What Is a Financial Plan, and How Do You Start One?

By Katana Dumont
December 14, 2020

Having financial independence and generating wealth is something most of us strive for in our lives. We each have our own personal financial aims, and whether that be saving for college, buying a house, or building towards retirement, planning ahead is one of the most effective ways to achieve any goal. That’s why financial planning is so important.

According to Schwab’s 2019 Modern Wealth Survey, people who have a written financial plan tend to demonstrate better money and investing habits. The survey found that more than 60 percent of those with a written plan feel financially stable compared to only about a third of people without a plan. 

One common misconception surrounding financial planning is that it’s only for the affluent. When in fact nothing could be further from the truth. Everyone—no matter your financial situation—can benefit from a financial plan. Through seemingly small steps, like setting up an automatic savings account or investing a portion of your paycheck each month, your financial plan will help you build healthier financial habits and can lead to a much brighter future.

  1. What is financial planning?
  2. What are the essential elements of a financial plan?
  3. Financial planning in 5 simple steps
  4. Tips for a better financial plan

What is financial planning?

Think of a financial plan as a roadmap to achieve your goals and prepare you for a healthy financial future. Financial planning is an ongoing strategic process that will support your current financial needs as well as help you build a nest egg for your long-term goals. 

A financial plan is usually a concrete document that identifies, organizes, and prioritizes your financial goals, then outlines the steps you need to take to achieve them. It also provides insights into your personal finances so that you can make the most of your assets. A good financial plan will ideally include details about your cash flow, savings, debt, investments, insurance, and any other elements of your financial life. 

While financial plans should be highly individualized to reflect your personal and/or family needs, risk tolerance, and future expectations, all financial plans follow the same basic elements and principles. Here’s everything you should know about starting a financial plan.

What are the essential elements of a financial plan?

There are a number of key elements that are typically involved in a strong financial plan. Although they all affect your money in different ways, their cumulative effect dictates what your financial future will look like. Here are the key financial components to focus on:

Budgeting

We are all guilty of splurging from time to time—impulse spending is all too real. And while the occasional compulsive buy probably won’t break the bank, it is important to maintain healthy spending habits as best we can. Budgeting is a great tool for this, as it tracks your spending and helps foster better financial awareness. 

How you can incorporate budgeting into your financial plan:

  • Create a cash flow statement showing your income sources and expenses
  • Draft out a balance sheet that reviews your assets and liabilities
  • Figure out what the positives and negatives of your current financial situation are
  • Manage your money based on a percentage-based budget, like the 50/30/20 rule

Investing

Investing sounds like something for the wealthy or well established, but in reality it’s for everybody interested in saving for the future. An investment plan is part of a comprehensive financial plan that maps out an investing strategy to help you meet your long and short term goals, such as retirement or buying a house. By taking into account your risk tolerance, diversification and asset allocation, investment plans are typically designed to help you decide how much to invest in stocks, bonds, cash, real estate, and retirement in order to maximize your returns. Plans should be highly customized and can be as small or as large as you deem fit.

How you can incorporate investing into your financial plan:

  • Diversify your investment portfolio 
  • Create a plan for asset allocation
  • Draft an overview of your retirement account investments
  • Invest a portion of your paycheck every month

Retirement Planning

No matter your age, saving for retirement needs to be part of your financial plan. Retirement planning is a multistep process that evolves over time. To have a comfortable and secure retirement, you need to build the financial cushion that will fund it. The earlier you start, the less you’ll likely have to save each year. You may be surprised to find that even a little bit over time can make a big difference. 

How you can incorporate retirement planning into your financial plan:

  • Draft out estimates for post-retirement and Social Security income 
  • Figure out what your ideal post-retirement lifestyle will look like
  • Calculate how much you will need and contribute to a 401(k), or other employer-sponsored plan
  • Invest in an IRA

Estate Planning

It’s not something most of us like to think about but deciding who will inherit your assets after you’re gone, is an important part of planning for the future. Without a plan in place, settling your affairs after you go could have a long-lasting—and costly—impact on your family, even if you don’t have a pricey home, large IRA, or valuable possessions to pass on. Estate planning is all about protecting your loved ones by arranging for their benefit and financial security.

How you can incorporate estate planning into your financial plan:

  • Create an estimate of your estate/inheritance taxes
  • Take a tally of your valuables and possessions 
  • Complete your will

Risk management

Managing risk is a very important part of every financial plan. There are many types of risk one should be aware of when drafting a financial plan—risk caused by stock market declines, economic instability, death, disability, loss of income, catastrophic events, and damage to assets, are some of the most common. These unforeseen events can have devastating financial implications to finances and alter the anticipated outcome of a financial plan. While risk is impossible to avoid, it can be managed appropriately.

How you can incorporate risk management into your financial plan:

  • Review your disability and life insurance, health insurance, and personal liability coverage 
  • Draft a beneficiary and survivor benefit plan
  • Invest in income annuities

Tax Planning

Almost every financial decision you make has tax consequences. That being said, setting up a strategic plan to reduce the amount of taxes you pay will have a significant impact on your financial future. Don’t wait till tax time to look at your taxes, by then it’s usually too late to make changes that significantly reduce your tax bill. Instead, look at each investment decision from a tax perspective—before you make it—so that you can better avoid potential mistakes or actions that could eat into your earnings.

How you can incorporate tax planning into your financial plan:

  • Review your tax returns
  • Take full advantage of deductions and credits you may qualify for
  • Choose tax-efficient accounts and investments
  • Make tax-efficient retirement withdrawals

Financial planning in 5 simple steps

Everyone’s personal situation is unique, therefore our financial plans will look a bit different. In general, though, there are five main steps that a well-designed financial plan should follow.

Step #1: Determine your financial goals

The first thing you should ask yourself when putting together a financial plan is what you want your money to accomplish. What are your short and long-term needs? Where do you want to be in five to 10 years? How do you imagine your life in retirement? Identifying and prioritizing your goals will act as a motivator as you plan out your financial future.

When you’re setting goals for your finances, there are a few rules to follow. For example, it helps to make sure your goals are S.M.A.R.T. 

  • Specific
  • Measurable
  • Achievable
  • Relevant
  • Time-bound

The idea is that when you’re setting financial goals, or any other kind of goal, you have a specific target you’re working toward that’s measurable. From there, you can reasonably achieve your goals within a set time frame. Look at your financial future as a whole when outlining these goals. All of your finances are connected, so don’t just focus on one aspect. For example, when it comes to family planning, you may want to think about not only starting a college savings fund, but also putting a down payment on a house.

Step #2: Calculate your current financial situation

In order to get where you want to go, it’s important to know where you are—consider your net worth (how much you have in assets minus your total liabilities) and your cash flow. Analyzing all of this information provides a more accurate understanding of your current financial standing.

To calculate your net worth, list all of the following:

  • Your assets: This may include a home and a car, some cash in the bank, money invested in a 401(k) plan, and anything else you own of value.
  • Your liabilities: These may include credit card debt, student loans, an outstanding mortgage, and a car loan.

🤓 Here’s how to calculate your net worth

Your assets − your liabilities = your net worth

  • Your income: This will include your paycheck and any investments and money you have coming in, month-to-month.
  • Your expenses: Document how much you’ve paid over a year in basic life expenses (i.e., rent or mortgage payments, utilities, credit cards,etc.) and document your day-to-day spending on things like food, clothing, and transportation, as well as any extra expenditures on things like travel, entertainment, and dining out. Add up all these numbers for a year and then divide by 12, to get an average monthly estimate of your spending.

Step #3: Create a comprehensive financial plan

With your financial standing and goals defined, you can start developing the actionable steps of your financial plan. Whether you need to reduce spending and debt, up your savings, or just refine the details, creating a comprehensive financial plan will set you up for future success.

Most likely, your financial plan will include saving money for retirement, an emergency fund or a big purchase. Investing will also likely play a prominent role in your financial plan, as will building up your credit. If your credit score isn’t where it should be, part of your plan should be to focus on paying credit card bills and student loans on time and utilizing other methods for building up credit. Debt consolidation may also be a big focus of your financial plan. How exactly you go about it — if you get a consolidation loan or not, if you increase your monthly payment or leave it unchanged, etc. — will be dependent on your situation.

Step #4: Put your plan into action

Now that you’ve mapped out your financial plan, it’s time to take the necessary action steps and commit to moving forward. Changes to your financial lifestyle do not have to be drastic and happen all at once, in fact it’ll probably be easier and more sustainable to start off small. For example, instead of saving half your paycheck at once, start saving in small increments. The timeline of your financial plan can stretch for years, so there may not be any immediate results. But stick to the steps outlined in your plan and you will reach those milestones in no time.

Step #5: Adjust accordingly

It’s important to follow the steps you set in your financial plan. However, it’s just as important to recognize that unexpected things do happen. A financial plan isn’t a static document — it’s a tool to track your progress, and one you should adjust as your life evolves. It’s helpful to reevaluate your financial plan after major life milestones, like getting married, starting a new job, having a child or losing a loved one. Any situation that arises that you didn’t expect can impact your finances, so you should make changes to your plan accordingly. That way, it can better reflect your financial standing.

Tips for a better financial plan

  • Get a financial advisor — A financial advisor can help you build on your work if you want additional guidance, analysis, and direction. 
  • Automate your finances — Creating an automated system to manage your bills, payments, savings, and investments, can better help you stick to your financial goals.
  • Use a robo-advisor service — A robo-advisor service can further simplify your investments, as they invest your money based on proprietary algorithms.

Work with an estate planning attorney — An estate planning attorney can help you better plan for complex situations and provide you with added support.

Katana Dumont is a freelance writer and Digital Content Specialist. She writes articles focused on simplifying personal finance topics, with the hopes of educating young people on the importance of financial literacy.

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