It’s quite amazing, and a little bit sad, how most people will spend more time planning their two-week summer vacation each year than they will planning for their thirty-year retirement. It’s easy to see why, of course. It’s fun to plan a trip to the Grand Canyon or to the south of France. But, for most of us, it is not so much fun, and certainly more complex and time consuming, to properly plan for retirement and other important financial goals. And, as we all know, when we have two projects in front of us, we almost always go with the one that is more enjoyable, even when it is not nearly as important.
The truth is, I guess I shouldn’t complain. After all, if everyone actually enjoyed planning their financial futures as much as they liked planning their next vacation, I would likely be out of a job. Just like our long-lost friend, the travel agent, I suppose. That being said, if you don’t already have a financial plan in place, and want to get ahead of the curve and start building one now, here are the five most important steps in creating a realistic and actionable financial plan for you and your family.
Step #1 – Define Your Goals
The best way to start a financial plan is at the end. Sounds odd, right? But, just as you cannot (or at least, should not) map out your cross-country road trip without a final destination in mind, you cannot/should not start your financial journey without the end goal in mind. Of course, there will always be roadblocks, obstacles, detours and other mid-journey changes to your plans, but before you start the engine and get on the highway, be it a physical or financial one, it always makes sense to have an idea of where you want to be at the end of the journey. Because without a destination in-mind, there is no way to ever really know if you are on-track, or hopelessly lost.
Step #2 – Determine Assets & Liabilities
The next step in a well-thought-out financial plan, is to compile an exhaustive list of your assets and liabilities. Before you can figure out how long it will take to complete the journey you are embarking on, you have to know where you are starting. What do you have working in your favor, and what do you have working against you? Items that may be in your favor are things such as: adequate cash reserves, a good sized 401(k) plan, a possible inheritance down the line, a bunch of untapped equity in your home, or a pension at retirement. Remember those? Some of the factors, or liabilities, that may be working against you are things like: credit card debt, student loan debt, dependents (usually children or parents) who require your ongoing financial support, and so on. The listing of assets versus liabilities is called a ‘balance sheet’ or ‘net-worth statement,’ and is something that should be updated and reviewed each year to see if you are getting closer to (or farther from) completing your financial journey. Only when you have a good idea of where you stand now, can you truly start to understand where you are likely to end up in the future.
Step #3 – Review Income Sources & Expenses
Now that you have a list of your assets and liabilities, it is time to figure out your current and anticipated income sources and expenses. Current income sources are things such as: your employment income, rental income, alimony, child support, and annuity payments, among others. These are income sources that you are currently receiving and you know with some certainty and clarity how much they are, and when they will stop or change in the future. On the other side of the equation are your expenses. Current expenses are items that you are paying for now and include items such as: groceries, dining, travel, home maintenance, insurance, etc. Once again, these are expense items that are current and somewhat predictable in the near term.
Next comes the harder part of the equation, which is predicting your future income sources and expenses. How will your employment income likely change? What will you receive from social security in the future? Perhaps you have a pension that will also start in the future. Do you plan to work part-time or consult after you retire from your current position? And the same goes for predicting future expenses. What new expenses will you see in the future, such as: increased health-care costs, the potential need for long-term care, major home improvements, paying for your children or grandchildren’s educations, weddings or home-purchase down payments. As we all know, determining the future with any precision is very hard to do, and, of course, you will never get it exactly right. But, to put together a realistic and actionable financial plan, you must make your best guesstimates now, and then be flexible enough to update your financial plan as the true numbers reveal themselves over the coming years.
Step #4 – Scenario Analysis
Here is where the rubber meets the road. Scenario Analysis is where you take all of the qualitative and quantitative data you have acquired in steps 1, 2 and 3, and put it together to determine if your assets and income, minus your liabilities and expenses, are likely to put you on track to meet the financial goals you desire. In other words, do you have enough gas in the tank to get you to your final destination?
Now, unless you just love numbers and Excel spreadsheets (any engineers out there?), here is the part where you will most likely want to enlist help from an expert, or at least from some very good financial-modeling software. The key to remember here is, your output can only be as good as your input. Or, as you may have heard before, “garbage-in is garbage-out.” Step #4, Scenario Analysis, will only truly be helpful if you have been diligent and honest with yourself in completing steps 1, 2 and 3.
Step # 5 – Review & Update
Ultimately, financial planning is not a one-time exercise. It is a living, breathing and evolving process. Once you have gone through that process, you will want to periodically review your progress and changing goals to see if you are still on track, and if not, what changes need to be implemented to do so. Once again, just like driving across the country, it is unlikely that the itinerary and roadmap that you painstakingly worked out at the beginning will be the exact path that you follow. As I’ve said, there will inevitably be roadblocks, obstacles, detours and mid-journey changes of mind along the way. And that’s okay. You just need to make sure your plan, and your mindset are flexible, and that you stay up-to-date on where you are, where you want to be, and on your planned course of action. In general, I recommend updating your financial plan at least every three years, or sooner, if there are significant changes to your financial situation or financial goals.
So now get out there and enjoy your summer vacation! And, when you are back home safe and sound, please take some time to start planning your longest trip ever, your trip to financial security.
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