FOOL'S EYE VIEW
Financial Planning for Specific Events

By Stephen Bland (TMFPyad)
August 6, 2001

I won't go on here about possibly the biggest specific event in most peoples' lives -- retirement -- because I and my colleagues have written extensively on this before and we have a pensions area and dedicated message board, as well as a retirement investing discussion board.

The concept of financial planning for a specific event, I guess, concerns only those who believe they won't have the money when the time comes. If you have a good income and/or capital available already, then you probably do not need to do much about planning for the event if you can cover it out of income or existing capital.

In practice I suspect that apart from some sort of retirement provision -- and even that is seriously underprovided -- people in general do not plan for major items of expenditure in the sense of saving for them. What they do is borrow when the time comes if they cannot afford to fund the cost out of existing savings or income. Many will borrow even if they do have the savings, preferring to keep their money available.

Let's look at the example of school fees, for those of a mind to pay for private education. A well-known London public school I have in mind, not boarding but merely day attendance, now costs over £11,000 per year. And the little dears attend there from ages thirteen to eighteen. You've probably sent them to a "prep" school (how I hate that expression -- and before I am accused of hypocrisy, yes my own lot attended just such institutions) beforehand from the ages of five to thirteen and that isn't exactly given away either.

Okay, so Rupert or Pippa has just been born; you can probably manage the prep school fees up to thirteen but then you want to try and fund in advance the £11,000 per year  -- at current levels -- to pay for the big one for five years, and you have thirteen years before it starts.

The first thing to do is forget those school fee ads you see in the press. They will normally involve some sort of insurance scheme, and using insurance plans to save money is not the Motley Fool way. So we are talking DIY here to avoid charges and to try and improve on the frequently abysmal performance of such plans.

The second thing is to allow for inflation. Now school fees will rise much faster than inflation, if history is a guide. If the increase is, say, 10% per year then after thirteen years the current £11,000 annual fee will be about £38,000, to start with. Frightening. If they rise at 7% then the eventual cost will be around £27,000 per year. Then, don't forget that the fees will go on rising at whatever projected rate you select throughout the five years of attendance. So my figures above are just for year one.

Let's use 7% as a projector and see what the fees will cost for the five years of attendance starting thirteen years from now. I have rounded to the nearest £500.

£26,500
£28,000
£30,000
£32,000
£35,000

A total of £151,500. You could knock off a bit because you do not need all this money on day one, so call it £140,000. That is the lump sum you will need to fund these five years without having to put in any additional money in at the time.

So how do you do it starting with nothing? Simply, you have to save such amounts monthly that will likely add up to this figure after thirteen years. Start with a very low risk idea. If you could get say 4% in the bank over this period you need to invest about £686 per month. The risk is that bank deposit rates are uncertain, but at least your capital cannot go down.

Go up the scale a bit and you have to start taking capital risks to try and deliver a higher return -- and then appreciate that it might not work. You might consider equities in the form of a FTSE 100 index tracker fund for example. Be very conservative, I suggest using a projected annual return of 8% at the outside. Using 7% to be a little safer, we find that the monthly instalments to produce the £140,000 are about £553. But I repeat, you have to be fully aware that once you get into this sort of territory, there is no guarantee at all that the required sum will be there on time. It may be more, but it may also be a lot less.

There are other equity-based ideas. You could for example avoid funds and put your monthly savings into purchasing individual shares every few months when a few thousand has accumulated. This, though, requires some stock picking skills. You could do worse than follow something like the High Yield Portfolio idea, buying the shares one at a time. It involves more risk than a fund but likely offers in my view a better long-term performance, if you can accept the risk.

There are other plenty of other ideas for those with serious expenditure plans for the future but who may not have the wherewithal at the time to fund them. Even if your savings plans don't provide the whole amount necessary, whatever you can afford to save will reduce the pain at the time.