Creating a Financial Plan
Henry Ford once said, “Obstacles are those frightful things you see when you take your eyes off your goals.” When you create a financial plan, it’s the equivalent of keeping your eye on the ball. You outline your assets, needs, and goals, and then identify investments and financial vehicles that will help you achieve those goals.
A financial plan is generally comprised of the following three components:
- Personal profile. The names and dates of birth of everyone in your family, as well as anticipated dates for college enrollment, retirement, and life expectancies.
- Financial scenario. This overview should include your household income, debts, property, and assets. You may also include an overview of your risk profile–how much risk you’re willing to bear to achieve your financial goals.
- Financial goals and objectives. These include buying a home, vacations, saving for college, retirement, or a second home.
Elements of financial planning
Once you have a basic roadmap of where you are currently and where you want to go, it’s time to break down your financial plan into a series of tactical strategies. All of these concepts are designed to help you achieve financial security for the future and ensure that your dreams become a reality.
- Cut costs to create discretionary income. In order to invest, you need to squeeze additional money from your income each month. Sticking to your budget is essential to your success.
- Create an emergency fund. Most experts recommend you maintain between three and six months worth of income in an accessible account should you unexpectedly lose your job, become incapacitated, or face another life emergency.
- Outpace inflation. You need to invest money aggressively enough to beat the effects of inflation over the long term. For example, if inflation is averaging 3% per year, your investments need to return at least that much for your money to increase in value.
- Minimize taxes. Like inflation, taxes decrease the value of your income. That’s why it’s important to understand which investment vehicles are appropriate for which goals. For example, there are many tax deductible and tax-deferred plans available for individuals saving for retirement. No matter what the goal, always look to minimize taxes through tax-advantaged investments.
- Diversify. A sound rule for all financial plans is to diversify your invested holdings. Spreading your assets among many different types of securities helps ensure you won’t lose your entire nest egg in one poor investment.
- Work with a professional. If you’ve never invested on your own, you may want to start out working with a financial planner. Ask friends, family, and co-workers for recommendations and look for someone you trust and with whom you are comfortable discussing your financial matters.