21 Oct Create a financial plan
Thankfully, a good financial plan doesn’t have to be complicated. Here’s a step-by-step guide to creating your first one.
Evaluate Where You Stand
Building a financial plan is like creating a fitness program. If you just start doing random exercises, you could end up injuring yourself without making any actual progress. You need to get an accurate assessment of where you stand, devise a strategy to address any weak points and construct specific goals to work on.
There are a few ways to determine your current financial status. The first is your net worth, or what’s left over after you subtract your liabilities from your assets.
Liabilities are debts, like your student loan balance, mortgage or revolving credit card debt. Even the $1,500 you owe your parents is a liability. Assets are what you own, such as the money in your bank account, retirement account or the equity in your home. Your assets and liabilities will change over time, especially if you pay off debt and grow your savings.
A recent college graduate might have a negative net worth if they carry a high student loan balance and have only $500 in the bank. After paying down that debt and increasing their income, that same person may have a high positive net worth.
You should track your net worth on a regular basis. If it goes up, you’re making progress. If it decreases, you’re probably doing something wrong. It’s that simple.
Track Your Spending
Another way to evaluate your finances is to measure your cash flow, or how much you spend compared to how much you earn. While net worth gives you a clear idea of where you stand financially, cash flow is a great way to determine where you’re headed.
Negative cash flow means you spend more money than you make, which could lead to a growing credit card balance and eventual bankruptcy. Positive cash flow means you spend less than you earn. This leads to a surplus, which you can add towards any financial goals you have.
Once you have an idea of your cash flow, it’s time to set up a budget. Budgeting will help you sort out your priorities and filter your money into the right areas.
Now that you have a clear picture of your finances, it’s time to put your money to work. The question is, what do you actually want it to do? Do you want to pay off your loans? Do you want to buy a rental property? Do you want to retire at 45?
Make a list of your goals and dreams, like running a doggy daycare or living part-time in Paris. A financial plan should incorporate what you want most in life, even if it sounds outrageous.
Goals aren’t static things, so expect them to change over time. When that happens, your financial plan should change with them.
Create a SMART Plan
Follow the acronym SMART to help you make an actionable and useful plan:
Specific: Your plan needs to be concrete and detailed. Don’t say, “I want to retire early.” Say, “I want to retire at age 50 with $2 million in my IRA.”
Measurable: They say you can’t manage what you don’t measure. Create a system to track your progress, whether it’s a spreadsheet, budgeting app or bullet journal. Check in once a month to monitor your plan and update it if necessary.
Achievable: Every plan should be achievable. It doesn’t have to be easy, but it should be possible and realistic. Saving $100,000 in three years isn’t doable if you’re earning $25,000 a year and have $50,000 in student loans.
Relevant: This is your financial plan, so make sure you’re planning for something you actually care about. For example, a lot of my fellow personal finance writers are on the early retirement bandwagon. That’s not something I want to reach, so creating a plan to retire at 40 wouldn’t be relevant.
Time-bound: A successful plan should have a timeline, which keeps you on track and helps you know if you’re veering off-course.