What Would You Do If You Could See the Future?
If any of us could reliably and definitively predict the future, they would have little need for the services of a financial planner; probably having won the lottery many times over and be as financially secure as anyone could be.
Of course, it’s impossible to accurately and precisely predict the future, but it is possible to have a pretty good idea what might be in store with a little bit of thought and the right tools.
What we’re talking about here is our financial future. How our financial picture develops over our lifetime has a massive bearing on how we live our lives. When we can retire; where we end up living; how we spend our days or where we enjoy our holidays every year. Just about every aspect of life is determined to some extent by money.
Mapping out how our finances could look in the future could allow us to take decisions now that really benefit our lives today and in the future. But is there such a thing as a financial crystal ball? There might just be.
There is one really big problem when it comes to thinking about the future. The human brain is seriously bad at making the connection between our present day self and our future self. Psychological studies have identified the parts of the human brain that have high levels of activity when people think about themselves and show that this region quietens down when people are told to think about themselves in later life. In fact, the response when we think about our self in the future is similar to when we think about the life of a stranger.
Follow-up studies have identified ways to help us connect to our future selves and suggested that thinking about milestones in life and key events is a good way to improve this cognitive process.
The power of financial forecasting
So what if we could take your situation today and project forward to sometime in the future – give you a time machine and let you see how things might turn out? That might just focus your attention more on the long-term rather than the short-term. It might also allow you to see how the actions you take today could shape your future.
‘Financial forecasting’ (or ‘lifetime cashflow forecasting’ as some call it) is a method used by financial planners to try to show you your financial future. In essence, it takes your income, expenditure, assets and liabilities and using a series of assumptions, projects forward your own (or your household’s) financial position.
A financial forecast is really valuable because it can provide:
- Clarity – you know where you are now and what you need to do
- Certainty – you know what action you need to take and that it will produce the outcomes you need
- Peace of mind – you know that you have your financial future under control
- Efficiency – you know the best way to structure your finances both now and in the future
- Foresight – you can plan ahead and take decisions before they become a serious issue
No two financial forecasts are the same – each one depends completely on the circumstances of the individual. For some, the initial forecast will be reassuring; for others somewhat scary, but whatever the outcome, it means action can be taken if needed.
Knowledge is power and knowing earlier in life is the one real way to plan for the future. Sure, some people get lucky with the way their finances and life turns out, but you can stack the deck in your favour with a well-structured financial forecast.
How does financial forecasting work?
Before any numbers are talked about or calculators switched on, the starting point is always about you – your life now and your hopes and dreams for the future. What are your big goals and what are your fears? Once these are known and a picture is beginning to be constructed, a financial planner can start formulating a rough outline plan, pencilling in some expenditure, a provisional retirement date and possible big one-off purchases.
Then we come to the numbers. The first step here is to look at your income, expenditure, assets and liabilities. The next step is to look at any events you can foresee. Are you likely to change jobs; push on up the career ladder; have a child and when are you likely to retire? Many of these things are often interconnected and this is the beauty of a financial forecast – the first iteration may have you retiring at 65 but maybe it will show you can retire at 60 if you make other compromises.
The other important set of inputs are the assumptions to use. How long might you live (with a margin for safety), what rate of inflation and wage growth to assume and how will your investments perform? This is where a skilled financial planner comes in; helping explore these questions and come up with sensible assumptions.
Once the initial plan is built, you will be presented with a number of charts showing a projection of your finances, much like this showing a projection of assets:
And a net worth chart like this for example:
Once of the crucial factors is to show your overall net worth – in other words, to ensure you never run out of money over your lifetime.
Once this initial forecast is complete, the real discussions can start. Can you retire earlier; can you afford to take a pay cut to spend more time with your family; can you give money away to help your kids and still be financially secure; will you be able to pay for care if you end up in a nursing home for 10 years in old age? Whatever the scenario, a financial forecast will be able to shed a huge amount of light onto it.
Disasters needn’t be disastrous
The other key thing that can be done with a financial forecast is running ‘disaster scenarios’. This is akin to a ‘stress test’ of your finances. Would you cope if you lost your job? How about if your partner died? We can run a number of scenarios to see what this could mean for your finances and put steps in place to protect you. Would life insurance or redundancy cover be a good solution? How much cover do you need? How would it affect your life? Disaster scenario modelling can be a really powerful and valuable part of financial forecasting.
Navigating the ship
Life is full of surprises and quite often throws us a curve ball. Sometimes things change for the better – an unexpected inheritance; a huge pay rise or a lottery win – and sometimes for the worse – a long-term medical condition, a death in the family or the loss of a job.
The other things that change are the assumptions used in your forecast. Rarely are financial projections right – they are simply the best estimate at the time. When inflation, investment returns or life expectancy changes, then so must your financial forecast.
However life turns out and however the world changes, it’s crucial to keep on reviewing your financial plan. Most financial planners recommend an update every 12 to 24 months to ensure you stay on course.
Think of a financial forecast like a nautical map. It shows you where your ship is currently, where you need to get to and the best route to take. But the sea is unpredictable and strong winds can blow you off course (or help propel you to your destination faster) so your navigator must keep reassessing your route and make changes where necessary to keep you on track.
A financial forecast is never a one-off exercise – a document to go through then file away. It is an active document that is regularly updated, reviewed and refined.
Some practical examples
So let’s look at a brief outline of a few practical examples:
Scenario 1 – A client is 60 and has always thought of retiring at 65. This client doesn’t enjoy their job and would retire tomorrow if they could. Their father died of cancer at the age of 62 so they want to make the most of life while they can. Without a financial forecast they would probably have kept working for another 5 years but with some expert input and careful planning, they ended up retiring at the age of 61 and travelling the world for 5 years. They still have enough money to last their lifetime as their forecast showed that downsizing and controlling their spending meant they could do what they had always dreamed of.
Scenario 2 – A client in their 50’s wants to live on £30,000 a year when they retire but has no idea when that might be. Their State Pension will kick in age at the age of 66, but could they retire earlier? On the current projections, it’s unlikely, but upping their pension contributions to £950 a month would allow the client to realise their dream and retire at the age of 60, selling up and moving down to the West Country. By assessing their spending and making a few other sacrifices, the client was able to increase their pension saving and is now just 4 years away from being able to retire at 60 with the lifestyle they want.
Scenario 3 – A client in their 40’s knows the importance of saving for the future and is actively contributing to savings and investments as well as paying a large mortgage. They want to send their two children to private school but are unsure if they can afford the fees. Their financial forecast shows them that taking a break from their pension contributions while their kids are at school will free up enough money to pay for their fees and they are they are still projected to have a sizable nest egg for retirement – enough for the lifestyle they want. They can do everything they want to do and have the confidence to take the plunge and enrol their kids in the private school.
Get your own financial forecast
At NorthStar, we offer all financial forecasting as part of our wider financial planning services for a fixed monthly fee. The financial forecast forms a central part of our ‘Lifetime Financial Strategy’ report so check it out for yourself to see the kind of work we do.
The reality is that nobody truly has a crystal ball, but financial forecasting can shed a lot of light on your future. This can help you take decisions now that can dramatically shape the years ahead. Having the ability to connect with your future self and make decisions they would approve of is not to be underestimated.
Financial forecasting can provide real clarity, certainty and peace of mind over your finances and help you get a real insight into your future. One day you may look back and wonder why you didn’t plan for your future. Don’t leave things to chance – think about the future and take action to achieve your goals and dreams. We all have the power to do it, but only those that plan for success, are likely to achieve it.