Financial Planning 101: The Pizza Principle
May 25, 2018
One of the best definitions of financial planning was suggested by a team of Canadian university professors who boiled it down to a single question: “What course of action will help me maximize my standard of living – in the smoothest way possible – over the rest of my life?”
You can see how practical this concept really is when you translate it like this:
“How can I make sure that the stone-oven pizza I love today won’t turn into microwave pizza when I retire?”
The thing is, without a plan, most people will experience a lifestyle decline at some point in the future. It could be when they put a child through school, when they retire, or because of something unexpected.
A financial plan is meant to avoid this. It gives you monthly recommendations so that the food you enjoy, the place you call home, and your hobbies and vacations can stay the same or even improve while you’re working and when you retire. At no point should you have to mourn your favourite pizza.
How your plan gets you there
Planswell has built tens of thousands of free financial plans for Canadians. Sometimes people ask us why we don’t let them choose their retirement income goal. The answer is found in the Pizza Principle.
When you build your plan, you tell us how much you currently put towards paying down debts (a low-interest personal loan from our friends at Borrowell can help) and saving for the future. From that, we can deduce that the remainder of your income goes towards the food, shelter and other lifestyle expenses that matter to you. Our financial planning engine can then figure out how to sustain that lifestyle into the future.
We make these calculations across three areas:
- Your borrowing. How much of your monthly cash flow is going towards debt? Can that debt be made less expensive? If so, how can the monthly savings be used to build and protect your wealth? For example, it’s often possible to use home equity or a consolidation loan to erase credit cards and other expensive debt.
- Your investing. How much money will you need in the future? How much should you invest each month to get there? Which types of investment accounts will lead to the maximum after-tax income when you need to spend it? For example, many people struggle with the question of RRSP vs. TFSA, which can have a huge impact on your retirement nest egg.
- Your protection. What types and amounts of insurance policies are required so that, even if there is an accident, illness or death in your household, there will still always be enough pizza? For example, working people need to insure their earning power, and parents need to make sure their kids are financially protected too.
A great plan will optimize each of these areas and tell you exactly what to do on a monthly basis to hit your goals. Once you retire, your plan should spell out how much money you need each month to maintain your lifestyle.
How to keep your plan working for you
OK, but what if you envision a higher standard of living for yourself in the future? Or what if you lose your job? Or earn a big bonus? What if the stock market goes way up or down?
All good questions. The solution is to update your plan every six months. This way, if your income has increased, your plan will adjust to a higher standard of living. If the market has made any major moves, your investments will be recalibrated. If you hit a rough patch or land a windfall, this will be captured in your updated plan too.
In the old days of human financial planners, this type of update-on-demand was totally impractical. Today, technology makes advanced financial planning a snap, even if you have no prior experience.
What are you doing for the next three minutes?
Homes. Cars. Trips. Weddings. Children. Retirement. There are a lot of financial demands in life, but underlying each of them is the basic desire to make sure that you will not run out of chicken parmesan ranch pizza well-done on a thin crust (just to throw out an example).
If you share this basic desire, we think building a free financial plan with Planswell is the best thing you can do in the next three minutes.
Grow your wealth. Manage your borrowing. Protect your assets. Planswell gives you a free plan that ties investments, insurance and mortgages together so you can maintain your lifestyle throughout work and retirement.