We all know we should make long-term financial plans, from building a nest egg for children to contributing to a pension. Yet, understanding the impact these behaviours have is more difficult the further you look ahead. Cashflow planning is one of the tools we use to help you get to grips with how your finances could change, whether you’re looking five or 40 years ahead.

You may decide you want to save more for retirement, dreaming of being able to take long haul trips abroad and relax in style. So, you know you need to increase pension contributions, however, it’s far more difficult to see how adding an extra 2% to your pot adds up over the rest of your working career. It’s even more challenging to see how this will have a direct impact on the lifestyle you’ll lead once you give up work. This is one situation where cashflow planning can help.

Cashflow modelling is a tool where you input data and show how your wealth will change visually. So, for example with the above scenario, you could see how your pension contributions accumulate. You could also set a retirement date and expected spending, with cashflow modelling then showing how your assets would deplete over the course of retirement.

So, how can cashflow planning help you? There are three key ways that it can improve your understanding of financial matters in the long term.

1. Demonstrating how wealth may change

Even when cash or investments are left alone, the value of them will change. Cashflow planning can help you put this in real terms.

You may know that your returns are expected to generate on average 4% per annum, what does this mean for the size of your portfolio in a decade? Likewise, cash savings will be earning interest, but inflation will be eroding some gains and in the current low-interest climate it could be reducing the value of saving in real terms. Cashflow planning can give you an idea of how your wealth will change.

2. Modelling the impact of your decisions

Over your lifetime, your plans and situation will change. Being able to model the impact of your financial decisions can help you see if they’re worthwhile and how they align with wider goals. So, how much extra would you need to add to your pension pot to achieve the goal of having £500,000 in retirement? If you want to help children or grandchildren financially with a lump sum, would it affect your lifestyle in the future?

Being able to see the long-term impact can provide you with the information needed to make an informed decision.

3. Providing answers to ‘what if…’ questions

Even the best-laid plans will be affected by factors outside of your control. If you’re worried about these, cashflow planning can give you the reassurance needed to put measures in place to limit the financial impact. It can deliver confidence in your future, even when barriers appear.

Some clients, for example, may ask:

  • What if I need to retire early, will I still have enough to maintain my lifestyle?
  • What if my partner passes away, how would it affect income?
  • What if investments underperform, will I have to adjust my plans?

Understanding what these scenarios and others mean for your financial future means you’re in a position to make adjustments where necessary.

The limitations of cashflow modelling

As with all tools, there are limitations to using cashflow modelling.

First, the results are only as good as the information that is used. The more limited the information is, the less reliable the output is too. You also need to keep in mind that the information will need to be updated on a regular basis, reflecting changes in your circumstances or goals.

Second, cashflow planning makes certain assumptions. The result of cashflow planning can’t be guaranteed for numerous reasons. We’ll make certain assumptions, based on evidence, such as the rate of inflation or average investment returns to give you a snapshot of your finances in the future. However, unforeseen factors and situations can still have an impact.

One of the ways we combat limitations is through stress testing. This involves using different scenarios to measure how strong your financial plan is, this could include a permanent reduction in the UK stock market, needing to pay for residential care in your later years, or the loss of income through the death of a partner. By using simulations that are repeated over many ‘lifetimes’ we’re able to highlight weaknesses and put measures in place where appropriate.

Despite this, cashflow planning is still useful and an important part of putting together a financial plan that suits you. If you’d like to discuss your long-term financial situation, do get in touch.