What is a financial plan?
A financial plan is like a roadmap for your personal finances. At its core, the financial plan does essentially three things: it assesses where you are now, defines where you want to be, and provides you with the action plan to help get you there.
Where are you now?
The first step of a financial plan is to assess your current financial situation. The two most important documents to help you do this are a statement of net worth (also commonly referred to as a personal financial statement), and a personal income statement.
The statement of net worth lists all of your assets (i.e., your home, bank, investment and retirement accounts, etc.) and subtracts the liabilities (credit cards, student loans, mortgages, and other debt) to calculate your net worth. This statement is your starting point. You will use it to track your progress over the years and benchmark it against your goals to confirm you are on track.
The personal income statement summarizes your income and expenses in a given year. If your net income is positive, you are saving more money than you spend, and your net worth is likely growing. Conversely, your net worth is probably shrinking if your net income is negative. Evaluating whether or not the change in net income is sufficient to meet your goals will be part of the planning process.
With these two statements, you can begin tracking your progress and making necessary adjustments.
Where would you like to be?
The next step is defining your goals. This is one of those exercises where you think about what you would like your life to look like years from now and identify both short-term and long-term goals to help get you there. Of course, your goals will evolve as life does, so it is a good practice to revisit them periodically.
Once you have identified your goals, it is time to develop an action plan to accomplish them.
How do you get there?
There are numerous elements to a financial plan. The following are the most common, but this is not an exhaustive list. Depending upon your goals and situation, your plan may have other facets. But the following should be a part of any comprehensive financial plan.
Budgeting
If your statement of net income is negative, budgeting will be an essential part of the plan. Budgeting will help ensure that you are living below your means and spending less than you earn. It will also help increase your savings and investing rates in growing your net worth to help you achieve your goals.
Debt Management
Not all debt is created equal. For example, mortgage debt is necessary to facilitate the purchase of a home and may be an income tax deduction. However, credit card and other personal debt are not, and they may charge a higher interest rate.
Prioritizing and paying down debt is an integral part of any financial plan.
Emergency Fund
An emergency fund holds a number of months of expenses in cash. This fund will help ensure that if jobs are lost, illness occurs, or worse, there will be sufficient cash reserves to maintain your lifestyle for the duration without having to liquidate assets in an unplanned manner or inopportune time.
Risk Assessment
Asset protection is a crucial component of any financial plan. On the personal side, health, disability, and life insurance policies provide necessary protection to you personally. In addition, automobile, homeowner, renter, and umbrella insurance protect you from liability. Evaluate your risks, and use insurance to limit your exposure.
Investment Planning
Investing is critical to reaching your financial goals. This includes developing an asset allocation with a projected return that will help generate the net worth required as defined by your goals. Stocks, bonds, real estate, businesses, and other investments will be part of this planning.
Retirement Planning
This aspect of the plan is to examine your needs during retirement and estimate when you might be able to retire. Elements of this will include examining the use of retirement plans, account draw-down strategies, Roth conversions, social security maximization strategies, Medi-care strategies, and long-term care insurance.
Estate Planning
The estate plan will direct where your assets will go when you die or become incapacitated. The primary documents associated with this part of the plan are the will, living will, living trust, healthcare directive, and power of attorney. It's also common practice to review all beneficiary designations on retirement accounts and insurance policies to ensure they are consistent with your intentions.
It is a mistake to think estate planning is only for the well-to-do. If you have assets, make sure they go where you want them to. Get your estate planning documents in order.
Tax Planning
You file an income tax return annually and use strategies to help reduce your income tax liability.
These strategies should also be a part of your life-long income tax planning strategy. A financial plan will help identify these opportunities and help minimize income taxes over your life, not just year by year.
What happens if things change?
Financial plans are a continually evolving process. Changes to jobs, family, and environment can create a need to adjust or pivot from current goals and strategies. Review your goals annually to monitor your progress and ensure they are still what you want to strive for and make sure your net worth is growing sufficiently to meet those goals. If you feel like you need more ongoing planning as opposed to just a one time plan, that is an option as well. You can learn more by reading this article about which plan is right for you.
What a financial plan is not
Beware! Financial plans can be used as a loss leader to sell financial products. These plans rarely delve into the level of detail described above. Instead, they are a device used to illustrate how a particular insurance product is a panacea for all your financial planning needs.
If a financial plan does not go into the details described above, it may be a sales tool rather than a roadmap. Proceed with caution.
In closing
A great deal of work goes into developing a comprehensive financial plan. Don't be overwhelmed! If you want to create a financial plan personally, take it in small actionable steps. Like anything, consistency and persistence are key.
If this is more than you you want to handle on your own, please reach out today! The earlier you start your plan, the earlier you can confirm you are on the path toward achieving your financial goals.
About the author:
JP Geisbauer is a Certified Public Accountant and a Certified Financial Planner ®. He is the founder of Centerpoint Financial Management, LLC, a financial planning, investment management, and income tax planning firm located in Irvine, CA.
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Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes individual financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, please consult with your own financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.