Topic 4
Monitoring and adapting personal
financial plans
Learning outcomes
After studying this topic, students will be able to:
◆ understand the need to monitor personal budgets and adapt plans in
response to changes in circumstances;
◆ explain how to monitor variations in a personal budget (ie budget variance);
and
◆ identify how personal financial plans can be adapted to respond to changes
in circumstances.
Introduction
In this topic, we return to the concepts of personal finance budgeting, cash-flow
forecasting and flexible financial planning, which were introduced in Units 1 and 2
(CeFS) and revisited in Topic 1 of this unit. After briefly recapping the essential steps
that an individual needs to take when first starting to plan their finances accurately,
we will look at the importance of regularly monitoring personal finances, comparing
expected income, expenditure, saving and borrowing with actual figures, and
amending current and future financial plans.
4.1 Establishing clear, measurable objectives
Before drawing up a financial plan, you need to know yourself – ie you need to have
a good idea of your own needs, wants, priorities, attitudes and aspirations, so that
you can develop a personal financial plan that reflects your own personality and
situation. You need to be aware of any financial constraints that cannot be changed,
because you will have to work around them. You also need to think about where you
are in the life cycle and what life events you may encounter.
The next step is to think carefully about your financial objectives. This may mean
deciding how important it is for you to earn the highest income that you can. Are
you prepared to work in a demanding, high-pressure job, working long hours to earn
a high income? Would you be willing to manage on a low income for several years
while studying for whatever qualifications you need to pursue a highly paid career?
Not everyone wants a highly paid job; it is important to understand what is important
to you when you are planning your financial future.
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Or are you more concerned about your quality of life? Are you prepared to earn a lower
salary if you are able to do a job that you really enjoy or one that you find satisfying
and rewarding in non-financial ways? What, in other words, is your attitude to the ideal
‘work–life balance’? Answering this question should then allow you to decide what kind
of financial targets and clear, measurable objectives you can realistically expect to
achieve, and over what time span you might be able to achieve them.
Figure 4.1 Work–life balance
Financial
stability and
security
Health and
well-being
Life
experience
and
adventure
Work-life
balance
Personal
development
and growth
Relationships
with family
and friends
Job
satisfaction
and career
development
Hours of
work and rate
of pay
Levels of
responsibility
and
autonomy
4.1.1 Attitudes to financial planning
The following are some questions that individuals can ask themselves to work out
their attitudes to financial planning and so what characteristics their personal
financial plan should include. These characteristics will apply whatever their level of
income and expenditure, but may lead to different financial objectives for those with
lower or higher levels of income and wealth.
a) What are your main needs and wants in life?
Are you satisfied with a basic level of consumption or do you like your luxuries?
Do you have any particular needs or strong wants that you feel you must finance
whatever happens?
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b) What is your attitude to spending money?
Are you easily tempted into making purchases or are you careful? When you want
or need something, do you feel a strong desire to have it now, or are you willing
to wait until you can afford it?
c) What is your attitude to saving?
Do you feel safer if you have a bit of money put away? Do you feel tempted to
spend the money that you have saved, or does it give you satisfaction to see
your savings growing?
d) What is your attitude to borrowing and being in debt?
Does it bother you if you owe money? Do you worry about how you are going to
pay it back, or do you see it as a normal way of affording something that you
could not buy otherwise?
e) What are your aspirations?
Do you hope to improve your standard of living as you get older? Are you
impatient to start earning as much as possible, or are you willing to invest time
in further or higher education, or in training, such as an apprenticeship?
f) What is your attitude to risk?
Are you happy to risk your money, even if you do not have much, in the hope of
gaining more? Or does it worry you to think that you might lose what you have?
4.1.2 The steps involved in drawing up a budget
The steps involved in drawing up a budget are as follows.
1. Identify and list all sources of income.
These sources include wages, allowances from parents or guardians, state
benefits, interest on savings and investments, and money received for birthdays
or other celebrations. It is helpful to list regular wages separately from wages
that are earned less frequently. This makes completing a cash-flow chart easier.
For example, students may wish to list wages from a regular part-time job
separately from wages earned during the holidays. People in full-time
employment may prefer to have one entry for their regular salary and other
entries for overtime, private jobs (eg an electrician or plumber doing extra jobs
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at the weekend or a teacher doing private tutoring), or income from selfemployment (running their own small business in their spare time, trading on
eBay or at car boot sales, etc).
It is important not to guess at these figures – your guesses may be wildly
overoptimistic or far too pessimistic, both of which will greatly affect your budget.
Few of us can remember exactly how much income we received last month, let
alone last year, so it is best to gather together whatever bank statements (current
accounts and savings accounts), payslips, business accounts, etc, you may have
and to work out your weekly or monthly income as accurately as you can. If you
have not been in the habit of keeping these income records until now, you must
make sure to do so from now on.
2. Identify and list all items of expenditure.
It is helpful to list all mandatory items first and then the optional items. This
makes it easier to see what spending must be met and what you might change
when you are using the cash-flow chart to manage your funds. Once again, you
cannot rely on guesswork, or expect simply to remember how much you spend
and what you spend it on. To compile an accurate assessment of your
expenditure, you have to keep a record of what you spend – ideally, every day.
Bank account statements will help you to identify the regular payments going out
by direct debit and standing orders, and credit card statements will similarly detail
how much you spent, where you spent it and what you spent it on. You should
keep receipts for purchases that you make using cash, debit cards and cheques.
Figure 4.2 A five-step cash-flow plan
5.Total income + total expenditure
= Surplus/deficit/balanced
4.Compile the cash-flow chart
3.Decide on the cash-flow planning time period
2.Identify items of expenditure
1. Identify sources of income
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3. Decide on the time period that you will use in the cash-flow chart, eg a week or a
month.
It is useful to choose the length of time between receiving your regular sources
of income. So a student who receives a weekly allowance may use a week as the
time period, whereas someone with a full-time job who is paid monthly will use
a month as the time period. Your cash-flow chart should comprise enough
columns for you to record incomings and outgoings over both the short and
medium terms. How many of your chosen time periods you choose to include will
depend on your own preferences: some people find it very difficult to plan more
than three months in advance, while others are comfortable with a year. (This is
discussed in more detail below: see section 4.2.2.)
4. Fill in the figures for all of the various income sources and types of expenditure
in the cash-flow chart.
Some items of future income and expenditure may be uncertain at the moment,
eg wages from a seasonal job picking fruit, or how much next summer’s holiday
is going to cost. Make a realistic estimate for these items for now and add this to
your chart, but make sure that you keep a record of how much you actually earn
and spend, because this will allow you to make more accurate estimates in the
future.
5. Now you can calculate the total income and total expenditure for each time period.
Write the figures in the appropriate fields and calculate the balances to see
whether your cash-flow forecast is predicting a surplus (ie income more than
expenditure) or a deficit (ie income less than expenditure).
4.2 Monitoring your financial plans
Once they are firmly established, it is vitally important that you monitor your financial
plans to check how closely real life matches your income and expenditure forecasts
as you live through the time period of your plan. Keeping weekly, or even daily,
records of your actual income and expenditure allows you to compare the income
received with the sums that you were expecting and what you are actually spending
with what you planned to spend. The difference between the expected and actual
figures is known as the ‘budget variance’.
But simply identifying and measuring budget variance is not, in itself, going to help to
keep your plans on track. The key to effective monitoring is to analyse the cause of
the variance: if your plans project a monthly surplus of £200 (which you plan to save),
but in reality you regularly end the month £100 or more overdrawn, you need to find
out why. Have you overestimated your income or underestimated your expenditure in
any way? If it is an income shortfall, what has been its cause, eg is actual overtime
worked less than you forecast it would be? If you have overspent, on which items of
expenditure have you spent more than you planned? Has the variance been caused by
a change in an external factor – perhaps higher inflation or lower interest paid on your
savings? Being aware of these variances should make you consider how to amend your
budgetary plans in order to make your forecasts more realistic.
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In the short term, if daily or weekly monitoring of your expenditure reveals that you
are spending much more than you have estimated, say, on petrol, you have the
opportunity to analyse why this is happening: have petrol prices gone up or are you
driving more than expected? You can then correct the problem – in the short term, at
least – by driving less, or by finding a petrol station that sells fuel at a lower price, or
by accepting the higher spending on petrol and reducing what you spend on something
else. If you have been thinking about buying a new car – perhaps part-exchanging the
old one for a newer one – it would help you to reduce the cost of running a car if you
were to make sure that the next car you buy is more fuel-efficient than the last.
4.2.1 Methods of monitoring
The simplest way in which to monitor your budget is to keep receipts for all of your
purchases and use them, together with bank account statements, to keep a written
record of your income and expenditure, writing the actual figures in a column next
to your forecast figures on your cash-flow forecast using a spreadsheet program
(such as Excel). With a spreadsheet, you can enter the projected and actual income
and expenditure data into the relevant boxes; if you have set up your spreadsheet
well, it will then automatically calculate totals, sub-totals, balances and variance.
In recent years, increasing numbers of people have taken advantage of new ways of
managing and monitoring their finances using the many specialised personal finance
planning computer programs, online services, or smartphone and tablet apps that
have become available – many free of charge. These make it even easier to monitor
actual income and spending, and to compare – even on a daily basis – the actual
figures with those forecast.
Popular software, online websites and apps include:
◆ free online planning tools, such as:
−
the free budget planner offered by the government-funded Money Advice
Service (MAS), online at www.moneyadviceservice.org.uk/en/tools/budgetplanner;
−
Money Dashboard, online at www.moneydashboard.com;
−
the Debt Advice Foundation budget planner, which you can download from
www.debtadvicefoundation.org/debt-tools/budget-planner; and
−
Money Saving Expert’s budget planner, online at
www.moneysavingexpert.com/banking/Budget-planning;
◆ paid-for online planning websites and apps, including:
−
You Need a Budget, online at www.youneedabudget.com;
−
Moneydance, online at www.moneydance.com; and
−
Goodbudget, online at www.goodbudget.com.
These and other similar systems allow you to manage and monitor your finances
‘live’ online; some will sync your financial information through wi-fi connections, so
that it is available on different platforms (ie PC, smartphone and tablet). This enables
you, for example, to use your phone when you are out shopping to update your
record of actual expenditure every time you make a purchase.
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Each system or tool is designed to be user-friendly and easy to use, and they do not
require any previous financial knowledge. There are usually comprehensive
instructions and ‘how to’ video tutorials available to help you to understand how
they work, and some also offer online advice and support, as well as contact with
other users through online forums and social networking sites.
Tara gives Money Dashboard a try
Tara wanted a way in which
she could organise and
monitor
her
personal
finances, so she signed up
with Money Dashboard, a
free
budget
planning
website and phone app.
After inputting her basic
personal information, she
was asked for the details of
any
current
accounts,
savings accounts and credit
cards that she wanted to
add to the system. She was reluctant to reveal her username, password, account
numbers and other private bank details at first, because she was worried about
the dangers of identity theft if the information were to fall into the wrong hands.
But searching the internet for information about Money Dashboard did not bring
up any criticisms of the site or warnings about using it; in fact, the only
comments that she found confirmed that the site is at least as secure and well
protected as bank websites. All of the providers with which Tara had accounts
were willing to link those accounts with Money Dashboard, which gave her more
confidence that it was a secure system.
After uploading the required information, Money Dashboard established links
with Tara’s current account, savings account and two credit cards. She was
immediately able to see all payments into and out of the accounts over the past
month. More importantly, the transactions were allocated to different categories
(some tagged automatically, while she had to allocate others to categories
herself using simple drop-down lists), which allowed her to see exactly what she
was spending her money on.
Shortly after opening a Money Dashboard account, Tara received her first weekly
email, detailing her income and expenditure during that week, and updating her
on the current balances in each of her accounts. It was not long before Tara
realised that she was spending far more on her regular visits to the supermarket
(using her credit card) than she had thought, which prompted her to find ways
in which to reduce this area of spending (such as cutting out unnecessary
purchases or shopping around for the best deals).
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4.2.2 Keeping an accurate record of the plan
It is important to keep accurate records of your financial plans. Different people will
do this in different ways and each will come across some problems from time to
time.
◆ Organised people – ie those who always keep receipts and other financial
documents, and who keep records of how much they earn and spend – will not
find it hard to compile detailed financial cash-flow plans, whether they use one
of the financial apps listed, simpler budgeting spreadsheets, or even simply a
pencil and paper. As they live through the time periods for which they have
planned, these people will record the actual amounts coming in and going out.
This will highlight which planned amounts were unrealistic and need to be
changed. Revising figures will be a normal feature of these people’s budgeting
and will show them clearly the need for flexibility in the plan. People like these,
who use detailed information in their plans, are in control of their finances.
◆ People who are less organised may simply jot down a few figures on the back of
an envelope every week or month to see how much they have spent and how
much money they have left until they receive their next allowance or salary
payment. Others will work out roughly what they are likely to spend in the coming
month (based on a vague idea of what they spent the previous month) to see
whether their income will be enough to cover their expenditure, preferably with
a potential surplus at the month end. Some planning is going on here, but it is
not very detailed and leaves quite a lot to chance.
◆ People who do not forward plan may do only a few mental calculations – or they
may simply check their current account balance when they think of it, or when
they need to use their debit card to withdraw cash or pay for an item. Some will
simply keep using their debit card until a card payment is refused because they
have used up that month’s money. This approach to personal financial planning
is very ‘hit and miss’. There is no planning for emergencies – or even foresight
that they will occur – so these people have to do a lot of ‘firefighting’ (ie they
simply deal with problems as they arise).
Drawing up an accurate
financial plan involves
keeping a record of
income and expenditure.
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4.2.3 The ‘envelope’ method of budgeting
A traditional method of budgeting – dating back to the days when the majority of
people were paid in cash and did not have bank accounts – is the ‘envelope’ method.
The idea is that the individual will set aside a number of envelopes and on the front
of each write the name of a different bill or other item of expenditure (over the short
or medium terms), along with the average monthly payment. When the individual
receives some income (eg they get paid), they will divide the available money between
the envelopes; if there is sufficient money, enclosed in each envelope will now be
enough to pay for the item of spending detailed on its front. When the time comes
to pay each bill, the money is taken out of the appropriate envelope to pay for that
bill. If there is money left over after all of the available cash has been allocated, the
surplus is then used to cover ‘pocket money’ spending and unexpected bills. This
system should therefore stop individuals from spending money that they will need
to pay their bills.
While there are probably few people
who still use cash and real envelopes,
some banks and building societies (eg
Barclays and Nationwide) and most
credit unions allow you to open multiple
savings accounts that can each be given
a different name, eg ‘holiday fund’ or
‘emergency fund’. You can choose how
to label these accounts in such a way
that they become ‘virtual envelopes’
into which you can transfer money
yourself (either in branch or online) or
automatically, by setting up regular
standing orders from your current
account.
Rent
ity
Electric
Supermarket
Savings
Bus ffare
Treats
Envelope budgeting developed when most
people were paid in cash but can be adapted for
electronic banking.
Many of the personal finance websites
and phone apps mentioned earlier in this topic (see section 4.2.1) are also based on
the same method of allocating available money to virtual ‘envelopes’, ‘pots’ or
‘buckets’ (the terminology varies). With the benefits of technology, the system can
reassure the user that there is enough money available to meet the expected
expenditure or warn them when there is not enough in an ‘envelope’ to pay a bill,
tell them when bills have been paid, or warn when they have overspent their
discretionary spending and are in danger of using up any surplus that they might
have been expecting at the month’s end.
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Savings ‘pots’ in practice
Aaron is 32 years old and has a well-paid
job with an American bank in London. He is
currently single, renting a small flat within
easy commuting distance of his office. He
would like to buy a property before he
reaches the age of 40 and has been saving
£500 a month towards a deposit. He also
spends around £5,000 per year on holidays
(beach in summer, skiing in winter), has an
expensive car that costs £2,500 per year to
insure, and likes to be generous with
birthday and festive presents for his three
nieces and four nephews, typically
spending £1,500 each year.
Aaron has a Nationwide current account
and uses its 2019 Help to Buy individual
savings account (ISA) to save for a deposit
on a property. When he has saved enough, he will use the money in this account
to get a 95 per cent loan-to-value mortgage from Nationwide.
Until recently, Aaron was also depositing £1,000 a month into a Nationwide
‘Instant Access Saver’ account, which has the convenience of allowing the
account holder to withdraw money at any time using a cash card. He found,
however, that the instant access to this account made it too easy for him to
spend more than planned each month on leisure activities, clothes and other
items of discretionary expenditure.
To solve this problem, Aaron has now transferred the balance in this account
across six new ‘e-Savings’ accounts. Nationwide allows current account holders
to open as many e-Savings accounts as they want and to give each account a
different name. Aaron has called his accounts ‘Summer Holiday’, ‘Winter
Holiday’, ‘Xmas’, ‘Birthdays’, ‘Beamer’ and ‘Emergencies’. He is using the Beamer
account to save enough to pay the annual insurance on his BMW (it is cheaper
to pay it as a single premium rather than in monthly instalments) and other
irregular car-related bills.
He has set up standing orders to transfer regular monthly amounts from his
current account into each of these e-Savings ‘pots’.
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4.2.4 Zero-based budgeting
A more recent variation on the envelope method is called zero-based budgeting. It
is an idea adapted from business accounting, and the aim is to ensure that every
penny of your income is spent purposefully and wisely. The problem with traditional
personal budgeting methods, which zero-based budgeting addresses, is that if your
forward planning consists only of making sure that you have enough income to cover
your essential bills and your regular discretionary spending – with a potential surplus
that is vaguely allocated to paying any unexpected bills that might crop up – it is
likely that, by the end of the month (if not sooner), you will have spent the surplus,
but have no idea on what you have spent it. You therefore will not be making the
most efficient use of your money, because you will have spent money buying things
that are actually not that important to you; as a result, you will find that you cannot
afford to pay for all of your intended high-priority purchases and / or cannot save
the amounts that you wanted to pay for future purchases.
With zero-based budgets, you have to draw up a detailed cash flow forecast allocating
every single penny of your expected income to a different expenditure envelope. The
envelopes need to cover all of your expected spending, preferably over a period
spanning the next 12 months. So you will have envelopes for all of your mandatory
and essential spending, and for all your expected discretionary spending, right down
to allocations for sweets and snacks, newspapers and magazines, takeaways, cinema
outings, etc.
Bills that occur only once a year or once every three months are quantified, then
‘chopped up’ into monthly deposits into separate envelopes, so that there is enough
money to pay them when the time comes. You can deal with paying for anticipated
‘big ticket’ items in the future (such as holidays, a new car or furniture) in the same
way, ie by means of separately labelled savings envelopes.
To allow for those nasty unexpected bills, such as car or washing machine repairs,
you must also allocate a sum of money to an emergency fund envelope. Your monthly
budget plan will not be finished until every penny of your income is allocated to a
spending or saving envelope – leaving a zero balance (hence ‘zero-based budgeting’).
The advantage of this system is that it forces you to be aware of where your money
goes and to prioritise every item of expenditure. It prompts you to consider, for
example, whether the TV sports and movie channels, which cost you £24 per month,
are more important than saving the money to help to pay for a summer holiday – or
the consequences of taking out a loan to buy new furniture: on which items of
expenditure will you cut back to be able to afford the monthly repayments? In other
words, it makes you consider the opportunity costs of your spending.
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Opportunity costs are defined as the value of what you have to give up to
consume something else, eg the value of the summer holiday that you have
foregone because you would rather keep your subscription TV channels, or the
value of the gym membership that you have cancelled so that you can afford the
loan repayments on your new furniture.
With a zero-based budget, when you have spent all of the money that you had allocated
this month to, say, takeaways, but you really, really want one more chicken tikka
masala with pilau rice, you have to decide which other envelope you are going to take
the money from to pay for it. In a very real way, you will be measuring the cost of your
extra takeaway in terms of something else that you are going to have to give up.
Zero-based budgeting is more complicated and requires more effort than other
budget methods, but there are spreadsheets available for free online that make it a
lot easier.
Some of the online financial planning websites and phone apps are also based on
the zero-based budgeting system – eg Zero Based Budget HQ, online at
www.zerobasedbudgethq.com,
and
You
Need
a
Budget,
online
at
www.youneedabudget.com – so it can be a practical way of organising your finances
if you are comfortable with using online tools or apps.
4.3 Financial planning with interlocking time periods
To be effective, personal financial plans should cover short-term, medium-term, longterm and very long-term time periods; the plans for each period should all interlock.
The short-term plan, in particular, should be sufficiently flexible to accommodate
changing future needs, wants and aspirations.
Suppose, for example, that a short-term plan is based on one week. During this one
week, the individual decides to take on a summer job and save as much as possible.
Several weeks of working and saving make up the medium-term plan; part of the
medium-term plan is to go on holiday at the end of the summer, but not to spend all
of the money saved so far – because, in the long term, the individual expects to need
some of these savings to buy winter clothes.
There are no commonly agreed or standard definitions of how long the short,
medium and long terms are because it depends on personal circumstances and the
perspective of the individual.
◆ The short term might mean one or two weeks, or it might mean several months.
◆ Someone planning to get married in two or three years’ time might consider
themselves to be making long-term plans, but a person putting money into a
high-risk investment product would need to be prepared to keep their money in
that investment for at least ten years.
◆ Students in their last year of school or college might see the school year as the
medium term and everything after that as the long term.
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◆ People in full-time employment may view the next few years as the medium term,
with the long term happening in five or ten years’ time – or even longer.
The key when defining the ‘short’, ‘medium’ and ‘long’ terms is to find the time
period that is meaningful to your own circumstances.
It is useful to base the length of a short-term plan on how often you receive regular
income. School or college students who receive a weekly allowance from their parents
and / or get a weekly wage from a part-time job will set their short-term planning
period at one week. People who are employed and paid monthly are likely to set their
short-term planning period at one month. University students, who may receive
instalments of their student loan and / or financial support from their parents at the
beginning of each term, might find it better to draw up a plan that spans each term.
These time frames highlight the key financial decision in planning: ‘What do I receive
and how am I going to use it?’
Many people base their medium-term financial plans on a period of one year, because
a year is a ‘complete’ period during which all regular events happen, including
religious and secular events (such as Christmas or Divali), birthdays and holidays.
Long-term planning spans several years; a ten-year plan is a popular period. A young
person may expect to experience several quite dramatic changes over the next ten
years, perhaps including (among other things): getting a job and / or going to
college; getting married, entering into a civil partnership or moving in with someone;
being promoted at work; perhaps even buying a first home or having children. All of
these events make a difference to that person’s financial needs, wants, attitudes and
aspirations, and they can be incorporated into a long-term plan.
And what about the really long term – by which we mean 20 years or more? In 20 years’
time, today’s young people may be concerned with the costs of raising their own
children, moving to a bigger house and, eventually, retiring from work. It can be difficult
for a young adult to incorporate old age into their current plans: retirement seems to
be so far away, and many people in their teens and 20s find it impossible to give up
things that they would like to buy now so that they can have a pension in later life.
As the years pass, that person might find themselves in their 50s without any savings
and with no private or occupational pension to supplement state pension. To avoid
this, many people make pension arrangements as soon as they find a regular job.
They may, for example, choose to start making regular direct debit payments into a
personal pension plan, or into an ISA, or to take out a whole-of-life life assurance
policy (or even more than one).
Someone might have a long-term contingency plan whereby they aim to build up an
amount of savings over the next five to ten years that they will use for anything
unexpected that might happen. If they find that they do not need to use these savings
to deal with such an event, they might use it instead for something exceptional –
whether a large wedding reception or an expedition to the Amazon jungle. And
remember: this exceptional long-term plan is the result of surpluses that the person
has built up over the course of five or more medium-term plans spanning only a year.
By ensuring that you build interlocking time periods into your financial planning, you
will be able to keep the longer term in mind while living your everyday life.
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4.4 Adapting plans to changing circumstances
It is harder to plan for the long term because there are so many unknown variables
that might affect your plans. There are personal factors, such as changes in
someone’s wants and aspirations, or changes in their needs, eg leaving home to rent
with friends or starting a family. There are some factors over which they have only
limited control, eg being able to work only at certain times to fit in with studies or a
shortage of local jobs. As we saw in Topic 3, there are also external factors over
which people have no control: interest rates might be low now, for example, but they
may rise in the long term. This does not mean, however, that planners should not
take the longer period into account and make the best plans that they can with the
information that they have now.
When something happens that significantly affects someone’s financial plan, their
first course of action should be to revisit the plan to assess exactly what the impact
is likely to be. This will enable the person to change their plans to take the new
circumstances into account and, where possible, to keep the planning on track to
achieve their medium-term and long-term objectives.
4.4.1 Adapting plans in order to fulfil longer-term goals
Different people have different approaches to setting themselves goals and achieving
aspirations. If, however, someone has a longer-term goal that requires money to
finance it, it is best that they plan for that goal rather than leave things to chance.
The key is to act now to make some provision for the future. Individuals do not know
what will happen to them in the future, but if they have some money saved or a plan
to work their way out of debt, their life choices are less constrained by their finances.
There must be a certain amount of flexibility in a budget because changes in
circumstances mean that things will not go according to plan; the longer the term of
your budget, the more likelihood there is that the actual outcome will be different
from what you had hoped. If you keep an eye on how things are going, then it is
easier for you to make adjustments so that you can still achieve your long-term
aspirations.
People’s typical long-term goals will, of course, depend on their stage in the life cycle.
Teenagers and young adults are likely to have aspirations regarding the job or career
in which they want to be established by the time they reach the age of 30. By their
mid-20s, leaving home, getting married, entering into a civil partnership or simply
cohabiting, perhaps starting a family and buying a home – perhaps by the time they
reach the age of 40 – may feature in many people’s medium-term or long-term plans.
Very long-term plans will be focused around pension planning for retirement.
Planning to achieve these aspirations will involve someone making a lot of
assumptions about how secure their job is, the likelihood of pay increases and
promotions, the effect of economic boom or bust, and what is going to happen to
interest rates and inflation. No one can predict precisely how these variables are
going to change over a 10-year or 20-year planning period, but there are things that
someone can do to try to anticipate their impact. Identifying what your long-term
goals are will be a good first step and it should be possible to estimate roughly how
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Sharon’s savings
Sharon wants to buy a flat and needs to save £5,000
for the deposit; she has given herself five years in
which to save this sum. She saves £1,000 in the first
year; in the second year, her car breaks down and
she has to face an unexpected bill of £400. She now
needs to increase the amount of monthly saving
over the remainder of the budget period if she is to
have a good chance of having saved the full £5,000
at the end of the five years.
Because the unexpected £400 bill has happened
quite early on in the budget period, Sharon will not
have to add much to her monthly savings for the rest of the time to make the
same overall savings – but if she ignores the extra expenditure and does not
increase her savings, she will be £400 short at the end of the period.
Asif’s budget
Asif bought a house three years ago with a £200,000
mortgage. There was an introductory 3 per cent
interest rate, fixed for three years, but the mortgage
has now reverted to the bank’s standard variable
rate, which has just gone up to 6 per cent thanks to
a general increase in interest rates. Although Asif did
plan for his monthly mortgage repayments being
higher when the fixed-rate deal ended, he is still
shocked by the amount by which his monthly
repayment has actually increased. He has already
noticed that a higher rate of inflation has increased
his monthly spending on groceries and household
goods, leaving less money available to save each month.
Asif decides that he now needs to adapt his plans in the following ways.
◆ He will identify items of discretionary spending that can be reduced or cut
out altogether.
◆ He will investigate whether he might be able to remortgage his property – ie
to replace his existing mortgage with a new one, which, like before, has a
low interest rate (fixed, discount or capped) for the first few years.
◆ He will look for opportunities to increase his income eg by working overtime
or getting a higher paid job.
◆ He will change his medium-term and long-term plans to match his new
circumstances – eg he will put back any plans for a luxury holiday or a new
kitchen for a year or two.
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much money you will need to achieve your goals. When deciding what kind of house
you would like to buy and in what area, in five or ten years’ time, for example, you
can first get an idea of the likely cost if you were to buy now. You might then look
at some different possibilities, eg that there could be a house price boom or a crash
over the term of your plan, or that prices could stay the same.
Figure 4.3 shows how average UK house prices have changed in real terms (taking
the general rate of inflation into account) since the late 1970s. There have been
prolonged periods – notably, from 1982 to 1989, and from 1995 to 2008 – during
which prices rose steadily year by year. Each boom ended with a sharp fall in prices,
which also lasted several years.
Figure 4.3 UK house price trends, 1977–2017
Source: Housepricecrash.co.uk (no date)
Requiring that you estimate the impact of all of the possible changes in relation to
every significant external variable is, of course, unrealistic. Most people will base
their plans on the present values of incomes and prices, and then simply build
enough flexibility into their plans to enable them to adapt whenever a significant
change occurs.
Further, it is not only changes in external factors that can affect financial plans, but
also changes in personal circumstances, eg changes in family circumstances. The
age at which someone moves into their first home of their own, or has a child, or
how long their first serious relationship lasts can all potentially impact on personal
financial plans. The death of an elderly relative may bring an unexpected inheritance,
while having to care for an ageing parent may have a negative effect on finances.
Again, you can anticipate both the likelihood and the effects of some of these
changes – and having clear, realistic plans in place, with the flexibility to adapt and
amend them when personal circumstances demand, will give you the best chance of
maintaining sustainable personal finances and achieving your long-term aspirations.
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Terry and Julie
Terry and Julie sat down to discuss
their long-term financial plans, and
decided that, in ten years’ time, they
would like to be able to buy a
detached house with at least three
bedrooms, in a popular part of town.
They used the internet and visited
local estate agents to find out the
current prices of such houses, which
was around £360,000 on average.
They began to draw up a long-term
plan to save a deposit that would be
sufficient to get an appropriate
mortgage in ten years’ time.
Terry and Julie decided that a 10 per
cent deposit should be enough to secure a mortgage, and so prepared a cashflow plan that included saving £300 a month over ten years. They realised that
this level of saving would require a degree of sacrifice (ie opportunity cost) and
decided to forego annual summer holidays abroad and instead ‘staycation’ at
home. They anticipated that the interest accumulating on top of their savings
would help to offset the impact of rising house prices.
Once the plan was put into effect, Terry and June carefully monitored their
income and spending to make sure the plans stayed on track. Unfortunately,
after two years, Terry was made redundant and it was 12 months before he
found a new job. Terry had not taken out any accident, sickness and
unemployment (ASU) insurance cover, so the couple had to stop saving – and,
worse still, they had to use some of the money that they had already saved to
supplement their income, so that they could meet all of their mandatory and
essential bills.
Terry and Julie’s plans were further damaged, shortly after Terry had gone back
to work, by an upturn in the economy, which generated a significant house price
boom: prices rose by more than 10 per cent a year for several years. The couple
were therefore forced to revise their plans, pushing back their long-term plan
to buy a house by another five years.
Two years later, they had better news: Julie got a big promotion, bringing with
it a significant increase in income. They were now able to revise their plans
again, deciding between bringing their goal date forward, or aiming to buy a
bigger and better house. Terry and Julie also now made sure that they both had
adequate income protection policies – eg ASU cover and income protection
insurance (IPI) – so that their long-term plans would remain achievable even if a
future economic slump or a serious illness were to affect their job security or
income.
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Key ideas in this topic
◆ The necessity of monitoring personal budgets and longer-term plans in
maintaining sustainable personal finances
◆ The various methods of monitoring finances, including free online services
and smartphone apps
◆ The need to adapt personal financial plans in response to changes in external
and personal circumstances if plans are to be kept on track
References
Housepricecrash.co.uk (no date) Nationwide average house prices adjusted for inflation [online].
Available at: www.housepricecrash.co.uk/indices-nationwide-national-inflation.php [Accessed:
14 January 2021].
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