Wealth Column: 4 steps to personal financial planning

Here’s a simplified, four-step personal financial plan that can help gain perspective on becoming financially independent.

Not everyone needs a full-blown retirement plan.

Maybe your financial situation is pretty simple: You’re in your 20s or 30s, working in your first or second job. You don’t have much credit card or college debt but may be trying to save up for a car purchase or first home. You can create a personal financial plan in four simple steps that will set you up to pursue these goals.

Step 1: Gather and organize your financial information

Having good information about your finances is the foundation of a good personal financial plan. Here’s what you’ll need to determine your assets (what you own) and liabilities (what you owe):

  • Investment account statements: taxable brokerage accounts, 401(k) and/or defined benefit pension, IRA, Roth IRA,
  • Your total indebtedness, such as school loans, car/boat loans, insurance premiums, mortgage and home equity line of credit, etc.
  • Estimates of any future expected inheritance.

Next, you need to pull together records showing your income and expenses over the past year or two:

  • Your annual salary (W-2),
  • Income from gig work if you’re a contractor or gig worker (1099s),
  • Certificates of deposit (CDs), interest from money market accounts or savings bonds,
  • Taxable dividends,
  • Your bank, credit card statements.

For expenses, you’ll need to create two lists: What you spend on non-discretionary items (such as groceries, utilities, health insurance, clothes, transportation, child support, annual debt payments on each of your loans, taxes, etc.) and what you spend on the “fun” things (such as eating out, traveling, entertainment, hobbies, charitable donations, etc.

Step 2: Focus on your total debt picture

What do you owe, and how do you intend to pay it off? Make sure you understand the interest rate are you paying, and whether the rate is fixed or variable. Is any of it tax-deductible?

Conventional wisdom says to pay off your biggest loans first. That may make sense depending on your tax situation, the interest rate you’re paying, and whether the debt is creating value.

Most folks agree that you should also pay off your highest-rate debt as quickly as you can, especially now that interest rates are poised to rise, according to the Federal Reserve.

Never just pay the minimum balance on any credit card. You’ll find it hard to get out from under the debt and will pay far more over time than you would have had you bought using cash.

We’re big believers in only using credit cards for convenience, not because it gives you the ability to put off paying for something you want. We generally advise clients to have no more than one or two credit cards and pay them off in full each month.

Step 3: Review your asset allocation in your savings and retirement accounts

Are you taking too much or too little risk with your investments? If you’re a saving for a big purchase within five years, such as a home, you probably want to put your savings into conservative accounts, such as a money market fund. On the other hand, if you’re saving for retirement that might be 20 or 30 years away, you may be able to take on more risk in the form of holding more stocks.

Over time, as you approach your retirement date (say, 10 years out) and depending on your personal situation and risk tolerance, you should probably maintain some stock exposure, but gradually dial in more conservative investments such as bonds or cash.

Stick to highly rated, low-cost funds you understand and rebalance them about once a year around your target allocation (that is, what percentage of stocks and bonds you favor in your portfolio — this should be adjusted as your risk tolerance changes).

Rebalancing means selling your winning funds and investing the proceeds into your underperformers, so that you maintain the amount of overall portfolio risk you feel comfortable taking.

Step 4: Build a working budget

Once you have a handle on your assets and liabilities, income and expenses, and how your long-term retirement money is invested, you should be in good shape to build a working budget.

Here are some guidelines to help you get started:

  • Separate your wants from your needs. Cut back on the wants as much as possible.
  • Build an emergency fund of six months of living expenses.
  • Pay off high-interest and small-balance credit cards.
  • Get in the habit of saving a small about every month and increase it over time.
  • Don’t forget to include your retirement plan contributions as a budget item!

This simplified, four-step personal financial plan is a good way to gain perspective on becoming financially independent. If you need help getting organized, consider working with a financial adviser to help build a comprehensive financial plan that considers the many sources and uses of your money, investment returns, interest rates and your future goals (including how those goals could change over time plan).
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Comments are closed.