Financial planning is time-consuming, dull--and absolutely essential


Personal financial planning is neither mysterious no glamorous. You won't see it on the national news, and it won't make you intriguing and sexier. But it can make you happier and, yes, it can even help you live longer.

And the most important investment decision you will make does not involve money, but rather the commitment you must make to your own future, and the future of your family. It's an investment of time -- the time needed to learn about personal finances, develop a good financial plan that meets your needs and take the steps to execute that plan.

You are not alone here. My files are filled with public-opinion surveys showing how worried we all are about making ends meet during our retirement years. The polls even show that our kids are worried about how they will help support us, especially when many of them will be struggling with the costs of raising their own families.

If you protest that you don't understand business and numbers and investment terms, my response is that it's really not hard to gain this knowledge, if you want to. Self-help guides abound, for a price, in bookstores and magazine racks and for free in public libraries. And I just don't buy the argument that personal finance is too confusing for a newcomer to grasp.

I'm regularly struck by the depth of sophisticated knowledge we unwittingly accumulate about things that really interest us. People who do lots of cooking amaze me with the range of knowledge they can summon instantly about ingredients, their selection and preparation, the proper ways to mix them, the spices and condiments that can be added (and when to add them) and many other facets requiring encyclopedic knowledge.

Sports fans carry around in their heads an incredible knowledge of rules, player histories and numbers. Yet the same baseball fan who has unconsciously mastered a base-nine numbering system for measuring pitching performance (earned run averages being based on nine-inning units) may draw a blank on money issues, saying, "I just don't get along with numbers."

So, while the first step on the road to financial planning is the realization of how necessary it is for a happy future, the closely related second step is the realization that the basics are not all that complicated, if you are committed to taking the time to learn about them.

If you want to kill two birds with one stone, Fidelity Investments has a personal-finance guide for children, complete with activity plans and budget work sheets that kids can complete. It's called "You and Money: A Learning Unit for Children," and can be ordered by calling (800) 544-8666. Maybe you can learn something while helping your children develop some of the personal finance tools that they'll need to appreciate money (yours) and better understand how to make ends meet when they're out on their own.

I hope that the first five installments of this series can also provide you with some of the tools you need. But before you invest in stocks, bonds or mutual funds, and before you become a real estate baron or dazzle us with your knowledge of annuities and insurance products, it's vital to come to grips with more mundane chores -- household budgets and the preparation of at least a rudimentary financial plan.

With your budget under control and with some type of financial road map to guide you, you face at least a fighting chance of achieving your financial goals. Without such preparation, you have literally no chance. Zip. None. Zilch.

Believe it.

Financial Planning

Even if you have enough money to afford the services of a professional financial planner, it's essential that you do enough work on your own to make sure that the planner ends up working for you, and not the other way around.

There's no absolute rule on how much money you should have before it's worth your while to pay someone to help you manage your capital, but I'd say that you should have at least $50,000 in investment funds and that $100,000 would be a more suitable starting point.

There has been terrific growth in the number of people providing financial-planning services, and you can find just about any stripe and shade of planner that you want. But what do you want?

Do you need current income, or would you rather take the bulk of your investment return in the form of appreciation in the market value of your holdings? What's a good mix of investments for you? How much risk are you willing to tolerate when investing the money you're counting on for retirement?

A good financial planner can help you develop answers to these questions that are right for you. But you'd be far better off in the process if you had worked on developing some of the answers yourself before seeking professional advice.

T. Rowe Price Associates publishes an "Asset Mix Worksheet" ** that lets you determine what types of investments might be right for you and possible ways to diversify your financial holdings. Call (800) 638-5660 for a copy.

If you do decide to work with a financial planner, make sure you're comfortable with the planner's professional background and, especially, with any specialized types of investments he or she may be pitching to you.

Some planners charge a straight fee for their advice and have no other financial interest in what you do with your money, but most planners pick up money from fees and commissions on the specific financial products you buy. Make sure you know how a planner is making his money before signing up to do business.

The possibility of conflict from a planner, even if unintentional, is a real concern in the selection process. Many financial planners, for example, have emerged from the insurance business, adding other skills to their insurance-product base. Might they "tilt" toward insurance products when giving advice? How about a stockbroker turned financial planner? Would his or her advice tilt toward stocks and other securities?

Such possible biases are neither surprising nor necessarily wrong. Insurance and brokerage professionals should believe in their products and, if they do, they shouldn't be shy about discussing them with clients. But it's important for the client to know enough about his own needs and preferences to arrive at a fair evaluation of the investment choices being discussed by a financial planner.

I don't believe in crash diets or crash financial plans. A good financial plan, like good eating habits, should last you a lifetime. Give yourself a year to come up with a total plan.

Preparing a budget

The actual process of developing a financial plan begins with a personal budget. Companies and governments do them (some better than others, obviously), and individuals should also construct budgets.

The budget process is, first of all, essential to providing the information you need to form a financial plan. But perhaps even ** more important, simply doing a budget demands the kind of systematic attention that is essential to carrying out a financial plan successfully. This regular and repeated attention to personal-finance basics develops the kinds of habits that will make your financial plan work.

Psychologically, I prefer to approach a budget as a document that tells me what I can do, not what I can't. Used properly over the years, a budget can be immensely useful in helping you achieve your goals in a positive way.

To begin a budget, start with reality. Don't sit down and figure outwhat you'd like to spend on various needs. Go through your bank statements and receipts and figure out what you actually have been spending. Do the same thing with your income.

A budget work sheet is reproduced here to help you. Use it as is or modify it to fit your needs. The initial aim of doing a budget is to know what you're spending. But the process can quickly lead to greater savings. Often, the results of that first spending analysis will surprise you,pointing up some areas that would seem ripe for painless trimming. Simply knowing what you spend on a category may sensitize you enough to save money the next time you're out shopping.

There are month-to-month variations in spending patterns. So, before coming to any conclusions about ways to change spending habits, I'd work up a new work sheet each month during the first few months of the planning process.

In refining a budget to anticipate the future and not simply reflect the past, I'd strongly advise developing a plan to eliminate debt from your life, with the exception of your home mortgage, a long-term education loan and, in a nod to reality, an auto loan.

The tax system once strongly favored personal debt. People who itemized their deductions could claim interest charges as a deductible expense. But tax reform has produced lower tax rates, making all deductions worth less. And although interest costs on mortgages for your primary and secondary residences are deductible for income-tax purposes, the deduction for other interest expenses has been phased out (1990 returns are the last that will include this deduction).

Given the recession and the war, you clearly need to be comfortable with your job prospects before paying down any debts. And I guess I'm kidding myself to think that anyone's going to read this and run out and pay off all their financial obligations.

Further, there's some concern that the weak economy may signal a period of falling prices, or deflation. Paying back debts is easier when prices are rising, because the dollars you're using to pay off debts are worth less than the ones you borrowed. During a period of deflation, the opposite is true, and experts can make a good case that this is not the time to go on a debt-repayment binge.

And, obviously, there are times when it simply makes more sense to borrow. But you should at least know the specific terms of the trade-off. If you want that roomful of furniture, fine. But know what the interest price tag will be. What could you do with that interest money over the life of your furniture loan? How does that compare with the use and enjoyment you'll get from the furniture during this period?

Give yourself another several months of this planning year to refine your budget to better reflect your current needs. Then, devote the last few months of the planning cycle to budget adjustments that reflect your future needs and desires.

If you have a personal computer and have been threatening to use it for financial planning, then by all means do so. I've never believed in simply keyboarding my checkbook register into a computer so it can tell me what I already know. But there is increasingly slick and affordable software that can make your financial life easier, and you should take advantage of it -- especially if you can link this work with any income-tax software. (I'll be writing about taxes next week in The Sun's Tax Guide.)

You need not have a financial plan that takes you to the end of your life, even assuming you knew when that would occur. Settle for some shorter-range plans with some longer-range goals in mind.

In adopting these interim plans, my basically conservative approach stresses that you engage in some "worst-case" thinking. What if something should happen to you? Are you adequately covered by life insurance? What about disability coverage? Health insurance? What would happen to your family if you were hurt and unable to work for a year?

Obviously, another goal of this process is to develop regular additions to savings that can form the basis of your retirement portfolio. Even if your investments returned 1,000 percent, you might fare poorly if you haven't much to invest in the first place. "The key to lifetime security," a financial planner once said, "isn't the rate of return but the rate of investing."

Besides saving for retirement, try to set aside other money to help pay for the large purchases you know you'll have to make in the future.

For example, if you're paying off a car loan, continue making these monthly payments after the loan is paid off, but make them to yourself, perhaps by writing a check that's deposited into a special savings account you've set up for long-term purchases.

If your employer has a pretax savings plan, by all means try to participate. This not only lowers your current tax bill but may feature a partial employer match of funds, and shields plan earnings from income taxes as well.

As you refine the expense and income sides of your revised budget, you also should be developing an investment program for what's left over.

Earlier installments of this series have discussed the virtues (remember, I'm a conservative planner) of setting up a contingency fund of several thousand dollars, or more if you have no protection against an unforeseen halt to your primary source of income. This fund should be invested in very safe, very liquid assets.

I've also briefly reviewed the benefits and roles of an IRA, 401(k) ,, and other retirement programs that give you some control over how your share of the funds is invested.

Likewise, you should take advantage of the tax benefits and appreciation potential of homeownership before considering any more-adventuresome investments.

And if you do reach the point of diversifying, please make sure you know how to walk before trying to run or fly. Learn the basics and stick to them.

Small Investor Index

Money magazine's Small Investor Index measures and tracks how a typical small investor's mix of in vestments is doing each week. The typical total, or portfolio, of personal investments is slightly more than $42,000. The types of investments held by the average small investor are measured in periodic government surveys, so the Money index is trying to measure what Americans really do with their investment funds.

Here are the 10 investment categories tracked by the Money index, as of last Friday, and what percentage they represent of the typical investor's portfolio (the index excludes primary residences and rental real estate):

N.Y. Stock Exchange stocks 18.28%

Certificates of deposit 22.46%

Cash 22.21%

Taxable bonds 17.26%

American and OTC stocks 5.77%

Municipal bonds 4.81%

Bond funds 4.22%

Equity funds 3.62%

Real estate 0.80%

Gold 0.57%

I question whether this average of both very wealthy and ver poor Americans really reflects a typical portfolio at all. For example, I'd venture that most average investors have more money in mutual funds and less in individual stocks than indicated here.

You can prosper by paying attention to basics. You can use your time and planning skills to create a series of financial building blocks. And you can use your financial resources wisely to turn those blocks into a strong foundation that can support a stronger and better life for you and the people you love.

Then, you can stop worrying.

Good luck.
