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11 Things to Consider for a Realistic Financial Forecast
Suppose you want to know ‘when will my retirement money run out?‘. If you can forecast your future account balances, you could estimate when you run out of money. But to forecast your future finances as accurately as possible, your plan needs track at least these 11 details:
- Your current income, expenses and outstanding loan payments. This includes projecting and estimating cash flows into the future, like a regular scheduled loan payment or electric bill payment.
- Your planned income, expenses and loan payments. These include items you want to buy later, like a new home next year. These will also include projecting scheduled cash flow into the future, but they start later. Some expenses are less clear, like how much you need to pay for health care when you are older.
- Your current accounts and their balances or market values. This includes all of your cash, checking, credit card, and investment account.
- Your estimated accounts’ balances into the future. These forecast balances will change based on all of those projected income and expense cash flows above. If your forecast balances ever go to $0 you’ve run out of money! You know your planned activities are leading you into trouble, and you need to reduce spending to meet future needs.
- Your plan to rebalance and transfer funds between your accounts into the future. Your plans immediate expense need to be available in checking accounts. The rest can be invested for longer term needs. You also need to plan for retirement to draw down funds across your allocations groups (e.g., taxable, retirement, Roth). You might also want to transfer funds from retirement to Roth groups to save on future tax payments.
- Your estimate of future inflation. Excess inflation increases expense cash flows into your future, so more likely to run out of money. All projected expense cash flows should consider inflation increases.
- Your estimated taxes. Taxes reduce your account balances and net worth. Your salary income and IRA withdrawals are taxed. Taking funds from taxable stock accounts triggers capital gains taxes. Required minimum distributions (RMDs) must be pulled from IRAs after a certain age. Your forecast must consider all these taxes to forecast more precisely.
- Your credit card debt. Credit debt requires interest payments, which drains funds from your account balances. You should forecast paying off this debt. But how quickly to do you want to pay down your credit debt? Should you pay highest rate credit debt first or lowest amount due?
- Your desired emergency fund. An emergency fund lets you pay your bills for a time if you lose your job. Throughout your financial forecast, you should build and keep up an emergency fund. This emergency fund should be based on several months of expenses at all points in your planned future.
- Your estimated net worth. This is your account balances plus asset values, minus loans your still owe and credit card debt. Your net worth ideally increases into the future. Adding homes and cars to your plan reduces net worth due to payments and loan value to pay off. It also pulls funds that could be used for investments, reducing future net worth. Over time though, a home’s asset value usually increases, boosting your net worth.
- Advanced planning. This extends the above concepts adding advanced planning aspects such as: estate planning, family trusts, retirement and tax planning (e.g.., Roth conversions), social security planning, income planning (e.g., annuities), and life insurance planning.
That’s a lot of things to consider to build a more accurate and realistic financial forecast!
Note that working with a qualified financial planner is recommended, especially for the last item above. However, financial tools can help you think through your future financial plans to share with your planner.
A Financial Forecasting Tool Can Help!
FarPlanner is a financial simulation tool that considers many of the details listed above. You start by building a long range financial plan including adding your current and planned homes, cars and kids. For the 11–th item above, you can include suggestions from other planning tools to improve your forecasts even more.
FarPlanner then forecasts your account balances and net worth for decades into the future. In seconds. It does this by mimicking your plan’s expense and income money transfer cash flows into the future. Your entire forecast future is summarized by a ‘color bar’:
In this example, we see our simulated plan might run out of funds by 2043. If so, you’d want to consider boosting your income, retiring later or reducing spending.
The color bar shows yellow if your accounts’ balances at that time can’t completely fund current and future expenses. This just means you rely on future salary income in your plan to pay for things. That is a normal situation for most people before retirement.
The purple color is similar to yellow, but the forecast sees a large outflow from your accounts. Similar to red, you should consider changing your plan now by boosting your income, retiring later or reducing spending.
A green color means your accounts’ balances can fund all expenses from that point forward into the future. Ideally the color bar is green from the year you retire onward.
As you build your financial plan out in FarPlanner, and import your actual financials, your forecast (and that color bar) becomes more realistic.
Download and quickly build your FarPlanner plan for free today. Then see if or when you might run out of money.