Part 3: Testing your strategies to ensure you reach your goals

12 Apr 2013

By Darren Higgs

You have probably noticed that in my last two blogs, I have not mentioned financial structures (such as family trusts, companies, self managed superannuation funds.) Nor have I mentioned financial strategies (such as superannuation contributions, loan repayments, insurances, estate planning) or specific investments!

While all of these things are really important, you cannot put the 'cart before the horse', which is what a lot of the previously mentioned 'experts' do. The best strategies and the best investments should only come into play once your goals and cashflows have been clearly articulated and prioritised. A great strategy or investment is not worth much if your cashflow is going in the wrong direction, or they are not meeting your goals!

While the focus for any financial plan should be you and your goals, the biggest enemy to any financial plan can also be you. Risk is often regarded as the chance of a negative return, or losing capital. I look at risk as the possibility of you not achieving your goals. Examples can be, having to work longer than you want to, being unable to assist loved ones, or having to make personal compromises that you wish you did not have to.

However, with a clear focus on what your goals are, how to prioritise them and what will be funding them, the financial strategies and investment portfolios can also be structured to minimise the chance of these risks occurring. Everybody reacts differently to risk, so the level of protection and risk management will also be different for each person.

So, what are some of the tests we consider to ensure you can reach your prioritised goals?

  • 'The means to what's important' test – this is ensuring that you have at least 5 years of 'must have' expenses in cash or quarantined fixed interest investments. Alternatively, we ensure that your after-tax salaries will be able to meet these 'must have' expenses (including protection for your salary if you were unable to work due to sickness or injury);
  • 'Sleep at night' test – this looks at how comfortable you are with cashflow volatility and investment portfolio volatility. While everybody wants the highest return possible (myself included), how would you react if your portfolio fell 30% in one year? Would you still have the discipline to maintain the plan?
  • 'The end point' test – this looks at whether your cashflows and asset allocation will provide you with a sufficient return for your monies to last you for the rest of your life. Sometimes you need to earn a certain investment return to meet your goals, but the higher the return you require, the greater the risk;
  • Total synopsis – the above three tests often reveal competing objectives, which will require a lot of consideration, as illustrated below:

Illustrative assumptions diagram 

Good financial advice is far more than just picking certain investments. Good financial advice is a goal setting process, which can only be achieved by understanding your needs.

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