Most people concerned with their financial well being will maintain a budget and keep track of how their investments are performing. People desiring to be more sophisticated in their financial planning might even hire a financial planner to help them target specific goals and develop an efficient way to achieve those goals. However, most people stop short of modeling their financial future. This articles touches on the meaning of financial modeling, its merits, ways to implement it and things to watch out for https://nicksasaki.com/tony-robbins-dean-graziosi-own-your-future-challenge-project-next-review/ .
Financial modeling is the projection of a set of financial figures to some future point based on a set of assumptions. One might create a base model with assumptions that he or she believes to be the most probable and then vary certain assumptions to see what the outcome would be. This is done by every major company and is even required for many types of companies that fall under regulatory scrutiny. However, individuals rarely have used this valuable tool for their own financial well being.
The benefits to individuals of financial modeling in this author’s opinion are tremendous. Merely in order to build a financial model, an individual must have a grasp of several important items. One is having a good understanding of their current financial situation. Assumptions for financial models, such as expense levels, are often developed based on a person’s financial history. The base step for a financial model is for a person to have at least a rough plan for the actions they might take during the model period that would affect them financially. Each of the items is a valuable tool that would help an individual before a financial model is even started.
Once the financial model is created and a base model using the most likely assumptions is established, a person should have a clear picture of where they are going. A person might be pleasantly surprised or this might be a rude wake up call. Either way, the person is better off having the knowledge available to them.
The most valuable part of a financial model is its application to analyzing risk. Have you ever asked yourself what would happen if you retired early? Would your savings carry you? What if you lost your job? How long could you survive without your main source of income and what expenses would you need to eliminate or reduce? How would a major purchase such as a vacation home or a recreational vehicle affect your financial position? You may know that your current budget has room for the loan payments, but may the purchase derail your retirement plans? Financial modeling helps you answer the question, “What if?” By adjusting your assumptions to reflect different possibilities such as the ones I have mentioned here, you can identify and understand the risks to your financial future and even test how effective plans to mitigate those risks are.
There are several ways to build a financial model. If you have the skills to do so, you can build one yourself with a spreadsheet application such as Microsoft Excel. Many people are not that comfortable with financial mathematics. For those of you that fall in the latter category, there are still several options available. There is software available on the market at varied costs and levels of sophistication. Financial planners often offer this service for free in order to up-sell their other services. There are also consultants that will build a financial model for you. There are, of course, plusses and minuses with each of these methods.