Now you understand how to budget, and plan and spend wisely, you need to create and follow a more detailed plan to properly manage your money and overall financial situation.
You need to do this if you want to be able to achieve your goals for how you want to live and how much money you want to have in the future.
It doesn’t matter what your goals are – you still need to have a plan that you can follow.
How can you plan
You need to think carefully about what is important to you.
There are likely to be lots of different things that matter, but you might not be able to achieve everything at the same time. So you must also choose which is most important.
Also, you need to think about important moments in your life – even if they seem like a long time away. For example:
- Your first bank account
- Your first part-time job
- Buying your first car
- Getting married
- Having children
- Buying your first home
- Starting work
There are also other things which need to be discussed with someone who is qualified to give financial advice. These relate to your individual personality and how you will want to invest your money.
How can you create a good plan
Putting together a sensible financial plan that will help you meet your goals involves several steps:
- Make a realistic budget that you can stick to.
- Set a time by when you want to achieve your goals.
- List all the things which may happen which will mean you cannot stick to points 1 and 2. For example, you might need to use some of your money to buy a replacement for something which gets broken and didn’t expect it to. Or you need to buy a friend a birthday present but you didn’t think about it before.
Why you need to set goals
There are many dangers if you do not plan your money:
- You might not have enough money when you need or want it for buying new things or making an investment.
- You might not be able to do things for your family – like go on holiday, pay for your child(ren) to go to the school you want.
- You might not be able to prepare yourself against unfortunate events such as injury, losing a job, or illness.
It is very important for you to understand why you need to manage your money carefully – and how you can do this.
This is typically done through the process of “wealth management”.
In the world of finance, this is done based on the amount of money and other financial assets someone has. So the term “wealth management” refers to a service of financial planning that manages the money and financial life of people in all parts of the world, with the aim to sustain and grow long-term wealth.
Why you should get advice
There are some people who are trained, qualified and experienced in providing you with advice for managing your money.
These people are generally called “financial advisers” or “financial planners”. Some of the ways these people can help you are:
- Talking openly with you so that they can understand what is important to you, what your current financial situation is, and what you want for your future.
- Identifying and trying to close any gaps between what you want to achieve and what money and other finances you already have.
- Matching what you need with investments and other financial tools to achieve your goals.
- Reviewing what you want to achieve on a regular basis, and also looking at your financial situation, to see if any changes are needed.
What you need to know about this process
As a starting point, there are 3 main things to keep in mind when managing money:
- You are an individual who is different to everyone else. You have your own ideas, needs and plans. So you need to make sure you manage your money and plan for the future based only on your goals and objectives.
- Professional advice is something which is provided by people who are trained and experienced to advise you. They are called “professionals”.
- You will be getting a service from these people, which you will need to pay them for. But this should mean that you get good advice and information because those people giving it to you are experts in this area.
Investing is about putting money to work with the expectation of making it grow. This means using your money to buy something which will hopefully help you get more money in the future.
This growth might be through generating additional income and/or growing the original amount of money (also called “capital”) in the future.
This means you can afford to buy more things that you want, increase your freedom to make more choices, and make you feel more secure about what you might need in the future.
Investing is NOT gambling, because when you invest you make a plan and carefully select what you invest in. This is also based on what you want to achieve, how quickly you want to achieve it, and why you want to achieve it.
Just as you are different to anyone else you know, the approach you take to investing is likely to be different also.
However, the choices of what you can invest in are generally put into three or four groups because this helps you to decide what to buy, to help you try to achieve your goals.
What can you invest in?
The different things you can invest in are broadly called “investment products”. There are lots of types, and some of them have slightly different names, but they can broadly be divided into groups.
- Cash and bonds – these produce an income and you should look to invest in these if you want to invest for a short period of time – maybe a few months or a year. The aim is to use your money to try to make it grow by a small amount that you expect to get back quite soon.
- Equities and property – these are assets you can buy to try to achieve more growth for your money. You should buy these if you have more time to wait for your money to grow. Also, there is a higher chance with equities and property that they might not always give you more money, so you might need to be more patient and wait for a longer time than with cash and bonds.
Watch out for the risks
You need to be aware that when you use your money to buy investment products, there are some risks.
This means that there are times when the money does not do what you hope or want it to do.
For example, the amount of money might shrink, not grow.
Or there might be a time when you want your money back, but you have to wait to get it because the product you have does not let you have your money back straight away.
There are also risks that some items you might want to purchase – including food, or a house, will cost more, so you will need more money tomorrow than you needed yesterday to buy the same thing.
What are asset classes?
Asset classes are groups of types of investments that are similar in the way they behave – which means what happens to your money.
The main “asset classes” that you can buy are:
- Bonds (or fixed income)
They tend to achieve the following, affecting your reasons for wanting to invest in each of them:
- Cash – to give liquidity without taking credit risk
- Fixed income – as more of a defensive asset class to get a certain level of capital preservation, as well as some yield
- Equities – as a growth asset, making it generally more risky
You can also invest in:
- Currency (the different type of money in general use in individual countries)
- Alternatives, which include other assets not included above
What is asset allocation?
Asset allocation is the process or strategy of choosing between the different kinds of assets you can buy.
These assets are then grouped together into what is called a “portfolio”. This contains a mix of the products you have bought.
The aim is to buy different products which can give you a better chance to meet the goals you have for your investments.
Doing proper asset allocation can also enable you to achieve something known as “diversification” – which is how people combine the different investments and assets they own within a portfolio.
The aim is to help them make their money grow more than if they didn’t have this mix, and/or make it less likely their amount of money will shrink.
Conservative portfolios – these include a large percentage of allocation to lower-risk securities such as fixed-income and money market securities. The main goal is to protect the money you originally invest, with some small possibility to increase the value, often to help offset inflation.
Moderately conservative portfolios – this would suit you if you want to preserve a relatively large portion of the total value of your assets in the portfolio, but are willing to take on a bit more risk to get some additional money back (return).
Moderately aggressive portfolios (or balanced portfolios) – the assets tend to be divided fairly equally between fixed-income securities and equities, to provide a balance of growth and income. There is a higher level of risk with this type of portfolios, so you might need to wait bit longer before you can expect to get a return – generally at least 5 years.
Aggressive portfolios – these mainly consist of equities, so their value tends to go up and down more than other portfolios. The main goal with this type of portfolio is long-term, to grow the value of your assets.
Think of the last time you lost something, or broke something, or got sick. These things happen to every family, and they can be annoying or worrying. They can also cost a lot of money.
Imagine, for example, you broke your parent’s most expensive plates, which cost hundreds of US dollars. First of all, you would be in a lot of trouble! But it would also be expensive for your mum and dad to replace them.
However, there are ways that people can protect themselves against some of the cost of such accidents, or bad luck. It is called insurance.
How insurance works
Insurance is an agreement by a company to pay you back if something bad happens.
The way it works is that you agree to pay an insurance company a certain amount of money each month to cover a certain type of risk. This is your insurance policy – which is essentially the agreement between you and the insurance company of the terms for you buying the insurance and them giving you the protection you want.
You then, for example, get a lot more money back if the risk you agreed to cover happens.
Why do insurance companies do this? They have worked out that if they get lots of people to take insurance, they will make more money from all the monthly fees they take than the money they have to pay out for claims. Meanwhile, the insurance can offer you or your family peace of mind.
There are a lot of different types of insurance available. Popular types of insurance coverage include insurance relating to objects, individuals and family.
House insurance, in which the insurance company agrees to pay for broken or lost items in a house, and will also usually cover the costs of a burglary too.
Personal liability coverage, which is within your house insurance, also provides coverage for bodily injury and property damage sustained by others for which you or your family members are legally responsible.
Fire insurance. Insurance companies agree to cover the costs of any fire damage to your house, or your company.
Motor insurance. In order to own and drive a car or motorcycle, everybody needs insurance.
This is so that if you are involved in a crash, the insurance company will help pay for the damage.
Travel insurance. Many people have experienced the annoyance of missing a flight, or losing a suitcase. This insurance offers some money when this happens.
Health insurance. Insurance companies agree to cover most of the costs related to any sickness you suffer.
Disability insurance. This insurance is paid if you suffer some sort of injury that could affect your ability to work, either for a short time, a long time or forever.
Life insurance. Eventually, everybody has to pass away. With life insurance someone can insure themselves so that the insurance company will pass money onto their family if this happens.
Education insurance. With this insurance parents pay money to an insurance company to save for their children’s education.
Pet insurance. This is like health insurance for a pet. Vets can be expensive, so getting pet insurance can help cover the cost of pets getting sick.
How insurance helps
Insurance can be a very helpful service. Many countries do not offer free healthcare, so taking out health insurance can help reduce the costs of visiting the doctor, buying medicine and any hospital stays.
Equally, families that rely a lot on one person to make money may well want to get life insurance, as it could make things very difficult if that person were to die.
And anybody that wants to drive has to have car insurance. So it’s very important to get!
Important things to remember about insurance
- While insurance can be very useful, it cannot cover all risks.
- Insurance policies are limited. It is a good idea to remember that insurance policies are usually very detailed, and only cover certain things. Insurance companies are very careful over what they agree to insure and how long they will do so, so they don’t have to pay too many people. So you have to be very careful when deciding what you want to cover!
- Compare different companies. There are lots of different insurance companies, and they assess risk in different ways. It’s a good idea to get quotes from several for the sort of insurance you want and the limitations they put into place before you agree to any policy.
- You should also work out how long you want the insurance coverage to last for. Term insurance has a set time frame, which makes it cheaper, but also means you are not covered outside this period.
- Holiday insurance and life insurance are types of term insurance.
Insurance as an investment
It is also possible to use some types of insurance products as an investment.
With these products you pay money on a regular basis, which the company invests on your behalf, and then pays you back money based on these investments.
Choosing the right insurance
Jenny is a keen horse rider. During holidays she wants to visit stables and ride horses. But on one of her recent holidays, in Canada she had a small accident and fell off the horse and needed to go to hospital for a minor injury to her arm.
Jenny has a personal accident insurance coverage (which excludes horse riding) and she gave the claim immediately to the insurance company when she got back from holiday.
However, her claim was rejected. Her insurer explained to her that horse riding was excluded in Jenny’s personal accident insurance policy.
Jenny also learnt that her travel insurance coverage also did not cover higher-risk sports.
She now realises the importance of assessing what coverage she needsand choosing the most suitable type of insurance policy.
What are the fees?
When you ask experts to give you advice or help you with complicated services, they often charge you money for their time and help. This is called a fee.
Lots of people charge fees. Doctors usually charge you a consultation fee when you need their help. Lawyers also charge fees per hour for offering their advice on any legal issues you have.
Many people who give financial advice charge fees too. For example, investment advisers such as fund managers, stockbrokers or private bankers charge you fees if you want their help on investing your money.
It’s important to know how the adviser charges you fees. Some people charge a flat rate fee by the hour. Others charge a fee as part of investing money for you. For example, a fund manager might charge 0.5% of the money you give them. The more money you give them, the more they earn from investing.
The cost of fees can change a lot too, depending on the person you hire, their level of experience, and the area that they focus upon.
It is fair that advisers (who are competent and experienced) charge a fee for their service.
But before you agree to use an expert, get them to tell you exactly how they charge fees, and if there are any other costs as well.
Some financial advisers claim to charge a certain fee, but include several other costs that they don’t make obvious. Every dollar you spend on fees is a dollar less that you have to invest.
Unless you ask, you may find your final bill is much higher than you expected!
Try to get the adviser to write down all the fees and costs they will charge you, before you agree to their help. This will help in case you are charged more costs later.
Get fee and cost estimates from several of the advisers you have been recommended. You may find that some offer the same service for less money than others.
It is also important that you can confirm that the individual you are getting advice from is qualified to give that advice.
This means that not only do they have the required training or licence to be advising you, but also that they have the skills, knowledge and experience to do so.
Everyone gets older, and eventually they decide they no longer want to work, and would like to relax and enjoy their lives. So they give up their jobs. Often they do so when they are 60 to 65 years old. This is known as retirement.
Many countries have a retirement age, usually at around 65 years old. After this age, some people can stop working and claim money each week from the government. This is called a public pension, and is offered to help these people cover their living costs.
However, in many countries only poor people receive a public pension. Most other people need to set up private pensions if they want to have money and enjoy themselves after they retire.
What is a private pension?
A private pension is a type of investment, which lasts a very long time. You start putting a certain amount of money into a pension fund each month, and this money is then put into various types of investment such as shares or bonds by a pension company.
This money then builds up over the years, and by the time you decide to retire there should be a lot of money available. You can then start taking some of it each month to cover your costs.
The amount of money you have should be much more than you put into the pension fund, because the investments should make money each year, and as the amount of money being invested rises, so does the total amount each year.
Mary starts saving USD10,000 a year for her pension when she is 30 years-old. The average amount that is returned on this amount is 5% a year, on average. She decides to retire at 60.
In total, Mary has USD740,827 in her pension when she retires.
Dad starts saving USD10,000 a year for his pension when he is 40 years old. He can also earn 5% a year, and wants to retire at 60.
In total, Dad has USD373,725.50 in his pension when he retires.
By saving for 10 extra years, Mary ends up with nearly twice as much money for her retirement as Dad. This is because of the benefits of compounding (which we discussed in Section 2 on Saving).
You should start putting money aside for a private pension as early as possible.
The earlier you do so, the more money you make, and the more you have left when you eventually retire.
You can start by saving a smaller amount and increase it as you get older and make more money.
Other retirement investmentss
Apart from a pension, you can make other plans to have money after you retire. A good example is to buy one or more houses when you are young, and pay off the mortgages.
Then, by the time you retire, you will usually have paid off the mortgage and own the house completely.
If you fully own a house when you retire, you can choose to live there without paying anything except your electricity, gas and water bills. If you have more than one house, you can choose to rent some of them out. Then you make money from the rent you get in each month, which can help cover your own bills.
Another option is one type of life insurance policy, which agrees to pay you a lump sum of money if you reach a certain age.
Think about how much money you would like to have each year when you retire. Then work out whether you goal is realistic, and how you can plan to reach it. If you start early enough, it may not be too difficult!