Budgeting is a great starting point for getting your finances sorted out. After that, though, it requires longer-term planning – the kind that involves making assumptions about the future, from your kids’ university fees, to buying a holiday home and your ideas for retirement. This can be done through cash-flow modelling which will enable you to plan to meet your financial objectives. Andrew Talbot of Avrio Wealth, tells us how.
What it’s all about
Cash-flow modelling shows your current position relative to your preferred position and your goals by assessing your current and forecasted wealth. It looks at income inflows and expenditure outflows to create a picture of your finances – now and in the future. This detailed picture of your assets includes investments, debts, income and expenditure, which are projected forward, year by year, using calculated rates of growth, income, inflation, wage rises and interest rates. Here’s a closer look at two aspects of this approach:
#1 Having the right asset allocation
Cash-flow modelling can determine the best course of action for your particular situation, lifestyle and spending, and direct you to the right asset allocation mix. The growth rate you require is calculated to meet your investment objectives. This rate is then cross-referenced with your attitude to risk to ensure your expectations are realistic and compatible with the asset allocation needed to achieve the necessary growth rate.
Where cash-flow modelling becomes particularly useful is the analysis of different scenarios based on decisions you may make – this could be lifestyle choices or investment decisions. By matching your present and expected future liabilities with your income and capital, recommendations can be made to ensure that you don’t run out of money.
#2 How much to save, spend and invest
A snapshot in time is taken of your finances. The calculated rates of growth, income, tax and so on that are used to form the basis of any cash-flow modelling exercise will always be assumptions. Nearly all decisions are based on what is contained within the cash flow, from how much to save and spend to how funds should be invested to achieve the required return, so there is a lot that needs to be managed.
Important tip: Run through the numbers
With every financial corner you turn, it’s important to be specific and look at the numbers. They will help you make the right financial decisions. It’s not sufficient to say, “I want to have enough to retire comfortably”. You need to think realistically about how much you will actually need – the more specific you are, the easier it will be to come up with a plan to achieve your goals. If your needs are not accurately established, then the cash flow will not be seen as personal, and therefore you are unlikely to perceive value in it.
Some years, there may not be any change – or just some small tweaks. However, in other years, there may be something significant; either way, you will need to ensure things are up to date. That way, you’ll also have peace of mind knowing your plans are on track.
Since assumptions about aspects such as inflation and growth rates have been made, the cash-flow model is only as good as the information provided, so it’s critical that it is reviewed.
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