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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.
How much would you like to invest?
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.
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.
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.
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.
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.”
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.
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.
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.
There are several things to keep in mind to ensure you find the right financial advisor:
The “Find a Financial Advisor” links contained in this article will direct you to webpages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.