While everyone — regardless of age, income, educational background, etc. — should have a financial plan in place, many do not work through the process of developing a comprehensive plan with a professional. At the beginning of the year, when many of us are establishing our new year’s resolutions, formulating an effective financial plan should be high on the list of essential tasks for 2014.
Working with a professional financial planner, and especially a CFP (Certified Financial Planner), can be highly beneficial, but anyone can develop a financial plan with a few simple steps.
The first step is to gather information. We need to know what we have to work with, and what our goals and objectives are, before we can create an effective financial plan. I prefer to write down all relevant information such as income, all expenses, assets, liabilities, expected future income and expenses (if they are significantly different from current income and spending), including any major purchases like homes, cars, educational costs for college, etc.
I also recommend writing down all goals and objectives. This would include saving for a home, retirement, children’s educational expenses and other major purchases, such as home remodeling, cars, furniture, vacations, etc. I also like to include a timeline for these expected expenditures. It's a good idea to use Excel or another spreadsheet program to organize this information for further analysis.
Once we have gathered all necessary information, we can begin to analyze it. The next step in the process is to build a detailed budget. I like to use Excel so I can use formulas to calculate totals and build in expected percentage increases over time, etc. However, it can work fine to simply write out a budget on paper.
I place an income section at the top and include income from all sources — all jobs, rental income, investment income, etc. — with a total income line that sums all income sources. Below the income section, I include an expenses section with nondiscretionary, or mandatory, expenses, followed by discretionary (nonmandatory) expenses below. I then include a total expenses line, followed by a cash surplus/deficit line that takes total income and subtracts total expenses, to see if there is any cash left over at the end of the month.
For those with fixed incomes, this process is pretty straightforward, and will be consistent from month to month for the most part, except for a few expenses that may occur once a quarter or once a year, such as taxes, insurance and the like. For those with inconsistent (lumpy) incomes, this process becomes more complex. For entrepreneurs and those who work on commissions or fees, who have varying income streams, there are several ways to approach the budgeting process. One way is to take an average over some number of months, and then use that average for the coming month. Three months usually will be enough, although the more variance one has in income, the more months that may be required to gain a more accurate estimate for planning purposes.
It is important to not only build a projected budget, but to also track you actual income and expenses over time — month by month — to compare your actual performance with what you've projected. Adjustments can then be made to the projected budget, as actual performance varies, to fine-tune the projected budget for accuracy.
Once the projected budget has been developed, we can see if there will be excess cash available each month, quarter, year, etc., to be used to address our stated goals and objectives. If there is not excess cash, and, more important, if there is a cash deficit, changes must be made to income, expenses or both to generate excess cash. This process can be involved and challenging, and is a topic for another day.
Assuming there is cash available, goals and objectives will need to be prioritized, according to the timeline we have established for achieving these goals and objectives. Projections are needed to match the monthly, quarterly and yearly expectations for excess cash generation, and these projections must be matched to goals and objectives, according to the timeline established, to ensure that the goals and objectives are reasonable, given the timeline. In other words, will you have enough cash coming in to achieve your goals and objectives within the timeline established? If the answer is yes, fantastic! You simply need to track your process over time to stay on track, and as long as your actual performance matches your projections, you should achieve your goals and objectives as desired.
If your projections, given your expected cash surpluses, will not meet your goals and objectives within the timeline established, you must return to your budget and increase income, reduce expenses or do some of both. By tweaking the projected budget with these changes, you can then rework your projections and compare the new, expected cash surpluses with your goals and objectives and your timeline. If the changes get you where you wish to go, great. If they don’t, you will have to be more aggressive with those changes. Alternatively, you may need to adjust your goals and objectives and/or your timeline.
By continuing to tweak you budget, objectives and timeline — in real time — over time, you can effectively pursue your financial goals and objectives. This process isn’t always easy, however. For many it can be the most challenging experience of their lives. Regardless of one’s situation however, it is critical to their financial success in life that they undertake this process.
While it is never too late to get started, the earlier one begins the financial planning process, the more time he or she will have to achieve goals and objectives. While I have generalized this process in this column, and there can be highly involved and complex analyses required to determine the financial aspects of many goals, such as retirement planning, educational planning, estate planning, charitable giving, etc., these general steps will at least provide even the most inexperienced person with a starting point to begin the financial planning process.
Don’t wait! Get moving on your financial plan today. If you need help, contact a financial planning professional. Your financial future depends on formulating and following an effective, well-developed financial plan.