Just as investors need a plan to build the foundation of their investing objective, they also need a financial plan to figure out what they want to achieve throughout their lives, and how best to organize their investments to coincide with life goals. Without a plan, investing can go off course and lead to underwhelming and unplanned results. We look at what a good financial plan should entail.
Creating Investing and Financial Goals
The most important part of financial planning is to find an ultimate goal that you are trying to reach. From this point, you are able to draw a roadmap to get there; you won’t know how to get where you’re going if you don’t have a destination in mind. First, you must understand your risk profile and where you are in life relative to what your final financial goals are. These two aspects go hand-in-hand, as the closer you are to retirement, the less you want to risk, and the younger you are, the more risk you’re able to take with your investments.
Risk and life stages also help you decide what to invest in – if you’re risk-averse, you probably will invest in more predictable and stable investment vehicles like bonds and annuities rather than stocks. The closer you get to retirement, the more costs you are able to reduce; find out what they are in How To Cut Retirement Costs.
An important thing for all investors to keep in mind is that flexibility is what allows your financial plan to succeed. If you have your goal, the initial plan you have to achieve this goal is not necessarily the one you will stick with throughout your investing life. One must only look back a few years to see how someone that planned on making their returns in real estate would have had to re-adjust their plan in order to get to the financial goal they had set. This is common for all investors; just as the market is changeable and ever shifting, so too must your plan be. In addition to markets, your life will change, and your plan must change with it. Retirement age, mortgages, debt, children and new jobs will all impact your desired returns and the amount of capital you have to invest. These changing expenses will also affect your risk profile.
As you age and start a family, there are other factors that need to be taken into account, and investing vehicles and financial tools that go along with these changing factors. If you have started a family, you want to ensure that your estate is in order, and you’ll want to decide on what kind of will or trusts you want to set up to provide for your family. You’ll also want to make sure you have designated beneficiaries for your holdings. As well, you’ll want to consider insurance for yourself and your family, to ensure that everyone is taken care of in case something should happen to you.
Yearly Check-Ups and Recalibration
Along with setting goals and flexibility, you must check your plan at least once a year to make sure that it is still in line with your life goals and shifting priorities. During this yearly check-in, investors should make note of any changes that have occurred over the year, including:
- Major purchases
- Job or salary changes
- New ongoing expenses, such as having a new child or paying for your child’s schooling
- New debt
- Performance of investments throughout the year
- Changes in interest rates
As well, you should make sure you plan for any changes in the economy in the coming year. Pay attention to finance papers to see if there is anything that economists are warning about. Is a recession coming? Are interest rates expected to be cut? Are certain sectors prepped for a correction? All of these mid-term expectations should be kept in mind when you’re doing your mid-year check-in. If you have a child that will be attending college in the next few years, is it time to transfer their college fund to something safer, in case the markets fall over the next few years? These are the kinds of questions you should be asking yourself each year when you go over your financial plan. If you plan on adding some income-producing stocks to your portfolio in the coming year, check out our Dividend Stock Screener to get some ideas.
Prioritizing Your Finances
A common question for families during their personal financial planning is where their priorities should be when it comes to putting their money to work. Figuring out what is best to pay off or save for can be overwhelming, but there is some straightforward finance logic that can help you out. The plan you come up with will completely depend on your situation and you must take into account levels of debt, mortgage, income and saving goals. For everyone, your plan will be slightly different, but there are some rules that can apply to all households. We’ll go over what your financial goals should be, and the best way to prioritize and determine how you pay off debt and start saving.
Before You Start
Prior to coming up with a plan, you’ll want to put together a realistic picture of your finances. Create a spreadsheet with the following: debts and loans, income, set monthly expenses, flexible monthly expenses. After this is done, you should be able to come up with a figure that is left over and can be put towards savings and debt-repayment goals. If you’re unhappy with your net monthly income, go through your monthly expenses and see where you can cut back (cell phone expenses, cable, air conditioning and heat, food). Once you have this all in order, you can start prioritizing your debt and savings.
Paying off High-Interest Debts
When it comes to debt, there are usually many different interest rates and amounts that you’ll be dealing with, and some debts (student loans, back-taxes), will not have much flexibility in terms of how much you need to pay per month. Still, if you have some money left over, there are debts that you should try to get rid of before doing anything else. For most people, the biggest aim should be to get any high-interest payments off your plate. These expenses would involve credit card debt and cash advances, bank overdrafts, and any other debt that is charging you an exorbitant amount in interest. Go through your debts and find the ones that are costing you the most in interest each month, and put those at the top of your list for repayment.
Building an Emergency Fund
Once you have the high-interest debt dragon slayed, consider building an emergency fund for 6-12 months of expenses in case of any job losses or emergencies. Keep this money in a high-yielding money market account so you can access it very quickly. You can also open a home equity line of credit in the event of an emergency as well, but it may not be as easy to find much equity to tap these days. For more on how to build an emergency fund, and a more in-depth look at the fund’s importance, check out Why You Need An Emergency Fund – And How To Build One.
Saving for Retirement and College
Once you have paid down your high-interest debt and built an emergency fund, it’s time to start looking at your retirement and college savings plans. These two options are equally important, and they give you advantages above and beyond being able to afford retirement and college for your children. For retirement, you have many options to look into, such as 401(k)s and IRAs, and both of these are tax-advantaged savings vehicles, meaning that you will get tax credits for adding to these accounts. Same goes for college, with Coverdell Education Funds and 529 Plans, you can contribute to these accounts while receiving tax benefits. The amount you can afford to put into these will depend on your income, goals and age, but these should become a priority.
The following table shows the impact of saving more each year in your retirement account:
For more in-depth information on the types of college and retirement accounts that are available, check out The Pros and Cons of 529 Plans and Dividend Stocks in Roth IRAs: An Exceptional Retirement Strategy.
Your mortgage and student debt are usually lower-interest loans that you will have to pay off each month regardless of your goals, but these should be a priority as well. The sooner you can pay off your mortgage and student debts, the sooner you can start adding to your retirement plan for yourself and a college savings plan for your children. As well, once you have more disposable income, you’ll have additional funds to start adding to your dividend stock portfolio, and really get your money working for you.
The Bottom Line
One of the most reliable ways to ensure that you have a solid financial plan is to find a financial planner that can help you keep on top of it. When working with a planner, don’t hold back on any of your financial information or goals. It’s always best to be honest, no matter what the circumstances; otherwise, you risk putting your and your family’s financial well-being at stake.