What Is a Financial Plan and How Do I Make One?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

Written By

Reviewed By

Updated on Tuesday, October 13, 2020

Financial planning involves identifying your future financial goals, assessing your finances and then creating an action plan to meet those goals. A thorough financial plan will take into account your assets, debts, cash flow, insurance, retirement and any other pieces in your financial puzzle.

You can create a financial plan with a professional financial planner or a free DIY plan on your own. We’ll take you through the steps of creating a financial plan below.

Why is financial planning important?

Financial planning is important because it can keep you and your finances from free-falling. The definition of a financial plan is a document that lays out your current financial status, your financial goals and your financial strategy to meet those goals. Essentially, the overall objective of financial planning is to get you and your finances from point A to point B.

Financial planning is like building a road map of your financial future. Especially when you’re young, you get to determine the financial goals and milestones you want to hit, such as paying off your student loans or perhaps retiring early. And as you go through life, you’ll want to update your financial plan as you cross off those goals and create new ones.

Creating a financial plan is crucial to help ensure financial health and keep yourself on the right track. Keep reading to learn more about the steps involved in building a financial plan and what you’ll need to make one.

How to make a financial plan

Before you get started with the financial planning process outlined below, it helps to collect all relevant financial documents. Organize the papers related to all of your sources of income, any loans or debts, bank statements, investments and the like. The more you’re able to collect, the easier the process will be down the road, and the more detailed your financial plan will be.

With that in order, you can get started on building your financial plan.

1. Establish your financial goals

You first want to establish what it is you want to accomplish. Are you creating short-term financial goals to help you save for an upcoming trip? Or are you in it for the long-term financial planning process geared toward bigger savings goals including retirement or college education? Perhaps you’re building an emergency fund from scratch, or creating an insurance or estate plan.

Whatever your main goal, remember that your finances are all connected within the bigger picture. For example, you’ll want to be saving for retirement while you also save for a house. But that’s what a financial plan is for; you’ll take everything into consideration to develop a holistic financial strategy.

2. Calculate your net worth and review it in relation to your goals

Calculating your net worth isn’t something just for the wealthy. It’s actually a handy financial tool for us all.

To calculate your net worth, you take the sum of your assets (savings and investments, equity in your home, etc.) and subtract the sum of your liabilities (debts and loans). Your liabilities will include any credit card debt you have, mortgages, auto loans, student loans and other debts. If you have more assets than liabilities, your net worth will be positive. If your liabilities outweigh your assets, you’ll have a negative net worth.

You can make it a goal to have more assets than liabilities. Once you calculate your net worth, you can then assess what’s holding you back from your financial goals versus what’s serving you. For example, is your credit card debt weighing on your financial health? Once you have a better understanding of your assets and liabilities, you can set up a better plan that outlines how you can improve your financial situation and increase your net worth.

3. Look at your cash flow and budget your monthly income

Now that you have everything collected and understand your net worth, you can sit down and start to build a monthly budget. In this step, you might find it easier to use a tracking app, such as Mint, or a budget worksheet to help you keep track of your spending.

Estimate your required expenses for each month. This will include the essentials such as insurance payments, rent or mortgage, retirement contributions and savings. Then you can look at all your other spending. Budgeting apps and cash management accounts like Simple can help you track and categorize your spending more easily.

Compare your expenses against your monthly income and make sure they align. If there are any gaps, that’s where budgeting comes in. Figure out which categories you can cut back so you can put that money where it matters more. You can also figure out whether there is room to contribute any extra income to your savings.

A common budgeting method is the 50/30/20 rule, where you set aside 50% of your income for needs, 30% for wants and 20% to savings.

Aiming for this budget is a good place to start, but of course you can adjust as need be. If your financial budget looks more like 55/20/25, that’s OK, too. Just remember to revisit your budget every so often and adjust as needed.

Note that retirement savings here falls under the 20% section, but this is considering after-tax money. Some experts suggest you should be setting aside about 15% of your pretax money toward tax-advantaged retirement accounts such as 401(k) plans and traditional or Roth IRAs.

As for housing, you should be spending about 30% or less of your pretax income on housing. This includes not only rent or mortgage payments, but utilities, maintenance and property taxes as well. Spending more than that on housing may leave you short in other areas, and you do not want to end up being “house poor.”

4. Write your financial plan

At this point, you or your financial planner, if you will be using one, should have the main tools to set up your financial plan.

Take a look at the financial goals you set at the beginning and determine what part of your current financial situation needs to change — or stay the same — in order for you to reach them. For example, if your goals include buying a house in five years, sending your kids to college and retiring on time, calculate whether your current investment strategies will carry you through to those milestones.

This is where a financial planner can potentially come in handy. You can set your goal amount and timeline, and they can help you understand how on track you are and advise on what more you need to do to get there. A human advisor or a robo-advisor can also help you set and adjust your asset allocation within your investment accounts.

As another example, if your financial goal is to pay off all your debt, your financial plan should include the ways you will set more money aside toward paying off that debt, whether this means depositing more of your paycheck into a savings account or cutting back on your “wants.”

A good financial plan should have reasonable action items. It should be specific to your situation and laid out in a way that makes it easy to understand it and follow the set plan. After all, this is your personal financial-planning process.

If you’re having trouble writing out your financial plan, perhaps start simply. For example, let’s say you’ve determined you have the financial capacity to contribute more money to your retirement accounts each month. You can write “In order to retire on time, I must contribute 15% of my income to my Roth IRA each month,” and place check boxes for each month underneath that goal. Then you can check off your progress every month.

5. Revisit your financial plan periodically

As hinted above, a good financial plan should be trackable and measurable. That way, you can easily check in on and mark off your progress. Revisiting your financial plan is crucial to its success, not just so you can keep on top of it, but also because circumstances can change and you must adjust your plan to match those changes. For example, if you get married, you now have someone to share in the household expenses. Or perhaps you had a child, or added to your family with another child. This means it’s time to reassess those college education savings amounts and goals.

It can also be satisfying to cross off completed goals, like you finally pay off your student loans (don’t forget to recalculate your net worth!). Your financial plan is a constant work in progress, but don’t think of it as homework. Rather, it’s a living document that you get to keep with you, one that tracks your goals and all the hard work you put in to reach those goals.

Should you hire someone to help with financial planning?

While you can create a financial plan on your own, enlisting the help of a financial advisor can be a wise move, especially if you have a lot of assets or a more complicated financial situation. For example, a financial planner can help you create an estate plan to maximize what you can leave to your heirs. Or they can help you figure out your insurance plans and payments, as well as help you assess and manage risk as time goes on.

A financial planner can also hold you accountable and keep you on track with your financial plan. It may be all too easy for many of us to set a financial plan and lose track of that document, or get sidetracked by a life event. Paying a professional may be just the thing you need to stick with it.

How to find a financial planner

There are several things to keep in mind to ensure you find the right financial advisor:

  • Find a certified financial planner (CFP), the top financial planner designation: For starters, make sure they have the CFP designation. CFPs have to undergo extensive training and testing to obtain this designation. Their education includes financial planning and management of taxes, estates and retirement, as well as other areas of expertise such as employee benefits, investment management and insurance. CFPs are also designated fiduciaries, which means they must act in their clients’ best interests.
  • Work with a fiduciary, who is required by law to act in your best interests: Finding a fiduciary is crucial when looking for the right financial advisor. Not all financial advisors are bound to have your best interests in mind. For example, if they work on a commission-based payment platform, they make more money when their clients buy and use certain services. This means an advisor may push products on you that you don’t need. If they work on a fee-based platform, they may take fees from third parties along with charging you a fee. Instead, you should find a fee-only planner who is paid only through a fee for services.
  • Check an advisor’s Form ADV for their background, expertise and any potential conflicts of interest: Once you’ve narrowed down your list, check for each advisor’s Form ADV. This form will indicate how they collect their fees, any potential conflicts of interest, the types of services they offer, their assets under management and more. Form ADV gives you a holistic look at the advisor to help you determine whether they’re right for you.
  • Don’t forget to consider a robo-advisor: You may also be able to find financial planners who specialize in certain age groups, such as millennials. Younger generations interested in financial planning may also turn to online financial planning via robo-advisors. For example, robo-advisor Wealthfront allows you to easily invest toward your goals online while also offering free financial-planning tools on its platform. Other robo-advisors may provide financial-planning features or access to an in-person financial planner for an extra fee.