The Retirement Corporation of America

Understanding The Financial Planning Process

A FINANCIAL PLAN is nothing more than a road map for the rest of your financial life. It's what takes you from where you are now to where you want to be. The purpose of any financial plan is to answer these four questions:

•  Question #1: Where are you now?

•  Question #2: What are your goals?

•  Question #3: How much will it cost to get what you want?

•  Question #4: Where will you get the money?

You start the process by establishing exactly where you are today in terms of financial success. The basic document here is a statement of your net worth. That establishes how much you own minus how much you owe. The greater your net worth, the closer you are to achieving financial success. Further along in this lesson, we'll have you work out what your net worth is today. When you have done that, you'll have answered question #1.

Then, you and your family should think through all the things you want that money can buy. That might include a nicer home, a boat, college for the kids, and a comfortable retirement. You, your spouse, and the kids hash through everything you wish for and whittle that down into a list of goals that are realistic. We'd all love to be worth $100 million, but the odds are against it. On the other hand, having a net worth of $1 million when you retire is probably very realistic. Later in this lesson, we'll help you set your goals in an orderly, understandable way. When you have created a realistic list of goals, you'll have answered question #2.

Next, you try to determine how much it will cost to achieve each goal, and when you are likely to need the money. One goal might be having $25,000 for the down payment on a house in two years. Another might be having a $100,000 college fund for the kids in 10 years. Still another goal might be having a nest egg of $1 million when you retire in 30 years. Once you have carried out this exercise, you'll have a financial road map—a document that will help you determine how much you'll need at each stage of your life. When you have done all this, you'll have answered question #3.

Finally, you think through where you're going to get the money to achieve each goal. How much must you start saving today to make sure you have $25,000 for the down payment on a home in two years? How can you create a $100,000 college savings fund in 10 years? What should you be doing today to help insure you'll have a nest egg of $1 million when you retire? Ideally, you should be saving 10% of each paycheck through most of your working life—and more after the kids move out and your expenses drop. Once you do serious thinking about where the money will come from to achieve your goals, you'll have answered question #4.

Why No Financial Plan Can Be Cast in Stone

You make these financial plans as early in your life as possible. A good time to begin would be the day you start at your first job. It's never too late to make financial plans—but the earlier you make them, the more likely you are to achieve financial success.

Obviously it isn't enough to make those plans once and forget about them. If you did, they would soon become hopelessly out of date and totally useless.

Things change in life. You might have been newly married with no children when you first made financial plans. Each child you have requires a change in your plans. Divorce or death of a spouse would require further changes. Career success might let you plan more grandly for the future. A career setback might cause you to cut back on some of your plans. Maybe it won't be Harvard for the kids, but your state university.

Circumstances change. You might have made one sort of financial plan in the late 1990s when the stock market was posting double-digit returns every year. You'd almost certainly want to rethink your plans based on the negative returns the stock market was delivering early in the 21st Century.

So you make your plans early in life and you make them again each time something basic in your life changes. Even if nothing major in your life has changed, you'd want to examine your financial plan once a year and think about making significant changes at least once every five years.

What Those Planning Steps Are All About

To make sure your financial plans are kept fresh and up to date, apply this basic three-step approach to planning:

•  Make your plans.

•  Implement your plans.

•  Benchmark your plans.

We've talked about making your financial plans: writing down your hopes and dreams for the future along with your best thinking today on how to make those plans come true. Still, no financial plan is more than a wish list of what you'd like to achieve in your life.

The next step is to implement your plans. That process can be simple or complicated, based on the nature of your plans. If it's just you and your spouse, your plans probably aren't that complicated. If it's you, your spouse, and three kids, then your plans can be pretty complicated.

To help get you started, here's the Six-Step Strategy for Implementing Your Financial Plan. Here they are in short form to get you thinking:

•  Step #1: Spend less. You probably don't want to live with a rigid budget. Still, if you don't gain control over your spending, you'll never reach any of your goals. Maintain reasonably tight controls over spending, so at least some of your income goes to make your financial dreams come true.

•  Step #2: Save more. Save at least 10% of take-home pay. That may be hard during your peak spending years, but it is your target. You should be able to save more than 10% in later years when the kids are grown and you've paid off the mortgage.

•  Step #3: Earn more. Do all you can to keep your income growing. That could involve advancing at your present workplace, or finding a better job. It could involve starting a business of your own—either part time to flesh out your income or full time so all the benefits of your hard work accrues to you.

•  Step #4: Invest wisely. You can't expect every year to produce the double-digit returns stocks were paying in the late 1990s. Neither can you assume stocks will deliver negative returns every year as they have in the early 2000s. Long-term studies show that a reasonable mix of stocks and bonds will return 10% a year over time. Invest so you achieve at least a 10% long-term return. Don't take big chances in hopes of returning more than that. But don't invest hyper-conservatively in hopes of never having a losing year with your money.

•  Step #5: Take advantage of all tax-favored savings plans. There are plenty of opportunities to see your money grow, sheltered from all taxes. There are such retirement savings plans as 401(k)s and IRAs, plus Keogh plans and others for the self-employed. Using these plans, you can build up a tax-sheltered retirement nest egg of hundreds of thousands of dollars. Section 529 College Savings Plans let you put as much as $250,000 into a tax-sheltered fund for your kids' education.

•  Step #6: Benchmark to keep your plans on track. Having made your plans and implemented them, pause periodically to see what progress you're making in achieving those goals. If you don't benchmark, then you won't know until it's too late whether you're on target.