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From defining your financial objectives to assessing their feasibility, we have you covered.
Financial plans serve as structured blueprints for maintaining financial well-being and achieving monetary goals. Creating a personal financial plan empowers you to manage your finances effectively and can improve your overall quality of life by minimizing uncertainties regarding financial matters and future requirements. While seeking assistance from a professional financial planner is an option, developing your financial plan is entirely feasible. Most financial planning experts advocate following a six-step process to craft a solid plan for your financial future.
Procedures
Evaluate Your Current Financial Status
Compile a record of your existing assets and liabilities. Assets represent your possessions with value, while liabilities denote your outstanding debts.
- Assets may encompass cash or equivalents like checking and savings accounts, personal assets such as home equity and vehicle ownership, and invested assets like stocks, bonds, and retirement funds.
- Liabilities may consist of outstanding bills and debts such as mortgages, auto loans, medical bills, credit card balances, or student loans. Refer to Strategies for Debt Relief.
Assess your current net worth. Add up all your assets, then deduct your total liabilities. This resulting figure indicates your current net worth, serving as the foundation for your financial plan.
- A positive net worth implies that your assets exceed your liabilities, while a negative net worth signifies the opposite.
Organize your financial paperwork. Establish a systematic filing method for your tax returns, bank statements, insurance policies, contracts, receipts, wills, deeds, titles, bills, investment statements, retirement account records, pay stubs, employee benefits documentation, mortgages, and any other relevant financial documents.
Monitor your income and expenses, or cash flow. Keeping track of your income and spending habits allows for a more thorough examination of your financial behavior, influencing your current net worth.
Define Your Financial Objectives
Establish short-, medium-, and long-term objectives. Personal financial planning centers on setting goals. Envision your desired lifestyle for the present, near future, and distant future, and outline comprehensive goals covering all aspects of your life:
- Your short-, medium-, and long-term objectives may complement each other — for instance, saving $100 monthly toward a home fund may contribute to your long-term goal of homeownership.
Employ the 'SMART' goal-setting approach. Ensure your goals are Specific, Measurable, Attainable, Rewarding, and Time-based. This ensures your goals move beyond mere aspirations and become actionable.
- Specific goals are clearly defined. Avoid vague goals like 'achieve financial independence.' Formulate precise goals that can be summarized in a concise statement.
- Measurable goals have quantifiable aspects, such as 'Raise my credit score to 750' or 'Accumulate $12,000 in emergency savings.' Without assigning a numerical value, it's challenging to gauge progress.
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Attainable goals are grounded in reality. Avoid setting unattainable goals, as this may lead to discouragement and abandonment of your plan.
- Rewarding (or Relevant) goals are satisfying to achieve. They should create a positive feedback loop where accomplishing one goal motivates you to pursue others.
- Time-based goals have deadlines and milestones. Plans are flexible and can adapt to new information; if you miss a milestone, adjust your expectations and set a new deadline.
Reflect on your financial values. Consider your relationship with money and its significance to you. Understanding your financial motivations will help shape your goals. For example, if travel is important to you, knowing this will inform your goal-setting process.
Involve your family in the discussion. Transform your 'personal' financial plan into a 'family' plan if you have a partner or dependents. Sharing values and goals fosters mutual understanding and informed decision-making.
- Recognize differing priorities and negotiate compromises that align with both partners' financial aspirations.
- Understand that financial acumen varies among individuals. Determine roles in budget management or explore ways to satisfy each partner's need for involvement.
Consider all your goals, even those beyond finances. While some goals may not initially appear financial, such as backpacking through Europe, they require financial resources. Broaden your perspective to encompass intellectual, career, lifestyle, residential, and retirement goals.
- Intellectual goals involve education, leadership development, college funding for children, and attending seminars.
- Plan your income generation strategy, whether advancing in your current career or exploring new opportunities.
- Lifestyle goals encompass recreational activities and essentials for your desired quality of life.
- Residential goals may include renting, homeownership, or relocation.
- Envision your retirement lifestyle and set financial goals to support it.
Explore Alternate Paths
Explore the available avenues to achieve your financial objectives. Generally, your choices will fall into two categories: optimizing existing resources or seeking additional income streams. Evaluate each goal to determine if you should:
- Maintain your current approach.
- Enhance your existing circumstances.
- Modify your current situation.
- Pursue a new direction.
Keep in mind that there are numerous ways to accomplish the same goal. For instance, to save money for your backpacking trip to Europe, you could replace daily coffee purchases with homemade brews, saving $20 weekly. Alternatively, you might offer babysitting services once a week and allocate the earnings toward your trip.
Assess whether one goal might influence another. Apart from exploring alternative approaches within your financial goals, consider their interplay. While traveling may seem like a 'lifestyle' goal initially, you may realize that pursuing an educational goal, such as learning a foreign language, could facilitate cheaper travel or even lead to a career abroad as a translator or businessperson.
Weigh Your Options
Choose the tactics you'll employ to execute your financial blueprint. Factor in your life circumstances, personal principles, and prevailing economic conditions.
- Reflect on your current financial standing versus your envisioned outcomes in each aspect you've examined. Are there particular deficiencies in a certain area? Consider giving it special attention.
- Stay pragmatic. Incremental progress toward your goals prevents feelings of frustration or defeat caused by overwhelming tasks.
Keep in mind that every decision carries opportunity costs. An opportunity cost refers to what you forego when making a choice. For instance, saving for your backpacking adventure by giving up coffee shop outings may entail sacrificing the time, planning, and enjoyable conversations with your favorite barista.
Approach potential choices with a scientific mindset. Gather extensive research and meticulously analyze your data. When contemplating an investment, for instance, pay close attention to the relationship between risk and reward — how risky is the investment, and what potential rewards does it offer? Assess whether the benefits justify the risks.
EXPERT TIP
Ara Oghoorian, CPA
Certified Financial Planner & Accountant
Certified Financial Planner & Accountant
Our Expert Agrees: Assessing risk holds significant importance in financial planning. Always question whether the potential benefits of a risky expenditure outweigh the costs. Apply this principle to all financial choices, whether it's dining out or investing in stocks.
Acknowledge that uncertainty is an inherent part of the process. Even after thorough research, your circumstances may shift unexpectedly. Economic fluctuations could impact investment prospects, and a new job may not meet your personal or professional expectations. Do your best and remember that you can adapt your decisions as needed later on.
Develop and Execute Your Financial Action Plan
Take a holistic view. Now that you've set goals, assessed alternatives, and compiled a list of strategies, evaluate your current situation. Then, prioritize the goals that are most feasible.
- Consider your current net worth. If your liabilities are high compared to your assets, focus on rebalancing this ratio.
- While increasing your net assets is important, don't overlook the benefits of debt reduction. Even small debts can accumulate significant interest over time, leading to financial strain. Allocating resources to pay off debts now can prevent future complications.
Determine which goals to pursue immediately. Aim for a well-rounded approach encompassing short-term, intermediate-term, and long-term goals, allowing you to plan for the near and distant future.
- Emphasize gradual progress to create a roadmap toward your objectives.
- Be pragmatic. You can't implement all identified strategies simultaneously, but selecting a balanced mix of goals will facilitate achievement and pave the way for tackling additional endeavors in the future.
Create a budget that integrates your financial goals. You've already assessed your net assets and liabilities, so now organize them within a budget framework that reflects your decisions. Hold yourself accountable to this budget. For instance, if you've committed to reducing coffee expenses by $80 monthly and redirecting that amount to savings, include it in your budget.
- Goals like securing a new job may not align neatly with a budget but should be documented in an easily accessible location as part of your active financial plan.
Explore the option of hiring a professional financial advisor. While you might be capable of making financial decisions independently, a professional advisor offers the advantage of emotional detachment from your financial circumstances.
Assess and Amend Your Financial Blueprint
View your financial plan as a dynamic document. Personal financial planning is an evolving process. Life evolves, and you'll need to revise your plan periodically to reflect changes in your situation and objectives.
Schedule regular reviews of your financial objectives. If your life experiences rapid changes (such as being a college student), consider reviewing your goals every 6 months. For more stable phases of life (like being an adult empty-nester), plan for an annual review.
Engage in a discussion about your financial strategy with your partner. If you're in a committed relationship, ideally, you've already embarked on this journey together. Financial conversations should be an integral part of relationship commitments, addressing values, aspirations, and strategies for achieving mutual goals.
Useful Tips
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Consider investing in personal financial planning software to automate the organization and drafting of your financial plan.
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Seek guidance from a professional financial planner if you're uncertain about choosing between different investment options.
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Educate yourself by reading books, articles, financial magazines, and online journals focusing on finance and economics. Stay updated with news and seek advice from individuals experienced in personal financial planning. The more you understand about financial matters, the better equipped you'll be to plan for your financial future.
Important Reminders
- Factor in a yearly inflation rate of 3 percent when estimating figures for your budget and future expenses.
