In the ever-evolving landscape of personal finance, having a clear and structured plan is essential to achieving long-term financial security and reaching your life goals. A personal financial plan serves as a comprehensive roadmap, guiding you through the complexities of managing your finances. Unlike a simple budget, which tracks your income and expenses over the short term, a financial plan addresses multiple aspects of your financial life, from savings and investments to retirement planning and debt management.
Managing and planning your personal finances can often feel overwhelming to the point that you avoid planning a healthy financial future. Only about 30% of Americans have a long-term financial plan. The key reasons for avoidance are due to:
- Lack of Financial Literacy: According to recent survey results from the World Economic Forum, approximately half of American adults lack financial literacy.
- Procrastination and Income Constraints: In 2023 it was reported that above 60% of Americans were living paycheck to paycheck, causing them to focus on immediate needs rather than their future financial health.
- Fear and anxiety: Facing your current financial situation and starting to plan for the future causes fear and anxiety by placing unnecessary pressure to make the right decisions today.
Regardless of your financial literacy or current income constraints, there are tools available to you to start planning today. Two of the most fundamental yet frequently misunderstood tools are the budget and the personal financial plan. While they are often used interchangeably, a budget and a personal financial plan serve distinct purposes in the journey to financial wellness. Understanding their differences is crucial for effectively managing your money and securing your financial future.
Creating a financial plan involves several steps that help you outline your financial goals, analyze your current financial situation, and develop strategies to achieve those goals. Here’s a step-by-step guide:
Define your Financial Goals:
First, start setting SMART financial goals. SMART financial goals are specific, measurable, achievable, relevant, and time-bound. These goals can be short- (within the year) such as planning a vacation, medium-term (1-5 years) such as paying off debt, or long-term (5+ years) such as buying a house. For more information on defining short-term and long-term financial goals check out Define Short-Term and Long-Term Financial Goals To Stay Motivated and Focused. The priority should be to have an emergency fund set aside. The gold standard for this emergency fund is typically enough to cover 3-6 months of essential living expenses. However, this can feel like a daunting task for many, so you should start this with a small goal of $500.00 which could help with an unexpected vehicle repair bill. Part of your short-term goal should include increasing this emergency fund over time. While planning for emergencies, you should also plan for your future. The best method of doing this is through contributing to your 401(k). If your employer offers 401(k) or 403(b) options, make sure you are investing in your future, which often includes a match by your employer, which means free money contributed toward your financial future.
To prioritize your remaining financial goals:
- How much will it cost? Achievable savings goals start with accurate cost estimates. Research the price of things on your shopping list to ensure your goal is in the ballpark of reality.
- How soon do you need the money? Divide that cost by the number of months, weeks, or years between now and your deadline. If that number makes you do a double take, consider adjusting the goal (substituting a less costly alternative) or the time frame (pushing the big vacation out until next year).
- Where should you put your savings? This depends on your answer to the previous question. If the funds are needed for the short term or within the next 5 years, you should consider short-term investments like online savings accounts, CDs, or money market accounts. If you do not need the money within the next five years, you can consider stocks. This is because you have more time to ride out any dips in the market and wait until recovery. If you choose to go this route, we do advise that you speak with a professional investor.
Assess Your Current Financial Situation
Create a detailed picture of your current financial status by gathering income information (listing all sources such as salary, bonuses, and investments), expenses (tracking all monthly and annual expenses, both fixed and variable), assets (documenting everything you own including savings accounts, investments, property, and valuables), and liabilities (listing all your debts including credit cards, loans, and mortgages). Budgeting apps like Neat can help see trends in your spending habits by category and compare them to your income.
Create a Net Worth Statement – A net worth statement includes all of your assets (what you own). This can consist of money in your bank accounts, investment accounts, your car’s value, your home’s market value, business interests, personal property, and cash value on insurance policies. Then subtract your liabilities (what you owe) from your assets. Liabilities can include mortgages, car loans, credit card balances, or student loans. Check out and use Neat’s Personal Net Worth Statement for free.
Develop a Cash Flow Analysis
Analyze your cash flow to see how money is coming in and going out each month. This helps you identify areas where you can reduce spending or increase your savings.
Conducting a cash flow analysis for an individual involves a systematic approach to examining their income and expenses to understand their financial health and plan for future stability. The process starts by gathering all necessary financial documents, such as pay stubs, bank and credit card statements, bills, receipts, and investment account statements.
The next step is to identify all sources of income. This includes regular salary or wages, bonuses, commissions, rental income, investment income, and any other sources like side jobs or alimony. Once all income sources are listed, the focus shifts to tracking and categorizing expenses. Common expense categories include housing costs, transportation, food, insurance, debt payments, entertainment, savings, and miscellaneous expenses like clothing and personal care.
After categorizing expenses, calculate the net cash flow by subtracting total expenses from total income. A positive net cash flow indicates that there is surplus money, while a negative net cash flow shows a deficit. This calculation helps in understanding the individual’s financial situation.
Analyzing the results of the cash flow calculation is crucial. If there is a surplus, it can be allocated towards savings, investments, or paying off debt. If there is a deficit, it is important to identify areas where spending can be reduced or explore ways to increase income.
Based on the analysis, provide actionable recommendations. These might include adjustments to the budget, creating a savings plan for emergencies or retirement, developing strategies for more efficient debt repayment, or identifying potential investment opportunities to grow wealth.
Using tools like Neat can help streamline the process and offer visual insights, making it easier to manage and adjust finances as needed. Check out Neat’s Personal Financial Statement which you can use for free.
Review and Adjust Regularly
A financial plan is not a one-time effort. Review and adjust your plan regularly to reflect changes in your life circumstances, financial goals, and market conditions. This ensures your plan remains relevant and effective.
By following these steps, you can create a comprehensive financial plan that helps you achieve your financial goals and secure your financial future.
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