How to Build a Financial Plan

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Your financial plan is a high-level view of your current financial situation. It entails your financial goals and your plan to achieve those goals.

All financial plans are living documents that should be regularly updated as your life circumstances change. Your financial plan will evolve to account for professional changes, like getting a promotion or changing jobs, and personal changes, like getting married or starting a family.

It’ll take some time to build your initial financial plan, but the effort is well worth it; having a roadmap for your financial future will reduce your stress about money, support your current needs, and help you afford the things you really want. For short-term and long-term goals alike, your financial plan is your blueprint for your tomorrow.

Because everyone has different spending and saving goals, everyone’s financial plan will look a little different. However, on the most basic level, every strong financial plan should include these elements:

  • Your cash flow
  • Savings
  • Debt
  • Investments
  • Insurance

We all want to be financially independent and build wealth. Building a comprehensive financial plan will take you one step closer to accomplishing a financially secure future.

Step 1: Set financial goals

Close your eyes and imagine your life 1 year, 5 years, and 10 years from now. What do you see?

Do you want to pay off your student loan debt? Start saving for your children’s college costs? Buy a home on the beach?

To accomplish any of these things, you need to set financial goals. By outlining your financial goals, you have a clear idea of why you’re saving your hard-earned money—which helps you keep your eye on the prize.

Here’s a quick framework for how to set good financial goals.

How to Set Good Goals in Your Financial Plan

step 1

Give every dollar a job.

At work, you have a set of tasks that you need to accomplish in order to meet all your professional goals. Similarly, in your financial life, your money should be working toward a set task.

step 2

Label each financial goal as short-, mid-, or long-term.

Short-term financial goals are achieved in six months to five years.

Some examples include paying down credit card debt, building an emergency fund, and saving for home improvement projects.

Mid-term financial goals are achieved in five to 10 years.

Some examples include saving for a down payment on a home, starting your own business, or a long-term trip around the world.

Long-term financial goals are achieved in over 10 years.

Some examples include paying off your mortgage, purchasing a rental property, or saving for early retirement.

step 3

Set a target date for each financial goal.

It’s helpful to have a specific date in mind, even if you need to adjust the date over time. For instance, if you have a tween heading to college in the fall of 2027, that’s your target date for your college savings goal. Want to go on your first safari in Kenya for your 15th wedding anniversary? You have a target date for your anniversary vacation goal.

step 4

Prioritize each financial goal.

Put your financial goals into one of three buckets: critical, need, or want. When you’re caught between two goals, this will come in handy for picking what’s most important.

For instance, if you have credit card debt with high interest rates, paying down your consumer debt would be a “critical” short-term goal. And if you wanted to remodel your master bathroom to be more spa-like—that’s a “want.” If you have a lean month, you understand where your money should go.

step 5

Monitor your progress.

Check back with your financial plan to see where you are versus what you want to have achieved by your target date.

For example, if you plan to purchase your first home in three years and you still need $50,000 for a down payment, divide that by 36 months. Then you know to save at least $1,400 per month toward that goal.

Step 2: Create a budget

Does the thought of tracking your spending sound so cumbersome that you just… don’t do it?

If so, you aren’t alone. A recent Mint survey found that 65% of Americans had no idea what they spent last month.

But we’re here to tell you: No, budgets aren’t scary. And yes, you need one. In fact, your financial goals become more attainable as you strategically cut back so you can “find” extra money to save and invest.

A budget is telling your money where to go instead of wondering where it went.

Dave Ramsey

American Personal Finance Advisor, Radio Show Host, Author

Some people resist budgeting because they think it’s too restrictive, akin to going on a diet and depriving yourself of delicious things. And no matter where or how we shop, there’s always the temptation to spend money on random things everywhere we go.

However, here’s the truth: a lot of the time, we overspend because we haven’t set limits on our spending.

Budgeting isn’t about deprivation at all. Think of it as a guideline for getting what you want—like a new phone or a trip to Mexico—and not a rigid set of rules that’s preventing you from buying coffee or spending a night on the town.

A budget is simply a tool to organize your monthly cash flow in a way that promotes your saving and investing goals.

Here’s our 5-step process for starting a budget.

How to Start a Budget

Step 1: Jot down what’s coming in versus what is going out

Pull out all your recent bills, as well as bank and credit card statements so you can be as precise as possible.

Step 2: Categorize expenses as fixed, variable, or discretionary.

Your fixed expenses are the simplest to account for and often the most difficult to change.

Fixed expenses include your rent or mortgage, car payment, and utilities.

Your variable expenses are required costs, but the amount changes every month according to your usage or choices.

Variable expenses include electricity costs, groceries, and transportation expenses.

Your discretionary expenses are those that are desirable, but you have discretion over whether to spend on them or not.

Discretionary expenses include categories like clothing costs, entertainment, and personal care.

Tip: One popular budget breakdown is the 50-30-20 budget.

It suggests that half of your income should go towards your essential needs like food, housing, insurance, bills, etc. The other half of your money is allocated to your wants and savings, or paying off debt.

Here’s how to break down your budget using the 50-30-20 model:

  • 50% toward fixed and variable expenses
  • 30% toward discretionary spending
  • 20% toward paying down debt & savings

Step 3: Subtract your budget from your monthly take-home pay.

Calculate your monthly take-home pay. Then, subtract your budget.

The difference is what’s left over that you could put toward those short-, mid- and long-term goals.

Tip: More income can mean faster progress.

Do you have a unique skill that could be turned into a side hustle? 

Is now the time to ask for a raise at work that you feel you deserve?

 

Are you ready to change jobs for a higher salary?

All these things could help you meet your financial goals faster if you stave off lifestyle inflation and continue saving toward your kids’ college funds, that Transatlantic cruise, or your first rental property.

Step 4: Prioritize.

Compare your goals and your discretionary expenses side-by-side.

Go down the list, and consider whether you’d rather spend your dollars toward a critical goal or a discretionary expense.

Would you rather pay down credit card debt or continue dining out three times a week? 

Would you rather build a 6-month emergency fund or book a trip to Europe?

Would you rather save for your children’s college or throw an extravagant 50th birthday party?

Step 5: Gamify your budget.

Who says budgeting is a bore? Make budgeting more of a game so it doesn’t feel like a chore.

  • Set up a monthly benchmark for your expenses, and try to surpass it every month.
  • Set a 30-day savings challenge.
  • Declare ‘no-spend’ or ‘needs-only’ weeks.

These small challenges will boost your ability to stretch your dollar over time.

Step 3: Build a Financial Plan for taxes

No one likes to talk about taxes, but they are a fact of life as long as you live in the U.S. and are making money or have money. After all, who wants to pay more in income tax, capital gains tax, wealth tax and other taxes on savings, investments, assets, and pensions? So, a little tax planning now can go a long way toward preserving your wealth and generating income growth down the line.

However, it’s easy to get DIY tax planning wrong, especially with the regulatory goalposts changing all the time. It’s well-worth the time to consult a tax professional to arrange your finances to be as tax-efficient as possible.

Here are a few things to consider doing now to help put a (bigger) smile on your face when you do your tax return next year.

  • Increase contributions to tax-advantaged retirement accounts. Any traditional IRA, 401(k), or 403(b) contributions reduce your taxable income, dollar for dollar. Your contributions grow tax-free until retirement, when you’ll (likely) pay taxes in a lower income bracket.
  • Take advantage of a Flexible Spending Account (FSA). If you have access to a FSA through your employer, your pre-tax contributions for dependent care expenses and/or medical expenses lowers your taxable income. Then you submit expenses for reimbursement as they occur.
  • Contribute to your Health Savings Accounts (HSAs). If you opt for medical coverage through a high deductible health plan (HDHP), you can contribute to an HSA to save for out-of-pocket medical expenses not covered by your plan.
  • Make energy-efficient improvements to your home. The government offers energy tax credits toward qualified energy efficient home improvements. As a homeowner, you can claim 30% of the cost of alternative energy equipment (including installation) like solar hot water heaters, solar electric equipment, wind turbines, and fuel cell property.
  • Make use of tax-loss harvesting. Keep an eye on your investments; you can sell some securities at a loss by year-end to offset capital gains to reduce your tax bill.

Step 4: Build a financial plan with an emergency fund

According to a survey by the Federal Reserve, 39% of American adults don’t have a spare $400 to cover an unexpected expense, or could only do so by borrowing or selling something. That’s a problem.

Your emergency fund is just as critical as your budget. Think about those ‘what-if’ worries—your dog breaks his leg, you lose your job, your car transmission stops working—and consider how that would impact your budget. Without rainy day funds to cover unpleasant financial surprises, your whole financial plan could be thrown for a loop.

How to Build an Emergency Fund

Step 1

Set small goals.

Start with a $1,000 emergency savings goal.

As soon as you reach your $1,000 milestone, continue adding til you have one month’s worth of expenses, two months’, three months’.

You’ll reach your ultimate goal—six months’ worth of expenses—before you know it.

Step 2

Create a strategy to meet those goals.

Look around the house to find what you could sell to convert to cash. List your kids’ old toys, exercise equipment, dusty power tools, and old electronics.

Or, take on some gig work. Try signing up to dog-sit, participate in focus groups, or offer online tutoring services.

To build it faster, transfer money from a bonus or tax refund. If you have extra money after paying for your necessities at the end of a month, add that, too. (That money is meant for goals like this.)

Finally, run through your budget to see where you can cut down on spending. Trim away the discretionary expenses that you won’t miss (too much). If you haven’t been to the gym since making your last New Year’s Resolutions, cancel your gym membership. If you find yourself ordering takeout 5 nights a week, consider picking up cooking as a new hobby.

step 3

Keep your emergency fund in an account that’s liquid and accessible—but not too accessible.

Look for a low-risk account with minimal fees that won’t charge you a penalty when you need to withdraw your money. Think high-yield savings accounts or money market accounts—you should be able to access it online, but not from an ATM, where you may be tempted to withdraw it. (Out of sight, out of mind.)

Step 5: Manage debt

Debt. It’s a fact of life.

It’s wonderful to think about living a debt-free life, but realistically speaking, the vast majority of Americans will take on debt in one form or another, for a variety of reasons. And that’s OK—few people can pay for a car, home, or college education in cash.

Moreover, not all debt is bad. Debt is required to build credit history, and you’ll need a solid credit score to qualify for major loans. Still, debt is something to be understood and managed appropriately.

Debt can generally be categorized as “good” (constructive) or “bad” (destructive).

Good Debt vs. Bad Debt

Good Debt

Good debt is defined as money owed for things that can help build wealth or increase income over time.

Examples of good debt:

  • Student loans
  • Mortgages
  • Business loans

Bad Debt

Bad debt is destructive, and does little to improve your financial outcome.

Examples of bad debt:

  • Credit card debt
  • Auto loans with high interest

Before taking on debt, always consider whether it’s good debt or bad debt. Then, ask these 5 crucial questions:

What to Consider Before Taking on Debt

Do I need to buy this, or do I just want it?

This is your ultimate question. If your car battery is on its last leg, that’s a need. Reliable transportation is important, especially if you need to get to work. More important than, say, installing a home gym in your garage. That’s a want.

How long would it take to save and pay cash instead?

It can take a long time to save enough cash for your first home. A home loan is necessary. But if you want to splurge on a new accessory for your weekend hobby, you should save up and pay cash for that instead.

Can I afford this debt?

Have you already met your six-month emergency savings fund goal? How would this debt change your debt-to-income ratio? Can you pay off this debt in a reasonable amount of time?

Do other lenders have better interest rates or terms?

Do your interest rate shopping before making a large purchase. It’s always worth the time investment.

Am I buying something that will increase in value?

A home mortgage or home equity loan can be a good debt. Most likely, your home value will appreciate over time. Compare that to the new iPhone that you want in order to replace last year’s model. It’s not increasing in value.

Here’s how to manage your debt before it overwhelms you.

  • Get to know your debt. Just like keeping a food diary helps you understand your eating habits, a debt diary helps you understand your spending habits. Keep a running document of all your debt, including the balance, interest rate, and minimum payment.
  • Pay it down. Two common debt repayment strategies exist: the snowball method and the avalanche method.Snowball method: Rank your debts in order of size, then start paying down the account with the smallest balance first. Keep making minimum payments on other debts. Once the first is paid, move on to the next debt with the lowest balance. This might be the right method if you’re motivated by seeing gradual small wins. Avalanche method: Rank your debts in order of interest rate, then start paying down the account with the highest interest rate first. Once you pay one, work on the one with the next highest interest rate. Continue making minimum payments on other debt. This might be the right method if you prefer to pay less over the life of your loans. (This generally gives you more long-term purchasing power.)
  • Manage your debt. Continue to manage your debt as part of your overall financial plan.Set up auto-pay. Paying late could hurt your credit, plus you may get hit with a penalty.Turbocharge your savings and income. To pay debt faster, cut expenses from your budget or boost your income.Consider your mid-term goals. If you have a large expense on the horizon, like buying a home or having a baby, take that into account in your overall financial plan.
  • Know your credit score. Know it and recheck it every year. Visit AnnualCreditReport.com to request your free annual copy. Focus on boosting your credit score by keeping credit card debt at a minimum, correcting errors on your credit report as soon as you identify them, and paying your loan balances.

Step 6: Protect with insurance

No one likes to think about disability or death, but insurance is there to protect you from these worst-case scenarios.

Disability insurance helps you cover your necessary expenses if you aren’t able to work due to illness or injury on the job. It covers a portion of your income if you get sick or injured on the job. Here are some important considerations:

  • Do I need short-term disability, long-term disability, or both?
  • How much of my income would I need to replace?
  • For how long?
  • How long until I start receiving benefits if I’m disabled?

Life insurance helps protect your family if something happens to you. It can help cover anything from funeral expenses to paying off the mortgage. Here are some important considerations:

  • Do I have life insurance coverage? How much coverage do I have?
  • Do I want term life insurance, or do I want whole life (permanent) insurance?
  • Do I need extra coverage (e.g., business travel accident insurance, advanced payment when terminally ill)?

Step 7: Plan for retirement

Even if you don’t plan to retire in the next decade, it’s never too early to start planning for your retirement future. After all, retirement isn’t an age—it’s a financial number!

Imagine yourself in retirement. What does it look like?

Do you plan to live in a warm, sunny, tropical destination for half the year? Maybe you want to buy your children’s first homes and help raise your grandkids. Or perhaps you’d like to spend your days immersed in that hobby that you’ve always wanted to explore, but never had time for during your working years.

The clearer your image of retirement, the easier it’ll be to plan for it. And when you automatically divert a portion of your paycheck into a tax-advantaged retirement savings plan, like your 401(k), you’ll be well on your way to earning a substantial nest egg for a financially secure retirement.

Creating a Basic Retirement Plan

step 1

Figure out how much money you’ll need to save by the time you retire.

You’ll first need to get a clear picture of the following numbers:

  • Your current take-home income
  • Your deferrals, or your pre-tax contribution to your retirement account(s)
  • Your current retirement savings
  • Your estimated Social Security benefit
  • Your current age
  • Your desired retirement age

Then, use an online retirement calculator to get a rough estimate of how much you’ll need to retire comfortably. This will be a good starting number for how much you should aim to save.

step 2

Save and invest for the long term.

You’ll first need to get a clear picture of the following numbers:

  • Your current take-home income
  • Your deferrals, or your pre-tax contribution to your retirement account(s)
  • Your current retirement savings
  • Your estimated Social Security benefit
  • Your current age
  • Your desired retirement age

Then, use an online retirement calculator to get a rough estimate of how much you’ll need to retire comfortably. This will be a good starting number for how much you should aim to save.

“Compound interest is the eighth wonder of the world.”

Albert Einstein

Compound interest allows you to receive interest not only on your initial investments, but also on any interest, dividends, and capital gains that accumulate. Through compound interest, your money grows faster and faster as the years go on.

Let’s say you invest $15,000. And you earn 7% over a year.

So now you have $16,050. Over the coming year, you make 7% not just on your initial $15,000 but also on the $1,050 you earned last year. That’s the benefit of compounding in action!

Source: JP Morgan Asset Management

Try to invest 10-15% of your gross income through tax-advantaged retirement savings plans, like your 401(k) or individual retirement account (IRA). Contribute at least enough to get your employer’s matching contribution so you don’t leave money on the table. If you didn’t start investing til later in life, you may need to bump that up.

If you’re trying to juggle multiple financial priorities like funding college for your kids and buying or paying off your home, that’s okay. Save what you can and commit to increasing 1% each year until you can hit the mark.

step 3

Have a Social Security strategy in place.

Each individual person’s Social Security strategy will look slightly different depending on your individual circumstances.

  • Your marital status
  • The age difference between you and your spouse
  • Your work history
  • Your desired retirement age
  • Your retirement income plan
  • Your expected longevity

Regardless of your individual circumstances, it’s important to understand the basics of Social Security.

When should I claim Social Security?

It depends. The earliest you can draw Social Security (or spousal benefits) is age 62, but the longer you wait to take it, the more money you’ll receive—permanently. By holding off until age 70 to claim your benefits, you can be paid up to 76% more per month.

Is Social Security taxable?

Yes. If your total income is more than $25,000 for an individual or $32,000 for a married couple filing jointly, you must pay income taxes on your Social Security benefits. Below those thresholds, your benefits are not taxed.

If you have other sources of income, like earnings from work or withdrawals from tax-deferred retirement accounts, the federal government can tax up to 85% of your Social Security benefits.

How do spousal benefits work?

When one spouse dies, the surviving spouse is entitled to receive the higher of their own benefit or their deceased spouse’s benefit. That’s why financial planners often advise the higher-earning spouse to delay claiming. If the higher-earning spouse dies first, the surviving, lower-earning spouse will receive a larger Social Security check for life.

Divorced spouses can collect Social Security benefits based on their ex-spouse’s work record under certain conditions.

Interested in learning more about maximizing your Social Security benefit?

We’ve compiled our best tips in a 12-step Social Security strategy guide.

step 4

Recover from a late start on retirement planning.

  • Max out your 401(k). Defer the maximum amount to your 401(k), or at least the minimum to get your employer match. Plan to divert extra earnings from bonuses, promotions, and raises to your retirement accounts.
  • Max out your IRA. Just like your 401(k), an Individual Retirement Account (IRA) allows you to invest in a tax-advantaged account.
  • Make catch-up contributions if you’re 50 or older. In 2021, you can contribute an additional $6,500 to your employer-sponsored retirement plan, and an extra $1,000 to your IRA.
  • Pay off high-interest debt. Manage your debt so you have more money in your budget for long-term savings.
  • Invest in a guaranteed income source. An annuity can provide a guaranteed income stream to help you reach your goals throughout retirement. It reduces the risk of outliving your nest egg, and it bridges the gap between savings and future income needs.
  • Think about working longer. Delaying retirement, even for a few years, can help boost your retirement income. By working longer, your retirement savings have more time to grow.

step 5

Review and rebalance regularly.

At the end of each quarter, take a few hours to review your 401(k) and IRA.

  • Brush up on asset classes to understand your options.
  • Evaluate whether your current asset allocation aligns with your financial goals and risk tolerance.
  • Rebalance by selling your high-performing investments and buying more low-performing investments, if necessary.

Step 8: Invest beyond your 401(k)

Now that you’ve built an emergency fund, learned how to manage debt, and have a good grasp on retirement planning fundamentals, it’s time to learn how to make your money work for you.

  • Your short-term goals should be served by the money in your savings account.
  • Your mid- and long-term goals are bigger, and thus require a more active approach. That’s what investing does—investing takes your saving strategy and puts it to work.

For your mid-term goals, you have more time to weather market volatility, but you’re still likely sticking to more conservative, fixed income investments like bonds.

For savings you won’t need for five or more years, you may consider other investments to help spread risk and grow your money, like mutual funds, stocks, exchange traded funds (ETFs), and annuities—depending on your risk tolerance.

Basic Investing Principles

1

Understand your risk tolerance

Risk tolerance is all about the level of risk that you’re willing to take. In general, young investors can tolerate more risk, as they have more time to recover from market losses. As you get closer to retirement age, your account should become much more conservative.

2

Understand the relationship between risk and reward

The higher the potential for return (meaning a gain or loss on investment) the higher the potential for risk of loss—and vice versa.

3

Diversify

Choosing a mix of investments from various asset classes helps manage risk. It’s also good to choose a mix of different investment options within each asset class.

4

Rebalance

Over time, some investments may grow more than others. After a while, your mix of investments isn’t the same as when you started. That could mean you’re taking on more risk (or less) than you originally intended.

Step 9: Create an estate financial plan

An estate plan lays out all of your final wishes, should something happen to you. Your estate plan includes the following:

  • Will. Your will describes how you wish to distribute your property. If you have minor children, you’ll appoint a guardian to look after your children when you’re gone.
  • Trust. A trust is a legal vehicle that allows a third party, a trustee, to hold and direct assets in a trust fund on behalf of a beneficiary. A trust can hold all different kinds of assets, including investment accounts, houses, and cars.
  • Financial power of attorney. A financial power of attorney grants a trusted person the authority to make money decisions on your behalf.
  • Medical power of attorney. A medical power of attorney grants a trusted person the authority to make medical and end-of-life care decisions on your behalf.
  • Advance directive. An advance directive, also known as a living will, explains how you want medical decisions about you to be made if you are incapacitated and unable to speak for yourself.

Read more about estate plan basics, including benefits, considerations, and how you can pass on your legacy on your own terms.

Final Tip: When to Review Your Financial Plan

Take a fresh look at least once a year or after a big life change:

Tip: Around age 50, you may want to include long-term care insurance and expand your plan to add income in retirement.

We Can Help

A solid financial plan is the foundation for achieving all your financial goals. If you need help building a plan that includes savings, budget, insurance, and tax strategies, please fill out the form below and we’ll get back to you shortly. We look forward to hearing from you.

DISCLAIMER: Advisory Services offered through Prosperity Financial Group, Inc., an Independent Registered Investment Advisor. Securities offered through Fortune Financial Services, Inc. Member FINRA/SIPC. Prosperity Financial Group, Inc. and Fortune Financial Services, Inc. are separate entities.

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