10 Steps To Creating A Sound Financial Plan

Everything goes better when there is a thoughtful plan in place. Whether single, married, and with children, you should build a financial plan that best fits your lifestyle now and in the future.

Everyone needs a financial plan to help them stay on track to achieve their dreams turned into financial goals. Women especially need a plan to gain financial independence due to the gender wage gap and carrying the heavier burden of caregiving.

What Is A Financial Plan?

Financial planning is an ongoing process to develop and implement a comprehensive financial plan to help you achieve financial success. By planning a roadmap for finances, you seek to grow and manage your income and wealth to reach your financial goals.

Your financial plan evolves from your financial and lifestyle goals for your immediate future, while long-term planning for your financial future is consistent with your values and lifestyle. Thinking about buying a car within a year is a short-term plan, whereas saving money in a 529 College Savings Plan for a toddler is long-term planning.

Starting with your current finances, you want to identify your goals for the short-term and long-term, recognizing there should be flexibility in your plan.  As you go through various life stages, you should modify your financial plan for significant changes.

Your short-term or annual financial plan will help you determine what you should do now in your current financial situation.  It may mean shoring up your finances by improving your creditworthiness, refinancing your mortgage, or rebalancing your portfolio.

You can create a financial plan on your own, use a financial planner, a Robo-advisor, or some combination. 

How To Get Started

You can create your financial plan or work with a financial professional. If you are just starting, focus on specific definable financial goals.

There are specific documents (e.g., financial records)  you will want to gather to create tools like a budget and net worth statement. These tools will give you varying angles to measure the financial health of your household. Where possible, automate savings so that you can transfer money from your paycheck to savings, retirement, and investment accounts.  

Pull together relevant documents like your latest bills and financial account statements to reflect financial transactions, such as credit card receipts, bills, all other applicable receipts, bank statements, tax returns, brokerage statements, and paycheck stubs.

A Monthly Budget helps you better manage your cash flows, so you control spending and save more.

A Net Worth Statement gives you a snapshot of your assets minus your liabilities, providing a path to wealth.

Setting  Specific Financial Goals Aligned With Your Values

Before you set your financial goals, you need to understand your values and preferred lifestyle. It will help to define each goal clearly and in their respective timeframe.

Make your financial goals reasonable, definite, and specific, so they go from vague thoughts to concrete and achievable objectives. Your goals or desires should align with your reality. For example:

  • Pay down the $2,000 in credit card debt within the next two years.
  • Automate your savings.
  • Save $200 a month for an emergency fund until you can meet six months or more of your living needs.
  • Start investing $100 per month in a brokerage account.

Strategies To Achieve Your Goals

Financial strategies can help you carry out your goals. Savings is an essential financial task to having a successful financial plan and learning to use money wisely.  By using a “pay yourself first” strategy, you should direct 20% of your income to savings so that it can work for you in building wealth.

Financial tools, like your budget and net worth statement, provide a way to measure your financial health.

By automating savings, you can regularly contribute money from your paycheck to go where you want these funds to go (e.g., savings, retirement accounts). This reinforces a good money habit of saving for capital accumulation.

Capital accumulation refers to emergency funds, college savings, retirement, investments, and tax reduction strategies.

Each individual or family has its own unique idea of its financial and lifestyle future. Couples need to talk about their aspirations to unify specific family goals while recognizing each individual’s personal goals.

Core Components of A Financial Plan

1. Create A Budget

A review of cash flow management will look at the specifics of your current and projected budget and net worth. You need to understand your current financial situation, make adjustments to plan for your long-term future. 

By creating a monthly budget,  you can review monthly inflows and outflows of money. Inflows are your sources of income that support outflows, that is, fixed and discretionary expenses. Ideally, your income sources should exceed all of your costs after spending. Leftover savings are financial resources that you can allocate based on your needs, like paying down debt or your investment accounts. The more the savings, the better for financial flexibility.

There are different types of budgets. You should use the budget that works best for you.

The 50/20/30 Budget Rule

I recommend the 50/20/30 budget rule as a rule of thumb. This method is simple as you are only tracking three categories, needs, wants, and savings. You have the flexibility of allocating the savings into other areas, like debt pay-offs. If you have considerable debt obligations, think about reducing the percentage of your wants.

Essentially, you are dividing your after-tax income into three buckets:  

  • 50% For Basic Necessities
  • 20% To Savings And Debt Prepayment-Pay Yourself First
  • 30% For Wants or Discretionary Spending

You want to carefully balance these three categories by tracking and reviewing your spending across major household categories: housing, food, transportation, entertainment, clothing, and personal care. Review your monthly budget for clues as to where you may cut some costs.

Consider spending less than you earn so you have savings that will work for you. Overspending by impulse purchases will derail your finances, so keep that in check.

Use your savings to enhance your ability to funnel into your other goals.  Evaluate and plan for your large purchases by earmarking savings with sinking funds. Automate your retirement savings, paying off debt, an emergency fund, and make investments.

2. Net Worth

Besides your budget, your net worth is an essential tool. Net worth is assets less your liabilities at one point in time. Your assets should be growing faster than your liabilities as you build your wealth from investments while keeping debt at low levels.

If your debt obligations are outpacing your assets, you seriously need to focus on paying off your debt by reducing your spending now and possibly engaging a finance professional.  

This tool gives you a snapshot of your wealth generation at a point in time and will grow more significantly with better management of your household’s finances. Liquid net worth is another tool and a subset of net worth that highlights your liquidity when you need to access capital. 

3. Build An Emergency Fund

Saving money for an emergency fund is essential. If you don’t have one, you need to prioritize building a fully-funded emergency fund. You never know when you may face an unforeseen event like dental surgery or a job loss, resulting in unexpected costs that you don’t have funds on hand. It becomes a financial challenge for you to take care of monthly bills like the rent, mortgage, utilities, or use your credit card to take care of these bills. Setting aside money for this specific purpose gives you a financial cushion in the short term.

4. Manage Your Debt With Timely Payoffs

You want to keep your spending in control and manage your debt to low levels. Carrying large credit card balances and only paying the monthly minimum is a fool’s errand. Doing so is hugely expensive given the prohibitive high interest rates of credit cards, making your purchases excessively higher. 

Instead, pay off your credit card balances in full and on time while slowing your spending. Resist putting everything on a credit card that you can’t afford to pay it off entirely. You want to maintain or improve your creditworthiness so your lenders will give the best borrowing rates.

5. Examine Your Credit Report

Your creditworthiness is a valuable asset. Many different parties will look at your credit report during your lifetime, including all kinds of lenders, landlords, employers, potential partners,  utility companies, insurance companies, and government agencies.

It’s an excellent idea to periodically review your credit report for potential errors or issues that you want to correct promptly. Typically, the higher your credit score, the lower your borrowing rate and better your access to credit when you most need it for purchasing a house or an opportunity to start a business.

 6. Risk Management

You need to get the right insurance coverage to protect you and your family from exposure to risks based on items you own, our activities like owning and driving a car, and potential financial loss.

Since we can’t entirely avoid these risks when living our lives, buying specific insurance with the right coverage will lessen your family’s hazards. Your workplace may provide some types of insurance, but typically at lower amounts that you can purchase additional coverage. 

 We believe the following types of insurance are essential for your list: auto, life, disability, homeowners’ and renter’s insurance, medical insurance, long-term care, and umbrella protection. Shop around for the best coverage and reasonable rates.

7. Build A Diverse Investment Portfolio

It is always the right time to invest your money for growth. Investing is the best path to building wealth. When you are young, you should create your portfolio for diversification and capital accumulation to benefit from compounding returns. With a long life in front of you, you can handle far more risk in your portfolio than if you are enjoying your retirement.

Start investing early by buying low-index mutual funds, ETFs, and possibly target-date funds. Be aware of your risk tolerance which is the ability to endure losing money on an investment. It varies for every investor. Typically, risk tolerance declines as you move towards retirement years when you are preserving your capital. 

Maintain diversification within an investment portfolio and various asset classes such as stocks, bonds, real estate, and high-risk investments.  Periodically, you need to review your investment portfolio for potential rebalancing and asset allocation adjustments. 

8. Retirement Savings

 Retirement savings is another form of investing, but with better tax advantages. You should begin saving for retirement as early as possible. An employer-sponsored 401K is one of the best benefits available to employees.

Take advantage of this benefit as soon as you can. You are contributing pre-tax compensation towards your retirement and investing that money over the long term. You need to consider what kind of lifestyle you expect for your retirement years.

In your twenties, that may be too much of an abstract concept for years to come. However, it is not too early to begin automatically saving small amounts to direct to your employer-sponsored 401K retirement account. By doing so, you get tax advantages, and if you contribute enough, you may earn your employer’s match contribution, which is like “free money.”

You should also set up a Roth IRA account to bolster your retirement savings. 

9. Tax Planning

No one should want to pay more money to the tax authorities than what they owe. In conjunction with tax professionals, tax planning is when you seek legal ways to reduce, eliminate, or defer income taxes. It is tax avoidance, not illegal tax evasion.

Tax planning should be a significant part of your financial plan, depending on the assets you own. Don’t ignore the impact of taxes on your financial planning because it can be very costly. 

You should apply tax reduction strategies to minimize your tax burden using capital gains strategies, charitable giving, tax-free and tax-deferred retirement savings, and health savings accounts. 

 10. Estate Planning

Once building assets over a lifetime, you want to make sure to transfer your wealth to loved ones most appropriately and efficiently. The last thing you want to do is cause your family stress with faulty estate planning that requires lengthy court battles. Generational wealth is about taking care of the next generation. You want to do the right thing but communicate with them about your plans and values when appropriate. 

You want to engage an experienced attorney to make arrangements during your lifetime that are consistent with your wishes for handling your estate when you are gone. Some assets will go automatically to your designated beneficiaries that you indicated on a form when you open accounts like retirement and banks. At the same time, wills and trusts will address the remaining assets.

Related Post: Your Guide To Basic Estate Planning

 

Do I Need A Financial Planner?

You can develop a simple financial plan on your own as you are starting. Even if you do not work with a financial planner, you need to consider and revise your short-term and long-term goals. Managing money well is time-consuming and requires expertise in many areas. You can also try the Personal Capital app which can help you build your tools for free. 

As your assets grow, you may need professional guidance and assistance in developing financial strategies.

Your Financial Plan Is It Not A Set And Forget Endeavor

The financial plan is a compilation of goals and strategies for your plan to manage your household now and in the future financially. Once you have a financial plan, don’t put it in a drawer and forget about it.

Review it frequently, primarily when changes are occurring in your household. You and your spouse or partner should be communicating about changes in your workplace or desires that are new to each other. Updating each other on significant decisions will help you avoid potential disappointment or surprise later on.

A Financial Checklist With  Specific Activities

1. Review your monthly budget often and your net worth statement at least annually. 

2. Refill your emergency fund to keep it fully funded if you withdraw money during the year. 

3. Spend within your means so you can save more and make it work for you.

4. Pay down your monthly debt obligations in full and on time or reduce spending.

5. Examine your credit reports at least once a year, and fix any problems. Maintain a good credit score, and consider raising it to better levels.

6. Make sure your investment portfolio remains diversified and do rebalancing if there has been too much concentration in one asset class.

7. If you get a generous raise or bonus, consider increasing your amount of automatic savings in your retirement accounts for the following year.

8. Review your insurance policies to ensure you have enough coverage and increase the amount for any significant changes in your household. See if you are eligible for lower rates.

9. You should review your estate plan periodically for significant changes in your household. Review your designated beneficiaries to see if they see make sense, and add any new family members.

10. Review tax and estate planning, especially when there are changes in tax laws.

Questions To Ask Yourself

1. Have I attained my goal of saving money to fund my emergency fund for at least six months?

2. Did I reduce my spending on luxuries enough, and what impact did it have on my savings?

3. Am I on the right career path, or should I consider more education to generate more income?

4. Should I consider a side hustle in my spare time and for extra income?

5. Why are my children’s college savings plans not growing as fast as the market?

6. Now that I receive a higher income and bonus, do I need to increase my contributions to my retirement, investment, and 529 accounts?

7. Have I automated all my accounts from my paycheck?

8. What new events have occurred that may be significant to my financial plan?

9. How can I achieve those goals that are eluding me?

 Final Thoughts

Prudent financial planning is vital to achieve your short- and long-term goals and to support your family values. Review your plan frequently and especially when there are significant changes in your household, the economy, tax laws, or just to make sure it is in line with your expectations. 

Thank you for reading! Please visit us at The Cents of Money to find other articles of interest. 

 

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