses
- Mortgage; how to plan towards owning or affording a rental decent accommodation
- Estate planning, how to protect and transfer your wealth
- Debt management;how to pay down debt and manage your liabilities
To accomplish any financial plan, you start with a financial goal. The financial plan should detail how and when you want to meet your clearly defined financial goal….so how we do this?
So let’s take the James Family, Tayo James aged 30 & Chinelo James aged 25, they are just married, Tayo works as an Architect earning N450,000 a month and Chinelo works with the state as a teacher earning N50,000 a month. They desire to save to buy a House in Ikorodu by 2019, the house costs N8m today they are currently renting, how should they draw up a financial plan?
- First thing what is their plan? The James Family will have to agree their financial goal or target, clearly, writing it out.
- Next they agree their level of risk they intend to take to achieve this financial plan.
- Next they consider how long they project to accomplish this financial goal.
- Then they consider key external factors outside their control eg inflation.
Ok so lets go to details
- The James have both agreed their financial goal is to own a home in Ikorodu, Lagos that costs N8m.
- Next since they want the house by 2019, their time horizon for investment is 4 years. In Nigeria, four years is long term. So this goal can be termed a long term goal in this context.
- Next the James say they don’t want to take a lot of risk with their saving…they want to open a savings account to save for 4 years to buy the home.
- The key external factors are mainly inflation and the bank interest rates, those are the factors that will affect this goal
So in summary, we have a goal of acquiring a home, costing N8m today, in 4 years, taking very little risk.
The next step is to draw up a net worth statement, by listing the assets and liabilities of the James and then subtracting the total assets figure from the liabilities figure…
So the James, took a paper or on a Microsoft Excel sheet, on one side they wrote all the things that saves them cash or gives them cash aka Assets. On the other side they wrote all the thing that takes cash from them aka liabilities, as structured below
- Assets
A1. Things you own that give you no income eg furniture
A2. Things you own that give you income eg shop
- Liabilities
B1. Things that take your income eg rent
B2. Things that take your income and charge you a fee eg credit card
Now at the bottom of the page, they subtracted their assets from their liabilities….and guess what? .they as a family had more assets than liabilities, N1,500,000 more in assets. Out of which N600,000 was cash in the bank.
So the net worth for the James family is N1,500,000, with N600,000 out of that N1,500,000 as income bearing assets. So clearly you can see there is a goal gap of N7,400,000.00 to achieve their financial goal (N8m cost of house less N600k cash in bank)….so how do we raise, N7.4m, with rising inflation, in 4 years from today to buy a house for the James Family?
Ok we stop here, next week we link this financial goal to the James budget which is the next step in a financial plan.
Financial Jargon of the Week what is an Assets and a Liability?
An asset as defined is a resource with economic value owned or controlled with the expectation that it will provide future benefit. A liability is a legal debt or obligation.
I define assets as objects or services that give you income eg a shop or a car you use to do business, I define a liability as objects or services that take income away from you eg rent. So if you own a car, is it an asset? The answer depends on how the car affects your wallet. If the car saves you time and transport cost, allowing you to earn more money, then the car is an asset, but if the car is constantly breaking down, or requires a lot of work to keep it running then it’s a liability…so is your phone an asset or a liability?
Home work
Draw up your net worth…on one side, list your assets starting with non-income earning assets then below income earning assets. On the other side, your liabilities starting with non-interest bearing liabilities and then below interest bearing liabilities…
At the bottom subtract your assets from your liabilities, that’s your networth. Do this keep it handy for next week
