How to Become an Investor Series: Financial Planning 101

Creating an all-encompassing financial plan is crucial to securing one’s financial future. But even the most meticulously drawn plan can develop gaps. Identifying and filling those gaps is essential to ensuring that your financial plan is comprehensive in structure. Here's how to make sure that all important components are included in your plan to avoid falling short in its preparation.

Financial Roadmap

A properly drawn plan will serve as a roadmap for achieving your investment objectives along the way and reaching your ultimate goals upon retirement. Thus it should encompass all of the various aspects of your financial life:

• Budgeting

• Saving

• Investing

• Insurance (disability, property and life), and

• Estate and retirement planning

In short, a well-rounded financial plan will help you navigate the many uncertainties that life brings, helping to provide a sense of security and direction along the way.

Avoid the Gaps

When developing a financial plan it’s hard to think of everything. But being alert to and recognizing the gaps is the first step in addressing them. Some areas where financial plans may fall short include the following, so be sure to follow these steps when your create your plan:

• Develop a budget: This is THE core, basic ingredient of financial planning. And THE critical ingredient of budgeting is saving money, so let’s start there. There is no more important habit to develop early in life than saving a portion of every paycheck.

• Set goals: Another part of budget development is setting goals. This must be a challenging task because so many folks go about the business of saving and investing without any particular goal in mind. What’s the point of saving if you don't know why you’re saving and to what end?

• Manage (and minimize) debt: As part of your budget development process, list all of your debts, including interest rates and minimum payments. Priortize paying off high-interest debt first and making required minimum payments on other debts. You can also consider debt consolidation and/or negotiating lower interest rates to expedite repayment. Over 60% of Americans have credit card debt. Over 60% of Americans are also investors, which implies that 30% or so of folks are investing despite having credit card debt, which if not paid off monthly, carries (gasp) 15%-30% interest rates. Isn’t it obvious that the best guaranteed return on investment for these credit-card-carrying Americans – before investing in ANY other thing – is paying off their credit card debt?

• Assess “credit card-type" opportunities: Developing a repayment strategy and managing debt effectively is vital to your long-term financial health. A mortgage is often a family’s largest debt, and over a career frequently offers opportunities to save sizable chunks of money by making multiple payments. Ignoring those moments can inflict significant “opportunity costs” if not seized. Homeowners who refinance their mortgages or prepay monthly mortgage payments are examples of "credit card-type" opportunities. Mortgage rates trend up and down. Should they downtrend  from what you are paying, refinancing might make sense. Or why buy a bond paying 3.5% while making mortgage payments carries a 7% rate? If you take on debt (most folks have automobile notes and/or mortgages), employ it carefully.  Don’t let a heavy debt burden hinder financial progress.

• Manage student loans: For those who seek higher education, student loan burdens have become a major factor in their future financial plans. Properly managing the cost of an onerous education debt is integral to sound financial planning. Without careful stewardship, student debt can delay marriage plans, child-bearing, homeownership and other important decisions often for decades.

• Plan your estate: Estate planning becomes increasingly important as one ages and gathers valuable assets. Work with an estate planning attorney to ensure that documents are legally sound and reflect your wishes. As net worth grows, consider setting up trusts, designating beneficiaries, and establishing various powers of attorney. And routinely update your estate plan to account for life changes and new legislation. Start with a will. You are never too young. Particularly once you start a family. A will’s most important function in life is to designate someone to care for your offspring in the event of your death. By the way, while we’re on the subject of designating things, after you become more financially secure and start opening important accounts like IRAs, HSAs, 401(k)s, or 529s, you’ll be instructed to designate beneficiaries of proceeds from those accounts. Very important. Do it. And should life entail changes (marriage, divorce, remarriage, death, etc.) update those beneficiaries. The cost to do so is zero, and the time required is minimal. Beneficiaries are a very important part of financial planning. Folks often neglect estate planning to manage and distribute their assets. Don’t. Remember, timely planning ensures that your wishes are carried out, which reduces the burden on your heirs.

• Establish an Emergency Fund: From day one on the job, your emergency fund will serve as a financial safety net, providing liquidity during those unexpected life events (job loss, medical emergencies or major repairs). This fund should be the equivalent of three to six months' living expenses. Set aside money each month in a safe, easily accessible bank savings or money market account, increasing contributions until a target amount is reached in a safe. This important emergency fund can also be used to avoid a costly disruption of raiding a retirement program prematurely, which usually involves a tax penalty.

• Start investing: Once that necessary emergency fund has been accumulated, saving for investment purposes (risk-taking) is now in order. Failing to save adequately for retirement early in life is a common occurrence. Because of the amazing power of compounding it’s  crucial to start saving early, making consistent contributions to savings and/or retirement accounts of one sort or another: (401(k)s, IRAs, or other pension plans.

• Continually evaluate your savings strategy: Along the way, evaluate your retirement savings strategy and adjust as needed. If affordable, maximize contributions to employer-sponsored retirement plans, always take advantage of employer matches (free money), and explore the various retirement account options. As your income level increases, adjust your savings rate accordingly.

• Keep and eye on your investment portfolio: Although “buy and hold” is my favorite strategy, an occasional review of your investment portfolio is necessary to ensure it is diversified across different asset classes (e.g., stocks, bonds, and real estate). Reliance on a single type of investment WILL expose you to unnecessary risk. Proper diversification spreads risk and will improve a portfolio's long-term, overall performance. And occasionally conduct an honest review of your investment strategy to ensure that it aligns with your risk tolerance and goals. While on this topic, remember that most major positive adjustments in the stock market occur on very few trade days of the year, so always be in the market, or you’ll likely miss the boat.

• Keep insurance policies current: Life, health, disability, and property insurance policies should be routinely reviewed to ensure current needs are met. Updating policies as circumstances change (marital status, children, acquiring a home) will ensure adequate protection. Lacking disability insurance coverage can leave an individual vulnerable to significant financial stress. Whether single or married, a provider needs to protect his or her greatest financial asset, time (i.e., the ability to convert that time into money). As to life insurance, it’s essential to update policies regularly to align them with changing family needs. Life insurance might not be a big gap in YOUR financial needs, but it could become a major factor in your survivor's financial planning.

In Sum

Filling gaps in your financial plan is a never-ending process, requiring regular review and adjustment. By taking proactive steps to address unnoticed or recurring gaps, whether it’s an insufficient emergency fund, inadequate insurance coverage, lagging retirement savings, poor debt management, investment diversification, or poor estate planning, investors can build a resilient and comprehensive financial strategy.

As with many things in life, the key to financial success lies in continuous education, careful planning, and most of all, the need and willingness to adapt to changing circumstances. If you follow these simple paradigms, you will very likely achieve greater financial security and peace of mind for both you and that future family. (By the way, if you see any gaps in this financial plan, fill ‘em!)