To A Mouse, on Turning Her Up in Her Nest, with the Plough – Robert Burns

As a big advocate of having a written and regularly reviewed financial plan, I also recognise that things can go wrong. Financial plans can fail for a variety of reasons.

The fact they sometimes fail is not a good reason to excuse yourself from putting in place your own financial plan. Knowing some of the reasons why financial plans fail should enable you to avoid these traps and construct a plan that is more likely to stand the test of time.

Here are six reasons financial plans fail along with the steps you can take to improve your chances of success.

1 – Unrealistic targets

Objectives in life and business should always be SMART – specific, measurable, achievable, realistic and time bound. Your financial planning targets are no different.

Setting unrealistic financial planning targets at outset will mean you stand less of a chance of reaching your goals. In fact, unrealistic targets are likely to leave you feeling completely disheartened, particularly if you find yourself getting further away from your goals rather than closer towards them.

Unless you have already started on the path towards a particular financial goal, it can sometimes be difficult to know how realistic it might be. A way to avoid falling into this trap is to experiment with making progress towards a specific financial goal before embarking on the full journey with your written financial plan.

You should also ’sense check’ any financial goals you might have. Have you managed to achieve something similar in the past? Do you know anyone in a similar position who has managed to reach the same goal?

2 – Incomplete information

The output from a financial plan is only ever as good as the quality of the input. The phrase Garbage In, Garbage Out is used in computer science to describe the fact that computers will process without question the most nonsensical of input data and produce nonsensical output. Feed garbage into your financial plan and expect to get garbage out the other side.

Before constructing your financial plan, make sure you have all of the information you might need readily to hand. This definitely includes details of your assets, liabilities, income and expenditure. Having all of this data available in a neatly organised fashion makes the process of constructing a financial plan that much easier.

3 – Lack of commitment to your goals

Embarking on a financial plan towards goals without strong commitment is unlikely to result in a happy ending. Motivation is what drives us to succeed in different areas of life. Financial planning is no different.

If you lack strong commitment towards a particular financial planning goal, step back and ask yourself why you are working towards that goal at all. Do alternative goals exist which you have stronger feelings about?

Lack of strong commitment can also be the cause of financial planning failure when a couple do not both share the same desire to reach a particular goal.

When financial planning as a couple it is important to agree on a consensus before constructing your financial plan. If you both want the same things, or at least understand that you want different things and you are prepared to share resources to reach those goals, then your chances of success will be greater.

4 – Overambitious assumptions

Accurate financial planning relies on reasonable assumptions. These can be the most variable aspects of a financial plan and are certainly something to keep under regular review.

Within your financial plan you might make assumptions at price inflation, investment growth, interest rates, life expectancy and earnings inflation. Getting them all absolutely correct at outset is not a realistic target. However, they can still be wrong with a certain margin without adversely hampering your ability to reach financial goals.

Looking at history is a good place to start when making your assumptions. The common regulatory risk warning about past performance not being a guide to future performance is important, but over the longer term things tend to behave in roughly the same manner. The longer the track record of your assumption, the more likely it is to be accurate.

5 – Unexpected external factors

As Robert Burns wrote in 1785, even the best laid plans can go askew. You can plan for as many eventualities as you can think of and chances are it will be the unexpected event that will throw your financial plan off course.

Losing your job, the economy entering recession, change of legislation or falling ill are all factors that can all play havoc with your financial plan. You might be able to plan for some of them or even insure against the financial impact of others, but at some point in your life there is a reasonably good chance that ‘life’ will happen.

The best remedy against this failure factor is to build a degree of flexibility into your financial plan and understand that it might not always be possible to stick rigidly to your original plans. You should certainly include the creation and maintenance of an emergency fund within your financial plan. It is this pot of cash that will get you through the financial impact of unexpected external factors when they arise, which they undoubtedly will.

6 – Missing milestones

Financial plans tend to focus on the achievement of very long-term goals. These include things such as retirement or mortgage repayment. Maintaining the necessary motivation to reach sometimes intangible goals in 20 or 30 years time is enough to challenge even the strongest resolve.

By setting shorter term milestones, it becomes easier to maintain your motivation and also measure progress. When you start with your financial plan, it makes sense to include a milestone you can hit after only a couple of months. Over time you might extend the length of these milestones to a year or longer.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice. You can follow him on Twitter @martinbamford. He planned to go to bed an hour ago, had an idea for this post and failed in his original goal.

If you are too optimistic with your assumptions, it is likely your Financial Planning will fall short of your targets. Make pessimistic assumptions and your Financial Planning could be unaffordable.

Because each assumption can have a big impact on the outcome of your Financial Planning, it is important to understand which assumptions to make and also how to make them.

Here are six Financial Planning assumptions you need to make and how you might make them.

1 – Your life expectancy

The likely date of your death will drive many elements of your Financial Plan. Understanding for how long you are likely to live helps you understand how much capital you will need to ensure you do not run out of money in your lifetime.

Life expectancy is the number of years you have left to live at a particular age. Average life expectancy varies between different countries, with the current world average estimated to be 67 years old.

Women typically live for longer than men. In the UK, the average life expectancy at birth is 76.5 years for men and 81.6 years for women.

The problem with looking at average life expectancy is that we tend not to be average. For this reason, whilst understanding your likely life expectancy is important for Financial Planning, a better number to use is 99 years old.

By picking an unlikely but possible age for your life expectancy you reduce the risk of running out of money too soon. This is a better outcome than living longer than planned and running out of cash in later life.

2 – Future price inflation

Goods and services typically become more expensive over time. We are all used to prices going up, although because these price rises tend to be quite gradual it can be easy to dismiss the relevance of price inflation for our Financial Planning.

The issue with price inflation is the compound nature of inflation over long terms. In the same way that compounding helps multiply returns from savings or investments, it also makes inflation incredibly damaging to your Financial Planning, unless you factor it in to your plans.

As a simple example, imagine you are 30 years old today and plan to retire in 35 years time at age 65. If you want an income in retirement equivalent to £25,000 in today’s money, inflation at 2.5% a year between now and age 65 means you need £59,330 of income to have the same purchasing power. That is the impact of inflation.

Of course inflation does not end when you retire. In fact, price inflation is typically higher for older people as a result of the types of goods and services they tend to consume.

We might be in a temporary period of negative price inflation (as measured by the Retail Prices Index – RPI) right now, but positive price inflation will emerge again. Start planning for it now by thinking about the real cost of living in the future.

3 – Interest rates

Understanding the rate of interest you can get on cash savings often forms a cornerstone of your Financial Planning. This is your ‘risk free’ return; the return you can get on your money without exposing capital to risk.

With the Bank Rate currently running at the historic low of 0.5%, it would be easy to dismiss cash savings as a sensible home for your money. It is important to always use cash as a starting point for your Financial Planning, and only consider taking investment risk if your financial objectives require a higher level of return (and you are prepared to tolerate the risk/volatility).

Interest rate assumptions also have a direct impact on the cost of servicing debts. Making reasonable assumptions about rates of interest in the future enable you to make important decisions about prioritising the repayment of debt over other financial objectives, such as investing for the future.

4 – Annuity rates at retirement

When you reach your selected retirement age, one way in which you can convert your pension fund into an income is to purchase an annuity. These financial instruments simply convert capital to income. They come in a variety of shapes, but can be a good starting point for understanding the income value of your accumulated pension fund.

Annuity rates vary depending on a number of factors including life expectancy, interest rates and gilt yields. They will also vary depending on the options you select, such as a benefit for your spouse or ‘indexation’ to reduce the impact of future price inflation.

A good plan to start when making assumptions about future annuity rates is the best rate you could obtain today, assuming you were at your selected retirement age. You should then keep this under regular review on at least an annual basis. It will change.

5 – Earnings inflation

Because the cost of living goes up (as measured by price inflation) we would usually expect earnings to go up over time as well. The preferred measure for this is the Average Earnings Index (AEI). This is published by the Office for National Statistics and is the key indicator of how fast earnings, or pay, are growing in Great Britain.

For the year to June 2009, AEI (including bonuses) rose by 2.5%, up from 2.3% in the year to May 2009. Over the long term we would usually expect to see AEI increase at a faster pace than the Consumer Price Index (CPI); the preferred measure of price inflation. For this reason you should link your price inflation and earnings inflation assumptions.

6 – Investment returns

Another important assumption for your Financial Planning is the return you are likely to get from your investments. This is another long-term assumption; unless you have a crystal ball you will not be able to accurately or consistently predict the investment return from a given market in a certain year.

We know that historically equities (company shares) have outperformed cash by a wide margin. Rather than selecting a single assumption for investments in general, you should make an assumption for each of the main investment asset classes – fixed interest securities, property and equities.

Based on these assumptions you can then work out an overall investment return assumption for the level of risk you are prepared to take with your money.

A final point

Because these assumptions can have such a big impact on your future financial well being, it is essential to keep them under regular review. Consider the assumptions you have made at the annual review of your Financial Plan to ensure they remain reasonable over the long-term based on current economic and investment market conditions.

If you keep your assumptions under regular review, and then adjust your Financial Plan accordingly when those assumptions change, you can keep your Financial Plan on track.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.