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Developing a Financial Plan

Developing a financial plan and an investment strategy are closely bound up together. Financial planning is the process of recording one's assets, liabilities and investments. Investment strategy is the process of establishing one's financial goals and objectives. Since there are so many investment vehicles to chose from (for example, mutual funds, stocks, bonds, and guaranteed investment certificates ("GIC")) it is essential to learn which investments offer the most attractive rates of return given an individual's specific needs, goals and objectives.

Rates of return vary with the type of vehicle chosen. It is important to understand the kinds of returns that Canadians have been used to , and the kinds of return that the different vehicles offer. This ensures that an investor's expectations are realistic. The financial planning process should be include a "needs analysis". The investment planning process should result in some specific investment strategies. It is also important to develop a financial plan and investment strategy that take advantage of Canada's strong economic position in the G7. The fundamentals of the Canadian economy currently look bright, and the longer term prospects are also very promising. The value of a sound investment programme must be put in the context of this positive outlook. Essentially, a strengthening Canadian dollar accompanied by a low interest environment and a low inflation environment lay foundation for continued slow steady growth. At each stage of an economic cycle there are specific investment opportunities, strategies and risks that need to be considered.

Once the risks the investor is willing to take are identified, the investor can identify his or her long term and short term goals. The long term goal for most Canadians is to maximize their RRSP savings. A great deal of discussion has recently focused on the fact that there will be inadequate funds from the government to supplement the retirement needs of Canadians.  How a portfolio is invested, therefore, will be very important. Juxtaposed to the long term needs of retirement is the need for real estate. Most Canadians have a mortgage to worry about. mortgage and RRSP requirements reinforce the importance of a financial plan.

Many people do not know how much they are worth, since they fail to realize the debt levels they have accumulated - for example, in mortgages, car loans, credit cards, and money borrowed to set up a business or to make investments. Once people understand what they are actually worth they understand the importance of establishing specific goals and objectives. A net worth statement will also show the assets and specific ownership of these assets. The financial plan highlights what amount of liquid cash is available, what amount is in short term investments and what amount is in long term investments (such as shares and bonds). A net worth statement is one aspect of the financial plan. itemizing daily expenses and yearly expenses in another. ideally, the earnings capability of an individual or family should match their expenses. If not, lifestyle changes should be implemented in order to reduce expenses. Moreover, early retirement is an option which more and more Canadians would like to have open to them. to ensure adequate funds are available for early retirement, some portion of an individual's salary must be regularly put aside.

The next step in the investment process is to evaluate an investor's short-term and long term goals. This is called "life cycle investing". As a general rule, different investments appeal to different age groups and different income levels. Up to age of 35, an investor is starting a career and building net worth. Cash is usually required to buy the first house and pay mortgage. If excess funds are available, the RRSP should be the main priority. At this age, growth is the main objective to building wealth. Up to age of 55, expenses usually decline as income and saving increase. With additional discretionary income, the main objective is capital appreciation and minimization of tax in the peak earning years. the main priority is to build a retirement nest egg. A balanced portfolio will have appropriate mix of bonds and shares. In the peak earnings years and the retirement years, safety becomes increasingly important. The main priority tends to be fixed income since no income is coming in. Some equity exposure is still important to protect purchasing power against its erosion through inflation.

The real question is how to increase net worth. The following are suggested guidelines:

1. establish a time horizon - how many years until retirement;

2. Establish a comfort level with different types of investments;

3. Put aside money from salary - establish a regular investing programme;

4. Reduce debt - regular payments on mortgages or loans increase net worth and reduce loans;

To build wealth there are four main issues which need to be addressed:

1. Rate of return expectations should reflect the degree of risk;

2. Time to compound;

3. Initial investment;

4. Timing of investment programme including regular contributions to RRSP.

Establishing financial goals at each age is important since goals and objectives change as income levels change. there are three main groups of investors:

1. those requiring income and safety of principal;

2. Those requiring some growth with income and safety of principal;

3. Those requiring growth.

Each category has a different time frame. The investor with excess cash after expenses will generally want long term investments. The investor requiring income may have insufficient funds to invest for the long term. It is a good idea for investors to define their level of financial security - what amount of income provides financial security? Will $75,000 or $100,000 provide financial security? If for example, an investor wants $60,000 of income annually then he needs to have assets of $750,000 yielding 8% annually.