Most people have heard of the benefits of personal financial
planning and want to better manage their personal finances. Yet it
can seem so overwhelming. If you're not sure where to start,
this financial planning primer can help. It establishes priorities
for anyone at any financial stage of life and lays out, in eight
simple steps, just how to take control of your finances.
Step 1. Create and review a financial plan. Basically, a
financial plan is a written set of goals, strategies and timelines
for accomplishing these goals: buying your first home, funding or
managing a retirement nest egg, funding your children's
education, paying off debts, and so on. Writing out this plan,
whether on a yellow pad, a spreadsheet or with the help of a
certified financial planner (CFP) professional motivates you to be
accountable and implement your to-do list of action steps. It
provides direction, gives you a benchmark from which to evaluate
your progress, and helps you prioritize the most efficient use of
your financial resources.
Be sure to review your plan periodically to adjust for changing
financial circumstances or desires, or life events such as a change
in marital status, job loss, retirement, the birth of a child, or a
death in the family.
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Step 2. Organize your financial records. It's much
easier to successfully manage your finances if you know what those
finances are. So gather up the following financial records:
- investment accounts
- bank statements
- tax returns
- mortgage and credit card statements
- insurance policies
- estate planning documents
Then organize them so you can find and access them easily. By
getting them all together, you'll be able to more easily
evaluate where you're at today and can set the stage for your
goals and priories going forward. And while you're at it,
don't forget to inventory your personal possessions. This
documents not only their value for planning purposes but also
provides a record for your insurance company in the event your
possessions are lost due to a theft or natural disaster.
Step 3. Calculate your net worth. Once your financial
records are organized, calculate your net worth. This is simply a
matter of figuring out what you own less what you
owe. If your assets (house, bank accounts, investments and
so on) exceed your liabilities (mortgage, student loans, credit
card debts, etc.), then your net worth will be positive. On the
other hand, if you owe more than you own, you'll have a
negative net worth.
Net worth is the best measurement of the state of your financial
health and should be used as the basis for any financial decisions
you make. Your goal should be to increase your net worth on an
annual basis. At year-end, you should recalculate your net worth
and compare it against last year's benchmark. By doing this,
you'll instantly be able to see your progress.
Step 4. Establish a spending plan. A spending plan
details where your money comes from and where it goes. The inflows
include your salary, bonus, interest income and any other source of
income you have. Inflow is the part that's generally easiest to
recall. The outflow section is a detailed listing of where your
money goes. The most important outflow should be your savings. If
you're living within your means, then your inflow will equal
your outflow.
Having a balanced spending plan should be a financial priority
regardless of where you are in life or what your net worth is. A
spending plan identifies the key areas where you want your
resources to go and highlights wasted spending. It can also provide
an early warning of impending financial problems.
If this is your first time establishing a spending plan,
consider using a software tool such as a spreadsheet or a software
package like Quicken to help you. These tools could significantly
cut down the amount of time and effort it takes to develop your
plan.
Step 5. Build an emergency fund. Ideally, you want to
have enough cash on hand to cover three to six months of basic
living expenses should you lose your regular sources of income.
Depending on your job security, you may want to increase the number
of month's worth of reserves. For example, self-employed
individuals may want to have twelve months of reserves, especially
if their income is variable in nature.
Step 6. Reduce or minimize consumer debt. Debt drags down
the rest of your financial efforts like a heavy anchor. If your
consumer debt--credit cards, student loans, auto loans and personal
loans--is eating up 15 to 20 percent or more of your monthly
spending, make reducing it a priority. And why waste funds paying
what are most likely very high interest rates on your cards and
loans?
Step 7. Draft four, key estate-planning documents. Every
adult should have (1) a will; (2) a durable power of attorney,
which appoints someone to handle your legal and financial affairs
if you're unable to; (3) a living will, which declares what
life-sustaining medical treatments you want should you be
incapacitated; and (4) a health-care durable power of attorney,
which appoints someone to oversee your medical interests should you
no longer be able to. Different states have different names for the
medical documents, but they're all critical to your smart
financial planning.
Step 8. Obtain adequate insurance. Managing risk is
essential to your long-term financial security. The point of having
insurance, from medical and disability coverage to life, auto and
homeowner's, is to protect you from financial catastrophe.
Simply stated, you buy insurance to cover expenses you couldn't
make out of your own pocket. It's imperative to keep in mind
that you should buy insurance when you don't need it, because
when you do need it, you can't get it.