Five year plans for Level 0 and Level 1
For people in net debt or with net assets less than £50,000
What does a five year plan look like and where do you start?
The idea of a five year plan is to set longer term goals, and to break down those goals into manageable chunks of one year or less – chunks that make sense.
The end of our third plan was 2004, when we changed our goals from a single fixed goal of net asset wealth to a “stochastic” model of the future, both for net asset wealth, and for net income achievable from those net assets. The latter is more important than the former.
“What’s a stochastic?”, I hear you say.
A stochastic process is one whose behaviour is non-deterministic, in that a system's subsequent state is determined both by the process's predictable actions and by a random element.
In 2004, we had over-achieved our long term goals in some part because of a random element. That random element had been the UK property price growth from 1999 to 2004. So we set a baseline (or worst case scenario) where property price growth would be 3% per year over the next ten years, and a maximum stochastic where property price growth would be 7% per year over the next ten years. We reset our goals to double our end-game net income from our original plans if achieving median plan results, or triple it if the maximum stochastic were to be achieved. That would either mean earlier retirement or a much bigger safety net where our 2015 expenditure would be less than one third of our 2015 net income.
So back to the five year plan, and this is targeted at the Level 0 investor (net debt) and the Level 1 investor (net wealth of between £0 and £50,000 excluding the equity in their private residence, or home).
I will also make the assumption that the Level 0 or 1 investor is going to make residential property one of the key investment areas in the portfolio. For anyone who is not interested in property as a wealth generator, skip this article and read about gold, stocks, options, fine art or any other investment vehicle. These are all investments, but this is about property.
From the 50,000 foot high level view, you have to make some assumptions about the long term, and my assumptions are listed below:
1 Real UK inflation baseline is 5% per year. Minimum stochastic is 3% and maximum stochastic is 7%.
2 UK property prices will keep abreast with real UK inflation, as will your personal expenditure, provided that your lifestyle does not change.
3 The cost of borrowed money will average out at 7% over the long term.
4 In 20 years’ time you plan to have net wealth of £5M with a net income stream of £150,000 per year.
Before you go thinking that this is pie in the sky, let’s look at NPV.
Net present value (NPV) or net present worth (NPW)[1] is defined as the total present value (PV) of a time series of cash flows. It is a standard method for using the time value of money to appraise long-term projects. Used for capital budgeting, and widely throughout economics, it measures the excess or shortfall of cash flows, in present value terms, once financing charges are met.
I don’t want to get technical in this article, but suffice it to say that with an inflation rate of 5% per year for 20 years, the NPV of a £5M portfolio in 20 years time is only £1.9M and the NPV of a £150,000 income stream is £56,000 per year in today’s money.
Since five years is a short space of NPV time compared with 20 years, think in today’s values when you make your plans, but be mindful to adjust your plans in each five year period.
Here’s the unscientific bit. In five years out of twenty years, plan to control assets worth only 10% of the entire projected asset value in 20 years’ time. In this example, choose £0.5M worth of property. Plan to achieve cash flow of only 5% of the entire projected cash flow in 20 years’ time. I will explain this in the next article.
So now your first five year plan involves controlling only £500,000 worth of property, with only £7,500 of cash flow. Do you think this will result in comfortable retirement in 20 years’ time? I’ll explain in the next article why this is so.
Tuesday, 23 November 2010
Sunday, 24 January 2010
How Much Is Enough - Part 2 Getting Organised
Getting Organised – The Filing System
I remember a time when life was very simple. People received their wages in cash in pay packets every week. Bills were paid directly in cash to suppliers. Rent was collected by rent collectors, and the man from the Pru collected mortgage payments and insurance premiums on the doorstep. Shopkeepers accepted cash for goods or marked up a slate for regular customers until they could pay at the end of the week when they collected their wages.
Come the 1970s, bank accounts became required to make some regular payments. Credit cards flourished. The 1980s brought video players, the 1990s saw mobile phones proliferating and the internet making accelerating penetration into every household in the UK. By the turn of the 21st century, it became almost impossible to live in society without a bank account, a debit card and at least one credit card, with multiple direct debit and standing order payments to be met.
The entire country moved from cash accounting to double entry bookkeeping of their personal affairs (time delay between receiving services and paying for them) without the majority of the public realizing how to keep their financial house and home in order. The organized amongst us kept papers in files, and now have to keep electronic records in files on a home computer system about suppliers who insist on moving from paper based systems to electronic records, including the government for personal income tax, national insurance and VAT payments. There’s no choice, everyone has to go with the flow or pay somebody else to file electronically on their behalf.
In all this technological change, with its effect on the complexity of life of Joe Average, I have noticed that no matter whether you work in a large multinational corporate, or just contemplate keeping abreast of your bills at home, there is absolutely no consistency of record keeping between companies or individuals, between departments of companies or indeed between people in the same department of the same company. You only have to look at the organisation and hierarchy of SharePoint sites to realize this.
I was fortunate enough over 20 years ago to work for an American multinational that established a global generic hierarchical numbered filing system, allegedly borrowed from the US military, that allowed flexibility yet kept consistency for the end user, and I adopted it for keeping personal and small company records for over 20 years. It has stood the test of time (for me anyway), so I have reproduced it here in this article for anyone who wishes to use it or modify it for their own record keeping purposes.
If you are going to make a wealth plan, you are going to have to know where to find papers you filed away, and also where you filed the electronic records of the same records on your desktop or laptop computer, or more recently on the cloud computing storage areas now offered (free of charge for the time being) by the likes of Google and Microsoft – links provided below.
I have included in this article a high level filing and index example from my own records, being sure to keep to the same hierarchy with both the paper and the electronic records. January 2010 was the first time in ten years that I have revisited, cleansed and adjusted the specific sub-folders in the hierarchy system, so that should be proof enough that the system has survived the technological changes of our lives.
Have fun with it, or ignore it at your peril.
Google Docs
http://www.docs.google.com/
Microsoft Live
http://smallbusiness.officelive.com/en-GB/
Saturday, 23 January 2010
Terms of Reference for Goals and Long Term Plans
Wealth Planning – Terms of Reference for goals and long term plans
Goals and Plans. What’s a Terms of Reference anyway?
Terms of reference, abbreviated as TOR, describe the purpose and structure of a project, committee, meeting, negotiation, etc. When used with regard to a project, they can also be known as a project charter.
Terms of reference show how the scope will be defined, developed, and verified. They should also provide a documented basis for making future decisions and for confirming or developing a common understanding of the scope among stakeholders. In order to meet these criteria, success factors/risks and restraints should be fundamental keys.
Creating detailed terms of reference is critical, as they define the:
• Vision, objectives, scope and deliverables (i.e. what has to be achieved)
• Stakeholders, roles and responsibilities (i.e. who will take part in it)
• Resource, financial and quality plans (i.e. how it will be achieved)
• Work breakdown structure and schedule (i.e. when it will be achieved)
They should include:
• Success factors/risks and restraints.
The terms of reference set out a road map. They give a clear path for the progression, by stating what needs to be achieved, by whom and when. There must then be a suite of deliverables which conform to the requirements, scope and constraints set out in this document.
So there’s the definition – it’s from project management parlance. In my humble opinion, wealth generation is a life project of continuous improvement, split into definite time periods, the beginning of which can be characterised by a starting plan date (eg. First two weeks of January 2010) and ending with a reconciliation date (eg. Last two weeks of December 2010) at which time you will compare the achieved results with the plan. Whatever the time period of the plan, the next plan should not be started before the results of the first plan have been evaluated to see how realistic your goals and plans were when you started.
To fail to plan is to plan to fail.
As Thomas Edison put it: “Many of life’s failures are people who did not realize how close they were to success when they gave up”
If you give up on anything too early, it’s unlikely you will be successful. In this series of articles, I am advocating an overall plan period of twenty years to move from no financial independence to total financial independence. Since most people spend forty years or more of their life in a job (which stands for Just Over Broke), it’s not too much to ask to spend some time taking stock of your current situation, making a plan, and setting about sticking to a plan.
If you are new to planning, don’t panic. Take it easy. You have twenty years to get on with it, or more if you don’t start NOW. It’s remotely possible that you will become wealthy without any planning or intention. People win the lottery - you have four times the likelihood of being struck by lightning than winning the first prize in the national lottery – about one chance in fourteen million. See the explanation of how likely you are to win the national lottery at this link:
http://www.murderousmaths.co.uk/books/BKMM6xlo.htm
You may inherit money from relatives who leave you a lot of cash in their will.
You may marry a rich partner who will promise that you obtain financial freedom.
But all of these remote possibilities would not guarantee financial freedom if you don’t know what your income and expenditure (spending) is today, or what it is going to be in the future.
The fact is, if your wealth (amount of money or assets) does not provide sufficient INCOME to cover what you spend every year AND to maintain the real value of the investment after accounting for inflation, you will become poor sooner or later.
There is a link below to a simple Terms of Reference for wealth planning, aimed at those people who are in debt (Level 0 investor).
Its use is to write down your life wealth objectives and to begin a wealth plan. Although this is targeted at Level 0 investors (those with net debt) it is equally applicable to those who have not previously planned how their wealth is going to increase with time, be they Level 1 investors whose wealth is less than £50,000 excluding the property they live in, Level 2 whose wealth is between £50,000 and £500,000 or Level 3 whose wealth exceeds £500,000.
http://tinyurl.com/ydrmozr
So how is this going to help you?
In the MoneySavingExpert personal budget referred to in the Wealth Planning Template linked above, the baseline result was a family earning £3,517 per month, and spending £3,731per month (£215 more than income).
In the example below, the spending categories were separated into Essential (eg mortgage/rent, water, electricity, gas) and Discretionary (eg beauty treatment, dining out, etc).
When all of the Discretionary categories were considered, the example family decided on the following changes to monthly costs:
The result of a mild cost containment plan is a reduction of spending of £634.85 per month PLUS, a 100% increase in credit card debt repayments from £50 per month to £100 per month.
Priority
Not everyone will agree which spending categories should be changed, with priority, but it is important to first know where the money is being spent, then to make changes to the amount of that spend to achieve an objective.
Stakeholder agreement
It is also important that all stakeholders agree with the plan, and agree with the targets for spend reduction. In this family’s case, if they stick to their desired spend in all categories, instead of spending £215 more than they earn, they will spend £421 LESS than they earn, and have paid off an additional £600 credit card debt in one year.
What's the real goal?
That amounts to a cash surplus of £5,650 in the first year from a cash deficit of £2,580 the previous year. If debt interest was being paid at 10% of debt, that also reduces debt interest by around £560 per year. So the real gain is £6,210 in the year.
In section 6 of the work plan and milestones, it is stated that a saving of £6,000 per year was required to reach the goal of zero debt. Detailed planning and budgeting shows this is possible within one year.
Goals and Plans. What’s a Terms of Reference anyway?
Terms of reference, abbreviated as TOR, describe the purpose and structure of a project, committee, meeting, negotiation, etc. When used with regard to a project, they can also be known as a project charter.
Terms of reference show how the scope will be defined, developed, and verified. They should also provide a documented basis for making future decisions and for confirming or developing a common understanding of the scope among stakeholders. In order to meet these criteria, success factors/risks and restraints should be fundamental keys.
Creating detailed terms of reference is critical, as they define the:
• Vision, objectives, scope and deliverables (i.e. what has to be achieved)
• Stakeholders, roles and responsibilities (i.e. who will take part in it)
• Resource, financial and quality plans (i.e. how it will be achieved)
• Work breakdown structure and schedule (i.e. when it will be achieved)
They should include:
• Success factors/risks and restraints.
The terms of reference set out a road map. They give a clear path for the progression, by stating what needs to be achieved, by whom and when. There must then be a suite of deliverables which conform to the requirements, scope and constraints set out in this document.
So there’s the definition – it’s from project management parlance. In my humble opinion, wealth generation is a life project of continuous improvement, split into definite time periods, the beginning of which can be characterised by a starting plan date (eg. First two weeks of January 2010) and ending with a reconciliation date (eg. Last two weeks of December 2010) at which time you will compare the achieved results with the plan. Whatever the time period of the plan, the next plan should not be started before the results of the first plan have been evaluated to see how realistic your goals and plans were when you started.
To fail to plan is to plan to fail.
As Thomas Edison put it: “Many of life’s failures are people who did not realize how close they were to success when they gave up”
If you give up on anything too early, it’s unlikely you will be successful. In this series of articles, I am advocating an overall plan period of twenty years to move from no financial independence to total financial independence. Since most people spend forty years or more of their life in a job (which stands for Just Over Broke), it’s not too much to ask to spend some time taking stock of your current situation, making a plan, and setting about sticking to a plan.
If you are new to planning, don’t panic. Take it easy. You have twenty years to get on with it, or more if you don’t start NOW. It’s remotely possible that you will become wealthy without any planning or intention. People win the lottery - you have four times the likelihood of being struck by lightning than winning the first prize in the national lottery – about one chance in fourteen million. See the explanation of how likely you are to win the national lottery at this link:
http://www.murderousmaths.co.uk/books/BKMM6xlo.htm
You may inherit money from relatives who leave you a lot of cash in their will.
You may marry a rich partner who will promise that you obtain financial freedom.
But all of these remote possibilities would not guarantee financial freedom if you don’t know what your income and expenditure (spending) is today, or what it is going to be in the future.
The fact is, if your wealth (amount of money or assets) does not provide sufficient INCOME to cover what you spend every year AND to maintain the real value of the investment after accounting for inflation, you will become poor sooner or later.
There is a link below to a simple Terms of Reference for wealth planning, aimed at those people who are in debt (Level 0 investor).
Its use is to write down your life wealth objectives and to begin a wealth plan. Although this is targeted at Level 0 investors (those with net debt) it is equally applicable to those who have not previously planned how their wealth is going to increase with time, be they Level 1 investors whose wealth is less than £50,000 excluding the property they live in, Level 2 whose wealth is between £50,000 and £500,000 or Level 3 whose wealth exceeds £500,000.
http://tinyurl.com/ydrmozr
So how is this going to help you?
In the MoneySavingExpert personal budget referred to in the Wealth Planning Template linked above, the baseline result was a family earning £3,517 per month, and spending £3,731per month (£215 more than income).
In the example below, the spending categories were separated into Essential (eg mortgage/rent, water, electricity, gas) and Discretionary (eg beauty treatment, dining out, etc).
When all of the Discretionary categories were considered, the example family decided on the following changes to monthly costs:
The result of a mild cost containment plan is a reduction of spending of £634.85 per month PLUS, a 100% increase in credit card debt repayments from £50 per month to £100 per month.
Priority
Not everyone will agree which spending categories should be changed, with priority, but it is important to first know where the money is being spent, then to make changes to the amount of that spend to achieve an objective.
Stakeholder agreement
It is also important that all stakeholders agree with the plan, and agree with the targets for spend reduction. In this family’s case, if they stick to their desired spend in all categories, instead of spending £215 more than they earn, they will spend £421 LESS than they earn, and have paid off an additional £600 credit card debt in one year.
What's the real goal?
That amounts to a cash surplus of £5,650 in the first year from a cash deficit of £2,580 the previous year. If debt interest was being paid at 10% of debt, that also reduces debt interest by around £560 per year. So the real gain is £6,210 in the year.
In section 6 of the work plan and milestones, it is stated that a saving of £6,000 per year was required to reach the goal of zero debt. Detailed planning and budgeting shows this is possible within one year.
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