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What is financial planning: part 2?

In the last blog post, I discussed what financial planning is and some of the benefits of it. In this post, I’ll discuss the process of financial planning and what happens when you use financial planning the right way.

Financial planning process

1. Start with your goals. List the top five or six things you want to accomplish in the next five years. Note that I say “five years” and not a longer time period. I find that most people can’t think more than five year ahead with any clarity. If you can, fine, that go further out, but most of us are challenged to think only about five years. For example, you might list a goal of starting a college savings program, retiring all non-house debt, having enough life insurance, getting your investments organized, or simply being on track with your retirement savings goals. Whatever your goals are, write them down and try to be as specific and measureable as possible.

2. Protect yourself. I’ve written about this before on this blog, but I’ll remind you here. You must be protected against un-expected financial mis-fortunes in order to feel financially free. That means think about the things that are important to you and set up a plan to reduce the impact of a loss event taking place. The major mis-fortunes have to do with our health, our income and our largest possessions. You can deal with the risk of a loss in one of three ways: set aside money to replace it, shift the risk to an insurance company or a combination of these. Start with a list of bad things that could happen and figure out how to reduce or eliminate the impact of a loss. At a minimum, you need three to six months of core living expenses set aside for emergencies. If you don’t have this much, stop all your other savings efforts (except matched employer savings plans) and focus on this one goal. Having the right estate documents for you and your spouse or partner falls into this category as well.

3. Use your cash flow and debt smartly. This includes creating a spending plan so that you set aside money for the high priority items first. For example, make sure you pay for insurance, save at least 15% for retirement, save for college (if that applies to you) and pay your housing costs first. Then comes the fun stuff in life. Also, do not borrow for depreciating assets; only borrow for appreciating assets. That means don’t take out a car loan, boat loan or a loan to buy a horse. And when you do borrow, get the best rates possible at the lowest fees. If you have not re-financed your house recently, now would be a good time to get a quote. My number one rule when it comes to income is that it doesn’t matter what you make, it only matters what you keep. In other words, effective tax planning is also a part of this third category of financial planning.

4. Know how much you need for retirement. The Employee Benefits Research Institute (EBRI) does a retirement confidence study regularly and they reported some distressing facts in this year’s study. For example:

  • Only about 55% of people know how much they need to retire on.
  • Among all workers, the average amount saved for retirement is $25,000; among workers over age 50, the average amount saved is $60,000.

I probably don’t need to tell you that the average worker is going to be in deep trouble when it comes to retirement. A rule of thumb is that you need 10—20 times your final average annual income saved for retirement when it comes time to retire. There is a debate among financial folks on the right multiplier, but to be safe, I recommend that people aim for the higher number.


5. Invest wisely. This means using a diversified, low-cost passive investment approach. There is no evidence that actively trading stocks or searching for the next great mutual fund has any but a random chance for success. It is wiser to allocate your longer term investments among a variety of investment types (U.S. and non-U.S. stocks, bonds and cash). Using low-cost index funds allows more of your money to work for you too.

6. Last, review your financial plan regularly and adjust accordingly. This is key: financial planning is a life-long commitment to taking care of your money so you can do more of what you love. It is NOT a one-time event in which you develop a financial plan (either by yourself or with the help of a financial advisor) and then rarely if ever look at the paper document. You should review your financial plan at least twice a year to see if you are on track to reach your goals. That way you can adjust your actions to take into account any changes in your situation or the environment around you. Had un-expected expenses in the last six months? Time to pump up the emergency savings again. Falling behind on your college savings goals? Time to focus on that. Good financial planning evolves as your life changes.

What happens when you use financial planning?

Imagine what it will feel like when you use financial planning the way we describe it? How will it feel knowing that you protected yourself and family from un-expected and potentially costly events like sudden sickness, the loss of a job, or a large car repair? How will you feel when you look at your personal balance sheet and see it growing as you reduce debt and add to assets? Imagine what it will feel like to know that you are going to be okay when it comes time to retire and stop working so hard.

These are the benefits of good financial planning: peace of mind, satisfaction, a sense of security, less worry and fear, more happiness when it comes to your money matters. I wish this for you and I know you can get there by engaging in financial planning for you  and your family the right way.