Financial modelling is a tool that helps you plan for your financial future. Like your Sat Nav alters your route to account for unexpected traffic, so your cashflow model should change regularly, with your input, to take into account changes in circumstance, aspiration and other factors.
Don’t run out of money before you die
Financial modelling (also known as cashflow modelling/lifetime cashflow) is the system of determining in financial terms where you are now and where you want to be in the future. The modelling tool takes into account details of assets & incomes as well as expenditures. It factors in possible growth or depreciation of assets and change in expenditure, based on lifestyle requirements.
In short, it is a tool that allows you to make clear plans, define possible retirement dates and make sure that you don’t run out of money before you die or die with too much money.
It sounds brilliant. But there can be problems: Used correctly, it is a very powerful tool. But misuse it at your peril – and some people (even some financial advisors) do use it inappropriately.
What can go wrong
Over-optimism is frequent problem, particularly for those who elect to go it alone without the help of a qualified financial advisor. To me this is about as daft as deciding to try to fly a plane from Cardiff to Edinburgh without first training as a pilot. The DIYers are often prone to re-arranging the figures to suit the outcome they want rather than accept that the figures are indicating a problem that needs to be addressed.
It’s very easy to forget to include certain data. When considering growth of assets, I recommend being extremely conservative. The same goes for inflation. I suppose it’s human nature to err on the optimistic side, but that doesn’t do you any favours down the line when the plan is adrift in terms of earnings.
You are in the driving seat
The whole point of financial modelling is that it puts you in the driving seat. It’s not just a question of this fund is better than that fund or one investment is better than another but more a matter of having intelligent conversations with your financial advisor about the future. Of course, this means you have to hold yourself to account in terms of the figures you have input and be honest with yourself about things like expenditure.
Revisiting your financial model is something that should happen at least every year. A good advisor will be able to ask the right questions to determine any changes that need to be made before the numbers are recalculated.
Here are three things to remember:
- Financial modelling isn’t an add-on to financial planning, it is an essential part of it.
- When you engage with it, be honest and conservative.
- Make sure you revisit it regularly, preferably with the help of a qualified financial advisor
If you have never come across the concept of financial modelling and you’d like to know more, please get in touch and I’ll be happy to help. Thanks for reading.