What's a Financial Plan?
A financial plan provides a path most likely to get you from where you are today to where you want to go in the future. It provides actionable steps you can take with your money and thinking to get the most out of life, given your unique situation and preferences. Many people separate financial goals from life goals, but I believe there are only life goals. Money is one of the tools available to help you achieve what you want from your life.
Building a financial plan
There are three steps to developing a financial plan:
Understand your current state
This includes both financial considerations (e.g., income, expenses) as well as personal considerations (e.g., experience with money, behaviour).
Understand your goals and priorities
This represents where you want to go in the future. It considers your values, needs, objectives, desired lifestyle and more.
Find the best path from where you are to where you want to go
Through prioritizing goals, it’s possible to chart a path most likely to achieve your top priorities. This involves the use of several disciplines, including finance, psychology and philosophy to work through trade-off decisions from an informed position.
Where you are today
Creating a snapshot of where you are today includes:
gathering current financial statements (e.g., credit card, savings, investments, debt) to calculate:
your net worth (everything you own minus everything you owe)
your cash flow (what you earn minus what you spend)
understanding your commitments (e.g., dependents, contracts, relationships) and how they impact your options.
considering unique circumstances (e.g., health, legal, experience with money) and how to address them.
Where you want to go in the future
Before you can map out a path, it’s critical to know where you want to go. This includes listing goals for your life. You may start with a set of needs, then layer on your top priority goals and finally, your aspirational goals. These will likely be determined by your values and designed to arrive at your desired lifestyle. Your list may include some of the below examples, or it could be completely different. It’s critical that your goals are what you truly want, and not what you feel obligated to do.
A sample list of goals could include:
getting married in a year
having children
living near family
avoiding commutes longer than 30 minutes each way
paying off student loans within three years
buying a house once ready to settle down
retiring at 68
The list provides direction when prioritizing trade-off decisions. Perhaps it’s not possible to live near family, own a home and commute less than 30 minutes each way given your current net worth and cash flow calculated above. This allows you to prioritize and chart a path to achieve your priorities, given where you’re starting from. In addition, your goals can become more specific as you get closer to each milestone. You can start with a broad plan for future goals and refine it as the future becomes better defined.
Topics covered in your financial plan
Cash flow
One of the largest considerations for your financial plan is your cash flow (what you earn minus what you spend). This determines how much money you have on an ongoing basis to help you achieve your goals.
Goals and trade-offs
Reviewing multiple scenarios will help navigate trade-off decisions by allowing you to compare different ways of reaching your goals. Continuing the example from above, perhaps you could:
wait five years before buying a home
earn additional income for several years to accelerate your savings
buy somewhere with a lower price but longer commute
By comparing the pros and cons of each option, you can determine the best path forward.
Use of debt
Borrowing is a standard part of most financial plans. Whether you have existing debt or plan to borrow for future purchases (e.g., education, house, investments), your plan can help decide when and how much makes sense for you.
Investments
For most, it’s challenging to save enough on your own to pay for all your goals. As a result, almost everyone relies on compound growth through investing. Determining the right level of risk and account type for your investments are critical.
Retirement plan
While it may be a while off, you’ll want an idea of your desired lifestyle and target age for when you plan to retire. Since you’ll no longer be earning income from working after you retire, you’ll want to ensure government pensions and your savings will be enough to provide the lifestyle you’re after.
Risk management
Insurance can help remove unmanageable risk from your financial picture. From property insurance to life insurance, it’s important to minimize the impact an unforeseen event can have on your life. Having a will, and more generally, a plan for your estate is helpful to reduce the impact of an unexpected passing.
What your financial plan provides
With a plan in hand, you’ll have greater peace of mind and can answer some of the most pressing questions people have, including:
Am I on track to reach my goals?
What should I focus on today?
What can wait for the future?
As we mentioned above, you can update your financial plan over time as your future comes into better focus. Remember to consider your priorities instead of what you feel obligated to do.
Closing remarks
A financial plan uses the tools within personal finance to help you move from where you are today to where you want to be in the future. You can develop a plan on your own or work with a financial planner if your situation is more complex or you don’t have the time to complete the required research.
For additional ideas on where to get started with your money, and in building a financial plan, you can check out our recent series that looked at:
If you enjoyed this post or value the material throughout the site, please consider sharing it with others. Thanks for stopping by and let me know if you have any questions in the comments below.