Financial planning is your roadmap to a secure and prosperous financial future.
This in-depth guide will delve into the intricate world of financial planning, covering each step with insights, real-life examples, and valuable tips.
Definition of Financial Planning
Simply put, financial planning is creating goals, understanding your current situation, protecting what you already have, and planting the monetary seeds now that will benefit you in the future.
It is the compass guiding you toward a brighter financial future.
Why is Financial Planning Important?
Financial planning is the cornerstone of your financial well-being. It empowers you to:
- Manage Risks: Safeguarding your family and your assets.
- Conquer Debt: Controlling and reducing your financial burdens.
- Create Financial Security: Ensuring a stable and stress-free future.
- Build Wealth: Making your money work for you through investments.
- Achieve Your Dreams: From buying a house to retiring comfortably.
Let’s break it down into some actionable steps!
Setting Financial Goals
Identifying & Prioritizing Your Goals
Begin your financial journey by clearly defining your aspirations, whether they’re short-term, like buying a car, or long-term, such as retirement.
| Short Term | Long Term |
| Buying a Car | Buying a Home |
| Getting Engaged | Planning a Wedding |
| Going on Vacation | Retirement |
Not all goals are equal. Prioritization ensures you allocate your resources efficiently.
Create a ranked list, focusing more on higher-priority goals.
For example, buying a home might be an important achievement for you. However, keep in mind that there is no shame in renting and saving up some money to be able to afford that ultimate dream.
Assessing Your Current Financial Situation
Now that you have your goals defined and prioritized, it is time to get honest with ourselves and take a long hard look at our finances.
Analyzing Your Cash Flow
Cash Flow: Money coming in – Money going out.
Before you start restricting yourself from having any fun at all just to save money, you want to make sure you have an idea of where your money is going every month.
Here’s an example:
| Category | Deposit | Withdrawal |
|---|---|---|
| Salary | $4,000 | |
| Rent | $2,000 | |
| Utilities | $150 | |
| Entertainment | $350 | |
| Food (Grocery and Eating Out) | $500 | |
| Loans & Other Debt | $700 |
Creating a Budget
With the information that you have gathered, it’s now time to create a budget.
This will be one of the toughest parts of the process, as it requires you to make sacrifices now in order to have a better future. Try to find alternatives and explore your creative side!
Some simple changes could be things like:
- Going out to eat only twice a week instead of every day
- Use less energy by turning off electronics the moment you stop using them
- When your friends want to hang out, try suggesting a hike or picnic in the park
If you feel like you need some extra help creating a budget, effective budgeting tools like Mint or YNAB (You Need A Budget), can help give you a more complete snapshot of your finances.
Managing Debt
Debt comes in various forms: credit cards, loans, and more. Understanding which ones to tackle first is vital to your financial health.
Let’s look at how to organize them first.
Using a Debt Management Worksheet
Organize your debts, noting interest rates and payment schedules. A sample worksheet might look like this:
| Debt | Interest Rate | Monthly Payment |
|---|---|---|
| Credit Card 1 | 18% | $200 |
| Student Loan | 4.5% | $300 |
| Car Loan | 5% | $250 |
Doing this step after the budgeting step is important for a few reasons:
- You will have a better grasp of how you are allocating your money each month
- The money you are saving can now be put towards your debts
- Being able to cross off your debts from your budget will feel amazing
When paying off your debts, either prioritize the smallest remaining balance or the highest interest rate. Even when you have paid one off, allocate the same amount of money to your debts each month and watch the snowball roll.
How Much Should I Save?
There isn’t an exact number that will apply to everyone. However, we will talk about a couple of important savings strategies that will be useful to almost anyone.
Creating an Emergency Fund
If you remember from the example in the beginning of the article, there was little money left if something unexpected were to happen. That’s where an emergency fund will come in handy.
An emergency fund is exactly what it sounds like, a fund that is for emergencies (and emergencies only.)
A good start would be in the range of one to two thousand dollars, but you can save any amount that you believe could be helpful in an emergency.
General Savings Account
If you do not already have a savings account with your bank or banking provider, it may be an important step to creating stability.
In this account, you want to strive to have 3-6 months worth of expenses saved up in the even of job loss or salary decrease.
Let’s take a look at the example used earlier:
| Category | Deposit | Withdrawal |
|---|---|---|
| Salary | $4,000 | |
| Rent | $2,000 | |
| Utilities | $150 | |
| Entertainment | $350 | |
| Food (Grocery and Eating Out) | $500 | |
| Loans & Other Debt | $700 |
Even though that number may seem ridiculous or out of reach right now, the peace of mind you will have from it being there is priceless.
Importance of Investing
After following each step above, the next ideal step is going to be putting your money to work for you.
Investing can be hard to get into. Where do I start? What do I invest in? What do I need to know? Will I lose all of my money?
I suggest reading up on the basics of investing with this article: Investments for Beginners: 6 Ways to Get Started
Once you have read that and fully understand, come back here so we can talk about the last step in the planning process.
Your Plan is Your Friend, Check Up On It
The last step is to make sure that your plan stays updated and aligned with your goals.
Coming back to it every three months or so should help you with both staying on track and using any new information to revise your plan.
Have you decided that your dream car is actually a Honda Civic and not a Tesla? Great, now update your plan! Maybe you want to change your debt allocation to $600 per month? Awesome, but don’t forget your plan!
Conclusion
Procrastination is your biggest enemy. If you are thinking that tomorrow is when you’ll start, then you should start today.
Just to recap, here are the steps:
- Take a step back and analyze your cash flow
- Find creative ways to cut back on certain expenses by using a budget
- Grab your sharpest metaphorical weapon and slice through that debt
- Start putting aside money to cover your essentials
- Consider investing, as your money only diminishes in value over time
- Finally, check back in here and there to make sure you are on track
Good luck on your financial journey!