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February 12, 2015

Financial Planning Process: 5 Simple Steps

financial planning processPlanning for the future and creating wealth are important for individual success. However, many people feel that they do not have the skill required to properly manage and grow their finances. The truth is, there are five simple steps that everyone can follow in order to save money, get out of debt and improve their financial standing.

Financial Planning Process

Step One: Know Where You Stand

The first step to creating your financial plan is to understand your current financial situation. This means taking an inventory of all of your debt, income and expenses.

Take time to make a list of your current assets, including:

  • The balance in your checking, savings and money market accounts.
  • Retirement savings.
  • Stocks and bonds.
  • The market value of your home and other properties.

Record all of your debts, including:

  • The balances on all credit cards.
  • Student loan debt.
  • Mortgage balance.
  • Personal loan balances.
  • Auto loans.

Subtracting your debts from your total assets will determine your current net worth. A negative number means that your assets are insufficient to cover your debts. While this is a key indicator of financial standing, it does not provide the full picture. A second, equally important measure of financial standing can be found by looking at your income and expenses.

Make a list of your take home income from all sources. Then, evaluate all of your expenses, including:

  • Debt payments.
  • Utilities.
  • Rent.
  • Cable and phone bills.
  • Food and dining out.
  • Travel expenses including gasoline and tolls.
  • Entertainment.

Comparing your income and expenses provides your cash flow and insight into where your money is going. This serves as the foundation for creating your financial plan. Once you understand your current financial situation, you can plan for where you want to be.

Step Two: Set Your Goals

The second part in the financial planning process is to set your financial goals. Your financial goals should be unique to your financial situation and reflective of where you want to be in the future. The goals you set should be realistic given your financial situation. Additionally, it is important to set both long-term and short-term goals. Common financial goals include:

  • Paying off debt.
  • Establishing an emergency fund.
  • Saving for retirement.
  • Planning for your children’s college expenses.
  • Saving for a vacation.
  • Buying a home.
  • Investing in the stock market.

The next step is to determine the importance and priority of each of your financial goals and how long each goal is expected to take. For example, saving for retirement in the NYC area typically happens over decades in order to establish adequate funds for surviving after leaving the workforce. In some cases, your financial goals may be dependent on one another.

Finally, think about how much money is required to achieve each goal. For some, this process can seem daunting. However, it is important to understand what achieving your financial goals will require. This information may then be used in comparison with your income and expenses. Look for areas where you can decrease expenses in order to work toward your financial goals. Bringing in additional income will also allow you to achieve your financial goals sooner.

Understanding what it will take to achieve your financial goals allows you to make better financial decisions.

Step Three: Plan for the Future

You know where you stand financially and where you would like to be financially. The third step in the financial planning process is to create a plan for achieving each of your financial goals. For some, meeting financial goals will simply mean continuing on their existing path. For others, realizing financial goals will require a change in lifestyle or outlook.

For each of your financial goals, think about what it will take for you to achieve that goal. For instance, saving for retirement takes place over several decades. Making small investments over a longer period of time is often more advantageous than waiting and making larger contributions. Achieving retirement savings may involve contributing to a 401K at work or opening an IRA account.

Look at your income and expenses. Chances are, there are some areas where you can reduce expenses in order to better allocate your funds. Taking simple steps, like taking your lunch to work and cooking at home, can quickly add up.

Step Four: Managing Money

Savings for short-term goals, including paying off debt, can typically be done through savings accounts. However, long-term goals or goals that involve investing require other options for saving money. There are several ways to save and invest money. To determine which investment vehicle is best for your needs, consider the following:

  • Risk Tolerance: Risk tolerance is a measurement of how comfortable you are risking your money in order to achieve greater returns in the future. There is no right amount of risk tolerance; it is dependent on your personality. Conservative individuals in the NYC area should invest in vehicles where the principle investment is likely to be maintained even if there is little to no growth. On the other hand, more aggressive investors will feel comfortable taking on riskier investments in order to receive larger rewards.
  • Time Frame: The amount of time you have to invest can also determine an individual’s risk tolerance. For example, if funds are needed within the next year to two, a conservative option may be best in order to ensure funds will be available. Investments that will not be needed for an extended period of time can be more aggressively invested as there is time to make up for losses.
  • Tax Implications: The type of investment selected can have a significant effect on income taxes. Therefore, it is important to consider your entire portfolio before deciding how to invest or save your money.

Step Five: Review Your Plan

Your financial plan should be a living document. Take time to regularly view your savings and investments to determine if they are on track for your savings goals. Consider if your current level of risk is providing the returns you’re expecting and make adjustments as necessary.

As your circumstances change, the financial plan should be updated. Designate a specific interval for reviewing your financial plan and determining where changes should be made. Additionally, reviews of your financial plan should take place when major life changes, such as marriage, having children or changing jobs, occur.

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