If the extent of your financial planning is, “I want to have a lot of money one day,” then it’s time to step up your game. Most people never do any financial planning because they:
- Don’t realize how important financial planning is for their future success.
- Don’t want to face their current financial situation.
- Mistakenly believe that financial planning is too complicated.
You’ll be glad to know that you don’t have to be a financial wiz to understand your money and set yourself up for success. Financial planning doesn’t have to take a long time or be complex. Although it may seem tedious, you have to hunker down and do it to make wise moves and create a financially secure life.
One of the best ways to turbocharge your financial life is to spend 30 minutes creating a simple financial plan. Chapter 2 of my book, Money Girl’s Smart Moves to Grow Rich, called “Creating a Financial Plan,” tells you everything you need to know. So be sure to read the entire chapter at least one time.
But I’ll give you the highlights of financial planning here. You’ll learn how to approach it in three basic steps—plus, get terrific resources that make it easy to implement your plan.
1. Understand your current financial situation.
To know where to go, you must know where you are now. The best way to understand your current financial situation is to get a bird’s-eye view of it using a personal financial statement (PFS) tool.
The purpose of your PFS is to calculate your net worth—so you may also see it called a net worth statement or summary. Net worth is a simple formula that equals your assets (what you own) minus your liabilities (what you owe).
For instance, if your total assets are worth $100,000 and your total liabilities are $80,000, your net worth is $20,000. Net worth can also be negative if you owe more than the value of your assets.
Your net worth is significant because it reveals the actual value of your financial resources (or lack thereof) at a given time. Your goal should be to increase your net worth by increasing your assets, such as savings or investments, and shrinking your liabilities, such as credit card debt and loans.
If you’re wondering what your net worth should be, here’s a rough guideline:
[Your age – 25] x [Gross annual income / 5]
For example, if you’re 35 years old and earn about $60,000 per year, a good net worth to have is approximately $120,000, as follows:
= [35-25] x [$60,000 / 5]
= 10 x $12,000
So, how do you determine your net worth and create a PFS? You can list your assets and liabilities on a blank page or spreadsheet. However, I recommend using a Net Worth Calculator like this:
I don’t do one-on-one financial coaching anymore; however, this is a tool I previously used with clients. I also use it to update my net worth regularly, such as annually or quarterly.
This Excel-based calculator has multiple asset and liability categories that you can change to your preferences. What I like best about this tool is that it gives you a high-level picture of your finances over time that you can print out for your files or safe deposit box.
A side benefit of creating a good PFS is that it will contain everything loved ones need if you die.
If you haven’t reached the target net worth for your age and income, don’t beat yourself up. Instead, complete the following two steps and start your financial planning to get there as quickly as possible.
2. Set financial goals.
There are three different types of goals that you may want to consider when you’re doing financial planning: short-, medium-, and long-term.
1. Short-term goals are those you want to accomplish within a year, such as going on vacation, establishing an emergency fund, or maxing out a retirement account.
2. Medium-term goals are those you want to achieve within the next one to five years, such as buying a car, saving a down payment to buy a home, or funding a new business venture.
3. Long-term goals are those you want to achieve beyond five years into the future, such as saving for retirement or funding college for children.
I encourage you to dream big and create as many financial goals as you like. Reflect on the big picture of your life and consider what you want it to be 5, 10, and 20 years from now.
Ask yourself what accomplishments would make you feel good if you only had a few more years to live or were on your deathbed. The answers to these tough questions are vital to planning for what truly matters to you.
If you’re unsure what your financial goals should be, I want to make sure you include at least two: maintaining an emergency fund and saving for retirement.
An emergency fund will make it possible to survive temporary financial hardships, such as a job loss or a hefty medical bill. Your retirement fund will allow you to pay for living expenses and maybe some nice extras after you can’t or don’t want to work.
In the last step, you’ll find out how to manage your money to achieve any realistic goal that you set.
3. Create a spending plan.
After you get a clear picture of your current financial life by creating your Personal Financial Statement and where you want it to be by setting goals, the next step is to close the gap between the two by creating a budget or spending plan.
A spending plan is simply a plan for how you intend to manage your money. Its purpose is to ensure you account for all your financial goals and necessary living expenses.
As you monitor your spending, you can adjust your expenses and ensure you have enough left over for your short-, medium-, and long-term goals. Here’s a rough guideline for allocating your gross income:
- 10% for long-term goals, such as retirement.
- 10% for short- or medium-term goals, such as an emergency fund.
- 30% for variable expenses, such as entertainment, groceries, or gas.
- 50% for fixed living expenses, such as housing, utilities, loan payments, and insurance.
A big part of creating your spending plan is incorporating your priorities and values. If you did a good job setting goals in step number two, they should give you the motivation to carry out your plan daily. A realistic spending plan should get you excited about aligning your money with your deep, core values.
Quicken is an easy-to-use personal finance software with terrific features that:
- Automatically and securely downloads transactions from your bank accounts and other financial institutions in seconds in one place.
- Puts your income and expenses into categories that are easy to manage.
- Shows your income and expenses in a simple chart.
- Forecasts your account balances.
- Reminds you to pay bills.
- Gives you reports to view or print.
- Organizes paper receipts with a photo.
- Offers a free mobile app to manage money on the go.
- Makes creating and sticking to a realistic spending plan simple.
Your job is to find a way to track your cash inflows and outflows that works best for you. When you spend too much, cut back on the easiest categories. Make more challenging spending sacrifices if you still can’t stick to your plan.
Understanding your cash flow is a powerful step in controlling your money. With a plan in place, you’ll feel more peaceful about your finances than ever. You’ll be able to live fully in the moment, shed your worries, and sleep better at night.