What kind of information do you need to create the cashflow model?
At a very basic level, your current assets, debts, pensions, income and expenditure. Lots of these will be estimates, but the better the data, the more confidence we have that the model gives a reasonable picture.
So, the more accurate the information, the clearer the report…
Yes. It’s pretty common for people to say they have household income of, for example, £150,000 per year before tax, so maybe £80,000 after tax. And they might say they spend about £50,000 per year, which begs the question: where is the other £30,000 going? Often, the spending is under-estimated, but it may be going into ISAs and pensions already – asking these questions helps improve the model.
Also, knowing when there might be changes to income and expenditure is important, particularly when we’re working towards financial independence, meaning you no longer need to work to support your lifestyle financially.
How do you use the cashflow model as part of the financial plan?
I guess I tend to use cashflow modelling and financial planning interchangeably. In reality, the cashflow modelling helps give an indication of how much needs to be saved or invested each year and the most efficient ways of putting money into investments and drawing it back out. It also illustrates how saving and investing is going to support your long-term prosperity, making it easier to hold the course in more difficult times.
Cashflow modelling on its own can’t tell us what your goals are, often a little coaching from a good financial planner is needed to help figure these out.
For more information read our article: When Will I Need a Financial Planner?
So, what does cashflow modelling tell us?
It can tell us whether your goals are realistic. Based on the information we have; can they be achieved? And it can give us the information we need to make your financial plan more effective. It can also tell us if you are being over-cautious. For example, could you potentially spend more or retire earlier or work less without needing to worry?
And I’ve heard you mention “what if” scenarios? Can you explain these?
A “what if” scenario is where we change what happens in the plan. Showing you what you are doing now and comparing the outcomes to what would happen when there’s an unexpected event.
For example, what would happen if one of you dies or is unable to work? This can help to inform what level of life insurance or income protection might be needed. Which in turn helps you understand the purpose of the insurance, so you feel the premiums are worth paying.
We also look at what might happen if the value of your investments suddenly crashes. Again, this can help you stay the course in case of a fall in the markets.
Can you give me an example of cashflow modelling creating a positive outcome for a client?
Using cashflow modelling as part of the financial planning process, we have recently advised a client he can take his final salary pension earlier with no penalty. Ultimately, this meant he could partially retire (he didn’t want to stop working completely) and start drawing a chunk of his pension. He reduced his work by a third, but his overall income increased! This gave him time to pursue more interesting projects.
A lot of the benefits of cashflow modelling aren’t specific and tangible. It’s about giving comfort, confidence and understanding of the plan, so you feel what you are doing is right. Knowing you are on the right track, and unlikely to run out of money, gives you the space and freedom to enjoy your money and your life.
We discuss cashflow modelling in an episode of our podcast, The Century Plan, which you can listen to here:
