Three steps to develop your own financial strategy

financial strategy

A few weeks ago I wrote a blog about the one thing that stops most people from making the most of their financial opportunities including making regular investments.

It was my thesis that a lack of context is the main cause. Having a long-term plan provides you with the context required to make mistake-free financial decisions. It is difficult to work out what investments to make (and when) if you don’t know where you are heading and how your will get there.

A financial plan will give you sufficient context in which to measure your financial decisions against.

We follow three distinct steps to develop and implement a financial plan for our clients. We have refined this process over many decades and have found this disciplined and logical approach helps develop very efficient evidence-based plans. 

Step 1: Develop a high-level financial strategy

Determine your future cash flow and net worth

The first step is to build a financial model. A financial model will forecast your future income and expenses and therefore, how much cash flow you have to allocate towards investing. It should also forecast your assets and liabilities i.e. net worth.

The purpose of a financial model is to do two things.

Firstly, to measure whether your chosen strategy will work i.e., achieve your goals. For example, if you plan to invest in 2 properties and maximise super contributions, will that be enough to generate $100k p.a. of income (after-tax) that you require in retirement?

The second purpose of a financial model is to compare strategies to eliminate inferior ones and pick the one that has the highest probability of working i.e., the one that generates the highest returns for the lowest risk.

Financial modelling is part-art, part-science. The science bit is the Excel skills and technical knowledge required to build financial models. The art is knowing what strategies work best in various situations, which can only be acquired with many years/decades of experience. Realistically, most people won’t have the skill and experience to complete their own financial modelling.

Mixture of asset classes

Most people would be well served by investing in a mixture of asset classes including super, residential property, share market investments and so forth. The financial modelling exercise will help you determine optimum mixture of asset classes that suits your goals, risk profile and financial position.

Level of gearing

Whether you will borrow money to invest and if so, to what extent is a major strategic consideration. A financial model will assist with determining the right level of gearing. It is important you consider whether you will have enough cash flow to service debt. But even more important is to determine to what extent you need to repay debt before you retire. It is prudent to not take high levels of debt into retirement so you must have a debt retirement strategy.

Of course, a strategy is only useful if it can be implemented, so you will need to consider your present and future borrowing capacity i.e., how much will the banks lend you. 

Ownership structures

Once you have determined the mixture of asset classes that you will invest in and how much gearing you will adopt, you can then determine the best investment ownership structures. Considerations include income tax payable over your lifetime, land tax (for property), CGT if your strategy includes selling, current and projected cash flow, borrowing capacity and asset protection.

Retain high-level focus

It is important to avoid getting bogged down in detail during this strategy formulation stage. The goal is to develop a high-level strategy only i.e. what assets to invest in and when. If you get too detailed at this stage, you will likely confuse yourself and suffer from information overload.

Step 2: Develop the detail that underpins your financial strategy

Once you have determined a high-level strategy, the next step is to formulate the detail that underpins the strategy.

Your investment methodology and philosophy

Most importantly, you will need to consider how you will invest in various asset classes. That is, what methodology you will use. Anyone that is a regular reader of this blog knows that I’m a staunch believer in only using evidence-based investment methodologies. Using evidence-based strategies dramatically reduces your investment risk.

If your strategy includes investing in shares, what approach will you use; (1) diversified, low-cost, and rules-based, (2) picking direct shares yourself or using a broker, (3) using an active fund manager and so on.

If your strategy includes investment in property, what methodology will you use. Will you invest in investment-grade property, try to identify a growth market, undertake property developments or something different?

My book, Investopoly outlines the evidence-based methodologies that I follow myself and the reasons why.

How to invest your superannuation

You will need to decide how to invest your superannuation. Will you use a retail fund (no! should be the answer), industry super fund, a wrap platform or set up your own Self Managed Super Fund?

Borrowing strategy

If your strategy includes borrowing to invest, then you will need to engage with an experienced mortgage broker so that they can develop a borrowing strategy to help you implement your plan. Their role is to help you obtain the required level of borrowings in the most cost and tax effective manner.

Ancillary planning matters

Now that you have formulated a clear strategy, it will be easier to work out how much insurance you need and how to structure your estate plan.

Your current asset base, borrowing plans and cash flow position will inform you how much insurance you may need (such as income protection, Life and TPD). It will also help you understand how you can minimise the cost of this over time. That is, as your financial position strengthens and your financial commitments reduce (kids are older, home loan repaid, etc.), you typically need less insurance cover. For example, you may need a lot of cover today but expect that you need dramatically less cover in say 10 years’ time if your strategy goes to plan.

Your financial plan and asset ownership structure will dictate how your will should be structured and other estate documents. It is important these documents align with your overall strategy.   

Step 3: Implement, review and refine

Once you have defined your personal investment strategy, you can begin implementing it. A typical strategy implementation includes:

  • Strategically divesting of any under-performing assets.
  • Optimise super which could include switching to a superior super fund.
  • Make property investment/s. If the plan is to purchase 2 or more properties, we must develop a strategy regarding the timing of said investments. We must consider borrowing capacity and market opportunities.
  • Commence regular share market investing, often monthly.
  • Refer client to an estate lawyer to draft estate planning documents (wills and power of attorneys).
  • Implement insurances to ensure strategy/financial risk is minimised.
  • Complete taxation planning including set up of any structures or restructure.

Navigate inevitable life changes

If there’s one thing that never changes its change itself. Therefore, it is unlikely that everything will go perfectly to plan. You will probably have to adjust along the way, but at least you’ll have a framework and context for doing so.

Reviewing investment performance

You must regularly review the performance of each investment and your progress compared to your plan, to ascertain whether any adjustments are necessary. Remember to always play the long game which often requires a lot of patience and discipline (a topic that I discuss in the coming weeks).

Ad hoc or strategic?

It stands to basic reason and logic that developing a long-term strategy will ensure you take the most efficient path to achieving your financial and lifestyle goals. Therefore, investing the time and money to develop your own personalised financial strategy will pay substantial dividends for the rest of your life.