A Financial Plan

With a good financial plan, you can set aside some of today’s income you for the things you will want and need in the future. It takes more than luck to get what you want out of life, you have to know what you want and have a plan to meet your goals, otherwise it is unlikely that you will get the things that you want for the future.

Financial independence is an important goal, but people sometimes miss the opportunity to become financially independent because they avoid making decisions and taking action to influence their financial well being.

A financial plan is a tool to help you reach your goals, it is not a straight jacket to keep you from enjoying life. Think of a financial plan as a road map to help you get where you want to go. People use a road map when they begin a trip where they have not traveled before, yet many will take a financial journey through life without a road map. As a sage once said, “If you don’t know where you are going, you may end up somewhere else.”

A financial plan works best if you keep it simple, use realistic income and expense estimates, and periodically review and adjust the plan to reflect changing conditions and goals. The first step is to carefully consider your present financial situation. How much money do you need for routine expenses, such as food, shelter, clothing, health care, transportation and entertainment? How much have you set aside for emergencies? Any money left over is the amount you can afford to invest.

An important goal of a financial plan is to protect against financial risk. Two ways people prepare for unexpected expenses or a decline in income are with emergency savings funds and with insurance. Everyone should have savings to meet financial emergencies that are not covered by insurance. Financial advisors suggest that you have money to cover at least three months living expenses in readily available funds. These funds should be placed in insured bank or credit union where money can be withdrawn easily when needed.

If you have worked hard to save up some extra cash, you’d probably like a safe place to store it. For some people the inside of a mattress seems like the perfect spot. But hiding your money doesn’t necessarily make it safe. It could get lost, stolen or damaged. Also, your money would not be “working” to make you more money, in fact, when you consider factors such as the increasing cost of living, the money hidden in your mattress would be worth less in the future.

A better way to keep your money secure – and productive – is to invest it. An investment is anything you spend money on with the intention of making more money. Investments can be almost anything, from land, to precious metals, to stocks and savings bonds. To help decide what investment is best for you, you should determine your investment objectives. Do you want your investments to grow slowly but steadily over several decades? Or would you rather earn money right away? How much risk are you willing to take to get these results?

Money works for you by making more money. When you invest your money in a company or in a bank account someone is paying you to use that money. That payment is the return on the investment or the interest rate on the account. When you put money in a bank account you know what they will pay you, when you invest in the stock market, you get paid depending on how well the company uses your money to make itself better.

Not only are you making money, but you are keeping up with the future. Everything costs more in the future, due to inflation. If you keep your money in a mattress, the $100 that could buy a …. in 1950 can only buy a …. today. By saving or investing you will be able to afford the things you need in the future.

The sooner you start to save money the more it can increase over time. If a 25 year old invests $2000 a year for 10 years and then lets the money sit until they retire, they will have $545,344 for their $20,000 investment. By comparison, if a 35 year old invests the same $2000 for 30 years until they are ready to retire, they will have only $352,427 for their $60,000 investment. Planning for your future and determining your goals early will make it easier to achieve those goals. Let’s look at how different deposits amounts can grow over time: for example, let’s say you are saving for your children’s or your own college tuition. $100 a month in a medium return account (8%) will yield $59,295 in 20 years.

Saving and investing will be more successful if you have specific goals in mind. Short term goals are those to be reached within a year or less. Some short term goals are to build an emergency fund, to buy a new stereo, to pay off a credit card, or to go on vacation. Long term goals are those to be achieved in more than a year, sometimes over a lifetime. Some long term goals are to buy a house, to go to college, to start a retirement fund, or to start a business.

Short term goals can often help to reach a long term goal, for example you may want to save $100 a month in order to make the down payment on a new car. After you have identified your goals you must figure out how much each goal will cost, which goals are most important, and how much money you need to save to achieve these goals. The amount of money you need to set aside each month may depend on how quickly you want to reach the goal and what you do with the money you set aside.

Once you are earning a living, you should prepare a net worth statement about once a year. This will enable you to compare your annual net worth statements and modify your financial behavior. A net worth statement is a balance sheet comparison of what you own and what you owe. It is not uncommon for young adults to have a negative net worth as they incur debts greater than their current income. A recent U.S. Census Report revealed that 11% of households have a zero or negative net worth while 9% were worth a quarter million or more.

Keep careful records for two or three months to see what your expenses are and where your money goes. Old records, receipts, bills and canceled checks will help you estimate future expenses. Then consider which expenses can be cut back and which should be increased.

Credit allows people to have and enjoy things now and pay for them later. It can be a cushion in emergencies and it is convenient. But credit costs money and tempts us to overspend. People who cannot pay their debts will soon have an unfavorable credit report which can influence their ability to obtain new credit for years to come.

Paying cash is almost always less expensive than using credit (unless you can pay off your credit card every month.) When you do use credit, it is best to borrow as little as possible, seek the lowest finance charge, and pay off the loan as soon as possible.

Example: You buy a pair of new shoes for $100 using your credit card. If your credit card charges 1.5% each month that the balance is not paid, and you take five months to pay for the shoes, they will have cost you over $107.64. On the other hand, if your credit card only charges you .6% every month that you do not pay off the balance the shoes will have cost you $103.04 in five months. While that may seem not bad, when scaled up to where most people have credit card balances, it adds up quickly.

It is important when you think of saving and investing to remember that you can make money in compound interest payments or you can be paying interest payments. It may be better to pay off your credit cards or mortgage than to invest or save money in accounts with low returns.

Another important consideration in your financial plan is how much you are willing to risk your money, this decision will affect both how much and where your put your money. Generally, the higher the return on an investment the riskier that investment is. When you put your money into an insured bank or credit union account, you don’t get as much in interest as you could by investing in the stock market. But in a bank account, if something goes wrong the government has promised to pay you back every cent (up to $100,000 per account). On the other hand if the company you invested in goes bankrupt and the stock loses all of its value you could lose your entire investment.

Diversification of risk. Is it a good idea to keep your entire 1,000 page novel on your computer with no back up copies and no printed version? Not if you are worried about keeping it. The same idea is true with money, investors put money to work for them in a number of different ways in order to meet different goals and in order to minimize the chance of losing all their money. People put money into savings accounts and savings bonds, they buy houses and other assets, and they invest in different markets to diversify where their risk lies. If the house burns down, or the stock market declines, not all off your money is lost.

Another difference between savings and other kinds of investment is how quickly you can get your money. With a savings account you can go to the bank and withdraw your money. Some kinds of accounts will charge you a fee if you take out the money before the specified time. Still other kinds of assets you cannot sell quickly or easily when you need cash. What kinds of goals you have set will help you determine how quickly you may need your money.

One last consideration for your financial plan is taxes; both how much you pay now and how much you will pay in the future. Some investments are tax-free for a number of years (usually until you take the money out) and so they can accrue more money in interest. It is important to compare tax-free and taxable accounts, because a 6% return on a tax exempt investment is the same as a 7% return in the 15% income tax bracket. (It is the same as an 8.3% in the 28% tax bracket and 9% in the 33% tax bracket.)