One of the most overlooked yet important elements of financial planning centres on expenditure. Very few of us know exactly what we spend, so investing a little time in calculating this, may be one of the best investments you make. It can be an enormously informative exercise to explore the cost of your lifestyle and how these costs may change over time. Looking to see how sustainable your lifestyle is over the long term means stress testing your personal balance sheet.
Fixed expenditure such as mortgage payments, school fees, and insurance premiums are easily identifiable, and are the ones that you likely have very little control over. However, it is the estimated costs of variable expenditure that pose the biggest challenge. Variable expenditure is much harder to track and represents your spending on such things such as holidays, cars, clothes, houses, and in time, long-term care. The combined cost of paying for these items (fixed and variable) is broadly the cost of being able to maintain your standard of living.
Why is this so important?
In order to conduct a Cash Flow Planning exercise and test the sustainability of your income and assets (both liquid and illiquid) throughout your assumed lifetime, the cost of maintaining your current - or desired - lifestyle is the crucial starting point. Moreover, carrying out a detailed expenditure analysis will form the bedrock of a cohesive Financial Plan, informing and educating you, and possibly also influencing your future investment decisions.
Whilst no one has a crystal ball, a Cash Flow Planning exercise allows you to make use of financial projections to assess what your financial position may look like at different points in time. This exercise is based on a number of pre-agreed assumptions and can highlight the likelihood of your liquid assets running out, and the point in time that this might occur.
In addition to providing a guide to your future financial position, this exercise will also bring to the fore other issues that you may not have previously considered, such as:
- Will your net business sale proceeds be sufficient to match the salary and dividend drawings that you were taking before you sold the business?
- If your liquid assets run out, which illiquid assets will need to be realised and how long will they last?
- What level of cash flow is sustainable?
- What is the likely value of your estate at death?
- Can large capital sums be gifted to loved ones during your lifetime without impacting your desired lifestyle?
- Can regular gifts be made to children?
- On death or should you contract a critical illness, will there be enough income and assets to sustain your family’s standard of living for the remainder of their lifetimes?
Once we have carried out a full expenditure analysis and stress tested your current situation, you will have a better understanding of whether your income streams and assets are sufficient to support your lifestyle over your projected lifetime. Those who have previously undertaken this exercise generally fall into three categories:
- More than enough assets to support desired lifestyle;
- Not enough to support desired lifestyle – projected to run out of money in year XXXX; or
- Just enough assets to support desired lifestyle.
After carrying out the initial cash flow and stress testing analysis, we will be able to provide Financial Planning advice based on all of the issues and touch points identified – whether this is Investment Structuring advice, Protection, Estate Planning, school fees planning or, as is common, a combination of all the above.
The outcome may be more or less as predicted, or it may turn out to be very different from the projection. For this reason, it is advisable to periodically test the projections against reality and to ‘recalibrate’ where necessary.
At HSBC Private Banking, our Strategic Financial Planning team works with our clients and their advisors on a range of Financial Planning areas from Cash Flow Analysis and Investment Structuring to Business Exits and Estate Planning.
Why not contact your Relationship Manager or Investment Counsellor to arrange a meeting to see how our Planning Specialists might be able to help you?