How to Create a Personal Financial Plan

A financial plan can help you tackle existing debts, secure your future financial stability, and even bring more happiness and peace of mind. Depending on your situation, a suitable financial plan may not require cutting back on spending. Instead, you might just need to make more efficient financial decisions.

Gather all necessary data to begin tracking your spending history. Collect old bills, bank statements, and receipts to calculate your monthly expenditures accurately.

Consider using software to calculate your personal finances. Personal finance software is rapidly becoming a new trend. These programs offer customizable financial planning tools based on your circumstances, along with analytical features to help plan future cash flow and gain a clearer understanding of your spending habits. Some personal finance software options include:

• Mint
• Quicken
• Microsoft Money
• AceMoney
• BudgetPulse

Create a spreadsheet on your computer. If you prefer not to use software for financial planning, you can create a simple spreadsheet. Your goal is to chart all of your expenses and income for the year. Therefore, set up a spreadsheet that clearly outlines all the information, allowing you to quickly identify areas where you can spend more wisely.

• Label the top horizontal cells (starting with cell B1) with the 12 months of the year.
• Create a column for expenses and income in column A. You can list your income or expenses first, but try to keep expenses and income separate to avoid confusion.
• You may need to group certain expenses under category headings. For example, you could create a category like “living expenses,” which would include electricity, gas, water, and phone bills.
• Decide whether to include deductions from checks, such as insurance premiums, retirement savings, or taxes. If you do not include these deductions in the spreadsheet, make sure to record your actual income (after deductions) rather than your gross income (before deductions) under “income.”

Record your financial data from the past 12 months. Keep track of all your expenses and income from the last 12 months using bank data and credit card statements to accurately reflect your sources of income and expenses.

Determine your average monthly income history. Are you receiving a fixed monthly salary and know exactly how much you earn each week? Or are you a freelancer whose income varies each month? Recording your income history over a year can help you determine your average monthly income.

• If you are a contractor or freelancer, remember that the money you take home is not the same as what you earn. For example, you might take home $2,500 a month, but that is your pre-tax income. You need to account for the taxes owed and deduct that from your monthly earnings to get a more accurate figure.
• If you are a salaried employee, do not count your tax refund as part of your total income. Your monthly income should be the amount you take home after taxes. If you do receive a tax refund, consider it a bonus, but don't worry about it unless it actually happens.

List all your monthly expenses in the spreadsheet. Are there any bills you have to pay each month? How much do you spend each week on groceries and gas? Do you go out to dinner with friends every Friday night or go to the movies weekly? How much do you spend on shopping? Tracking actual expenses for a year will help you understand your spending habits, as most people tend to underestimate how much they spend monthly.

Analyze your income and expenses. If your expenses exceed your income, it means you are living beyond your means. Your spending plan should be divided into two categories:

• Fixed Expenses. These include regular monthly costs such as utility bills, insurance, loan repayments, groceries, and essential purchases like clothing and household goods.
• Discretionary Spending. Discretionary spending refers to non-essential costs that you can choose to adjust. This category includes savings, entertainment, vacation funds, and other luxury expenses.

Create a preliminary plan. The data from step 1 will help you form an accurate preliminary financial plan. Begin by calculating fixed expenses and income, and then determine how much you can allocate for discretionary spending.

• To estimate fixed expenses, calculate the average monthly cost over the past year and add 5%. For example, if your electricity bill varies seasonally but averages $210 per month, round it up to $220.
• Be sure to account for changes in fixed expenses, such as student loan payments or additional costs for a new car purchase.

Set goals for discretionary spending. Once you have identified the excess money available each month, decide how to allocate it. Your goals should be clear, specific, and achievable. Some short-term goals could include:

• Saving $8,000 for an emergency fund
• Putting 5% of each paycheck into a savings account
• Paying off credit card debt within 12 months
• Saving $6,000 for an anniversary vacation

Maximize tax benefits. There are ways to save money that offer tax advantages. If you contribute directly to a 401(k) or an individual retirement account (IRA), those contributions may be deducted before taxes. Some employers even offer matching contributions to your 401(k), meaning they will add the same amount you contribute, which can further boost your savings.

Calculate the remaining discretionary spending. This part is entirely based on your perception of value. What do you value, and how do you want to spend money to reflect those values? After all, money is just a tool to achieve a goal, not the goal itself.

• What type of person are you, and what do you aspire to do? Many people spend money on hobbies, pleasures, or charitable causes. Think of it as investing in an experience or a feeling of fulfillment.
• Think about the things that truly make you happy. There is a view that those who spend money on experiences are happier than those who invest in material possessions.
• Consider saving more for travel or vacations.

Stick to your financial plan and avoid overspending. This is the first and almost the only rule of a spending plan. It seems obvious, but it’s easy to overspend, even when you have a plan in place. Pay attention to your spending habits and the expenses you need to cover.

Try to reduce expenses. Cutting large expenses can be the most challenging but also the most effective way to stay within your budget. If you typically take vacations every year, consider staying home this time. Even cutting back on smaller expenses can add up over time.

• Try to identify and reduce unnecessary luxuries you often indulge in. If you regularly enjoy massages or expensive wine, limit yourself to indulging in these luxuries once or twice a month.
• Save money on smaller expenses by switching to generic brands and dining at home more often. Try to limit eating out to once or twice a week.
• Think about whether you can reduce any fixed expenses, such as switching to a cheaper phone service, changing your TV package, or improving energy efficiency in your home.

Treat yourself periodically, but responsibly. Money should serve you, not the other way around. You certainly don’t want to become a slave to your budget or money in general, so it’s important to indulge yourself each month without breaking your financial plan.

• Don’t overdo the reward system to the point where it backfires and negatively impacts your finances. Treat yourself to smaller, less expensive things like a latte or a new shirt, and avoid splurging on expensive items like vacations or luxury shoes.

Pay off credit card debt each month. If you plan to use a credit card, aim to keep the balance at zero every month to avoid high interest charges. If you can't pay off the current balance in full, prioritize paying down the balance within a reasonable timeframe until it's cleared.

• Consider switching to paying with cash for most of your weekly purchases, especially for 'extras' like dining out or coffee. This can help you manage your spending, as people are typically more aware of their spending when using cash than when swiping a card.

Reduce the taxes you owe. Make better use of tax deductions each year.

• Start keeping receipts, especially if you're a freelancer, work from home, or have remote work. There are many expense deductions related to home office setups that you may be able to claim when filing your taxes.
• An idea worth considering is researching ways to get a better tax refund if you're a contractor, or ask your accountant for tips on maximizing your refund.

Appeal your home's valuation. If you own a home and have sufficient evidence, you may be able to lower your property taxes by contesting the valuation placed on your property by the appraiser.

Don't rely on 'windfall' money. Avoid factoring in uncertain income sources such as year-end bonuses, inheritance money, or tax refunds. Only include guaranteed income in your budget.

• Throw loose change into a jar and then take it to the bank to exchange. You might be surprised at how much those small coins can add up to.
• Avoid high-interest credit card debt and payday loans, as these types of loans come with high interest rates, and in the long run, you’ll end up paying a lot more, especially if you struggle to pay off the monthly bills on time.