Sound financial planning is indispensable for a secure future. However, most people think of financial planning as a burden and often delay creating a structured financial road map for the future. Some others take up financial planning only as a task that they have to accomplish or a box they need to tick off their to-do list. There are only a few people who focus on their financial plan and develop a strategy that is best for their future.
When it comes to realizing your financial goals, there are many roads you can take to achieve your objective. While they may all be suitable in some aspects, not all lead to the same outcome. However, to know which route to take to create the best possible financial plan, you have to know all options available before you begin your journey.
Typically, you can adopt two routes for financial planning, whether you create a plan yourself or engage with a professional financial advisor to do it for you. These two mediums are – goal-based financial planning and cash-flow-based financial planning. Even though the final objective of both – goal-and cash-based–strategies is to achieve your financial goals, their approach towards the same is widely different. Generally, a goal-based strategy involves analysis of your goals, financial resources, personal life situation, etc., to create a roadmap that can guide you to achieve the set targets. However, this is only a limited time approach and does not account for holistic financial well-being. In contrast, cash-flow-based financial planning is more intrinsic and looks at the whole picture rather than simply your goals to ensure your all-round financial security. The approach involves determining where your funds originate and how to strategically use your money to fulfill your current demands while also securing your future. A part of the cash flow strategy can also involve goal-based planning. However, the scope of the former is much broader than the latter. If you wish to learn about goal-based and cash flow-based financial planning to understand which strategy would suit your financial situation and enable you to achieve your goals better, consult with a professional financial advisor who can advise you on the same.
Here is a quick guide to help you understand the differences between cash flow and goal-based planning:
What is goal-based financial planning?
Most often, when you engage with a financial advisor, you have certain goals in mind that you wish to attain such as – retire at 60, create an education fund for children, draft an estate plan, etc. The advisor then uses these foundational goals to create optimal strategies that support you in achieving those goals. The advisor will assess your life stage and current finances, and accordingly, build your roadmap to achieve a set target, such as retirement at 60. However, your goals could change, given the circumstances. If given an option, you might want to quit your hectic job at the age of 55 years but would love to take up a part-time offer to lead the same lifestyle after retirement. Also, you may later realize you do not want to retire early and would like to continue working for much longer than 60 years. Moreover, you will need to figure out how much you would get from Social Security benefits, when will you start withdrawing funds from your retirement accounts, and will Social Security and retirement account balance be enough. Therefore, starting with a goal-based approach to financial planning is not always a smart idea. You cannot assume that markets will always grow at the same rate or you will receive a specific return from an investment all your life. You also have no idea about the unexpected events in the future, and you cannot assume if a specific event is bound to happen. The nature of financial planning is not static; it is iterative and requires consistent updating and efforts. It is not feasible to create a fixed plan and continue to follow it. You might need to course-correct your strategies every year and adapt them to your changing needs, life stage, market situation, and more.
Using goal-based financial planning is like looking at the pieces of the puzzle rather than the whole picture. However, goal-based planning is less time-consuming and simple to use. Therefore, it is often preferred by fee-based financial advisors who associate with you for a particular product like an insurance policy, etc. and earn commissions by selling you the target product. Fee-based advisors are generally not governed by fiduciary duty. However, in this case, there is a risk of receiving biased counsel. Fee-based financial advisors might suggest an asset allocation that advances their profits rather than improves your financial well-being. They may support specific product recommendations, like an annuity policy, life insurance plan, stocks, etc., because they have a higher commission cut on the suggested products. That said, even though there is a risk of biased advice, goal-based financial planning assures you reach your set objective (irrespective of the asset allocation).
Goal-based plans are not ideal for interdependent or multiple financial goals. Further, goal-based financial planning might not be suitable for complex situations, such as complicated tax status, huge estate plans, etc., but it can work for simple options, like saving for college, near-term retirement planning, long-term care insurance, lifelong care planning, and more. Some people argue that goal-based financial planning is not the best approach because people only have a vague idea of their goals. Most people generally pick goals based on their surroundings, peer suggestions, family history, etc. While this might be true to an extent, it is important to remember that goal-based planning is to help you achieve what you want out of life rather than holistically plan your future. The first step, in this regard, is to assess your goals, dig deeper to understand their nuances and relevance in your life, and then use these findings to build further on your financial plan.
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What is cash flow-based financial planning?
In contrast to goal-based financial planning, cash flow-based financial planning is about looking at the broader picture and determining the finer details. It zooms in on your cash inflow and outflow to help you minutely understand your spending and saving patterns. It might appear like budgeting on a larger scale, but the scope of cash-flow-based financial planning is much wider than budgeting. Even though budgeting is a key element of all financial plans (including goal-based financial planning), cash-flow-based financial planning is more focused on budgets. This approach adopts a boots-on-the-ground strategy and uses foolproof budgets to create the building blocks of a solid financial plan. Goal-based planning involves setting a budget with a high-level overview in contrast to a cash-flow-based budget that details every penny you earn, spend, and save.
Typically, cash-flow-based financial planning includes assessing your current financial situation to make projections regarding where you will financially be in the future. If you are engaging with a financial advisor, they may also use the best cash flow-based financial planning software – to determine possible ways to achieve one or more of your financial goals. The approach involves consistently monitoring and modifying your strategies to adapt to the changing life needs and demands. Cash flow-based financial planning aims to identify the most tax-efficient approach to help you achieve your targets. This method is much more intensive compared to goal-based financial planning and demands intensive efforts from you and your financial advisor.
Your financial advisor will break out your deductible expenses like loan mortgage, qualified medical expenses, property taxes, etc., to check your probable income tax rate. Your funds will then be categorized into earned or capital gains to better understand your income tax bill. Cash flow-based financial planning also examines your monthly expenses, savings and insurance transactions, irregular expenses in the year, etc., to determine the whole cash flow picture. The objective is to understand where your money is originating from, where you are spending your money, which expenses you can eliminate, limit, or reduce, and where you are lacking in your savings target. With the right cash flow estimates, you can organize the flow of your money to create wealth and reduce debt.
Your cash flow plan will also comprise details of money you plan to spend in the next five years on big-ticket items, such as home improvements, transportation, education, etc. Incorporate the assets you aim to invest in to create more income to realize these five-year goals. This could include investing in real estate, etc. List all aspects and circle back later to work out the details. This will help you analyze if your cash flows are in sync with your targets or if you need to make modifications to get them on track.
Cash-flow-based financial planning is more thorough and detailed than goal-based planning and requires more time and effort. Apart from considering your financial situation, targets, and life stage, cash-flow financial planning also accounts for inflation, investment allocation, the timing of your expenses, potential taxes, etc. This approach is ideal for people who desire holistic financial security. Cash-flow-based financial planning can help if you have interdependent or multiple goals. This strategy assumes that some goals like retirement planning, education fund, estate plan, etc., can work in conjunction with other targets like minimizing taxes.
However, the level of detailing in cash-flow-based financial planning is much higher than in goal-based financial planning. While this may be too much for some people, it is generally what most people prefer and benefit from. If you are engaging with a financial advisor, it is not mandatory to have a financial goal if they adopt the cash-flow-based strategy. They can guide you on maximizing your current income, spending less, and saving more to ultimately see where you can be in the next five years. Cash flow projections can also help you see where you can be in the next 15 years if you continue to save, invest, and modify your plan over time. Besides, cash flow projections can give you answers to questions like:
- When to claim your Social Security benefits?
- How will RMDs (Required Minimum Distributions) shape your retirement finances?
- Is it beneficial to convert a Traditional IRA (Individual Retirement Account) to a Roth IRA? Or is it advantageous to invest in a Roth 401(k)?
A cash flow-based financial plan is also suitable in cases where you want to ponder with your advisor about alternative approaches that can address your goals. You can also assess the tax impact of a particular event, such as the purchase and sale of property, giving lifetime gifts, etc. This strategy can also help you plan for unexpected events like the death of a spouse, change in marital status, extended long-term care, delayed or early retirement, market downturn, etc. However, to be done properly, your cash flow statement should ideally be updated at least annually. This means your cash flow projections per year will modify based on your living expenses, income, asset allocation, beneficiaries, estate plans, etc.
Which is better - goal-based vs. cash flow financial planning?
Ideally, cash-flow-based financial planning is heavily detailed, listing all aspects of your finances to create a wholesome picture. This strategy is best for people who desire holistic financial well-being and value-addition and require help with complex, multiple, or interdependent goals. Alternatively, if you only want support for a particular goal or need assistance in creating a portfolio to achieve a specific monetary target, a goal-based approach might be suitable.
To conclude
Even though there is no clear winner between cash-flow and goal-based financial planning, the former is still a wiser approach than the latter. Financial planning is not silo planning, which is almost the case with a goal-based strategy. Since life is always changing, a more dynamic approach, like a cash flow-based financial plan, that is interdependent, can be preferable.
You can consult a professional financial advisor to get investment advice regarding your cash flows and how your income and savings are structured. It can help to look at the bigger picture to easily achieve the smaller targets.
If you are unsure about which strategy to adopt, you can use the free advisor match service to engage with a professional financial advisor, who can help you understand the pros and cons of both cash-flow and goal-based financial planning and which strategy would be more suitable for your financial needs and future goals. Based on your requirements, the service matches you with 1-3 advisors suited to meet your financial needs and goals.
For additional information on the most suitable financial planning and saving strategies tailored specifically for your financial goals and current financial situation, visit Dash Investments or email me directly at dash@dashinvestments.com.
About Dash Investments
Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm, managing private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.
Dash Investments offers a full range of investment advisory and financial services, which are tailored to each client’s unique needs providing institutional-caliber money management services that are based upon a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.
CEO & Chief Investment Officer Jonathan Dash has been profiled by The Wall Street Journal, Barron’s, and CNBC as a leader in the investment industry with a track record of creating value for his firm’s clients.