Personal Financial Planning: How to Make a Financial Plan
- Financial plans have three parts: your current money situation, your financial goals, and the steps you’ll take to get where you want.
- You’ll complete seven steps: calculating your net worth, determining your cash flow, setting your financial goals, creating a budget, establishing your investment strategy, managing your risk, and monitoring your progress.
- Financial plans can and should be altered when your situation changes.
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You might think that financial planning is something only wealthy people do. That's just not true. Financial planning is how people of all income levels and life stages control their money and create a better future for themselves and their families.
A financial plan can help you balance your current needs and future goals. It can help you solve money problems you've gotten into and avoid those problems in the years ahead.
What Is a Financial Plan?
A financial plan can be as simple as a household budget or as complex as a multi-generation estate plan.
The nature of your financial plan depends on your needs. The best way to think about a financial plan is to start with your current financial situation and then consider the conditions that are likely to arise in the future.
Often, a financial plan is made up of many different projects. When you think about your goals for the years ahead, you'll work through several stages to hit your targets.
Personal financial planning helps tie those individual goals together. After all, you have different demands on your money at various stages of your life. A financial plan can help you figure out how to divide your money to meet each goal at the right time.
Personal Financial Planning Goals
What are some examples of goals a financial plan might cover? Below are some of the needs you might have over the years, with some comments on how a financial plan can help you meet those needs.
Making ends meet
Stretching a paycheck to make ends meet involves choosing which bills to pay first, how much to spend each week on food, when to buy clothes, etc.
These needs come up at different times and in different amounts. You can't simply throw money at the first thing to come up because then you might not have enough left over to pay the next bill.
Organizing what you can afford to pay and when you'll need to pay it requires a plan. You need to compare your income and needs to develop a budget that will make sure money will be available at the correct times.
A simple household budget is the first type of financial plan most people have. It will remain a vital part of any financial plan for the rest of your life.
Getting out of debt
As if making ends meet isn't challenging enough, the challenge is even more significant if you're in debt.
The problem with debt isn't just that making payments adds another demand to the everyday costs like food and housing. Debt also becomes more expensive the longer you have it, costing you more interest every day.
A personal financial plan can help you with debt in three ways:
Budgeting to have money available to make your debt payments on time.
Organizing your debt to pay the lowest interest rates possible.
Accelerating repayment to reduce the amount of time you'll be paying interest.
Establishing a good credit score
Credit cards, car loans, mortgages, etc. - borrowing is a routine part of managing household finances.
Being able to borrow and how much it costs to borrow depend on how good your credit is.
Whether you need to establish or re-establish credit, a financial plan can help you make the moves that will give you good credit history.
Building an emergency fund
Once you've come up with a plan to cover your routine expenses and debt payments, you need to plan for the unexpected.
From car repairs to losing a job, unexpected setbacks will create a variety of demands on your money outside of your financial plan.
An emergency fund can make the unexpected less disruptive to your finances. An emergency fund is a reserve of money in savings or another type of account you can access quickly.
Budgeting to build up an emergency fund should be an early part of your financial plan.
Managing taxes
Taxes take a bite out of your budget, usually before you even get your paycheck. So what can you do about it?
While taxes depend mainly on how much money you make, other factors determine how big a bite the tax collector takes.
Where you live, what deductions or tax-advantaged vehicles you take advantage of, and various investment decisions all affect how much tax you have to pay.
So, if you don't want to pay more than your fair share, make tax considerations part of your financial plan.
Buying a house
This is likely the biggest single investment you'll ever make, so naturally, it takes some planning.
After all, the financial impact goes beyond a one-time purchase. It is felt for years, both before and after that purchase.
Personal financial planning can help you with these tasks:
Getting your credit in shape so you'll qualify for a mortgage
Saving a down payment and closing costs
Finding the best mortgage for your situation
Budgeting for your mortgage payments and the other costs of owning a home
Putting kids through college
According to information from the College Board, a four-year college education today costs over $100,000 if a student attends a public school in-state. Attend the average private school, and the cost rises to over $200,000.
If you have more than one kid, those costs are multiplied.
Naturally, you can't meet those kinds of expenses without planning. A financial plan for a family can include elements to help your children afford college, such as:
Using tax-advantaged college savings plans like a 529 account
Finding information on financial aid for college
Calculating loan payment costs to see if they'll be affordable after graduation
Funding your retirement
Suppose you're going to fund decades' worth of retirement expenses. In that case, it naturally takes decades of planning and savings in advance.
That's why retirement savings should be part of your financial plan from the very start. This can help you:
Figure out how much retirement savings you'll need
Find the best accounts and investments for your situation, from IRAs to employer-sponsored plans
Manage your financial resources to last throughout your retirement
Making a will
Estate planning isn't just for the rich. If you have a family, you should have a financial plan for what happens after you die.
This goes beyond figuring out who inherits what. It may include making arrangements for children should they lose both parents. It may also involve figuring out how much life insurance would be necessary to replace your lost income.
Think of it this way: the final stage of any financial plan should involve how you'll hand your finances off to the next generation.
How to Create a Your Own Financial Plan
When they think about a financial plan, most people start with two things: paying their bills from month to month and saving for retirement.
Those are critical goals, but you are likely to have a series of smaller objectives between now and retirement. You may need to save up for your next car. You may want to buy a house. It would be nice to carve out some money to splurge on a big vacation now and then.
If you have kids, there are even more factors to consider. A financial plan for a family might include budgeting the extra costs for childrens' food, clothing, and healthcare, saving for their college education, and providing for them when you die.
Creating a financial plan is like a trip into the future -- from now until the end of your life and everything in between. It should account for the various financial needs that will arise along the way, detail how to meet each one, and figure out how all the pieces fit together.
As complicated as that sounds, it's a lot easier if you take it one step at a time. The section below covers seven steps you can take toward formulating a personal financial plan.
Financial Plan Steps
Here are seven steps towards assembling a comprehensive financial plan:
1. Calculate your net worth. Suppose financial planning is primarily about setting goals for the future. In that case, this first step is measuring where you are today. That means adding up your assets (including bank and investment accounts and real estate) and subtracting your debt.
2. Determine your cash flow. This is a measure of the money you have coming in and going out every month. First, determine your income, including wages after taxes and other payroll deductions. Then subtract your monthly bills and what you usually spend on necessary things like groceries transportation, plus discretionary stuff like entertainment, gifts, and clothing.
3. Set financial goals. As discussed earlier in this article, these may include near-term goals like getting out of debt and setting up an emergency fund. And longer-term ones like sending kids to college and funding your retirement.
4. Create a budget. Once you've figured out your cash flow and listed your financial goals, you can see how much money you'll have available to put towards those goals each month. Budgeting a set amount to save for those goals helps ensure you keep enough money going towards savings rather than short-term spending.
5. Establish an investment strategy. Savings for long-term goals will be more effective if it's productively invested. You need to decide on an investment strategy that fits your cash flow, the timing of your objectives, and your tolerance for risk.
6. Manage risk. The right risk level for your investments changes over time. This depends both on your resources and how close you are to needing the money. Make sure your investment approach changes as your situation does.
7. Monitor progress. Naturally, when you make plans that stretch out over decades, not everything goes as expected. Staying on track requires checking your progress and making adjustments when needed.
What Do Financial Planners Do?
What role do financial professionals play in all this?
There are a variety of specialists who can help with your financial needs. These include:
Tax accountants
Estate attorneys
Insurance agents
Investment advisors
Debt counselors
Financial planners are professionals who can tie all this together. They have enough familiarity with all these functions to incorporate them into a well-rounded plan. Often, if they don't have expertise in a particular specialty, they can refer you to someone who does.
Can You DIY Your Financial Plan?
Do you need a professional to put together a personal financial plan for you? Or can you do it yourself?
There are plenty of resources to show you how to make a financial plan. These range from templates for financial planning documents to comprehensive guides on putting together a plan.
Especially if your needs are pretty basic, you may be able to put together your financial plan, at least as a starting point.
However, some of the individual functions of a financial plan, such as tax preparation or investing, require specialized expertise. In particular, because laws and conditions are constantly changing, it can be helpful to work with a professional who keeps up with the latest information.
Whether you hire a professional or DIY, putting together a plan is an essential step on your financial journey. As the old saying goes, "those who fail to plan, plan to fail."