We all have an idea about what our future looks like. Planning is the exercise of making those ideas a reality. It’s about avoiding the regret of “why did I spend so much money on X rather than saving it for something that truly matters to me”. The first step of planning is determining your values. These values can then help you understand why you have those ideas about your future, and what those goals really mean to you. Effective planning is about setting priorities to establish which goals are most important. Often people skip this step and launch immediately into selecting specific investments. They might believe they are setting themselves a good goal of “getting rich”, but without a quantifiable target, a timescale, or a recognition that other goals are less important, there is no real commitment or way to track progress.

Only once you have your priorities set, can you worry about efficiency – the best route to achieving your goal. Investment advisors are often measured on how well they can outperform the market, also known as generating alpha. Studies show that as an industry, investment professionals don’t do this on a consistent basis. Even if a fund manager can, it’s impossible to determine who that will be before the fact. Even if you could, that isn’t necessarily the best way to measure an investor’s success. Take Josh and Mindy as an example. Josh and Mindy want to pay for their child’s education in 15 years. They chose their current investment advisor because he has a proven track record of beating his benchmark, the FTSE TMX Canada Short Term Bond Index. Fifteen years from now, Josh and Mindy go to take the money out of their RESP to pay for their child’s tuition, but realize they don’t have as much as they thought they would. It’s not because their advisor hasn’t managed their assets well – he even matched or outperformed the benchmark the majority of the time, creating alpha. The problem started far before they even gave their money to their advisor. They didn’t have a plan.

For individuals, the main reason for investing is so that they can achieve their long-term goals. While it is important to make sure that advisors aren’t consistently underperforming their benchmark, it’s even more important for investors to make sure that their investments are on track to provide the returns they need to meet their goals. This is where planning comes into play.

Defining Your Goals

Planning takes stock of your financial position today, defines your goals (i.e. where you want to end up in the future), and helps you make decisions on how to get there. Let’s return to Josh and Mindy. They invested $3,000 over the next 15 years with their advisor. Since he was investing in Short Term Bonds, we use PWL’s expected returns for a 100% fixed income portfolio, 2.48% per year on average. They wanted to have $60,000 in today’s dollars for their child’s education. Some quick calculations would have shown that they should expect to fall short of their goals by $13,000. While that isn’t a happy conversation to have, it enables Josh and Mindy to make some key decisions now, while they have time to make an impact. They have a number of options to choose from: they could say, “that’s fine, our child can fund a portion of their schooling with a part-time job or with student debt”; “we can squeeze another $850 out of our budget each year to make up the difference”; “our cash flow is high enough that we can top up the extra $13,000 when our child starts school”; “we’d like to invest in more equities, in hopes of a higher return over the long-term (while understanding that this poses a higher risk)”; or a combination of the above. While Josh and Mindy’s advisor may have managed to provide alpha (i.e. beat his benchmark), Josh and Mindy still didn’t achieve their goals. This is why planning is so important, so that investors can see ahead of time if they are off track, and what decisions to make to give them a better chance of achieving their goals.

While this is a simplistic example, it outlines how planning can help inform important decisions. Two of the main levers that Josh and Mindy had at their disposal were the amount of savings, and how to invest their contributions. More complex planning, such as retirement planning can be even more important because retirees often don’t have the opportunity to use their regular income or earn more money to make up for shortfalls like Josh and Mindy could. Retirement planning allows investors to frame decisions around saving and asset allocation, deciding when to retire, and tax minimization while they still have options to make a material impact.

For many young professionals, savings goals (like retirement) can be very far away, which makes it seem impossible to plan for. While it may be difficult to determine a specific plan right now since so many factors are unknown, it’s best to at least have a guidepost for your savings and investing, so you can determine whether or not you’re on track. Otherwise you might wake up one day and be in that position of regret, thinking “why did I spend so much money on X rather than saving it for something that truly matters to me”. Financial planning helps to determine how much money you need to set aside, and how to invest those savings, so you can feel confident about reaching your goals, even if they change along the way.