How to Use Financial Planning to Create Your Plan

I spent a week researching and creating the content. The stages are based on the Certified Financial Planner Board of Standards’ Code of Ethics and Standards of Conduct. Also, I have considered my experience in a few countries to enrich the descriptions

The Gist (“Too Long Didn’t Read” version of the article)

• A financial plan is a road map on how to use your money to achieve your goals.
• Financial planning is the ongoing process of 4 stages:
  1. State your goals
  2. Define where you are
  3. Describe how to achieve your goals
  4. Adjust as your situation changes

Here below the detailed description of every item in the gist section.

What is a financial plan?

It is a road map on how to use your money to achieve your goals. It plans for the next 10,15 or 20 years.

The plan states your current finances and how to use your money towards your goals. It contains also the financial milestones that represent your goals and the strategies to reach them.

Besides, the plan depicts your current financial situation. This covers your cash flow, savings, debt, investments, insurance and other financial elements you might have or need.

You can make a financial plan yourself or with a professional’s help.

The financial plan type depends on the people covered:

• You
  • Don’t assume you will meet someone who will handle finances.
  • If you plan for yourself, later planning with significant other will be easier as you have experience planning.
• With your partner
  • Each one can keep an account but sharing information is useful. It shows involvement in shared projects.
• With your dependents (parents/children)
  • Children education or parents retirement.

What is financial planning?

It is the ongoing process of making and reviewing your financial plan. As life goes on, you need to adjust your financial plan. It is even more important at major life events. For instance; when you get married, get a new job, get a new income stream, have a child, lose a loved one.

The ongoing process of financial planning reduces uncertainty about how your money serves you. It reduces stress about your finances and helps you stay on track to reach your goals. Be it retirement, buying a house, taking a big trip or whatever you aim to achieve.

Common myths about financial planning

1. It is only for the rich: It is not just for the wealthy, but everybody.
2. I have to own a lot of money: There is no need to have a lot to make a financial plan.
3. It is too expensive: You can start doing it yourself and do not spend a penny unless you want to hire a professional to help you with it. Even more, the professional first consultation can be free. And many of the resources they use are available online like the Certified Financial Planner Code of Ethics [1]

Stage 1 – STATE YOUR GOALS

CFP step 2: Identifying and selecting goals

The CFP Code of Ethics recommend starting with the person’s current situation. Here we consider a slight change of order just for the first step. Start the financial planning with your goals will give you motivation. It will state your WHY. Think about those things you want to accomplish in your life and how your money will help you achieve them. Because at the end of the day, money is the means to an end. And here that end is your life goals.

1. Inspiration for big goals

Why money is important to you? To inspire you and describe your goals clearly, think about what would create sustainable happiness in your life. What are the areas of your life that make you happy? Use the answer to start modeling your goals. For instance:

• Is your body and health a basic need that you need to protect in order to enjoy life?
• What activities and things generate good feelings for you? Do you love traveling ? Being charitable and see how others overcome life threatening conditions thanks to your help?
• Do you want to allocate more time to your well being through spirituality or learning process? Would you appreciate an early retirement to spend more of your time on those soul-rewarding activities?

2. Break down big goals into smaller chunks

For example, a person wants to spend more time in outdoors and stay healthy. He/she might consider buying a bike or running shoes to enjoy more the time outside.

3. Translate aspiration into money measurable goals

Let’s say a child wants to buy a bike. He knows that his parents give him $5 per week. His desired bike costs $100. So, it would take him 20 weeks (5 months) to save enough to reach his goal. Those calculations about how your money let you reach your goals are the heart of financial planning. He could put those $20 per month in a monthly budget/spending plan. Then, each month he could see a small chunk of progress done towards his goal.

An adult might want to get a car to enjoy more the outdoors and go running in the mountains. This could translate in $28,000 for the desired car. And same calculations would be applicable to determine the monthly amount to use to pay for that car.

You could classify your goals in short-,mid- and long-term. For instance:

• Short term:
  • Have money for an emergency ($1k)
• Mid-term:
  • Send children to college ($75k)
• Long-term.
  • Owning properties ($1M)
  • Retire rich in Bahamas ($2M)

Stage 1 expected result: your list of goals and their money requirements.

Stage 2 – DEFINE WHERE YOU ARE

CFP Step 1: Understanding the client’s personal and financial circumstances.

Your financial circumstances can be represented by your net worth and cash flow.

Your net worth is the result of subtracting your liabilities’ value from your assets’ value.

• Assets (what you could sell and get money for): A real asset puts money in your pocket. That’s why a house can contribute to your net worth but its mortgage counts against it.
  • Money in bank (savings, investments, checking accounts).
  • Retirement accounts.
  • Home, car, jewelry
• .Liabilities (all debts)
  • Mortgage, credit cards, student and consumer loans, etc

Your cash flow is the result of subtracting your expenses from your income in a given month. It gives you clarity on how much money is going in and out. A positive result enables wiggle room to allocate more towards goals achievement. You can check our guide on how to make a budget to help you identify your cash flow.

Once your net worth and cash flow calculated, you have an idea of your financial position. And with that, you could know a few key financial ratios. The values below concern a specific month:

• Are you saving enough?
  • Savings rate = (savings / income)%
• Are you borrowing too much?
  • Indebtedness = (debts / assets)%
• Are you paying too much debt?
  • Debt payment capacity = (debt payment / income)%

Stage 2 expected result: Your net worth, monthly cash flow and financial ratios.

Stage 3 – DESCRIBE HOW TO ACHIEVE YOUR GOALS

CFP Step 3: Analyzing the client’s current course of action and potential alternative course(s) of action.

You might have already a list of actions to achieve your goals. Here below are a few ideas to consider:

• Do you already track your money?
  • You might want to consider our list of budgeting apps to help you on that. Once you know how much money you have available you can put it to work towards your goals. We aim here to make money work for us and not the other way around.
• Do you know what are your frequent bills and their monthly dates? Are they being paid on time to avoid interests?
• Do you have an emergency plan?
  • Are you able to pay $1,000 in case of an unexpected situation like car repair?
  • You might want to consider starting an emergency fund of $1,000.
  • Do you already have it? Great, congratulations. Then build it to the equivalent of 3 to 6 months of your expenses.
• Do you have a debt payment plan
  • Would you like to consider paying-off first the debt with highest interest rate? The faster you pay it, the more money available you will have to pay the remaining debts and be debt-free.
  • Do not limit yourself to the smallest payments. The more you delay the payment, the more interest you will have to pay later.
• Are you already planning for retirement and afford the lifestyle you want?
  • Keep in mind that in the US, the Social security trust fund is projected to be exhausted by 2031. As stated by the Congressional Budget Office outlook done on September 2020 [2]. So you can not rely on the government to take care of your retirement entirely. Even more as baby boomers reach retirement in 2030 according to the US. 2020 census [3].
  • Are you already getting the employer match on retirement account 401(k)? It is essentially free money as the same amount you contribute will also be contributed by your employer.
• Are you investing? Think about what the investment is for, when you’ll need the money and your risk tolerance. Keep investing expenses as low as possible. Maybe current investments are not really performing or draining most of your returns through fees.
  • What percentage of your income is going to investing?
  • Do you invest for the long term to take advantage of the compounding effect?
    • Your money grows as interest is earned on it through time [4]
  • Have you defined your investing policy?
    • You might prefer to invest only on asset types you understand.
    • What asset types do you want to consider? Stocks, funds, bonds, real estate, commodities, index funds, ETFs, certificates of deposit, cryptos?
  • Have you considered a diversified portfolio to avoid putting all your eggs on same basket?
  • Do you have an asset allocation strategy ?
    • What are the percentages of your invested portfolio that you allocate to the asset types chosen?
    • Are you comfortable with the risk taken for the potential return you might get?
    • Have you identified your loss aversion? What is the largest percentage of your invested assets you accept to put at risk of being lost?
• What streams of income do you have?
  • Would you like to increase the income from your job? It could be active income like a side hustle or passive though lending for instance. You could take a look to our article on passive income ideas.
• Have you considered insurance (for you and your loved ones)?
  • Do you have dependents like children or parents? You might consider a term-life insurance to help them if something happens to you.
  • You might want to take a look at other type of insurance but avoiding getting caught in many high payments. Do you need health insurance, disability insurance, car insurance or home insurance?
• Do you have a plan for taxes?
  • Capital gains tax are lower than income tax
    • You probably already know what is your income tax bracket.
    • Long term capital gains tax percentage is lower than income tax as described by the IRS [5]
  • Tax allocation
    • Tax deferred: like traditional IRAs [6] and 401(k)s [7]
    • Tax free: like Roth IRAs [8] and Roth 401(k)s [9]
    • Other tax laws apply if you have a business.
    • 529 college savings plan in US
  • Have you estimated the tax burden in the future?
    • A high amount in income at retirement could be taxed as regular income. Would that amount make you be linked to a higher tax bracket? Does higher pension force you be labeled in a higher tax bracket and finally ending with less money in your bank account?
  • Check whether tax deductions are available to you. Examples for a few countries:
    • In US through IRS: https://www.irs.gov/tax-reform
    • In France : https://www.service-public.fr/particuliers/vosdroits/N19785
    • In Switzerland (Geneva): https://www.ge.ch/dossier/revision-impot-source-2021/volet-fiscal/questions-frequentes
    • In Peru: https://www.gob.pe/1049-devolucion-de-impuestos-por-mis-gastos-en-hoteles-restaurantes-y-bares
• What happens to your assets once you’re gone?
  • Create an estate plan
  • Will or trust in place to protect assets
    • To inherit in the future and be prepared for a life-ending event.
• Risk
  • Identify hidden dangers that prevent you from reaching your goals.
    • Medical bills
    • Disabilities
    • Death
    • Recession
    • Retrenchment
    • Short-term gratifications/distractions
    • Disasters

CFP Step 4: Developing the financial planning recommendation(s)

You can decide what is more important to you based on your goals identified at stage 1. This will let you prioritize. The prioritization should be reflected in your spending plan (budget). Besides, consider strongly the building of an emergency fund as stated in the previous CFP step.

Here below are a few ideas to help you save and make the most of your money

• Automation: Automate transfer to savings accounts as you see it convenient.
• Savings account: Let users earn interest on money deposited. Take into consideration that there are savings accounts that charge you for withdrawing money before a deadline. So, be sure to check with your bank about the withdrawal conditions.
• Consider the 72 hours rule: Wait 72 hours before buying something to eliminate impulse buying.
• Windfalls: Use them as an opportunity to fast-forward your goals achievement
• Spending cleanse: You might want to consider a week when you don’t spend. Try taking the time and effort used for shopping and put it towards your goals achievement.

CFP Step 5: Presenting the financial planning recommendation(s)

This is where you obtain the list of elements you want to work on based on previous CFP steps. To avoid getting overwhelmed, start by building your emergency fund. Once done, choose another goal like paying high interest debt and so-on. As soon as you get the one with the highest interest paid-off you get more money to pay for the rest and to put it to work towards your goals.

CFP Step 6: Implementing the financial planning recommendation(s)

As you are applying what you defined in previous step, you could start consolidating your financial well-being through:

• Increased contributions (towards retirement/savings/investing or any goal you planned)
• A fully funded emergency fund with an amount equal to 6 months of your expenses

Stage 3 expected result: List of actions that let you achieve the goals stated in stage 1.

Stage 4 – ADJUST AS YOUR SITUATION CHANGES

CFP Step 7: Monitoring progress and updating

The purpose is to stay on track to reach your goals. It is convenient to review and adjust as needed your plan every 6 months or with any major life event. For instance, a new job, new income, new child, a marriage or a loss from a loved one.

• Think of it as a habit. You brush your teeth every day to avoid illnesses. It’s a habit. Financial planning could be a habit that prevents financial stress and many money problems. Hopefully, it is done every 6 months or 1 year and not 3 times per day.

In case 6 months seems too far and you are worried about losing track and not reflecting on your current situation, consider a monthly review. It could be quick. You can consider:

• Check financial goals.
• Reconcile bank accounts and bill payments.
• Review savings and investments.
• Were automatic transfers properly done? If you prefer manual transfers, did you do them?
• Check fees. Are they lower in another financial institution with a good reputation?
  • In transfers, bank accounts, saving accounts, retirement accounts.
  • You could prioritize a financial institutions in which the amounts are covered by insurance. Here below examples on a few countries:
    • In the US, since 1933 there is the Federal Deposit Insurance Corporation. It covers now $250,000 per depositor, per insured bank, for each account ownership category.
    • In France, the French Deposit Insurance and Resolution Fund covers up to €100,000 per bank.
    • In Switzerland, Esisuisse guarantees money held with Swiss branches and securities firms per client and per bank up to CHF 100,000
    • In Peru, the Fondo de Seguro de Depositos covers PEN 104,377 as of May 2021 for its members.
• Check your net worth evolution. Is it growing?

This review could be the opportunity to reflect on previous experiences and improve faster. Try answering the questions below to inspire you on how to improve:

• What steps get you closer to your goals?
• What steps put you further from your goals?
• Is your spending aligned with your values/goals?
• What money mistakes did you make since the last review?
• Why you did those?
• Are your financial goals still realistic?
• What big expenses are coming soon?
• Does your emergency fund contain 6 to 9 months of expenses?
• Are you saving enough to retire comfortably?
• Are you meeting short-term goals?
• Are you on track to save for children?
• How can you improve for the next review?

As you see, the global purpose here is to avoid overspending and learn from mistakes. You can:

1. Increase your resources
   • As goals inspire you to get more income, work harder, and get higher investment returns. Hence, reaching your goals faster
   • Get advantage of opportunities to speed-up (e.g. financial recovery after a recession)
2. Adjust your goals
3. Adjust your finances to reach goals faster:
   • Cut expenses
   • Reduce bad debt (consumer debt, the one that does not generate any revenue)
   • Increase leverage (good debt, the one that generates revenue like an online lending platform where you lend and earn interest)

Stage 4 expected result: review analysis describing whether you are getting closer to your goals or not

What is the next step?

Be sure you have your financial plan with the expected result of every page. You might want to read our article on passive income ideas and how to make passive income. This will let you increase your income and returns. Hence giving you more resources to reach your goals faster.

Sources

[1] Certified Financial Planner Board, CODE OF ETHICS AND STANDARDS OF CONDUCT; at https://www.cfp.net/ethics/code-of-ethics-and-standards-of-conduct (visited June 28, 2021).

[2] Congressional Budget Office, The Outlook for Major Federal Trust Funds: 2020 to 2030; at https://www.cbo.gov/system/files/2020-09/56523-Trust-Funds.pdf (visited June 28, 2021).

[3] United States Census Bureau, By 2030, All Baby Boomers Will Be Age 65 or Older; at https://www.census.gov/library/stories/2019/12/by-2030-all-baby-boomers-will-be-age-65-or-older.html (visited June 28, 2021).

[4] Investopedia, Compounding; at https://www.investopedia.com/terms/c/compounding.asp (visited June 28, 2021).

[5] Investopedia, Income Tax vs. Capital Gains Tax: What’s the Difference?; at https://www.investopedia.com/ask/answers/052015/what-difference-between-income-tax-and-capital-gains-tax.asp (visited June 28, 2021).

[6] Internal Revenue Service, Traditional IRAs; at https://www.irs.gov/retirement-plans/traditional-iras (visited June 28, 2021).

[7] Internal Revenue Service, 401(k) Plans; at https://www.irs.gov/retirement-plans/401k-plans (visited June 28, 2021).

[8] Internal Revenue Service, Roth IRAs; at https://www.irs.gov/retirement-plans/roth-iras (visited June 28, 2021).

[9] Internal Revenue Service, Retirement Plans FAQs on Designated Roth Accounts; at https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts (visited June 28, 2021).