Today I’m going to show you how to make a financial plan.
It’s a simple DIY process that requires no advanced math skills or degrees. It’s a process I refined over my years working as a CERTIFIED FINANCIAL PLANNER™.
But first, why do you even need a financial plan? Aren’t they only for the rich?
Having a financial plan is important for the same reason setting personal goals is important: it helps you to identify and prioritize what it is you want in life.
A joint study between the Consumer Federation of America and the CFP Board found that 48% of households with a financial plan described themselves as “living comfortably.” Those without a plan expressed this sentiment only 22% of the time.
Perhaps most interesting, however, was what the study found regarding households that earn below $100,000 a year:
“As many people who plan and who make $50,000 to $99,999 a year say that they live comfortably as non-planners in the $100,000 and above income bracket.”
Greg McKowen, author of the New York Times best-seller Essentialism, has said:
There’s a lot of wisdom in that quote. For me, it helps explain why those who make under $100,000 per year, yet have a financial plan, feel just as comfortable financially as those earning over six figures without a plan.
A financial plan helps you both prioritize what’s important and set a realistic plan for accomplishing those priorities. It gives you a sense of meaning that you’re working towards something that matters — a sense that you’re on a journey worth being on.
Without a plan, it’s easy to live in a state of always wanting more. Since everything you want has equal priority, very little actually gets accomplished. And as a result, you lack that feeling of fulfillment and satisfaction that comes from accomplishing something that matters.
Big Ideas About Financial Planning (TLDR)
- It’s easier to become a great planner and saver than it is to beat the market or make millions of dollars. Beating the market or scoring a windfall of cash is difficult and rare. Yet this is what a lot of people rely on in order to realize their goals. Financial planning, on the other hand, is far easier and within your control.
- Cash flow planning is the most important aspect of financial planning. Most people equate financial planning with managing an investment portfolio. But it’s far more important for most households to focus on cash flow planning — i.e., on deciding what to do with your income.
- Financial planning is about maximizing opportunity costs. That means knowing which goals to prioritize, while understanding that not every goal can be accomplished at the same time.
What Is Financial Planning?
To create a DIY financial plan, it helps to start with:
- What a financial plan is.
- What the process looks like.
The Financial Planning Association summarizes financial planning well, saying:
Financial planning is a process, not a product. It is the long-term method of wisely managing your finances so you can achieve your goals and dreams, while at the same time negotiating the financial barriers that inevitably arise in every stage of life. In order to create a sound financial plan, goals must first be established. Data is then gathered to analyze and evaluate your financial status. Once complete, your plan can be developed and implemented. Monitoring the plan on an ongoing basis is essential in order to make necessary adjustments to reach your goals.
- A process, not a product. The aim isn’t to create a document you’ll never refer to. What you’re trying to create is awareness of where you are today and a plan for achieving what’s most important to you going forward.
- Goals and dreams. Many people make the mistake of thinking that their finances are separate from other areas of their life. To the contrary, they’re one and the same.
- Developed, implemented and monitored. You need to not only take action — i.e., implement the plan — but also have systems in place for monitoring your progress and making adjustments when necessary.
With that in mind, let’s go over what the financial planning process looks like.
The Financial Planning Process
If you were to work with a CERTIFIED FINANCIAL PLANNER™ to create your own financial plan, you’d work your way through a seven-step process.
All CERTIFIED FINANCIAL PLANNERS™ are required to work through this process whenever engaging in a financial planning relationship.
The process, as defined by the CFP Board, is:
- Understand the client’s personal and financial circumstances.
- Identify and select short and long-term personal and financial goals.
- Analyze the client’s current course of action and potential courses of alternate action.
- Develop the financial planning recommendations.
- Present the financial planning recommendations.
- Implement the financial plan.
- Monitor and update the progress.
I mention this process because it allows someone who has never worked with a financial planner before to understand more about financial planning.
Overall, this will be our guiding framework for this post. While we will use different terminology and minimize the steps (as there is no third party involved), the method is very much the same.
Phase #1: Gather Data About Where You Are
Step #1: Create A Net Worth Statement
Do this: Calculate your net worth by adding up all your assets, while subtracting your liabilities.
A net worth statement — sometimes also referred to as a balance sheet or a personal finance statement — allows you to see exactly where you’re at today. By adding your assets together and subtracting your liabilities, you’ll get your net worth.
When it comes to listing and valuing assets, focus on larger assets. Primary examples include bank account balances, retirement accounts, taxable investments, and cars.
It’s of little value to invest hours listing every single possession you own, like clothes, technology, furniture, and so on. Instead, stick to your main financial accounts, as well as larger possessions such as real estate and vehicles.
If you own valuable assets like expensive jewelry or artwork — things that could be considered investments rather than just possessions — you should also include those.
On the debt side, list anything that you currently owe on. Major examples here are credit card balances, student loans, mortgages and auto loans.
Step #2: Benchmark Your Current Spending
Do This: Benchmark your current spending against the 50/30/20 budget to analyze your current habits.
With your net worth statement in hand, you’re ready to take a deeper dive into how you arrived at your current level of wealth. The goal now is to analyze your current spending habits, checking for areas that are out of balance.
The easiest way to do that is to compare your spending against the recommended 50/30/20 budget.
The 50/30/20 budget separates your expenses into three categories:
- 50% towards needs. Mainly housing, food, transportation, education and healthcare.
- 30% towards wants. Examples would be a gym membership, dining out and travel.
- 20% towards savings. Debt repayments, 401(K) contributions, and saving up for an emergency fund.
Pro Tip: To get this data, I recommend using one of the many free personal finance budgeting apps. My budgeting app is Rocket Money.
Categorizing your past spending provides very valuable data. If you’re overspending in one of the three categories, you know which category to focus on.
It’s here that you’ll want to start considering opportunity cost.
The 50/30/20 budget is only a benchmark. At the end of the day, you get to decide where and how to spend your money.
For example, if it’s worth it to you to live in a high-cost area, then you’ll have to consider the tradeoffs. Doing so might mean delaying retirement or not being able to save for your children’s education. At the end of the day, the decision is yours.
What matters is prioritizing what’s most important to you, while understanding how those priorities affect other areas of your financial life.
Step #3: Perform a SWOT Analysis
Do This: Identify the strengths, weaknesses, opportunities and threats (the SWOT) of your current financial situation.
Analyzing your net worth statement and budget provides a great foundation for analyzing your overall financial situation. But, as is true in many areas of life, numbers don’t tell the whole story.
Are you a small business owner whose income is highly variable? Do you have a low credit score, making it hard to secure a mortgage? Are there a set of long-overdue financial tasks you’ve been procrastinating on, like buying a life insurance policy or estate planning?
It’s these highly-variable situations that should play a large role in the way you manage your money, as well as the goals you set.
A SWOT analysis, which is a strategic planning technique often found in the business world, can help you go beyond the numbers to better understand your current situation. More so, it can help you set the proper financial goals.
The exercise is simple: what you’re doing is analyzing your strengths, weaknesses, opportunities and threats of your current financial situation.
- Strengths: What are the strengths of your current financial situation? Think of what you’ve already accomplished, such as building a fully-funded emergency fund, having a secure job, having two incomes, etc.
- Weaknesses: What are the major weaknesses of your current situation? This would include things like a lack of career stability, feeing unfulfilled in your current line of work, not having life insurance, lacking knowledge about how to get started investing, a high debt-to-income ratio, and so on.
- Opportunities: What actions can you take today to improve your current situation? Could you increase your 401(K) contribution? Do you expect a bonus or raise in the future? Is your side hustle starting to do well?
- Threats: What are the most likely events that can harm your financial situation? Brainstorm potential negative scenarios, such as upcoming expenses you haven’t started saving for (like replacing a car). And think of worst-case scenarios, such as how a disability — one that would severely limit or prevent you from working — would impact your finances.
Take the time to go analyze your situation through the SWOT Analysis framework. You’ll then use this information, as well as your net worth and current spending habits, to help you set financial goals.
Phase #2: Choose Your Financial Goals
Do This: Pick at least three financial goals that excite you.
The big mistake in financial goal setting is not connecting goals with a deeper purpose. At first glance, many financial goals sound boring. I mean, who wakes up excited to save for retirement or build an emergency fund?
That’s why it’s important to tie financial goals into bigger life goals. For example, an emergency fund allowed me, as the sole income provider for a family of four, to leave the comfort of a job I held for 10 years and run this website full-time.
Building my own business was a goal that I’d had for years, and a proper emergency fund (as well as a very supportive wife) helped me make that happen.
When it comes to choosing financial goals, here are three helpful tips as outlined by the financial psychologist Brad Klontz:
- Pick up to three goals that would rank at least a 9 out of 10 on the excitement scale.
- Give your goals an exciting name — think “financial freedom” rather than “saving for retirement.”
- Give your goal a deadline, such as “I’m debt-free by January 1, 2023!”
Where your current financial situation will play a large role is in the time-frame of your goals. If you’re living paycheck to paycheck, it’s best to focus on short-term goals.
While you definitely want to have a long-term vision of where you want to go — e.g., saving up for a down payment on a home and saving for retirement — focus today on shorter-term goals that can allow you to get to that point.
Pro Tip: If you have high-interest debt (like credit card debt) and no emergency fund, familiarize yourself with the Baby Steps. The steps are an easy-to-understand framework that will help you prioritize your financial goals.
If you do have a solid foundation, such as some cash in the bank and the ability to allocate money towards goals each month, you might have a combination of both short-term and long-term goals.
Your goals definitely will change throughout your life, so pick what’s important now, knowing that goals and priorities change as your life changes.
The objective here is to have one to three goals you’re looking forward to and motivated to accomplish.
If you want to take a deep dive into financial goal setting, download our free workbook below:
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Phase #3: Create and Automate Your Cash Flow Plan
Step # 1: Design Your Cash Flow Plan
Do This: Map out your cash flow plan according to your financial goals.
Cash flow planning — i.e., how you decide to allocate your current and future income — is the most important aspect of financial planning. Get this step right and you’ll set yourself up for success.
In the simplest terms, cash flow planning is how you decide to allocate your income. The idea here is to take your financial goals — aka, your priorities — and make sure they’re actually prioritized in your budget.
The simplest way to do that is to create a reverse budget.
This is where you’ll “pay your goals” first. Specifically, you’ll allocate money towards your goals right after it hits your bank account.
Here’s what the flow will look like:
The opposite approach would be to wait until the end of the month to see what you have “saved” for the month, and then put that towards your financial goals. But as many people have learned before, this approach fails for a variety of reasons — mainly because we tend to spend the money we have in our accounts, whether it truly is a priority or not.
Putting your money towards your priorities first ensures that, as the Habits of Highly Effective People author Stephen Covey said, you “keep the main thing the main thing.”
Step 2: Implement Your Cash Flow Plan
Do This: Automate savings towards your goals as much as you can.
As much as possible, you’ll want to automate your savings towards financial goals. If your goal is to pay off debt, it’s here that you’ll want to go in and increase the principal payment on that debt.
If you’re looking to build an emergency fund, set up an automatic transfer from your checking account to your savings account.
Looking to increase your retirement savings? increase your 401(K) contribution or set up a transfer from your checking account to a traditional or Roth IRA.
The objective is to eliminate having to manually go in and save for your financial goals. Ideally, a day after your income hits, your money flows towards your financial goals.
Phase #4: Monitor and Adjust When Necessary
Step #1: Monitoring Your KPIs
Do This: Have one number that allows you to track your progress.
A KPI, or key performance indicator, is a business term for a variable that helps you analyze your current situation. In other words, KPIs are facts and figures that tell you whether you’re trending in the right or wrong direction.
When it comes to financial planning, your KPIs should let you know exactly how you’re progressing towards your financial goals.
For example, if your goal is to build an emergency fund of three months of expenses, your KPI could be:
KPI = Current Emergency Fund Savings / (Monthly Expenses x 3)
One trick for setting powerful KPIs is to track the date you’re on-target to accomplish your goal.
For example, instead of saving a certain amount of money for retirement, track the age at which you’ll achieve financial independence.
Or, instead of tracking the total amount of debt you have, track the date you’ll pay off your debt. (We’ve designed a free spreadsheet to help you do this, which you can read more about here.)
Why choose dates over dollar amounts? In my experience, dates are far more motivating. In addition, they often tell a more realistic story about your progress.
Step #2: Making Adjustments
Do This: Set calendar reminders for reviewing your KPIs.
KPIs are only useful when used over time as a way to measure your progress. If the date you’re expected to be debt-free is getting farther and farther away, it should be obvious that more changes are needed.
The most important thing you need to understand about financial goal setting is that the speed at which you achieve your goals comes down to the gap between your income and expenses.
Benjamin Franklin said:
“There are two ways to increase your wealth. Increase your means or decrease your wants. The best is to do both at the same time.”
Saving money, at first, is often a lot easier than earning more. However, saving money comes with diminishing returns. In other words, before long you’re driving across town to save three cents a gallon on gas.
Making money, on the other hand, is far more scalable. There’s no limit to how much you can make.
As such, once you make some smart moves to get your spending down, it’s best to shift your effort towards making money.
Final Thoughts On Financial Planning For Non-Millionaires
A 2015 study by Dr. Nathan Hudson and Dr. Chris Fraley found that personality can be changed through goal setting and continuous effort.
A lot of people avoid financial goal setting and planning because they think they’re not good with money — that personal finance, or money in general, is something they’ll just never be good at because of some inherent trait.
The truth is the opposite. Research shows that through goal setting, and putting in the effort to achieve those goals, you can indeed change how you think about yourself. And that can fundamentally reshape your financial future.
For example, you can change yourself from someone who thinks they’re not good at managing money to a diligent and disciplined saver, a high income earner, or the type of person that retires early.
You get to choose. It all starts with setting the right goals and putting in the work to achieve them.