Financial Planning In Six Simple Steps
My favorite definition of financial planning is this one: “planning the acquisition of funds to finance planned activities”. Although it’s redundant and looks confusing, it’s the most accurate definition around and points out the simplicity of the whole thing. Basically, financial planning is nothing but figuring out where you’re going to get the money to do what you want to do. A fancier definition says that it’s the process of determining your financial goals and how you will reach them.
No matter how much money you have, financial planning is essential because it keeps you in charge of your money and ultimately, of your life. Actually, the more money you have, the more likely you have already implemented financial planning into your life, be it formally or informally.
Financial planning is not a one-time activity but an ongoing process. Ideally, you should start your financial planning early in life so you don’t have to worry about money after you stop working. If you are getting a late start, a good financial plan can go a long way towards help you catch up. Even after you retire, financial planning is still necessary because you have to make sure that your income is going to last as long as you need it: the biggest fear most retirees have is that they’ll outlive their money. Unfortunately, there’s no surefire way to figure out how long you’ll live or how much money you’ll need. That’s why you need a plan, so you can at least prepare yourself.
Making a financial plan
Your financial plan can be as simple or as detailed as you want it to be. You can develop it yourself or you can hire a financial planner to help you prepare it. Your plan can chart your fiscal course over the next 5 or 10 years; or it can help you make sure you have enough money to buy your next car or house. Of course, every financial plan should include a strategy to help you save for retirement. Making a financial plan is best done in steps:
Step 1: Get organized.
Organizing your household’s important papers will give you a clear picture of your financial status. Start by listing your family’s bank, investment, and retirement accounts. Find and file your financial documents, including real estate documents, insurance policies, and tax records. Make a master list of all these papers and where they can be found. I highly recommend filling out an EFFAK when completing this step. If you don’t know what it is, read this article to learn about EFFAK’s and why they’re important.
Step 2: Set your financial goals.
Goals identify what brings us pleasure. They give us something to look forward to and work towards. Your goals might include buying a house, taking a vacation, or saving for retirement. Write down your goals. Next to each goal, put how much you think it will cost to meet it, and your target date for reaching it. Leave a space so you can fill in the date when you actually reach it.
Step 3: Evaluate your cash flow
You can’t make financial plans until you know how much money you make and where you spend it. This is called your “cash flow.” To calculate your income, add up all the money you receive from salary, pensions, Social Security, bank interest, investment returns, and other income sources. Your expenses will include your regular bills, plus the money you spend using cash or credit cards. Use this information to decide whether you need to make more money (or cut back on your spending) to meet your financial goals. Actually you’ll fare much better if you save more AND earn more, but (in my humble opinion) saving more is the place to start.
Step 4: Calculate your net worth.
Identify everything you own (assets like your home, boat, saving accounts, mutual funds) and everything you owe (liabilities include your mortgage and credit card debts). Subtract your liabilities from your assets to determine your net worth. This figure tells you how much you would be worth if you had no debt. Calculating your net worth is a good “reality check” when you’re making financial plans.
Step 5: Make assumptions about the future
You can bet that your life, and the financial world, will change over the next 5 or 10 years. Inflation can take a bite out of your earning power. Interest rates may fall. Your investments could take a plunge. You might even get sick, lose your job or lose your spouse. You can’t predict that these things will happen. But you can be financially prepared in case they do. For example, if you expect prices to rise, you might invest your money more aggressively so its value keeps pace with inflation. If your family members tend to live well into their 90s, you might decide to put aside extra money for retirement, or buy long-term care insurance.
Step 6: Adopt a financial strategy.
After reviewing all the financial information you’ve collected, take another look at your goals. Decide which goals are priorities. Then, figure out how you will find the money to fund those goals. Should you cut back on your expenses? Use your annual bonus to fund a goal? Move money from your savings account to a mutual fund? Revise your goal? Put it on hold for a while? The choice is yours!
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As you can see, developing a financial strategy is nothing really complicated. All it requires it the will to devise a plan and the discipline to follow it. You don’t have to plan out your entire life on the first try. You can use this guide to plan your next big-ticket purchase, like a car or a house. Once you’ve used it a couple of times, you’ll be ready to tackle goals that are further into the future and are more complex, like funding your children’s college education, or your retirement.
Source: Money Matters, Your Guide For Financial Security. Published by the AARP
June 28th, 2008 at 10:38 am
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