Financial planning is the process of determining your financial goals, looking at your current situation, and devising strategies for achieving those goals. It’s best viewed as a process because it will need to be updated as your life changes.
The tangible result of a financial plan is a document which details your goals and the strategies for achieving them.
The purpose and value of financial planning and it’s fundamental goal is providing peace of mind knowing your affairs are in order.
I could write a book about this and many already have. Instead, I’m going to give you my condensed view on the important aspects of a financial plan and the key things to keep in mind.
I’m excited to share my experiences of working in personal finance for over 20 years. It’s an honor to be named to Investopedia’s list of the top 100 financial advisors in the US three years in a row.
I’m curious, why are you thinking about financial planning?
Whatever your reason, keep it top of mind as you learn about and potentially engage in the process.
I’m going to talk about the fundamental process of financial planning
Where you are. It’s important to have a clear and accurate picture of your current assets, liabilities and perspective on money.
Where you want to be. If you don’t know where you want to go, it’s impossible to know how to get there. Crystalizing your goals and priorities is essential.
How to close the gap. The simplest but not easiest part; you’ll look at where you are, where you want to be, and close the gap.
From there, I’ll talk about everything that goes into financial planning through the lens of the three stages of our financial lives
Protection. This is where you’ll set your foundation, which is built on cash flow, insurance and legal documents.
Accumulation. This is where you save money for things. Short, mid and long-term goals.
Distribution. This is where you’ll take all the assets you’ve accumulated and turn them into retirement income. You’ll also formalize your estate plan.
By the end, you’ll have a solid understanding of what financial planning is and how it works. Also, please know that while many of these concepts may be new to you and may seem confusing and or intimidating, you’re perfectly capable of understanding and completing your own financial plan if you’re so inclined.
What I’m trying to say is, it’s my goal to provide you with the information and resources to DIY a financial plan.
Where you are
It’s important to have a clear and accurate picture of your current assets, liabilities and perspective on money. You should gather any current statements, policies and documents. Keeping a spreadsheet will also help you get and stay organized.
Cash flow and budget. Your current income and expenses and your personal budget.
Assets and liabilities. This is a very cut and dried accounting of your current financial situation. What accounts and assets do you have, what is their value, how much debt do you have. You’ll determine your current net worth.
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Risk management. This is referring to your existing insurance policies and legal documents.
Planning tolerance. An understanding of how you like to receive and process information. Do you prefer visuals or spreadsheets, do you want all the details or a broad overview? This is particularly important if you’re going to be working with professionals; the process will be more effective if you’re clear in your expectations and wants.
Values and beliefs. Your values inform your priorities and where you’ll focus your attention. Your beliefs about money play an integral role in how you interact with it. If you’d like to dig deeper into these, you can access our Values Course at no cost.
Appetite for planning. Are you ready to start this process? It will be time and attention intensive and it’s important that you’re going to be fully engaged. We are after all talking about your money and your future.
Where you want to be
Without question, this is the most important part of the financial planning process; your vision for the future. You’ll need to think about what you want for your “future” self, your “future” family, and your “future” life. I put future in quotations because it’s difficult and abstract to think about ourselves getting older. But it’s happening to all of us.
So, what do you want the future to look like? I encourage you to think about these six key areas
- Family. What do you want for your family?
- Community. What does your community look like and how are you active with it?
- Money/Career. What will your financial and work future look like?
- WellBeing. How will you nurture your physical, mental and emotional health?
- Personal Development. What will you learn simply for the sake of learning?
- Contentment/spiritual. What will you do to secure peace of mind?
If you’d like to dig deeper into these, you can access our Goals Course at no cost.
Time horizon is a valuable tool in financial planning
Short-term. When thinking about short-term priorities, think three years and less
- What’s the value of your emergency fund?
- Will you take annual vacations?
- Will you be debt free?
- What are your other priorities?
Mid-term. When thinking about mid-term priorities, think 3 to 10 years
- Will you own real estate?
- Will you start a business?
- Will you help a child with educational costs?
- What are your main priorities?
Long-term. When thinking about long-term priorities, think 10+ years
- When will you stop working full-time and retire?
- How much income do you want to have in retirement?
- How long will you need it to last for?
- Where will you live?
- Will you work?
- How will you spend your time?
- Will you leave a legacy to your family or someone/something else?
- What are your other priorities?
Closing the gap
We explored your current situation, you thought about where you’ll be in the future, and now it’s time to close the gap. There are five key areas to address.
Risk tolerance. This is a measure of how comfortable you are with risk. How do you think and feel about market fluctuations? How do you think and feel about investing versus speculating?
It’s important to take into consideration both thinking and feeling because while we may intellectually understand something, we make a lot of our decisions emotionally and we need to be mindful of that. Your risk tolerance will dictate the types of investments and asset classes you utilize.
Right coverages. You’ll need to ensure you have the proper types as well as the proper amounts of insurance including but not limited to health, life, disability, long-term care and property and casualty.
Right accounts. There are a lot of different types of accounts to save and invest in. Selecting the proper account based on purpose, time horizon and taxes is imperative.
Right vehicles and asset classes. From stocks to bonds, real estate, cryptoassets, mutual funds, and commodities, there are a lot of vehicles available to save and invest in. Taking your preferences and other important variables into consideration, you’ll choose which to utilize to reach your goals.
Right amounts. Once you’ve decided on which accounts and vehicles to save and invest in, you’ll determine how much to contribute and for how long. You’ll run projections and make assumptions in order to ensure you’re on track to meet your goals.
The three stages of our financial lives
Whether you’re building a building, or creating your financial plan, it’s imperative to start with a strong foundation. Without that, the rest of your plan is at risk. It’s for this reason the first stage of our financial lives is protection.
Once we’ve set our foundation, we want to proactively save and invest for our goals and objectives. This second stage is the accumulation stage.
The Third stage is distribution. When you’re no longer earning an income from working, where will your income come from? And finally, where would you like all of your assets and possessions to go when you’re gone?
While you may not move directly stage to stage, it’s a helpful framework for understanding all of the considerations to keep in mind for your financial plan.
Protection
You’re setting the foundation upon which you’ll build your financial plan. Along with making sure you have the proper insurance coverages, you’ll make sure you have a solid understanding of your cash flow, your personal budget and your emergency fund. You’ll put a plan together for getting out of debt and put the appropriate legal documents in place.
- Cash flow. It’s important you understand how much money you have coming in each month, and how much you have going out.
- Budget. This is simply a process for making a plan for your money on a monthly basis. Budgeting allows you to forecast and make financial decisions, and it lets you know if you can afford to spend and invest.
- Emergency fund. Your initial emergency fund should be $1,000 and should be in a savings or money market account which is separate from your everyday checking account. I strongly encourage you to get to six month’s worth of expenses saved in your emergency fund. If you’d like to dig deeper into this, you can access our Get Out of Debt course at no cost, where there is a section that walks you through this process.
- Debt reduction. Paying off credit card and consumer debt needs to be a top priority.
Insurance
- Health insurance. We most commonly obtain this coverage from our employer, but can also obtain it from other places which we will list in the Additional resources section.
- Life insurance. While there are many different kinds of life insurance, the most important consideration for this section is the death benefit. Having a minimum of 10 times your annual income is a good rule of thumb. Having 20 times is considered “full coverage” because it would essentially replace the insured income in perpetuity.
- Disability insurance. As with health insurance, this is commonly acquired through our employer. If you’re a highly skilled professional, protecting your income with this coverage is imperative.
- Long-term care insurance. This coverage pays for the cost of care (commonly in our later years) should you require it.
- Property and casualty insurance. It’s imperative to make sure you have the proper auto, home as well as umbrella liability protection.
- Identity theft protection. As our lives continue to expand online, some form of this coverage is required. You’ll find information on this in the resources section.
- Legal documents. Creating estate planning documents such as a will and or trust, as well as creating an entity if you’re a business owner is an essential part of your financial foundation. You’ll find information on this in the resources section.
Accumulation
Before we get into the accumulation stage, I want to quickly go over the accounts and vehicles which are available to help you accomplish your goals.
Accounts
- Checking, savings and money market accounts. These are bank accounts which can be opened at no charge, where you can access the money whenever you need it.
- Taxable brokerage accounts can be opened at institutions like Robinhood, Charles Schwabb and most banks. They allow you to buy and sell investments like stocks, bonds, mutual funds, ETFs and cryptocurrency.
- Qualified accounts. These are accounts that receive special tax treatment and are commonly used for retirement planning. Common examples include IRAs and Roth IRAs, 401(k)s and 403(b)s, as well as pensions. These are traditionally used for long-term saving and investing because of rules around when you can access the funds. With traditional IRAs and 401(k)s, withdrawing funds prior to age 59 and a half can lead to a 10% penalty.
- Managed accounts and roboadvisors. These are accounts where you pay a fee to have your money professionally managed by a human (or humans) or through technology.
Vehicles
- Stocks. Also known as equities, represent a fractional ownership in a company. These are traditionally thought of as more aggressive investments than bonds.
- Bonds. Also known as fixed income, it represents a loan made by an investor to an entity. These are traditionally thought of as more conservative investments than stocks.
- Mutual funds and EFTs. These are companies that pool money from investors and invests in many different equities and fixed income. Owning a mutual fund or EFT allows for diversification.
- Target date funds. These are age based investments which correspond to your retirement date. For example, if you’re 40 years old, you intend to retire at 65, and it’s the year 2020, you would invest in a 2045 target date fund (years till retirement + current year). Each year as you get closer to retirement, the fund automatically becomes more conservative.
- Annuities. There are many different types of annuities. I’m going to talk about annuities that pay a fixed sum of monthly income for the rest of your life. This is known as a guaranteed lifetime income annuity.
- Real estate, businesses and commodities. These are very popular asset classes and proven means to build wealth. That being said, I’m not going to spend time talking about using them in this post.
Now it’s time to put your saving and investing plan together. To keep everything organized, it’s helpful to think about your goals in terms of time horizon, short, mid and long-term. For each time horizon, I’ll share common goals, the available accounts and vehicles, and then talk about developing your strategy for achieving your goals.
In order to successfully plan, you’ll need a way to calculate your values. You can utilize a free trial from one of our Certified Partners, OnTrajectory to do this. You’ll also find calculators to accomplish this should you open an account at a financial institution, or your 401(k) provider may also have one.
- Short-term goals. Building your emergency fund, eliminating credit card debt, saving or annual vacations or a larger purchase are examples of goals which fall into this category.
- Accounts. These are accounts which are suitable for short-term goals.
- Checking, savings, money market, taxable brokerage accounts
- Vehicles
- Cash, CD’s
- Stocks and bonds
- Mutual funds and ETFs
- Managed accounts
- RoboAdvisors
- Strategy
- For each priority, select the account(s) and vehicle(s) you’ll utilize, decide on the amount you’ll need to accomplish it, and then utilize a calculator or tool for determining how much you’ll need to be saving.
- For example, if you’d like to pay off $1,000 of credit card debt over the next 12 months, you’ll need to contribute at least $90 a month.
- Mid-term priorities. Saving for the down payment on a home and funding a child’s education are common examples of goals which fall into this category.
- Accounts and assets. These are accounts which are suitable for mid-term goals.
- Checking, savings, money market accounts, taxable brokerage accounts, and 529 plans.
- Vehicles
- Cash, CD’s
- Stocks and bonds
- Mutual funds and ETFs
- Managed accounts
- RoboAdvisors
- Strategy
- For each priority, select the account(s) and vehicle(s) you’ll utilize, decide on the amount you’ll need to accomplish it, and then utilize a calculator or tool for determining how much you’ll need to be saving.
- For example, if you’d like to purchase a $100,000 home and you’ve decided on a 20% down payment, you’ll need to save $20,000. If you’d like to have it saved in 5 years, you’ll decide on an interest rate and that will determine the monthly amount you’ll need to be contributing to the account.
- Long-term priorities. Retirement is the most common goal which falls into this category.
- Accounts and assets. These are accounts which are suitable for long-term goals.
- Qualified plans (Traditional IRAs, Roth IRAs, 401(k)s, pensions) taxable brokerage accounts, real estate, businesses.
- Vehicles
- Cash, CD’s
- Stocks and bonds
- Mutual funds and ETFs
- Target date funds
- Managed accounts
- RoboAdvisors
- Strategy
- For your retirement accumulation strategy, select the account(s) and vehicle(s) you’ll utilize, decide on the amount you’ll need to accomplish it, and then utilize a calculator or tool for determining how much you’ll need to be saving.
- For example, if you’d like to have $50,000 in retirement income starting at age 65 and lasting to age 95, you’ll need to decide on the interest rate you’re comfortable using. Once you’ve done that, you’ll be able to create a projection for how much you’ll need to start saving this year.
Distribution
This is the time you’ll take all the assets you’ve accumulated and turn them into retirement income.
What we want in retirement is predictable income. We don’t want to be worrying about how much we can be taking out any given year because of market conditions or other factors. We don’t want to be worrying about running out of money if we live longer than expected. Designing your retirement income strategy is extremely important so you get the results you want.
It’s also important to develop a plan for how you’re going to be spending your time and attention during retirement.
You’ll also finalize your estate plan when planning for the distribution phase.
- Designing retirement income. This is one of the most challenging aspects of your financial plan, because there is no definitive “right” answer or formula for doing it. In fact, if you we’re to ask 100 financial advisors, you’d probably get 100 different answers. Here are some guidelines to keep in mind.
- Have enough guaranteed lifetime income (GLI) to cover your fixed expenses. You most commonly get GLI from Social Security, pensions and certain types of annuities. If you know your fixed annual expenses are $30,000, and your annual Social Security benefit is $20,000, you’ll look to find $10,000 of annual income from a pension or an annuity. Another major benefit to these income sources is that they will last for your entire life; whether you live to 85 or 105.
- To cover your remaining expenses, you’ll tap into the other vehicles and accounts you chose to accumulate assets for your retirement. You could withdraw funds from your qualified accounts, take income from rental real estate, take income from fixed income assets like bonds or CDs, or dividends from stocks.
- You should also keep your six month emergency fund in place.
- Retirement lifestyle. Developing a plan for what you’re going to do with your time is essential for a happy retirement. You may think playing golf everyday is a good idea before you retire, but could find that daily golf is too much. I encourage you to think back to the six areas of goals planning, and look into the future again to determine what you’d like your life in retirement to look like.
Family. What do you want for your family in retirement?
Community. What does your community look like and how are you active with it?
Money/Career. What will your financial and work future look like?
WellBeing. How will you nurture your physical, mental and emotional health?
Personal Development. What will you learn simply for the sake of learning?
Contentment/spiritual. What will you do to secure peace of mind?
- Your estate plan. You’ll need to consider medical, financial and legacy matters when designing your estate plan. What do you want your end of life medical care to consist of? Who will handle your financial matters? Do you want to leave assets to others? These are some of the key questions you’ll need to answer.
Closing
Thinking about your financial plan as though you’re building a house is an appropriate analogy. If you intend to do your own planning, you’ll take on the most important role; the general contractor.
As with any project, there has to be someone whose job it is to get everything done. To understand what the overall plan is, and to ensure all of the subcontractors (Accounts, vehicles, legal documents) are doing their jobs.
A good general contractor has experience, expertise, and can make the project run more smoothly.
If you find you need additional help, I wanted to share some thoughts on how best to engage with professionals.
Financial coach. A coach can help guide you along your process, they’ll be an additional set of eyes and a valuable third party to communicate with and help you to create your plan.
Financial advisor. Finding a financial advisor who focuses on planning and who is a fiduciary would be my suggestion. Should you decide to engage with a fiduciary advisor, they will take on the role of general contractor from my house building analogy earlier. It will become their job to manage the financial planning process and ensure all of the subcontractors are doing their jobs, and the job gets completed.
If you choose to engage with a professional, communicate that you value transparency and would like to know all the fees and expenses that go along with their service. Ask them if they believe in a collaborative approach and if they have experience working with other professional advisors and helping people with financial planning.
However you decide to complete your financial plan, I encourage you to be as active and engaged as possible. Once you’ve completed your initial plan, you’ll need to revisit it at least once a year because our lives change.
Resources
Technology and innovation are benefiting us as consumers of everything, including the resources we need to complete a financial plan.
Going through the financial planning process will require your time and attention, which can be in short supply.
As you get started, keep in mind the end result will be peace of mind, knowing your affairs are in order. A very worthwhile investment.
Best of luck, we’re here to support you however you need; here are some additional resources:
If you’re ready to take control of your financial life, check out our DIY Financial Plan course.
We’ve got three free courses as well: Our Goals Course, Values Course, and our Get Out of Debt course.
Connect with one of our Certified Partners to get any question answered.
Stay up to date by getting our monthly updates.
Check out the LifeBlood podcast.
If you’d like help getting on the same page with your partner, check out our Same $ Page Course.
If you’d like to help your kids get good with money, check out our Teaching Kids about Money course.
This post is not financial advice.