What Is a Financial Plan?

A financial plan is a document containing a person's current money situation and long-term monetary goals, as well as strategies to achieve those goals. A financial plan may be created independently or with the help of a certified financial planner.

In either case, it begins with a thorough evaluation of the individual's current financial state and future expectations.

Key Takeaways

  • A financial plan documents an individual's long-term financial goals and creates a strategy for achieving them.
  • The plan should be comprehensive, but also highly individualized to reflect the individual's personal and family situation, risk tolerance, and future expectations.
  • The plan starts with a calculation of the person's current net worth and cash flow and ends with a strategy.

The Fundamentals of Financial Plans

Understanding the Financial Plan

Whether you're going it alone or with a financial planner, the first step in the creation of a financial plan involves getting together a lot of bits of paper or, more likely these days, cutting and pasting numbers from various web-based accounts into a document or spreadsheet.

The following steps in creating a financial plan may, of course, be completed by an individual or a couple.

Calculating Net Worth

You're about to learn your current net worth. List all of the following:

  • Your assets: This may include a home and a car, some cash in the bank, money invested in a 401(k) plan, and anything else you own of value.
  • Your liabilities: These may include credit card debt, student debt, an outstanding mortgage, and a car loan. In some cases, you may have access to a grace period or moratorium.

Your total assets, minus your total liabilities, equals your current net worth.

Determining Cash Flow

You can't create a financial plan without knowing where your money is going every month now. Documenting it will help you see how much you need every month for necessities, how much might be left for saving and investing, and even where you can cut back a little (or a lot).

One way to get this done is to skim through your checking account and credit card statements. Collectively, they should be a fairly complete history of your spending. If your expenses vary a lot seasonally, it's best to go through an entire year, count up all the expenditures in each category, and then divide by 12 to get an average monthly estimate of your spending. This way, you won't underestimate or overestimate what you spend on utilities, or forget to account for holiday gifts or a vacation.

The main elements of a financial plan include a retirement strategy, a risk management plan, a long-term investment plan, a tax reduction strategy, and an estate plan.

Document how much you've paid over a year in basic housing expenses like rent or mortgage payments, utilities, credit card interest, and even home furnishings. Add categories for food, clothing, transportation, medical insurance, and non-covered medical expenses. Document your real spending on entertainment, dining out, and vacation travel. Don't overlook cash withdrawals that may be used on sundries from shampoo to sodas.

As you look over your own financial records, your personal spending categories will stand out. You may have an expensive hobby or a pampered pet. Document the costs.

Once you add up all these numbers for a year and then divide by 12, you'll know exactly what your cash flow has been.

Considering Your Priorities

The core of a financial plan is a person's clearly defined goals. They may include funding a college education for the children, buying a larger home, starting a business, retiring on time, or leaving a legacy.

No one can tell you how to prioritize these goals. However, a professional financial planner may be able to help you choose a detailed savings plan and specific investments that will help you tick them off, one by one.

Special Considerations of a Financial Plan

Financial plans don't have a set template. A licensed financial planner will be able to create one that fits you and your expectations. It may prompt you to make changes in the short-term that will help ensure a smooth transition through life's financial phases.

The following elements should be addressed, and revised as necessary:

  • Retirement strategy: No matter what your priorities are, the plan should include a strategy for accumulating the retirement income you need.
  • Comprehensive risk management plan: That includes a review of life and disability insurance, personal liability coverage, property and casualty coverage, and catastrophic coverage.
  • Long-term investment plan: A customized plan based on specific investment objectives and a personal risk tolerance profile.
  • Tax reduction strategy: A strategy for minimizing taxes on personal income to the extent allowed by the tax code.
  • Estate plan: Arrangements for the benefit and protection of your heirs.