Financial Planning vs. Investing: Why Your Employees Should Understand The Difference

Over the last several years, companies have faced escalating demands from employees for help with financial matters. This is due to the increasing stress and anxiety many people feel around financial matters and that employers are seen as a trusted source of information.

Employees' Increasing Demands for Financial Help

At Montridge,  we regularly receive requests from companies to conduct education sessions on money matters for their staff.  A common theme that emerges from these sessions is that many employees conflate investing with financial planning.  Moreover, the frequency of equating those two things has increased over the last several years.  This phenomenon appears to be correlated with the rise of “do-it-yourself” investing via online platforms.

In and of themselves, there is nothing inherently wrong with online platforms or  do-it-yourself investing but as many of your workers likely discovered in the last year, living through a bear market and high inflation can erode anyone’s confidence.  New doubts and questions have arisen that didn’t surface during strong markets with positive returns.

So as an employer, why should you care?  Uncertain financial conditions lead to increased stress and anxiety which negatively affect workers’  engagement and productivity.  Employee financial stress = lower profitability.

An important way to address employees' financial worries is to teach them the basics of financial planning.  And more importantly, help them to make investment  decisions based on their goals and objectives – their financial plan – and not current market conditions.

So where to begin?

4 Steps Of Financial Planning - The Financial Planning Pyramid

We often find the best place to start is with the financial planning pyramid. When building a financial plan, as with building a pyramid, it is important that each layer is constructed with care.  Skipping levels of the pyramid can lead to a poorly built plan which will collapse when the unexpected arises.

1. Protection

The first layer of the pyramid is often the most overlooked.  There is nothing exciting about this layer and in fact, it contains elements that many people prefer to avoid.  Often referred to as the protection layer, this foundational level includes debt reduction, insurance, and wills.  The importance of this layer cannot be overstated when something unexpected arises.  Without proper insurance, wills, powers or attorneys, or health care directives in place, your employees will quickly erode their savings and investments or acquire large amounts of debt.  

2. Savings

The second layer is all about savings.  Establishing an emergency fund and saving for retirement are universal.  The rest of this level is concerned with goal setting and establishing savings for objectives that are important to your employees.  These goals will vary from person to person but common ones are home ownership, post-secondary education for children, and travel.  With goal setting, comes investing.  However, the common error that people make is to begin investing with no clear goal or objective in mind. The challenge with that approach is that time and risk are inextricably linked.  The more time someone has before they need to utilize their money, the more risk they can assume.  This is why the key to successful investing begins with a plan.  Preferably one that is written down and accompanied by a timeline.

3. Building Wealth

With the third level of the pyramid, employees will begin to build their wealth.  Essentially accumulating savings in excess of their specific goals.  In this stage of planning, people begin moving beyond savings into investing.  Even though your staff likely hold investments in their retirement accounts, this stage of the plan is about building wealth beyond the goals set in stage two. And this is where people tend to conflate investing with financial planning.  

4. Risk

Many of your employees likely created investment accounts during the long bull market from 2010 to 2022.  With that unusually long period of positive returns, planning wasn’t on most people’s radar because investing seemed easy. People also tended to accumulate debt and avoid ordinary savings because interest rates were so low. However, when the stock markets corrected in early 2022, many of your people panicked. They moved their money out of the markets to places that felt safe.  Unfortunately, anyone fleeing the markets locked in their losses and they will have a hard time recouping their funds.   

This type of behaviour occurs with most market corrections but investors with financial plans tend to stay the course because they understand the connection between time and risk.  They know that over the long term, equity markets will outperform bonds, real estate, and savings accounts even when markets fall.  In addition, they have emergency and other savings in place to help them ride out the storm.        

Most people will spend their working lives on the first three levels of the pyramid.  However, one of the challenges of the last decade is that many people moved straight to level four and failed to create a financial plan.  Low-interest  rates had Individuals investing in real estate or cryptocurrencies without understanding the risks.  

Cryptocurrencies

Cryptocurrencies  are in their relative infancy and do not provide any income in the form of interest or dividend payments which makes their return completely dependent on market forces.  This makes them speculative.  It’s fine to hold crypto or other high-risk  investments but they should represent less than 10% of an overall investment portfolio.  Speculation isn’t inherently bad but speculation without a financial plan and savings can lead to serious financial stress and anxiety.

Real Estate

Risk in real estate is mostly related to mortgage rates although there are inherent risks in the location of real estate.  If demand falls in an area, selling may be difficult or done at a loss.  As well, your employees who financed a home or other property with a low-rate  mortgage, may now be feeling anxiety about upcoming renewals that can result in mortgage payments increasing by hundreds or thousands of dollars per month.

The Power of Planning and Saving to Avoid Financial Stress

So do you have help?

Provide education and resources to your people so that they understand the basics of financial planning.  The key is having written short, medium, and long-term  goals with savings and investments appropriate for the timelines  associated with those goals.  

Short-term  goals such as emergency funds, an annual vacation, or any goal with a timeline of less than three years should be invested in cash or near cash.  Choices include savings accounts, term deposits, and money market funds.

Mid-term goals usually fall within a three to seven-year window.  This could include saving for a sabbatical or the down payment for a home.  Investments suitable for these types of goals include bonds, conservative mutual funds, and large company stocks that pay regular dividends.

Long-term goals are usually seven to ten years or longer.  These include retirement, saving for a child’s education, or vacation property.  Stocks or equity funds generally make up the bulk of the investments for these goals although that depends upon someone's risk tolerance and the quality of the companies chosen.

Conclusion

To help reduce financial worries among your employees, help them to understand that building wealth needs to be done in stages and in order to be successful they need a financial plan.   It’s not enough just to start investing.  One must understand where one is going, the best route to take, and how far away is the destination.   Investing without a financial plan is like being dropped in an unfamiliar location without a GPS, roadmap, or compass.   It doesn’t matter whether you are walking, cycling, or driving a car, if you don’t know where you are or where you are going, you may never get to where you want to be.