Developing A Financial Plan

Some guides to help you develop a sound financial plan for today and the future, no matter where you are in your life’s journey.

Financial Guides

This Financial Guide tells you how to begin the financial planning process. It provides worksheets to help you find out where you are financially and where you want to be in the future. It will help you identify your goals, determine your net worth and cash flow, plan to achieve your goals as well as begin to put your plan into action.

Financial security derives not only from acquiring more money but from planning. A solid financial plan can alleviate financial worries about the future and ensure that you will meet your financial goals–whether they relate to retirement, asset acquisition, education, or just vacations.

Tip: Review your financial plan every year to keep it up to date. If you set it up properly initially, it is relatively easy to review and keep current.

This Financial Guide allows you to take the first step towards a solid plan. By following the instructions and guidelines contained in it, you can find out where you are now and how you can put your plan into action.

There are many ways to approach setting up a financial plan. The one outlined in this guide is just one of a number of approaches. Your financial advisor can assist you in setting up the financial plan that best meets your particular situation and needs.

Identify Your Goals

Spend some time thinking and talking with family members about what you would like to achieve financially. What would make you and them happy? What would be fulfilling? Would you like to start your own business? Retire early? Acquire a vacation home? Pursue a hobby? Travel?

Perhaps you’d like to change careers, and you’ll need money to finance an education in a different field. Or perhaps you’d like to have a large amount of money to give to your favorite charity. Once you’ve got some idea of what you’d like to accomplish, fill out the Goals Worksheet below.

  • The “Goals” section should state what you’d like to accomplish. Be as specific as possible, e.g., instead of writing “Acquire a bigger home,” write “Acquire a home with at least 12 rooms in Anytown.”
  • The “Amount” needed should be an estimate of the amount of money you’ll need. For instance, to retire early, you might estimate that you’ll need a $400,000 nest egg by the time you reach age 50, or to buy a vacation home, you might estimate that you’ll need a $50,000 down payment.
  • The “Target Date” section should include the approximate year or, in the case of short-term goals such as a vacation in the current year, the month in which you would like to achieve your goal.
Goals Amount Needed Target Date
$
$
$
$
$
$
$
$
$
$

Determine Your Net Worth

Your financial plan should include an inventory of the existing financial resources you’ll be using to achieve the goals you decided on above.

Fill out the personal statement of net worth below. This will enable you to estimate the value of everything you own, minus the value of your debts. When asked for a value, use what the property would fetch if you sold it today at its market value.

It may take some time to do this, but the effort will be worth it. This is the foundation for your financial plan.

FINANCIAL STATEMENT

Date:

ASSETS (Current Value) TOTAL SELF SPOUSE
Checking accounts $ $ $
Savings accounts $ $ $
Brokerage accounts $ $ $
Money market accounts $ $ $
Certificates of deposit $ $ $
IRA accounts $ $ $
Keogh accounts $ $ $
401(k) plans $ $ $
Pension plans $ $ $
Other retirement accounts $ $ $
Life insurance (cash values) $ $ $
Annuities $ $ $
Bonds (government) $ $ $
Bonds (corporate) $ $ $
Mutual funds $ $ $
Stocks $ $ $
Other securities $ $ $
Money owed to you $ $ $
Home $ $ $
Other real estate $ $ $
Automobiles $ $ $
Household furnishings $ $ $
Jewelry $ $ $
Other assets $ $ $
Total Assets $ $ $
LIABILITIES (Current Value) TOTAL SELF SPOUSE
Home mortgage
Other mortgages
Automobile loans
Credit card balances
Installment accounts
Contractual obligations
Money owed to others
Income taxes
Pledges
Other debts
Total Liabilities
Total Assets (from above) $ $ $
Less Liabilities (from above) $ $ $
Net Worth (Assets less Liabilities) $ $ $

This statement should be reviewed to determine which assets are available to achieve the goals you listed above. If most of your net worth is tied up in your home and personal use assets (such as furniture and cars), you may not be able to achieve your goals. Which assets are available to invest towards your goals? Are they sufficient? If not, you may need to liquidate other assets or start a savings plan out of your cash flow to come up with the necessary funds.

Determine Your Cash Flow

Once you’ve completed the net worth statement, fill in the cash flow statement below. This will give you an estimate of what you earn per year-your salary, investment income, and retirement income and what your current expenses are. To fill out this form, it will help to have on hand your check register and one year’s worth of credit card receipts.

Here’s why the cash flow statement is so important: once you know how much is coming in and how much of it is going out in the form of expenses, you can start to make adjustments in your discretionary expenses in order to meet your saving and investment goals.

CASH FLOW STATEMENT

Period: to

Income Total Self Spouse
Salary/Wages $ $ $
Interest/Dividends
Social Security
Retirement Plans
Reimbursements (only if included as an expense)
Sale of investments
Other income
Total Income $ $ $
Expenses Total Self Spouse
Savings (including pension plan contributions)
Income taxes
Property taxes
Insurance (health, disability, life, car, home)
Mortgage/rent
Other debt payments
Utilities (heat, electric, water, garbage, phone)
Transportation
Vacation
Medical (other than insurance)
Personal (small cash expenditures, such as haircuts)
Charitable contributions
Food
Restaurants
Recreation
Holiday expenses
Gifts
Education
Clothing
Other (children, professional fees, hobbies, etc. — if large expenditures, create a line item for each)
Miscellaneous
Total Expenses

Note: Omit one-time, non-recurring items as they should not be used for budgeting or future planning.

How much cash flow is available to accumulate assets for the goals identified above? Is it sufficient in combination with your available assets from your net worth statement? If not, you need to examine the above expenses in detail and cut back on those which are discretionary until sufficient cash flow is identified.

Plan To Achieve Your Goals

Now that you know what your goals are and have an idea of your financial resources, it’s time to begin making a plan.

Financial Safety Net

Determine the funds you’ll need in case of a disaster or emergency. Coverage of such contingencies comes from insurance and from an emergency fund.

Emergency Fund

You should have a fund of three to six months (we’ll leave the number of months to your judgment) worth of living expenses to tide you over in case you lose your job or have unexpected bills. The emergency fund should be kept in an accessible account: a money market account is good for this purpose.

Life Insurance

Make sure your coverage is adequate. You should have enough coverage, should a catastrophe occur to ensure your family would continue to enjoy the same level of income it does currently.

Disability Insurance

Disability insurance is intended to replace lost income due to the occurrence of illness or accident. Consider whether you need to provide coverage for your family.

Auto, Home, and Health Insurance

It’s important to make sure these types of policies provide adequate coverage. If not, an accident or other catastrophe could wipe out a large portion of your assets or cash flow and you may be unable to achieve your goals.

Establish How Much You’ll Need

Once you have covered your insurance and emergency-fund needs, you can start working towards your financial goals.

Go back to your Goals Worksheet (above) and enter the goal in the Worksheet below. For each goal, estimate the “Cost of the Goal,” i.e., the cost of achieving that goal. For instance, if you want to retire at age 55, estimate the nest egg you’ll need to accumulate by then. (Don’t bother accounting for inflation right now; this is just an estimate.)

Then fill in the “Amount On Hand,” i.e., the amount you have already saved for that purpose. For instance, if you have $10,000 in a mutual fund IRA, you might wish to allocate that amount to your retirement nest egg.

Next, write in the “Amount Still Needed.” Then, fill in the “Years to Target Date,” i.e., the year you want to achieve your goal. Finally, enter the “Intended Yearly Savings,” the amount you need to save each year (the “Amount Still Needed” divided by the “Years to Target Date”).

Goal Cost of the goal Amount on hand Amount still needed Years to target date Intended yearly savings
$ $ $ $ $ $

Add up the “Intended Yearly Savings,” i.e., the yearly amounts you need to save, in the extreme right-hand column. Look back at the “Savings” amount in the expense portion of your cash flow statement (above). How much are you currently saving? How does this compare with how much you need to save to meet your goals?

Most people find that the amount they are saving is inadequate.

Tip: Here are some ways that you might increase the amount you are saving each year:

  • Pay yourself first. Save and invest at least 10 percent of your after tax income.
  • If possible, earn more or spend less. Put a stop to discretionary spending.

You might also want to take another look at your goals. Perhaps they need to be modified or the target dates need to be deferred.

Put the Plan into Action

Make a savings plan. How will you save the amounts you have targeted? Will you have them deducted from your paycheck? Will you deposit them into a savings account each month?

Once you’ve accumulated a chunk of savings for each goal, you’ll need an investment strategy. For each goal, determine how much risk you are willing to take with your savings. This will depend on how much of the money you can afford to lose, how essential the goal is, and your own risk preferences.

You may have read recently about asset allocation, and wondered whether an investor such as yourself needed to worry about this concept. The answer is a resounding yes. Asset allocation–not fund or security selection, not market timing–is the most important factor in determining how much money you make on your investments. In fact, according to Nobel-Prize-winning research, asset allocation the type or class of security owned–determines 90 percent of the return. The remaining 10 percent of the return is determined by which particular stock, bond, or mutual fund you select, and when you decide to buy it. In short, asset allocation and diversification are the cornerstones of good investing.

Related Guide: For a comprehensive discussion of asset allocation, please see the Financial Guide: ASSET ALLOCATION: How To Diversify for Maximum Return.

Here, in a nutshell, are the three most important things an investor can do:

  1. Establish a financial profile. Your financial profile is the translation of your goals, risk threshold, and time horizon into a graph or curve, using a computer software program. The three factors we just mentioned are plotted on a graph according to the program’s formulas.
  2. Find the right mix of “asset classes” for your portfolio. The right mix of asset classes will balance each other in a way that will give the best possible return for the amount of risk you are willing to take. Using computer programs, asset allocation professionals will determine the proper mix of assets for your financial profile. Over time, the ideal allocation for you will not remain the same; it will change as your situation changes, or in response to changes in market conditions.
  3. Choose investments from each class, based on performance and costs.

How Does Asset Allocation Work?

Using computerized formulas, asset allocator’s take down information they glean from a questionnaire you have filled out. This information gives them what they need to become familiar with your needs, constraints, and unique circumstances. The following factors should become apparent from the questionnaire.

  • Your risk threshold (how much of your capital you are willing to lose during a given time frame),
  • Your goals (whatever financial planning goals you and your family want to achieve), and
  • Your investing time horizon (mainly, your age and retirement objectives).

In addition, the professional needs to consider how wealthy you are, what your income tax bracket is, how much of your portfolio needs to be kept liquid, and how often withdrawals will be made from the portfolio.

The allocator’s goal now is to come up with the right blend of six or seven asset classes, in the right percentages, that will match your financial profile–your risk profile and time horizon.

A budget is an essential component of your financial plan. Not only does it force you to monitor your spending, it enables you to focus on which items (such as loans and credit card debt) you can pay off or pay down so that you can accumulate funds for retirement, education, or buying a home.

Here is a guide to effectively organizing and keeping a check on your expenses.

While this Financial Guide offers you guidance on how to develop a budget that works for you and your family, don’t hesitate to contact your financial advisor if you need additional assistance.

Note: The budget guidelines suggested here are intended for people who need to rein in their spending or have no idea what they spend their money on every month. If you have a good grasp of your cash inflows and outflows and have your spending under control, there may be no need to prepare a budget plan.

Note: Personal-finance computer software programs such as Quicken make it easy to set up a budget. If you have such a program, then simply follow the guidelines that the software gives you and use the information contained here as a guideline.

Step 1: Analyze Your Income and Expenses

The first thing you need to do is to review your income and spending for the past year. This “cash-flow analysis” will lay the groundwork for the budget you create. You’ll need your checkbook, your credit card statements (paper copies or online records), and your most recent tax return. This should give you sufficient data to analyze your spending and income for the past year.

Your Income

Using an excel spreadsheet, ledger paper, or even notebook paper (as long as it has lines), list your income for a one-year period, breaking it down by month and year. Include the following types of income:

  • Salary/wages
  • Income from self-employment
  • Retirement pay and/or government-source income (e.g., Social Security, disability, unemployment, annuity, and pension payments)
  • Interest and dividends
  • Alimony and/or child support
  • Rents and/or royalties
  • Income from trusts

Your income analysis might look something like this:

Income Item Monthly Yearly
Salary (Gross) $10,000 $120,000
Dividends $100 $1,200
Rent $1,500 $18,000
Total $11,600 $139,200

Your Fixed Expenses

Add up your fixed expenses. These are expenses that generally do not vary from month to month. Again, break them down into month and year. Make sure you include the following categories, whether or not they’re immediately evident from the past year’s bills:

  • Taxes (federal, state and local)
  • Mortgage or rent
  • Insurance, including medical, auto, homeowners, life, and other
  • Utilities
  • Automobiles (costs of operating minus insurance cost)
  • Dues and fees paid to associations and clubs

Where the amounts vary by month, as with a phone bill, add up what you paid for the year and divide by twelve to get the monthly amount. For bills that you pay yearly or quarterly, add the total amount paid for the year and divide by 12 to arrive at a monthly amount. This will help you to arrive at a more functional budget. If you have large credit card debt, indicate the amounts you actually paid, not the minimum monthly payments.

Your Variable Expenses

Next, add up your variable expenses for the previous one-year period using your checkbook and credit card statements. Be sure to include the following:

  • Food
  • Clothing
  • Furniture and appliances
  • Entertainment
  • Gas, oil, and commuting costs
  • Medical care
  • Gifts
  • Vacations
  • Fees paid to accountants, lawyers, and other professionals

Estimate if you need to do so. Here’s what your variable expenses might look like:

Expense Monthly Yearly
Groceries $950 $11,400
Gifts For Weddings, Birthdays, etc. $50 $600
Magazine Subscriptions $10 $120
Movies, Theatre, Restaurants $175 $2,100
Vacations $250 $3,000
Gas, Oil, Car Repair $400 $4,800
Clothing $150 $1,800
Total $1,985 $23,820

You’ll be able to tell whether you’re overlooking any variable expenses by subtracting the total yearly amount you arrive at for variable and fixed expenses from your yearly income figure. If this amount is the amount you put away in savings for the previous year, then you can be pretty certain that you’ve included all of your variable expenses. If there is a large gap between income minus expenses and the amount you saved, do some digging to try to find out where the extra money went.

Step 2: Set Budgeting Goals

Your budget should tie in with your financial planning goals. For instance, you may have taken a closer look at your retirement plan and decided that you needed to save $20,000 per year for the next ten years to accumulate the nest egg you want for retirement.

Or, you may be saving for a new home and figured out that you need to save $5,000 per year for the next three years to come up with a down payment.

You may also want to reduce credit card debt or pay down a mortgage with your increased savings.

When setting your budgeting goals, decide how much you want to put away each year and what you will do with the savings. Your saving goals will depend on the financial planning goals mentioned above as well as on your age and income level.

If you want to save more than you have been saving, then you’ll need to cut down on optional expenditures. To do this, you’ll enter an amount under “budgeted amount” that is less than “last year’s actual.”

Tip: Review your budget each year to make sure it fits in with your financial goals, both long-term and short-term.

Step 3: Create Your Budget

Now it’s time to actually create a budget. The easiest way to do this is to use an excel spreadsheet. If you’re not computer proficient, then use ledger paper or 8-1/2 by 11-inch paper used in “landscape” format (used horizontally instead of vertically).

Note: As we stated before, if you have a computer software program that formulates a budget for you, use that, as it will be more convenient than writing up a budget by hand. But read through our guidelines anyway to get a grasp of the concepts involved.

Each sheet of paper should be headed by the name of the month. Once you’ve come up with January’s version, you can photocopy that 11 times, since each month’s version will be the same. You will end up with one sheet of paper for each month of the year.

Each month’s budget sheet might have five columns:

  • Column 1, labeled “Expense,” will contain each of the items you listed under fixed and variable expenses.
  • Column 2, labeled “Last Year’s Actual,” will contain the monthly amounts you came up with for each fixed and variable expense.
  • Column 3, labeled “This Year’s Budgeted,” is where you will write in what you will allow yourself to spend on that item for the month. (It can, and probably will, differ from last year’s actual expense).
  • Column 4, labeled “This Year’s Actual,” is where you will write in what you spend on that item for the month.
  • Column 5, labeled “Increase/Decrease,” is where you will write in how much more–or less–you spent during that month than you had budgeted.

Here is a partial view (showing just two expenses) of what your monthly budget might look like:

Expense Last Year’s Actual This Year’s Budgeted This Year’s Actual Over/(Under) Budget
Electric $780 $825 $800 ($25)
Groceries $950 $1,000 $1,100 $100
Total $1,730 $1,825 $1,900 $75

Arrange the items in whatever way is convenient for you, but make your budget easy to use because this will help ensure that you use it. If you prefer to categorize your expenses in an orderly way (fixed vs. variable or optional vs. mandatory), then do so. If you prefer to categorize them in the order in which they come up during the month, or by the manner in which they are paid (cash, check, or credit card), then do it that way.

It takes discipline to record each amount in your budget as you pay it, but the discipline will pay off at the end of the year when you will have a clear picture of your spending.

Tip: Keep receipts for cash payments until you are able to record expenditures in your budget.

Tip: Don’t try to track every penny; instead, maintain a category called “petty cash” or “miscellaneous expenses” to cover spending cash that does not go for categorized items. This will cover cash that you withdraw from your checking account, but do not keep track of. Allow yourself a reasonable budgeted amount for this category.

At the end of each month, and then at the end of the year, look at your monthly totals to see whether you’ve under- or overspent your budgeted amounts. Performing a monthly and yearly review will help you to set or revise goals for next year.

Step 4: Review Your Adherence to the Budget

At the end of each month and again at the end of the year, look at your monthly totals to see whether you’ve under or overspent your budgeted amounts. Performing a monthly and yearly review will help you to set or revise goals for next year.

Frequently Asked Questions

How do I determine which investment options are best for me?

Check out our special report:

Investment Options:  Frequently Asked Questions

How do I determine my long-term financial goals?

The first step is to decide what you realistically want to achieve financially. Financial goals might include early retirement, travel, a vacation home, securing your family’s financial comfort on the death of a bread-winner, planning for the care of elderly relatives or building a family business.

Is there any validity to financial planning “rules of thumb” such as “saving 10 percent of your gross income?”

The following rules of thumb may work for some people, but they do not make financial sense for everyone. What is more important is to be able to know whether a particular rule of thumb suits your situation. Here are six of the more common rules along with some considerations that should not be overlooked.

1. Life insurance should equal five times your yearly salary
This rule of thumb has been used to answer the question: How much life insurance should I have? The ideal amount of life insurance is the amount that will, when invested, generate enough income to allow your survivors to maintain the level of income they are used to. “Five times your salary” will accomplish this objective in some cases, but there is no substitute for making the calculations necessary to find out how much life insurance you need to buy for your particular situation. The amount of life insurance you need depends on how many people there are in your family, whether there are other sources of income besides your salary, how old your children are, and a few other factors.

2. Save 10 percent of your salary per year
You may need to save much more than ten percent of your gross income to have a comfortable retirement. The amount you need to save for retirement depends on how large your existing nest egg is and how old you are. Those who started saving late in life, for instance in their 40s, need to save at least 15 or 20 percent per year.

3. Contribute as much as you can to retirement plans
This makes sense for most people, but if you’ve accumulated a large amount of money in a retirement plan, say close to a million dollars, you may reach the point where the negatives of contributing to your retirement plan savings outweigh the positives.

4. You need 80 percent of your pre-retirement income to retire comfortably
Although people may need 80 percent of their salaries during the first few years of retirement, later on, they are often able to live comfortably on less. The amount of income you need depends on whether you have paid off your mortgage, whether you will have other sources of retirement income, and other factors.

5. Subtract your age from 100 and invest that percentage in stocks
This is one of those “cookie cutter” rules that only pans out for certain investors. For others, it results in a portfolio that is much too conservative. The best method of allocating percentages among various types of investments depends on your investment goals and needs and your willingness to risk your capital. In this case, rules of thumb do not serve the investor very well at all.

6. Maintain an emergency fund of six months’ worth of expenses
Depending on your family’s situation, three months’ worth of expenses might be enough. On the other hand, for some families, even six months’ worth might be totally inadequate. The amount you should keep on hand depends on how easy it would be for you to take out a short term loan and how much money you have in savings and investments among other things.

Tip: Do not rely on any rule of thumb to make financial decisions. Instead consider carefully what your needs and goals are, and then calculate what you’ll need to do to fulfill them.

What do women in particular need to keep in mind with regard to financial planning?

With more women remaining single, nearly half of all marriages ending in divorce, and the odds of becoming a widow by the age of 55 hovering around 75 percent, nearly 9 out of 10 women will be solely responsible for their financial well-being at some point in their lives. But many are ill-prepared to do so.

Here are several areas where women fall behind when it comes to planning for their financial future:

  • Women save considerably less for retirement, on average 60 percent less than men according to a 2010 study conducted by LIMRA of close to 2,500 employees. This is significant because women typically live longer than their male counterparts and need more retirement savings.
  • In that same LIMRA study, 29 percent of men and only 14 percent of women consider themselves knowledgeable about financial services and products. Fifty-four percent of women felt at least somewhat knowledgeable about financial products and services, but nearly three-quarters of men felt the same way.
  • And, in 2011 a Harris Interactive survey commissioned by RocketLawyer.com found that of the more than 1,000 people surveyed, 5 percent of the women do not have a will, 26 percent of them citing cost as the primary reason they don’t have one.

What special problems do unmarried couples have to be concerned with in financial and estate planning?

In 2010, there were 7.5 million unmarried couples living together in the US, according to the US Census Bureau. This represents an increase of 13 percent over the previous year. And because unmarried couples don’t enjoy the same legal rights and protection as married couples do, financial planning considerations for issues such as retirement planning, estate planning, and taxes can be quite different. For example:

  • Unmarried partners do not automatically inherit each other’s property. When an unmarried partner dies intestate (without a will) the estate is divided according to laws of the state, with property and assets typically going to parents or siblings and rarely or never to the beloved partner. In other words, married couples who do not have a will have state intestacy laws to back them up, but unmarried couples need to have a will in place in order to make sure that their wishes are met.
  • Couples who aren’t married also do not have the right to speak for each other in the event of a medical crisis. If your life partner loses consciousness or becomes incapacitated, someone has to make a decision whether to go ahead with a medical procedure. That person should be you, but unless you have a health care directive such as a living will in place, you have no legal right to make decisions for your partner.
  • Tax and estate issues are also more complicated. In most cases it makes more sense not to own property such as a car or electronics equipment together or to have a joint loan. Whereas marital assets can be divided equally by a judge, there is no legal recourse for unmarried couples in the event of a breakup. Another example is home ownership. If one partner is listed as the sole owner of a home that the couple lives in together and he or she dies, the surviving partner might be left homeless. This can be resolved by properly titling assets, in this case making sure the home is in joint tenancy with rights of survivorship.

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