Mechanics of a financial plan

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Mechanics of a financial plan

Simple steps to develop an effective personal financial plan

by Tony Novak, CPA, MBA, MT
, revised 11/30/2011

Most people understand the concept of a financial planning and would agree that having a personal financial plan is a good idea. Yet few people have actually taken any action to develop a formal financial plan for themselves. There may be many reasons for this: procrastination, concerns about time involved, lack of information on details required, cost, a belief that they can “wing it” without putting anything in writing, etc. I suspect that most people do not realize that a very effective financial plan could be drafted in about an hour, by yourself, at virtually no cost. Perhaps more people would actually get involved in the process if they had a little help with the mechanical aspects of developing a personal financial plan.

Whether you take it on alone or with professional help, a good financial plan needs to be no more than 2-3 pages and can be substantially completed in a few hours (although you will likely want to fine-tune it as you move forward). The point is to help map out a direction that makes since and can be used to stabilize your reactions to life’s surprises over the long term. The plan should always cover certain crucial items. This article is meant to provide a mechanical framework for building a simple but effective personal financial plan.

Start by drafting an outline with at least a few thoughts on each of these topics

  1. Statement of Objective – Businesses start their planning by reviewing their mission statement. The same principle applies to personal planning. Start with a broad statement of what you want to accomplish, where you want to be, and when all this should happen.
  2. Cash Flow and Budgeting – Most people need to get to a point where their cash expenses total about 70% of their net income before they can consider themselves financially successful. Try to allocate 70% of your income toward expenses, 10% to reducing debt, 10% for savings, and give away 10%. (This is usually difficult or impossible at first but get easier over time). If you are using a computerized accounting system, budget planning is easy. If not, maybe this is a good time to start. Make the cash flow projection extend for your full expected lifetime just to force long term thinking.
  3. Financial Statement – a snapshot of your current and expected future financial position.
  4. Income – Identify opportunities for increasing income.
  5. Expenses – Identify opportunities for lowering expenses.
  6. Debt Reduction Strategy – You need an “exit strategy” or way to get away from consumer debt. Include an acknowledgement of strategy for investment or business debt.
  7. Credit – Acknowledge the importance of a good credit rating and include a plan to manage and improve upon your credit score. Credit score now affects everything from cost of housing and insurance to the jobs and contract opportunities that are available.
  8. Risks – What are your greatest financial risks and how do you cover them? This is the insurance section. Risk management tends to become the most important part of the financial plan around age 50 and its importance increases with age and amount of personal assets.
  9. Taxes – Incorporate strategies to minimize taxes for the long term. Be aware of your marginal tax rate and the significant taxes that can be manages as well as acknowledging those that cannot be reduced.
  10. Investment – A personal investment policy statement should be incorporated or attached to the financial plan. It should be build around the dollar amount of investments and your time objective.
  11. Marriage – Incorporate by reference a pre-nuptial or post-nuptial agreement. Don’t have one? That leads to considerations beyond the scope of this article. For now, simply acknowledge the scope and amounts of contingent liabilities that arise from family law in your state which may include the necessity to fund for #12 below.
  12. Education – A reasonable plan to get the kids through college without breaking the backbone of the rest of your plan.
  13. Estate – Incorporate by reference the three key items everyone needs: 1) will, 2) durable power of attorney, and 3) advance health care directive. It is also important to list the titling and beneficiary designations of all assets. (If some of these are incomplete or out-of-date, have them updated now!).

When these sections are outlined, two other sections should be added. These last two are actually the most important.

First a Summary Paragraph should be developed to force the author and the reader, if applicable, to focus on the most important issues. This can be placed at the beginning or the end, it does not matter. I prefer to place it at the beginning in bold type.

Finally an Action Checklist should be extrapolated from the other sections and added to the end of the plan. This is the result of the planning that now becomes the focus of attention.

A good financial plan does not need to be complicated. A paragraph on each topic and a few documents or spreadsheets is a great start. Of course, more detail and professional input into certain areas will likely improve results. But the important thing is to get started, get it on paper, and then go forward from that point.

More Resources

Choosing a Financial Adviser

Not Your Father’s Bean Counter

Financial Planning Checklist for Unmarried Couples

Tax Planning Checklist

Ten Common Mistakes of Mutual Fund Investors

Six Strategies for Cutting Health Insurance Costs

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