What is a Financial Plan and Why Do You Need One?
Have you ever wondered what a financial plan is and why it might be crucial for your financial well-being? A financial plan is a document that outlines your current financial situation, sets short- and long-term monetary goals, and includes strategies to achieve those goals. It can help you manage life's risks, income, spending, and debt reduction, providing the guidance you need to meet your financial obligations and track your progress over time.
The Fundamentals of Financial Plans
Creating a solid financial plan is essential for achieving your financial goals and securing your future. It involves understanding where you currently stand financially, setting clear goals, and outlining strategies to reach those goals. Here are the key steps to help you build a comprehensive financial plan.
What is a Financial Plan?
Creating a financial plan, whether independently or with a certified financial planner, is a vital step toward securing your financial future. It offers the guidance necessary to assure financial success. Start by gathering information from your various financial accounts and making some basic calculations to understand your current financial standing.
Calculate Net Worth
To calculate your net worth, subtract your liabilities (what you owe) from your assets (what you own). Assets may include your home, car, cash, and investments. Liabilities could be bills, credit card debt, student loans, mortgage, and car loans. This calculation gives you a snapshot of your financial health.
Assets - liabilities = net worth
Determine Cash Flow
Cash flow is the money you earn compared to the money you spend. Documenting your cash flow helps you understand how much you need for necessities, how much you can save and invest, and where you can cut back. Review your checking account and credit card statements to get a complete picture of your income and spending habits.
Establish Your Goals
Setting clear financial goals is a crucial part of a financial plan. Whether it's funding a college education, buying a home, starting a business, or retiring comfortably, identifying these goals helps you create a roadmap to achieve them. A financial planner can assist in finalizing a detailed savings and investment plan.
Benefits of a Financial Plan
Thorough examination of income and spending.
Improved understanding of financial circumstances.
Establishment of short- and long-term goals.
Guidance on actions required to achieve goals.
Focus on reducing debt and building savings.
Higher likelihood of achieving financial success.
Reduction of financial stress and worry.
Reasons for a Financial Plan
Financial planning is beneficial for everyone, regardless of age, earnings, or financial dreams. It helps document personal goals and stay on track to meet ongoing and major financial needs.
When to Create a Financial Plan
You can create a financial plan at any time, whether you’re new to the workforce or have been working for years. Specific life events that call for a financial plan include:
A new job with added income or expenses.
Income changes affecting your ability to save or pay off debt.
Major life events like marriage, children, or divorce.
Health issues redirecting income and spending.
Unexpected windfalls like inheritance or insurance payments.
How to Create a Financial Plan
Creating a financial plan might seem daunting, but it’s a crucial step toward financial stability and achieving your goals. Whether you do it yourself or seek professional help, following these essential steps will help you build a comprehensive and effective financial plan.
Do It Yourself or Get Professional Help
Decide whether to create your plan independently or with a financial planner. While you can build a plan on your own, a professional can ensure it covers all essentials.
Build an Emergency Cash Fund
Set aside enough money in a liquid account to cover 6-12 months of expenses for unexpected events. This fund provides a safety net during financial uncertainties.
Plan to Reduce Debt and Manage Expenses
Eliminate debt as quickly and effectively as possible to improve your savings and standard of living. Make it a habit to cut unnecessary expenses and stay on top of obligations like taxes.
Manage Potential Risks
Plan for accidents, health problems, or the death of loved ones with appropriate insurance coverage, including home, health, auto, disability, personal liability, and life insurance.
Plan to Invest
Participate in a retirement plan at work and maximize tax-advantaged investing with a personal IRA. Allocate any additional income to taxable investment accounts to grow your net worth over time, considering your risk tolerance and future needs.
Include a Tax Strategy
Reduce your income taxes with deductions, credits, and tax loss harvesting, using all legal opportunities available to taxpayers.
Consider an Estate Plan
Make arrangements for the benefit and protection of your heirs with an estate plan, considering your stage in life, marital status, and legacy goals.
Monitor and Adjust Your Financial Plan
Revisit your plan at least yearly or more often if circumstances change. Adjust as needed to keep it working efficiently and effectively.
Purpose and Writing of a Financial Plan
Writing a financial plan serves as a roadmap to your financial future. It helps you make the best use of your money and achieve your long-term goals. Here's how to get started on writing your own financial plan.
What Is the Purpose of a Financial Plan?
A financial plan helps you make the best use of your money and achieve long-term goals like sending children to college, buying a home, leaving a legacy, or enjoying a comfortable retirement.
How Do You Write a Financial Plan?
Creating a financial plan is an essential step toward achieving your financial goals and securing your future. Here’s how to get started:
1. Set Financial Goals
Before you can figure out how to get somewhere, you need to decide where you're headed. Establish specific financial goals that guide your plan. These could include:
Saving for a down payment on a new home.
Establishing a college fund for your children.
Paying down or minimizing existing debt.
Launching a small business.
Accelerating retirement investing and savings.
Think about what you want your life to look like in 5, 10, or 20 years. Organize your goals into three time horizons:
Short-term goals (6 months to 5 years): Include budgeting, paying down debt, and building an emergency fund.
Mid-term goals (5 to 10 years): Might include buying insurance or expanding your investments.
Long-term goals (10+ years): Focus on detailed retirement planning.
Set specific target dates for each goal. For instance, if you have a toddler and plan to save for college by the 2040s, that gives you a clear deadline.
2. Follow a Budget
A budget is a tool to organize your monthly cash flow and ensure you can save and invest while enjoying life. Track your income and expenses, including both fixed expenses (housing, transportation, debt) and discretionary expenses (dining out, entertainment).
Consider using digital apps to help you create and maintain a budget. These tools can link to your financial accounts and set alerts to categorize and monitor spending.
3. Build an Emergency Fund
Prepare for unexpected expenses by building an emergency fund. Aim to save at least three months' worth of living expenses, though six months to a year is ideal. Start by automating your savings or setting aside lump sums like tax refunds. Choose a liquid account, like a high-yield savings account, to store your emergency fund.
4. Manage Debt
Managing debt is crucial for financial stability. Focus on paying down high-interest debt first, such as credit cards and payday loans. Use strategies like the snowball method (paying off smaller debts first) or targeting high-interest debts to reduce overall payments.
5. Protect with Insurance
Insurance safeguards your financial plan against unexpected events. Ensure you have adequate disability and life insurance coverage. Evaluate your current policies and consider additional private coverage if needed. Check with your employer for options that may offer lower premiums and additional benefits.
6. Plan for Taxes
Incorporate a tax strategy into your financial plan. Understand your tax bracket and utilize deductions and credits to reduce your taxable income. Consider tax-advantaged accounts like 401(k)s, IRAs, Roth IRAs, and HSAs to minimize your tax burden and boost savings.
7. Plan for Retirement
Think about your long-term financial goals, especially retirement. Save aggressively early in your career to take advantage of compounding interest. Aim to replace 80% of your income in retirement and evaluate tax implications for different accounts. Consider rolling over 401(k) savings into an IRA for more investment options and consult a financial professional to tailor a retirement plan to your needs.
By following these steps, you can create a comprehensive financial plan that helps you achieve your financial goals and secure your future.
Key Components of a Financial Plan
Budgeting, saving, and investing each month.
Emergency savings plan.
Retirement plan.
Risk management.
Long-term investment strategy.
Tax minimization plan.
Key Takeaways
A financial plan documents your financial goals and strategies.
It should be comprehensive and tailored to your unique needs.
It starts with calculating your net worth and cash flow.
It offers guidance and tracks your progress toward financial goals.
When It's Time to Seek a CERTIFIED FINANCIAL PLANNER™
Creating a financial plan on your own is a great start, but there are times when professional help can make a significant difference. Here are some scenarios when you might want to consider seeking a qualified financial planner:
Complex Financial Situations
If your financial situation involves multiple income sources, significant investments, or complex tax issues, a financial advisor can provide expert guidance to navigate these complexities effectively.
Major Life Changes
Life events such as getting married, having children, buying a home, or going through a divorce can have significant financial implications. A financial advisor can help you adjust your plan to accommodate these changes and ensure you're on the right track.
Planning for Retirement
As you approach retirement, the decisions you make become more critical. A financial advisor can help you maximize your retirement savings, manage your investment portfolio, and create a sustainable withdrawal strategy.
Estate Planning
Ensuring your assets are distributed according to your wishes and minimizing estate taxes can be complicated. A financial advisor, in conjunction with an estate attorney, can help you create a comprehensive estate plan that protects your heirs and fulfills your legacy goals.
Investment Management
If you’re unsure about how to diversify your investments, manage risk, or optimize your portfolio, a financial advisor can provide personalized investment strategies based on your goals and risk tolerance.
Tax Planning
Effective tax planning can save you a significant amount of money. A financial advisor can help you take advantage of tax deductions, credits, and strategies to minimize your tax burden.
Lack of Time or Expertise
If you don’t have the time or expertise to manage your financial plan effectively, a financial advisor can take on this role, allowing you to focus on other priorities while ensuring your financial health is well-managed.
Seeking the help of a certified financial advisor can provide peace of mind, professional expertise, and a tailored strategy to help you achieve your financial goals. Whether you’re just starting out or need help managing a complex financial situation, professional advice can be invaluable.
The Bottom Line
A financial plan is an essential tool for financial well-being. It outlines your current finances, sets goals, and provides methods to achieve them. No matter your financial situation, a financial plan helps you determine the best ways to meet your needs throughout life’s stages.
Start your financial planning today. The benefits of a well-structured financial plan are immense, providing security, reducing stress, and guiding you toward financial success. Whether you do it yourself or seek professional help, having a financial plan is a step towards a stable and prosperous financial future. Ready to take control of your finances? Visit One Advisory Partners for expert guidance and personalized financial planning services
Reference
https://www.businessinsider.com/personal-finance/what-is-net-worth
https://www.schwab.com/learn/story/5-ways-financial-planning-can-help