Financial Planning Basics: How to Make a Plan
Creating a financial plan may seem overwhelming to those that have never completed one, but taking the first steps to creating a plan is much easier than you may think.
Set Specific Goals
What are your short-term and long-term goals? What does financial success look like to you?
You may want to save for a vacation, a down payment on a house, a wedding, a new car, or to start a family. You may also want to save for retirement, your children’s college education, or to start a business.
Whatever your goals are, you need to be specific. How much will it cost? When do you want to achieve it?
The more specific you are with your goals, the more likely you are to achieve them.
Create a Budget
Budgeting is a key part of financial planning. It’s how you make sure your spending habits line up with your financial goals. And it’s how you determine how much you can save and invest.
To create a budget, start by listing your income. This should include your take-home pay, any side hustles, and any other money you receive. Then, list all your expenses. This should include everything from your rent or mortgage, to your monthly subscriptions, to your groceries and eating out. Be sure to include any debt payments and bills.
Finally, subtract your expenses from your income. If you have money left over, you can allocate it to saving and investing. If you don’t, you’ll need to look for ways to cut back on your spending.
Identify your Sources of Income
One of the most important parts of your financial plan is going to be how much money you can afford to spend. This will be determined by how much money you have coming in each month, also known as your income.
You will need to identify all of your sources of income, including your salary, any rental income you earn, interest and dividends from your investments, and any other sources of income.
Identify your Expenses
Take a look at your expenses and identify which are fixed and which are variable. Fixed expenses are the same amount each month, like your rent or mortgage. Variable expenses change each month and may include things like groceries, utility bills, or entertainment.
Once you have your expenses listed, you can subtract them from your income to see how much money you have left over. If you have more money left over than you expected, you can put it toward your financial goals. If you don’t have enough money to cover your expenses, you may need to look for ways to cut costs.
Set up an Emergency Fund
You never know when the transmission on your car might go out, or when you might have to replace the hot water heater in your house. That’s why it’s so important to have a cushion of cash to cover the unexpected expenses that life will inevitably throw your way.
A good rule of thumb is to keep three to six months’ worth of living expenses in your emergency fund. If you’re just getting started, aim to save $1,000 before you do anything else. Then, once you’re debt-free (except for your mortgage), build your fully funded emergency fund.
Pay off Debt
If you have any high-interest debt, like credit card debt, that should be your first priority. You might also want to pay off other types of debt, like student loans, before you start investing.
That being said, you don’t need to be completely debt-free before you start investing. The key is to strike a balance between paying off debt and investing for your future.
Save for Retirement and College
If you have children, you should consider saving for their college education. The earlier you start, the less you will have to save. There are many different types of college savings plans to choose from.
You should also make sure you are saving enough for your own retirement. If you are employed, you should take advantage of your employer’s 401(k) plan, if they have one. If you are self-employed, you should consider setting up an IRA or a SEP-IRA. If you do not have access to a retirement plan at work, you can also consider setting up an IRA on your own.
Manage your Investments
Once you have a budget, a savings plan and an emergency fund, you can start to invest. Investing is a long-term strategy and can help you build wealth over time.
There are many different ways to invest, from real estate to stocks to mutual funds. It’s important to consider your risk tolerance, time horizon and investment goals before you start investing.
If you’re not sure where to start, you can use a robo-advisor. A robo-advisor is an online platform that uses algorithms to create and manage an investment portfolio for you. They are a great option for beginner investors.
Review your Plan
Financial planning is an ongoing process. As your life changes, so will your financial situation. The more often you review your plan, the easier it will be to make changes.
Getting married, having a baby, changing jobs, or buying a house are all events that will require you to update your plan. And, of course, the closer you get to retirement, the more you’ll want to check in on your plan to make sure you’re on track.
Update your Plan
Finally, you need to update your plan regularly.
How often is up to you, but at least once a year is a good rule of thumb.
You should also update your plan when you have a major life event, such as getting married, having a child, or buying a home.
Even if nothing significant has changed in your life, you should at least review your plan to make sure you’re on track to meet your goals.
Conclusion
Financial planning is a big concept that includes things like budgeting, retirement planning, saving, insurance, and getting out of debt. You don't, however, need to be a financial planning expert to have a firm grasp on what each of these concepts means and how they impact you.