The first step in the financial planning process is typically establishing a budget. A detailed understanding of money coming in and money going out is the starting point for developing a sound financial plan. Through the budgeting process, one can begin to prioritize any existing debts to formulate the most effective repayment strategy.
While many of my clients are wealthy, and do not have any significant debt challenges, others struggle to manage their debts so they can eventually repay them, and then begin to build wealth.
Often, I find that clients with debts have no real plan for repaying their debts, and usually just live paycheck to paycheck, never making any meaningful progress toward building their nest egg for retirement, paying for their children’s college or other educational expenses, or planning for any unexpected, significant future expenses such as health care or estate planning/legacy distributions.
Like many things in life, taking the first step — or knowing which step is the appropriate first step to take — is usually the toughest thing about the financial planning process. While the help of a professional financial planner such as a Certified Financial Planner is advised, individuals can do a lot on their own, and the process is actually fairly straight-forward.
Again, the logical first step is establishing a detailed budget, and this is something anyone can do.
It is a good idea to save all income and spending receipts for at least three months. Most of us have once per year or other nonrecurring expenses, so these will need to be added to the recurring expenses.
Using a spreadsheet program like Excel is a good approach to record these values. I place income sources at the top, then expenses, then net the two to see if there is a positive or negative balance each month. I create a separate spreadsheet for each month.
These can be saved within a single Excel file. You can sum the income sources and expenses as well, to see your totals for each month.
The simple spreadsheet described above is the most basic approach, and represents a good starting point to begin an analysis of income and expenses. The next step is to separate expenses into discretionary and nondiscretionary categories.
Discretionary expenses are for “wants” and nondiscretionary expenses are for “needs.” Nondiscretionary expenses are things like mortgage or rent payments, car payments, food, gasoline, etc. Discretionary expenses are things like entertainment, travel for leisure, and the like.
Once you have reordered the expenses into these two broad categories, you can start to prioritize your payments. This is where a detailed analysis of any debts you may have can really help focus your repayment strategy to get you out of debt as quickly as possible, so you can start to save.
With credit cards, the best way to prioritize is to order them from the highest interest-rate card first, to the lowest interest-rate card at the bottom. The purpose of this ordering approach is to apply any extra money you have available to the card with the highest interest rate, until that balance is paid in full.
Once that card has been paid off, you switch to paying down the next highest interest-rate card with any surplus cash, until that one is paid off, and so on.
One additional point I should make is that everyone should save an emergency fund with at least three months of monthly spending, with six months of expenses a safer goal. Bad things tend to happen to us at the worst possible time, and having an emergency fund can make the difference between staying current with expenses and possibly defaulting on obligations. The first thing I always recommend for any client, regardless of income, assets, expenses, etc., is to establish an emergency fund.
Some may already have defaulted obligations. If this is the case, at some point, they will want to deal with these debts. While there is a seven-year statute of limitations on many types of debts, creditors can go to court and secure a default judgment against the debtor, which has a 10-year life and can be reset after that anyway, which means that the obligation is pretty much permanent. In addition, defaulted debts that are not settled can devastate one’s credit. It is always best to deal with these debts if at all possible.
While many creditors are willing to work with a debtor directly, and many will negotiate reduced settlement amounts, others can be extremely difficult to deal with, and aggressive about recovering.
In these cases, I have found that the help of an attorney can be invaluable. The trouble is finding a good attorney who specializes in debt issues. I have been helping clients with financial planning and, specifically, with debt management for many years, and struggled to find attorneys who focus on debt issues, and have specific expertise in this area.
I was fortunate to find Eric Ridley, a Port Hueneme attorney and an expert at dealing with creditors, especially the most aggressive, most difficult of them. The cost of using an attorney like Ridley is well worth it, in my experience, especially when dealing with collection agencies.
Ignoring defaulted debts may seem like the preferred course of action, especially if one is struggling with paying basic expenses. However, time usually does not improve one’s situation with regard to defaulted debts.
Creditors, and even collection agencies, are usually willing to work with the debtor, and may even agree to a payment plan, as long as the debtor is communicating and shows a willingness to settle the debt. An attorney can save one a lot of money through the negotiation of the settlement amount and the payment amount and schedule.
By taking some time to develop a basic budget — including prioritizing expenses and debts in particular — we can begin the financial planning process, eventually transforming our financial landscape into one that generates positive cash flow that is then available for savings and investment.
If you haven’t taken that important first step, do yourself a favor and make the effort. You will find that, once you get invested in the process, it is not all that time-consuming or difficult, and will yield meaningful results for your financial future.
— Craig Allen, CFA, CFP, CIMA, is president of Allen Wealth Management, and has been managing assets for foundations, corporations and high-net worth individuals for more than 25 years. He can be contacted at craig@craigdallen.com or 805.898.1400. Click here to read previous columns or follow him on Twitter: @MPAMCraig. The opinions expressed are his own.
