8 Components of a Good Financial Plan
While there are many ways to go about developing a plan—do it yourself, use a robo-advisor, work with a financial planner, or a combination thereof— BMR has identified the eight critical components.
Financial goals
If you're writing your own plan or working with a professional, your plan should begin with a list of your goals, both big and small because you can't develop one until you know what you want to do with your money. Organizing them according to when you'll need the money can be useful:
Goals that you want to accomplish during the next five years include paying off debt and purchasing a new vehicle.
The five to ten-year time frame for medium-term ambitions includes things like saving for a down payment on a house or launching your own business.
College and, of course, retirement are examples of long-term goals, which are those that are 10 years distant or more.
For each goal, specify a dollar figure and a target date. The more specific your goals, the easier it is to measure your progress toward them.
A financial plan can be created at any moment.
Although it's ideal to begin investing for financial objectives early in life, it's a good idea to check in on your finances at any moment to see if you're still on track. Do you have any other objectives that you hadn't thought of before? You can evaluate where you are now and where you want to go next by using a financial plan.
Net worth statement
The next step is to calculate your net worth because every plan needs a baseline. Make a list of all your assets, including real estate, valuable personal property, bank and investment accounts, and another one of all your debts (credit cards, mortgages, student loans). Your net worth is the sum of your assets minus your obligations.
It’s not uncommon for your liabilities to outweigh your assets when you’re just starting out—especially if you have a mortgage and student loans.
Budget and cash flow planning
Planning-wise, your budget is truly where it all comes together. It might assist you in figuring out where your money is going and where you can make savings in order to accomplish your objectives.
A budget calculator may ensure that you don't forget about sporadic but significant bills like car repairs, out-of-pocket medical expenses, and real estate taxes. Make a list of your spending and divide them into two categories: necessities (like groceries and rent) and extras (like dining out and gym memberships).
You could wish to pressure-test your budget by exploring "what if" scenarios while determining how your goals fit into it: What happens if you need or want to retire sooner? What if your mortgage was reduced in size? Some online tools provide calculators that let you change some of the underlying assumptions to see how they can impact your savings plan.
Debt management plan
Although debt is occasionally referred to as a four-letter word, not all debt is bad debt. For instance, a mortgage can aid in the development of equity while also raising your credit score. On the other hand, high-interest consumer debt from credit cards has a negative impact on your credit score. Additionally, every dollar you spend on financial fees and interest cannot be used to further other objectives.
Make sure you develop a plan that will enable you to pay off your high-interest debt as rapidly as you can if you do. If you don't know where to begin, a financial counselor can help you prioritize your goals and figure out how much of your monthly budget should be allocated to paying down your debts.
Retirement plan
According to an outdated maxim, you'll require about 80% of your current income in retirement. However, this presupposes that you have paid off your mortgage, your children will be financially independent, and that you will be free of all work-related bills and taxes once you retire.
Additionally, it's crucial to remember that Medicare isn't comprehensive, and the costs of healthcare that it doesn't cover, such as long-term care, can add up quickly. In retirement, you might also spend more on extras like vacations, eating out, presents, or helping out a friend or relative financially.
Plugging in different scenarios into a retirement savings calculator can help you figure out what you may need in retirement.
Don’t count on the 80% rule.
The 80% income-replacement rule is a smart place to start if you are saving 20–30% of your pre-retirement income. If not, it's wiser to aim for 100% of your pre-retirement income coverage, less any retirement savings. There are numerous exceptions to every generalization. Therefore, as the time approaches, make sure you sit down and adjust your retirement budget. Given that you cannot borrow money for retirement, this should be your primary priority.
Emergency funds
An emergency fund can prevent you from using your long-term savings to make ends meet when something unplanned occurs, such as losing your job or being slammed with an unexpected medical bill.
Generally speaking, it's a good idea to save enough money to cover at least three months' worth of essential living expenditures, but ideally six months (e.g., groceries, housing, transportation, and utilities). Put this cash down in a highly liquid checking or savings account so you may quickly access it if necessary.
Insurance coverage
Insurance is a crucial component of preventing financial setbacks, but you shouldn't overpay for coverage you don't require. All in all:
Without health insurance, even basic care can be rather expensive, and a catastrophic accident or prolonged hospital stay might cost you tens of thousands of dollars. You might want to think about long-term care insurance as you get older.
Disability insurance: In the event that you are unable to work, this policy will safeguard your family. Disability insurance paid for by your employer typically replaces 60% of your income.
Make sure you have enough protection if you own a car, a house, or you rent and can't afford to replace your belongings out of pocket.
Life insurance is typically a wise decision for people who have dependents. Work with an insurance agent to determine the kind and amount of coverage that is most appropriate for you.
Estate plan
You should, at the very least, have a will that details your ultimate desires for your property, your dependents, and the executor of your estate. Additionally, you should keep your beneficiaries for retirement funds and insurance plans up to date. Powers of attorney for financial and medical choices should also be established in case you become incapacitated.
For help getting started or tackling more complex estate-planning tasks, consider working with an estate attorney or a qualified financial planner.
To learn more about financial planning feel free to contact me anytime at brenault@liahona.ca.
