A financial plan is designed to be specific to each individual’s situation, but there are certain parts of the planning process that I find are especially helpful to everyone. These are the parts that make it more likely that a person will follow through with their plan.
Identify Your Goals
The first and probably most important step of developing a financial plan is to clearly identify your goals. This is laying out what you need to be financially secure and happy. This step moves you closer to reaching your goals because you clearly have in mind what you are working towards.
Unfortunately you may not be able to reach all your goals — both retiring early and spending a lot during retirement may be tough to accomplish. So you’ll also need to prioritize your goals. Retiring early will be easier if you decide you only need $100,000 per year instead of $200.000 during retirement. Spending some time thinking about what goals are most important to you will make the plan more likely to stick.
If you are part of a couple, developing a plan is a perfect time to compare goals and get on the same page. Two people may start with very different ideas of what they want, but by quantifying their goals and seeing what is possible usually helps them figure out a way to reach their most important goals.
Determine the Steps
To put your plan into action, you’ll also need to determine the steps you’ll to need to take. The more details you can add about your steps, the better. This part takes more legwork and may require help from a financial planner.
If you plan on buying a house, you’ll need to know how much you can reasonably spend, how much to save, and what type of loan to use. If you are running retirement numbers, it helps to know how much money you’ll need in retirement, how much to save each year, and where to invest the funds. The more details you can add, the better.
Run Different Scenarios of Your Financial Plan
I encourage all my clients to consider different scenarios. You may be trying to decide whether to buy a bigger house or save more for retirement. Seeing how each one affects your plan can help you make a more informed decision.
Having a plan also helps when your situation changes. Once you have the framework of a plan in place, it’s easy to see how changes like switching jobs or having a baby will affect your other goals. Knowing the possible outcomes can make planning for the future less stressful.
Monitor Your Progress
Tracking your progress helps make your plan a success. Having some key numbers to look at every month or every year will help you stay on track.
One key number to monitor is how much you spend and save. It doesn’t matter how much you are making if you end up spending it all. These are great numbers to track because often people are good at projecting their future income, but not so great at projecting future expenses. Not only do you need to know how much you spend on your basic necessities, but you also need to know how much you spend on variable expenditures and unexpected bills.
Your net worth is another important figure to get a picture of your overall financial health. You calculate net worth by adding up all your assets and subtracting all your liabilities. Tracking net worth makes sure you are moving in the right direction. Saving more and paying down debt will increase you net worth. You can be making a lot of money each year, but if you spend it all, your net worth will not change.
Finally, monitor your investments. Most of your long-term goals will involve saving and investing money. It’s crucial your money is correctly invested. Too often people keep their money in high-cost, underperforming funds, or their investments are not diversified properly. Take time once a year to see how your investments are performing and rebalance your portfolio.
Everyone I work with that spends time developing a financial plan is in a better place financially a year or two down the road. Putting everything together with clear action steps puts the wheels in motion. The plan may change along the way, but the end results are almost always better.
