Structure is essential for growth. Without a clear-cut strategy, it is easy to waste one’s time and energy and go through life without making much headway. Smart planning enables you to prioritize your resources and achieve your goals.
This is particularly true when it comes to your finances. Without a sound financial plan, saving money might prove just as hard as navigating your way through a new city without Google Maps.
Continue reading to find out how a financial plan can help you and how to go about creating one.
What is a financial plan?
A financial plan is a living document that helps you be in control of your income, expenses, and investments so that you can achieve your financial goals. It includes your present financial situation and short-term and long-term financial goals and acts as a road map, showing you how to get where you want to go. Without a financial plan, you are just paddling in the sea, hoping that you are going in the right direction at the right speed.
Good financial planning includes your cash flow, debt, savings, and life insurance. It ensures you make the most of your assets and can build a large enough nest egg for long-term goals, such as retirement. Financial planning is an ongoing process, so revisit and readjust your financial strategy whenever there is a major life event, like a new job, a marriage, or birth of a child.
Financial planning is for everyone — not just the wealthy. It helps you reduce stress about money and manage it in the most efficient manner. You can create a personal financial plan yourself or with a financial advisor.
Creating your own financial plan
You can create a financial plan on your own. It is not difficult; all you have to do is follow these seven easy steps.
1. Write down your financial goals
Start by asking what is important for you. Is retiring early your biggest financial goal? Do you want to be self-employed in the next three years? Or is buying a bigger home your most important financial goal?
Jot down your financial objectives as long-term and short-term goals. What do you want to accomplish in the next seven years? Fifteen years? Twenty years? Saving for a family vacation, paying down debt, and creating an emergency fund are all examples of short-term goals. A long-term financial goal might be to save for retirement or make a down payment on a home. Either way, a strong financial plan is needed.
After setting your priorities, think about what you need to do achieve them. You may have to make life-altering decisions to achieve your goals, so be prepared. For example, if your main priority is early retirement, downsizing to a smaller home can help you save more for it. Once you know your priorities, it comes down to balancing them with your current realities.
2. Calculate your net worth
Your net worth is assets minus liabilities. That is, it is everything you own minus all your debts.
Here is the equation:
Net Worth = Assets – Liabilities
To calculate your net worth, take inventory of all that you own. This will include assets for which you are still paying loan installments. For instance, say you have a home loan on a house worth $300,000 and your mortgage balance is $100,000. You should write down your home’s market value ($300,000) in the assets section and include the balance on the home loan ($100,000) in your liabilities.
As you can see, your annual income does not figure in the equation. One can earn a large salary but still fail to accumulate much wealth if they buy depreciating assets and do not save much. The opposite is also equally true. Someone with a modest income can have a high net worth if they save prudently.
In case you are not completely sure about what counts as assets and what as liabilities, follow these simple guidelines:
Assets: An asset is something you own that has an economic value. It can be something tangible (existing in physical form) — like a house or a car — that you can sell and convert into cash if needed. Or it can be something intangible (not existing in physical form) — like stocks or bonds.
Liabilities: Liability is just a fancy term for something that you owe. Liabilities can be short term, like current taxes due for payment or credit card loans. Or they can be long term, like a student loan or a mortgage.
3. Track your cash flow
Tracking the cash flow helps you evaluate your current financial situation. Start by taking into account your monthly net income — the amount of money you earn every month after taxes and deductions. If you have a second job or other sources of income — like child support payments — include that too. Factor in the interest or dividends earned on investments as well.
Next, figure out how much money you spend each month. Your monthly expenses include your mortgage, rent, car loan, credit card payments, and insurance premiums. Do not forget money you spend on utilities, groceries, and transportation. Also, include spending on non-essential items, like gym fees, cable TV subscriptions, clothing, etc. To get the average monthly expenses, calculate your actual monthly expenses for 12 consecutive months and then divide it by 12.
Finally, calculate your monthly cash value using the equation:
Monthly cash value = Monthly net income – Average monthly expenses
If you are spending all or much of what you bring home, you may have to reassess the goals and timelines set for them. Or consider cutting down the expenses so that you can achieve your goals within prescribed time periods.
4. Match your spending to your financial goals
Is your spending considerably lower than your earnings? Congratulations, you are in a great position to start saving for your goals. Look at your average monthly expenses to determine how much you can save every month.
Once you have got a figure in mind, put aside that amount each month. Making regular contributions to your investment and savings accounts is the key to achieving your financial goals. Treat these contributions as much of a priority as paying rent or mortgage installments.
If you are spending the whole paycheck or in debt, it is probably time you get your finances in order. Unless your spending priorities match your life priorities, you will have a hard time achieving the latter.
Here are some tips that can help you save more if you are spending all of what you earn:
- Consider cheaper housing
- Consider driving a cheaper car
- Shop for more affordable auto and home insurance
- Check for discounts, rebates, coupons before shopping
- Sign up for reward programs
- Use a cash back credit card and cash back apps
- Use your credit card wisely
- Compare prices before buying
- Work out at home instead of a gym
If you are in debt, the following tips can help you get out of it faster:
- Switch to a lower interest rate credit card
- Pay more than the minimum payments
- Pick a debt-paying method that best works for you (You can start by paying off either the smallest debt or the debt with the highest interest rate)
- Get a second job to increase your monthly income
- Get a debt consolidation loan
5. Make an investment plan
Now that you have figured out the amount you can realistically save every month, decide where to invest. Create a personalized investment plan that is right for your risk tolerance and time horizon.
Generally speaking, younger investors are at an advantage because they can seek out bigger returns by taking bigger risks. If they lose money, their portfolio has time to recover from the losses. For older adults, less risk investment accounts are likely to work better. They should consider investing more money upfront as that will spur growth.
Likewise, you may want to choose higher-risk investments for long-term goals. On the other hand, lower-risk investments or a balanced strategy may work better for short-term financial goals.
6. Review your insurance needs
Insurance is all about protecting yourself and your loved ones from life’s uncertainties. While car insurance is mandatory for driving in Canada, the law does not require you to purchase home insurance, health insurance, or life insurance.
However, these are just as important as car insurance. Take for instance life insurance, it provides your family with a safety net if you die suddenly. Many Canadians do not buy life insurance thinking it is too expensive, but that is not the case. For example, term life insurance — which provides coverage for a predetermined period — is affordable for most people. In fact, the monthly premiums for a healthy 30-year-old can be as low as the cost of a large pizza.
7. Make a will
Your last will is a legal document that speaks for you after you pass away. It spells out how you want your property and assets to be distributed, saving money, time, and stress for your loved ones. Making a will is neither expensive nor complicated, so there is no reason for not having one. Also, review and update (if necessary) your will after any major life event, such as a divorce, marriage, birth of a child, etc.
How does a financial advisor help?
You can do financial planning alone or get assistance from a financial advisor. If you are not a DIY type, you may want to take the second route. Roping in a financial professional also makes sense if your financial situation is complex.
An experienced financial advisor brings much to the table. An advisor can help you:
- Create a comprehensive plan that spells out how you can build funds for each of your financial goals
- Make sense of hundreds of investment options and pick the ones that best suit your risk tolerance and goals
- Decide if your portfolio needs repositioning if the market rises or falls dramatically
- Stay disciplined during times of market volatility
- Revisit your financial goals and investment strategies after every major life milestone.
How to choose a financial advisor
Financial advisors are available for all kinds of financial situations and budgets. Here is how you can find one that is right for you.
1. Decide which type of financial advisor you need (or can afford)
Financial advisor is a broad term, encompassing different classes of advisors, from robo-advisors to online and in-person financial advisors.
With a robo-advisor, you receive automated, algorithm-driven financial planning services. This is a good option for people who are investing money for the first time, thanks to low fees and zero or low account minimums. Consulting a robo-advisor also makes sense when you want help investing for financial goals and not a comprehensive financial plan.
Online financial advisors are one step up from robo-advisors. You receive all the services that a robo-advisor provides, plus the option to consult a human financial advisor online. An online financial advisor is pricier than a robo-advisor, but can be worth the cost if you want a complete plan. Some online services require you to invest at least $25,000; others have no account minimums.
Hiring a conventional financial advisor, by contrast, may be the best course if you are looking for specialized services or your financial situation is complex. Traditional advisors are usually the costliest option, and some have a high minimum balance requirement (e.g. $250,000).
2. Ask family and friends for recommendation
Once you have decided on the type of financial advisor you need, ask people you know (and trust) for recommendations. Doing online research to find a suitable service is also a good idea.
3. Vet the advisor’s background
Do not forget to vet the individual or company you are considering. Look into whether they have been subject to disciplinary actions. Also, check them for complaints.
Benefits of financial planning
There are numerous advantages of financial planning, such as:
1. Provides a reality check
Nothing causes more financial stress than not knowing where you stand financially. A financial plan gives you an objective assessment of your financial situation by highlighting your income, expenses, savings, and liabilities.
2. Help you set realistic financial goals
Everyone has financial goals, but the question is — are yours realistic?
Your dream home can quickly turn into a financial nightmare if you do not have a clear idea about how much you can afford to spend. A financial plan helps you check if your financial goals are attainable. If yes, it also shows you exactly what you need to do, to achieve it.
3. Help identify opportunities to save money
Having a financial plan can help you identify money-saving strategies that are best for you. For example, depending on your age and goals, topping up your TFSA or RRSP may make good financial sense.
4. Plan better for unexpected events
Life is full of uncertainties. While we do not know what awaits us round the corner, we can prepare for unexpected risks. For instance, if you have dependents, putting a life insurance plan in place can help your family maintain their living standard if you die unexpectedly.
5. Helps create peace of mind
Financial planning helps you manage money in a more efficient manner. It also helps you reduce risk through tools like insurance. Ultimately, it provides you and your loved ones with peace of mind, no matter what life may throw at you.
When you put a financial plan in place, worries about money are less likely to cause sleepless nights. Rather, it provides clarity, thus alleviating anxiety and stress, while improving quality of life.
A financial plan is a document that gives a complete picture of your current money situation, long-term and short-term goals, and strategies you have decided to achieve those goals. You can create it with or without the help of a financial advisor. Follow the tips shared above, and you will be fine. However, if your financial situation is complex, it may better to seek professional advice.