Posted on May 18, 2015 in ,

Financial Planning Basics – Part I

Most Americans need a little nudge to start the financial planning process.  Even for the ones that have a financial plan in place, research from a 2012 survey conducted by the University of Chicago shows that just 33% were happy with their current plan.  Many Americans spend their lives pursuing financial goals that they are not excited about or are not motivated enough to start since most of those goals are long-term, such as saving for a down payment on a house, children’s college savings accounts, and even their own retirement.

Here is what I propose to most clients that haven’t begun the financial planning process: begin by dreaming about your future finances and take a financial assessment of your current assets, debts and your annual income.   Below are a list of items to find out where you should start and how much you could be saving to reach financial independence.

First:  Begin by writing down your specific your short and long term financial goals.  Be as specific as possible in dollar terms and time frame.  For example, accumulate $1 million at age 65, fully fund my two children’s education or accumulate a six month cash reserve as a rainy day fund.  Your spouse should prepare his or her own specific goals and then compare them with yours.  Often times your goals are quite different from yours.  Together you should set priorities for each goal.

Second: Prepare a current statement of your net worth.  This is different from your current income.  Net worth is the difference between what you own minus what you owe to others.  Separate your financial assets from your personal assets.  The key assets that count toward retirement are investment assets such as your 401k, IRA’s, stocks, rental properties, etc.  Your principal residence, cars and boats don’t count because they don’t send you a check……but rather, you send those assets a monthly check.  In other words, they are not assets that will support you in retirement or fund a college education.

Third: Create a cash flow analysis of your current income and expenses.  It is critical to determine your after tax take home pay.  Start with your gross salary and deduct all taxes including FICA and withholding taxes together with any other subtractions such medical insurance.  This number will be the key to establish what you have to work with.  Your next step is to determine what your fixed and variable expenses are.  Fixed expenses include your mortgage, car payments, insurance, utilities and food.  Variable expenses include entertainment, eating out, clothing, vacations, gifts and donations.  Total these two categories and compare with your after tax take home pay.  The result is hopefully a positive number eligible for savings.  You now have a starting point to prioritize which goals to fund first.

Saving money is one of the most important steps you can do for your family.  Saving money can lead to financial freedom (financial independence) which very few Americans ever achieve.  Studies have proven that self-reliance with your finances enables you to have more choices in life and generally is one of the components leading to a happy and healthy family atmosphere.

Most people think that investments are the cornerstone of financial planning.  In reality, saving money is the critical component in a financial plan and investments, while very important, play a secondary role.  Earning singles and doubles on your investments rather than trying to hit home runs is crucial for a “steady as you grow” investment plan which will be discussed later.  Over the next few articles, I’ll review the basics on cash flow & budgeting, income tax planning, risk management & insurance, estate planning and life insurance, education funding and finally investments.

Source: Fidelity Investments