Different Ways To Optimize Your Financial Plan
Fee-for-service financial planner and founder of PlanEasy.ca
We want to make the most of our hard-earned money. But that can mean different things to different people. The way we “optimize” our financial plan can vary greatly from one person to the next.
There are a few different ways to optimize a financial plan. Some will be obvious and widely accepted, like minimizing income tax where possible, but some are a bit less obvious or will depend on personal preferences.
Because a financial plan represents our personal preferences and personal values, no two financial plans are the same.
While two people may have similar income, assets, and net worth, they could have dramatically different financial plans depending on what they’re optimizing for.
We all want to make the most of our money, but what that looks like will vary greatly from one person to the next.
Here are a few of the different ways you can optimize your financial plan… what are you optimizing for?
Optimizing for total dollar is easy to understand. It’s a clear goal and it’s easy to know when you’ve achieved it. Sometimes people have goals like $1M in financial assets or $1M in net worth. These are clear goals to optimize for but often they’re quite arbitrary. Why aim for $1M and not $887,231? If $887,231 is enough to achieve your goals, then why aim for a full $1M?
Optimizing for total dollars can also lead to some less-than-optimal decisions…
Optimizing for total dollars could mean doing one more year of work, even when it’s not really necessary. Those who have reached their target retirement age can attest to the “one more year” syndrome. The financial benefit of working just one more year is so attractive because it provides a huge boost to your total financial assets both now and in the future.
Optimizing for total dollars could also mean spending less (perhaps much less) in an effort to get that snowball of compound growth started. But this may mean missing out on opportunities today.
Risk vs Reward
Optimizing for risk versus reward is a more subtle trade off. While easy to understand in theory, the problem with risk vs reward is that both risk and reward are hard to quantify perfectly.
It would be easy to optimize for risk vs reward if we knew those details perfectly, but because we don’t, there is a certain amount of personal preference that must be taken into account.
Your willingness and capacity to take on risk are important factors to consider. Your past investment experience is also an important factor. Someone who has been through a few stock market dips will be better equipped to manage a future drop in investment values.
Optimizing for risk vs reward typically means making decisions around investment opportunities, for example…
- Deciding on asset allocation between equities and fixed income
- Investing in a rental property
- Using the Smith maneuver and leveraged investing
Some people will focus on reward, aiming to increase their investment return even if it means taking on more risk.
Others will focus on risk, aiming to reduce risk while still being able to achieve their financial goals.
Optimizing for income tax means paying the least amount of income tax possible over the course of a plan.
It’s important to highlight that when optimizing for income tax, a long-term view is best. Paying more tax this year may be a better decision if it means paying less next year or the year after. This might mean strategically drawing down an RRSP/RRIF in early retirement.
Or, in the case of TFSA vs RRSP it can mean deciding if it’s better to pay more tax now (by using a TFSA) or more tax in the future (by using an RRSP).
Optimizing for income tax could include:
- Making decisions between TFSA vs RRSP (picking the right one could help save $100,000+)
- Making decisions around what investments to hold in a non-reg account (getting the benefit of Canadian dividends)
- Planning retirement drawdown to optimize for tax rates and tax credits (like the pension income tax credit)
- Using asset location to hold specific assets in specific accounts (but is asset location really necessary?)
Similar to income tax, optimizing for government benefits means triggering the least amount of benefit clawbacks over the course of a plan. By minimizing clawbacks we can maximize the government benefits received.
Again, similar to income tax, when optimizing for government benefits, a long-term view is best.
Child benefits like the Canada Child Benefit (CCB) and retirement benefits like the Guaranteed Income Supplement (GIS) are generous government benefits but only apply during specific periods of a person’s financial plan.
Optimizing for government benefits means anticipating which government benefits you may qualify for in the future and planning how to avoid or reduce their associated clawbacks. These clawbacks can be steep, as high as 50% to 75%, so a little bit of optimization can go a long way. Learn more about the different federal and provincial government benefits and how to optimize them.
Optimizing for financial flexibility and freedom is much harder. Flexibility and freedom can mean different things to different people.
Is it the flexibility to take time off from work for short period of time, like a parental leave? Or perhaps the flexibility to make a large purchase? Or maybe leave a toxic workplace? Or could it be covering a large, unexpected emergency?
Or is it the freedom to quit work all together, take a lower-earning job, and just “coast” until retirement.
Some people may only need a bit of flexibility and freedom in their financial plan while others may want the ultimate in flexibility and freedom.
At a minimum someone optimizing for flexibility could be aiming for a sizable emergency fund or a small pile of “FU Money”.
At a maximum someone optimizing for freedom could be aiming for Financial Independence, the ability to walk away from employment at any moment.
Even a small amount of flexibility and freedom can provide an enormous amount of well-being, so it’s an important consideration when optimizing a financial plan
Personally, we like to ‘spend our money on freedom’, read more here…
They say you can always get more money, but you can never get more time.
Time is arguably our most precious commodity. We all have a finite amount of time and when optimizing a financial plan increasing the amount of “time” can be very important for some people.
This might mean saving more today in an effort to have more time in the future. Someone making $90,000 per year is earning around $367 per day. Buying one day of time will cost $367 today, but that same amount of money, if invested over 20-years with a real return of 3.5% (after inflation), would buy two days in the future! For some people, optimizing for time might mean having less time now in an effort to have more time in the future.
However, other people may look at time differently. They may feel that increasing the quality of time is an important factor. They may consider spending more now to improve the quality of their time, even if that means spending more time working in the future.
What Are You Optimizing For?
What are you optimizing your financial plan for? There are a lot of different ways to optimize a financial plan, more than just the few we mentioned above.
Some ways to optimize a financial plan will be important to most people, like minimizing income tax, but many will depend on personal preferences.
Because a financial plan represents our personal preferences and personal values, no two plans are the same. Two very similar people can have dramatically different financial plans depending on what they’re optimizing for.
So, what are you optimizing for?
Financial planner, personal finance geek and founder of PlanEasy.