At the very surface level of constructing a financial plan, the journey can feel linear. We begin with what we have and plan to move towards an end goal of ‘having enough’ and being financially independent. But this is not where financial planning ends; it’s just the toe-dipping beginning as we gain courage and confidence to engage more with our financial planning.

It feels linear because financial independence has always been closely associated with retirement, and retirement has been seen as our final epoch. There are not simply two stages of financial dependence; there are several, and we don’t necessarily go through them all, neither do we all end up fully financially independent.

Life is a little like snakes and ladders – we can be moving forward (upward) on our chosen path until illness, divorce, or retrenchment changes our financial dependence status. Or we may have a windfall or unexpected success that boosts us up several spaces in our plan.

The importance is not in sticking to the linear journey but in creating check-in points to mitigate stress and measure success according to our personal milestones. 

This gives us the freedom to make choices that might move us up or down a level in our financial dependence – like extending our bond to buy a larger house, or turning down a better job offer to spend more time with our family.

Understanding different levels of financial dependence helps us with the framework of our financial plan.

Dependence is where many of us start. At this level, our lifestyle depends on others for financial support. Support from parents, needing to spend more than we earn, or if our debt payments (credit cards, personal loans, student debt) exceed our income, are all common at this level.

Solvency is the ability to meet our financial commitments. We reach this level when our income exceeds our expenses and when we are no longer accumulating debt. We are fully able to support ourselves with our income.

Stability is a stage of financial dependence where we have no credit card or personal loans, have established an emergency fund, and are growing our asset base.

If we can keep growing our wealth, we will start to have free agency, meaning that we can work and live how and where we want. Typically, we will have eliminated all debt (including property loans), and have enough savings and invested assets to have the confidence to quit our job at a moment’s notice.

After this point, we now have a certain level of financial independence. We have financial security when our investment income can cover basic needs for the rest of our life. It’s not about luxury or comfort; it’s about financial security to have all the basics covered.

Full financial independence is a stage in life where we can fund our chosen standard of living for the rest of our lives. You can afford the basics and some comforts too. This is what many term as “having enough”.

Abundance is a rare stage where we have enough — and then some. We can share our wealth with others or indulge in luxury.

Remember, these are levels of financial dependence and not levels of happiness or peace of mind! They are purely a helpful way to frame where we are on our financial journey but do not make our journey wrong or right, or complete or incomplete.

“How much should I be charging my clients?”

This is a common question as we work with an increasing number of people setting up their own businesses. In the wake of a radical economic downturn, our creativity and necessity to generate an income spark new business ideas. The entrepreneurial spirit begins to take centre stage in the micro economy, and we have an awesome opportunity to create value for others.

And this is how we answer the question. Because it’s not about the fees, it’s about the value.

In our own industry, we’ve learnt that our fees should be linked to our value proposition. Whether you’re talking about products or professional services, there needs to be some benefit or value to the end-user. This benefit is measured by the difference that the product or service provider will make for the consumer.

It sounds like a simple formula, but it can get fairly complex. We need to consider factors like experience, expertise and the need for the product or service that we’re providing.

There’s an old story of Pablo Picasso, who, at the height of his fame and influence as an artist, was asked by a fan to sketch something for him. This happened when Picasso was out for dinner at a restaurant. 

The fan gave Picasso a napkin to sketch on and said he would pay for the sketch. In fact, he supposedly said to Picasso, “Name your price.” Picasso took a charcoal pencil from his pocket and quickly drew the image of a goat.

He then said to the fan, “That’ll be $100 000.” The fan was astounded, saying, “But that only took you 30 seconds to draw.” Picasso then crumpled up the napkin and stuffed it into his jacket pocket. “You are wrong,” he said. “It took me 40 years.”

Another way of looking at this concept is to remind yourself that it’s not the hour you spend in that meeting with your client; it’s the years of experience you bring to that hour. Or, it’s not the price tag of the widget you’re selling; it’s the hours of frustration it will save your customer – or the hours of joy it will bring them!

When you start a new business, you will have a learning curve where you will need to adjust price, service, experience – all of it, but remember that it all starts with confidence in your value. It starts with being confident to charge what you believe you’re worth. Price influences our perception of value. Experience confirms it.

As a rule of thumb, always start higher. It’s easier to negotiate down than to negotiate up, and, if you need to, you can always walk away if they aren’t willing to pay you what you’re worth.

Have you ever gone down the #Fintwit rabbit hole? According to fintwit.ai, #Fintwit is a vibrant community of investors on Twitter, who tweet trading ideas, active trades, personal portfolios and well thought out insights about financial securities. Millions of investors around the world are increasingly using Twitter to stay abreast of the financial market and make informed investment decisions.

This financially savvy community is almost as popular as the #BTC (bitcoin) and #crypto communities who are determined to be the next billionaires from investing in cryptocurrencies. They create boundless content on how to best the systems and one could easily spend days scrolling through all of the tweets.

The challenge with these strongly supported content-creating communities is that they have enormous influence and create the perception that investment planning and management is the main (or only) focus of financial planning. The reality is that investing is just one area of about six.

Financial planning is more about managing behaviour than managing money. This is why the first area is cash flow management.

CASH FLOW MANAGEMENT

Some people refer to this as budgeting or a spending tracker. Ultimately, the goal is to have an enlightened conversation about where your money is going every month. Once we know that, we can plan how we can protect your assets and grow your assets.

RISK MANAGEMENT & PLANNING

From a financial perspective, we typically look at the different assets that need protecting; from your personal health to your income, accumulated savings and investments, this is a list that will keep changing throughout your life. Risk planning falls into two categories – your short term and long term risks. 

INVESTMENT PLANNING

Your accumulated savings are great for emergency funds and rainy-day savings, but for long term growth with the benefit of serious compounding interest, we need to plan on how you invest your wealth. This is all about growing your wealth and allowing your money to work for you. This is where the #Fintwit bunch are always abuzz with ideas – but at the end of the day, you need a person who you can trust and lean on to keep you committed to your investment plan.

TAX PLANNING STRATEGIES

As your wealth grows, your tax liabilities will increase. Optimising your portfolio becomes a necessary discussion in order to reduce the amount of money you will have to pay to The Man. There are loads of strategies to legally protect and grow your wealth without eroding it to tax.

RETIREMENT PLANNING

In a nutshell – this is a sum of money that will help you rely less on income generation later in life. It doesn’t mean you have to stop working, or stop adding value – it just means that you are working to create more freedom for yourself so that you don’t have to work every day in order to pay your monthly bills and finance the lifestyle that you’d like to live.

ESTATE PLANNING

All of this asset building, combined with your risk portfolio, creates value in your personal estate. It doesn’t have to be millions; whatever you’ve built will be taxed when you pass away. To plan for this and reduce that tax liability and associated fees, estate planning ensures that your loved ones will have access to most of what you’ve been able to provide for them.

These are the most common areas of financial planning: cash flow management, risk management, investment planning, taxing planning, retirement and estate planning. They create the starting blocks for our conversations to help you manage your behaviour to ultimately manage your money better.

How do you decide on the better of two products you are not really familiar with or can’t visually tell the difference?

For example – I had to buy a new cellphone charger the other day, and there were two options – one was two-thirds the price of the other, but both were reasonably priced (according to my limited experience of buying chargers!).

I went with the more expensive one because the price tag convinced me that it would be the better choice. If I knew the industry, I would probably know that they were both made in the same factory in some far-off land – but the higher price convinced me of higher value.

You’d probably do the same. It’s the same with buying a car, paying for food at a restaurant, purchasing new shoes and just about everything else that we pay for. Price skews our perception of value.

It’s also the same for investment fees. Sometimes we can assume that the higher the fee, the better the return.

But – as we can see in the graph above, this is not the case for long-term investment strategies. Over time, fees can erode over 60% of our final portfolio value. That’s why, when it comes to hard and fast rules for fees and certainty in investing – they simply don’t exist.

However, we can say that in most cases, lower fees lead to higher returns.

As Occam Investing wrote in a recent blog, “There are no such things as laws in investing.”

When it comes to markets, we can never share the same level of certainty as we do in Newton’s laws of motion.

Trying to prove something in investing is like Newton trying to prove gravity exists in a world where sometimes things are pulled towards each other, sometimes they aren’t, sometimes the opposite happens, and sometimes something invisible comes out of nowhere and throws everything around a bit.

To make matters even more difficult, the environment in which we’re operating is always changing. Newton was able to prove gravity existed because the laws of physics never changed – he was able to run experiments while keeping everything else constant. But markets are always changing.

Investors can never really be sure of anything – we’re left to make the best of unprovable theories and confidence levels while navigating an environment in constant flux. But no matter how much changes in markets, no matter how many theories you choose to place confidence in, one thing will remain true regardless of approach.

All else equal, lower fees will result in better performance.

And although all else isn’t always equal, both the theory and the evidence show that the best and most consistent way to increase returns is to reduce fees.

This is a powerful conclusion for investors. While so much of what happens during our investing lifetime is outside our control, how much we pay for our investments is very much inside our control.

Given that the amount paid in fees is a great predictor of performance in investing, focussing on reducing fees is the most reliable way investors have to increase their odds of investing successfully.

If you’d like to read more of the technical analysis of this conclusion from Occam Investing in the UK, you can click here.