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How to Create a Long-Term Financial Plan

Have you read our previous blogs and agreed that the state should not be relied upon when it comes to our financial future and that most investment options in the CEE region have major, potentially dangerous shortcomings? Then Finax is the right choice for you – it's time to research what style of investing suits you the best.

Mato Barišić | Personal finance | 23. September 2022

We are all different and have different goals we want to achieve with investing. Our incomes, financial and family situations, housing solutions, and risk aversions all differ. Therefore, you'll probably agree that it's not appropriate for all of us to invest the same way.

In today's article, we will go through all the critical segments with examples of specific questions you should answer before you get the investment ball rolling. We'll explain how you should organize your long-term financial plan.

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If any part isn't entirely clear to you, don't despair. At the end of the article, we explain how you can get to grips with your situation in ten minutes by answering a few key questions to a robo-advisor by Finax.

Analyzing Your Financial Situation

Most financial advisors and experts recommend that, before you start investing, you should accumulate enough funds to cover basic living expenses for 6 months in your bank account. There is no ideal recommendation (one that would be universally applicable to all living situations) for exactly how many months your emergency cash should be able to cover. A certain rainy-day fund, however, is something everyone should have.

Once we have built up our emergency reserve, we need to start by analyzing our current financial situation to decide where to invest our surplus money. Answer a few basic questions:

  • What is your net worth – compute it by subtracting your liabilities (loans, account deficits, credit card payments, etc.) from the value of all your assets (car, real estate, savings, etc.)
  • Asset allocation - How much of your surplus do you want to invest? What portion of your total assets will this investment make up?

Of course, if you have many assets (e.g., a flat you rent out, a piece of land, 3rd pension pillar savings, and plenty of cash), you can afford to take a little more risk when investing. If you only have a freshly accumulated emergency fund mentioned above, are just starting with investing, and plan to put all your money into, for example, Finax, your approach should be a little more balanced.

  • How many liquid and illiquid assets do you have?

One of the advantages of having an emergency fund is that you don't have to sell other assets below their market price to get urgently needed cash in case of a crisis.

We all know how valuable an apartment is, for example. However, it is also known that a valuable asset can become illiquid during an emergency. For example, selling an apartment at short notice is difficult. Even if you find a buyer, legal and financial matters can take several weeks.

Of course, if you struggle to find a buyer, it is often necessary to reduce the price considerably if you want to sell the property as soon as possible. For this reason, it is vital to always have liquid assets, preventing situations where you would be forced to sell assets below their fair value.

That makes liquidity a crucial aspect when assessing your financial situation, almost as important as the value of the asset itself.

  • What is your salary? Can you expect it to rise in the future?

It makes a difference whether you are a school teacher or a hospital nurse, where you can expect a slight long-run increase in salary, or a programmer at the beginning of their career who can expect a noticeable increase in income over the next few years.

The same is true when comparing relative competition in different professions. Slovakia, for instance, has many workers in the spheres of tourism or mass media, but there is a prevailing shortage of computer scientists.

Conclusively, if your net worth is low, investing the entire surplus in one investment class, for instance, would certainly not be an ideal option, as you need to diversify the investment to reduce the risk.

However, if you have a high salary that you expect to continue to grow and a lot of assets, a large portion of which are highly liquid, you can certainly afford to take a higher risk with a higher expected return.

Analyzing Your Personal Situation

It is not enough to simply look at your financial situation to decide which investment class to choose for your savings. To make an even better decision, you need to answer a few non-financial questions such as:

  • How old are you?

It is generally accepted that you should start investing as early as possible. That way, not only are you allowing the compound interest to multiply your money over many years, but even in the event of a recession or stock market crash, you have many years to recover financially.

  • What is your risk attitude?

If you are young, adopting a more dynamic or aggressive approach to investing is sensible. However, if the idea of your hard-earned invested money being able to temporarily lose 10%, 20%, or 30% in value wouldn’t let you sleep peacefully at night, this approach is not the right fit for you.

  • For what period do you plan to invest? Will you need the invested money soon?

Imagine you are planning to renovate your home in two years, intending to invest the money you have saved until then. Although shares provide the highest return in the long term, they are not necessarily the best choice in the short term because they are a volatile investment (their value fluctuates in the short run). If, after a year, shares were to fall by 20%, you might not be able to renovate the apartment, and your plans would be disrupted.

To avoid such trouble, it is recommended that, for short-term investment horizons, you should not invest all or even most of your money in stocks, but in a more conservative investment class such as bonds.

  • Are other household members dependent on you?

Of course, if you are at the end of your career and take care of children, we would recommend putting a large portion of your investments in bonds. If you are in your 30s and planning to invest for around 20 years, it would be ideal to put as much of your money as possible into stocks.

Stocks, although known to be a slightly more volatile investment, still provide the highest return in the long run and are the best choice for those who won't need their savings for many years.

Risk and return are linked. With bonds, we have the opposite situation: they are significantly less volatile, but as a result, they also yield lower returns. They are, therefore, more suitable for those who will need their invested money after a shorter investment period.

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As you can see, there are many questions we need to answer before picking the optimal destination for our invested money. Skipping any one of them can jeopardize your returns or bring disappointing performance.

To individualize a long-term financial plan, many questions from different segments of life need to be answered to determine the ideal mix of bonds and stocks.

Bonds have lower returns but carry less risk, while stocks offer a higher long-term return but as we have already discussed, they also involve higher risk. This is most pronounced in the case of shorter-term investing, where you can’t grant the investment enough time to recover from a potential crash.

Although the questions are quite simple, they can produce a mixture of answers that might confuse you. For example, you are young but risk averse, and own a lot of assets but they are illiquid. Or you work in the IT sector but have to take care of three children. In such cases, you are probably not sure what your ideal stock/bond ratio is.

That's why you need to answer similar key questions when registering at Finax, after which Four robo-advisor will determine the upper limit on stock proportion in your portfolio. This will be the ideal strategy to meet your current life goals based on global standards in risk management.

Finbot registration.

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You'll be confident that you haven't taken too much risk given your situation without investing too conservatively at the same time, which could lower your long-term returns, pushing you away from your financial goals.

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Mato Barišić
Mato Barišić
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