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10 STEPS TO DEVELOPING YOUR FINANCIAL PLAN
Turn-around time A financial plan is often about reversal. That is, you can go along for years with the sense that money controls your life, dictating don'ts and can'ts that determine where you go, what you do, and how you do it. Developing a good financial plan can turn much of that around. Instead of money controlling you, you control it and your future. Unfortunately, developing a financial plan—and the accompanying freedom from financial stress and worries that interfere with relationships, personal happiness, and physical well-being—happens infrequently. Experts in personal finance estimate that less than 5 percent of Americans have a written financial plan. Why? Busy schedules and procrastination, mostly. That and many people may be under the illusion that financial planning is too complex, above them. In a word, say experts, it is not; the principles of personal finance are easily within the grasp of most folks. Another illusion: A financial plan does not apply to people who are not wealthy. To this, financial planners will ask: Does wealth create a financial plan or does a financial plan create wealth? Your interest in financial planning may be out of frustration. You may make good money, but you also wonder if you are making good decisions about handling it. With good reason. Consider the following:
This brochure will explain there is a better way to achieve financial success than winning the lottery. It is called financial planning, and we have put the basics of planning into 10 steps. These steps are not from the mountaintop, do not guarantee wealth, and do not substitute for a plan from a professional. But they will get you thinking about how the skillful use of money can help determine your direction in life. A financial planning primer Before getting into our 10 steps, let's do a bit of defining. Financial planning is taking control of your money—no matter how much money that is. This taking control begins with a written plan. The plan itself can be one to 80 pages long, depending on your situation. A single person starting out in life with few assets should have a plan, but it will not be as detailed as the plan for a married couple in their 40s with two careers, a house, a vacation home, children, trusts, investments, and parents in poor health. A financial plan gets you from point A to point B. You determine point A by establishing where you are financially, listing assets and liabilities. Then you determine point B by writing about where you want to go with your life. What are your goals? How much money will it take to reach those goals? How are you going to get the money, and how much time do you have to get it? Savings, budgeting, insurance, use of credit, tax protection, investments, as well as retirement and estate planning are the nuts and bolts of financial planning. They help you get to point B and can involve many details. But keep the big picture in mind, that the whole point of a financial plan is simple: Go from point A to point B. The cost of a financial plan varies. There are workbooks and software programs that can help you do a financial plan yourself. You can also develop a plan through personal finance seminars, usually under $100. If you seek the advice from a fee-based professional financial planner, expect to pay $300 to $1,500. Many financial planners are paid on commission from the products they sell, or they are paid a fee as well as commission. You may opt for a less costly, simpler plan that summarizes your goals, the investment approach you want to take, and the type of investments the advisor recommends. Whatever your cost, keep in mind that your purpose in financial planning is not just to come up with a financial plan. “The document itself is not it," says Daniel P. Mulheran, president of Mulheran and Associates, in Minneapolis. “Everyone gets hung up on the document, but the plan is impotent without implementation." A financial plan should give you direction now but may need reworking according to life changes and the economy. Bill Gold, president of Gold and Associates, Inc., a Scottsdale, Arizona, draws up plans that are comprehensive yet often very simple, one to three pages handwritten on a yellow legal pad. “The plan develops as you talk with me; I am creating it with you," he says. “Yes, I could punch a lot of stuff into a computer, which would then put out a 50-page report. But those big, thick plans, most clients never read them. They don't understand them, and that's why they never take action. When you are dealing with money, if you are the least bit confused, you won't take action." Benefits include a good night's sleep A financial plan gives you an idea of your future. Planning encourages you to dream and then get down to the realities of making those dreams come true. It reminds you of personal possibilities and is a guard against “I wish I would have" regrets that can haunt old age. “If you fail to plan, you are planning to fail," says Mulheran. A financial plan can help you enjoy a comfortable life-style, pay your bills on time, and set aside money for emergencies. A plan can mean protection in the form of insurance. A plan gives you a working knowledge of a variety of investments that provide the resources to buy a house, educate your children, start a business, and live comfortably in retirement. In short, a plan can remove many of the barriers that stand in the way of your peace of mind. “In our experience," write Jack B. Root and Douglas L. Mortensen in their book The Seven Secrets of Financial Success, “we have seen that it is quite difficult for people to have the other aspects of their lives in harmony when their finances are in a miserable state." Step 1. Use discomfort A Some of you want to do financial planning because it makes sense. Great. If good sense is enough for you to make a good plan and act on it, move on to step 2. A However, many of you want to take control of your money because of discomfort—even pain—about your finances. The discomfort could be related to anything from a bankruptcy to nasty overdraft notices from your bank to witnessing a friend struggle in retirement. Or heading into a marriage or out of a divorce, you believe that what you are doing financially is just not going to do it down the line. You have had enough. You will now do what it takes to get your finances in order and get control of your future. A Experts in financial planning believe that real change comes only when real discomfort is upon you. So the first step, which may be the most personal and important, is this: Instead of discounting the discomfort, use it for change. Step 2. Hire help A You can do a financial plan yourself, but experts say you probably won't. “People are aware of the need for a plan," says Mulheran. “They all say, ‘Yes, I got to do that.' But you talk to them eight to ten weeks later about it, and they usually say, ‘No, I haven't gotten to it.'" A Even if you get to it and finish a financial plan, then what? You may be left with a big plan but little action. “Very few people have the discipline or knowledge to execute a financial plan," says Jim Gelder, executive vice president and COO of Security Connecticut, in Avon, Connecticut. “The biggest risk in making the plan yourself is not being able to carry it out. In that case, you are doing very little except setting yourself up for disappointment and failure." A Seek advice from a professional. This person should have knowledge about the hundreds of financial products available and on the safest yet most effective strategies to help you reach your goals. Just as important, a financial planner should be a change agent who gets you started and provides an objective evaluation of the realities of your plan. She or he can help you maintain discipline, assist with adjustments due to life changes, and keep you on course during setbacks. A Many professionals—insurance agents, stockbrokers, accountants, tax attorneys, bank representatives—can call themselves a financial planner. Finding one you like and trust requires the same sort of care and effort used in finding a family physician. A Interview a few financial planners before settling on one (see sidebar). Make sure you check credentials. The letters behind the name do not guarantee good advice, but they ensure that you are dealing with a professional who has passed exams and made years of effort to obtain these credentials. There are several credentials but the most important are CFP (Certified Financial Planner), CLU (Certified Life Underwriter), ChFP (Chartered Financial Consultant), RFC (Registered Financial Consultant), and CPA (Certified Public Accountant) with the title of Personal Financial Specialist. Ask before you plan (sidebar) When interviewing financial planner candidates, ask these questions and then follow up with questions of your own.
Step 3. Dream a while This is the fun step of setting goals. It is a time for realism but also for thinking big. It is asking, “Gee, what have I always wanted out of life? Travel? Paying for my child's college? A vacation home? To quit work at age 55 and become a sculptor?" It is brainstorming at its best, scribbling down lists and dreaming up schemes. But dreaming is only part of this step. “You can daydream until the sun goes down, but the reality is that most dreams need money to materialize," write Root and Mortensen. After setting your goals, you must determine how much money you need to achieve your goals. Otherwise, you are probably working under false assumptions, maybe even believing you cannot realize your dreams because of insufficient funds. The pity is, say Root and Mortensen, “we find ourselves casting our dreams aside and waiting for a windfall." Success is seldom the result of waiting for windfalls, so set goals using the chart below. As you develop your goals, consider the following Harvard University study. Researchers interviewed the graduating class of 1953. Students were asked if they had goals and specific, written plans for achieving their goals. Only 3% did. Twenty years later the researchers re-interviewed the class of ‘53. They discovered that while all students had shared the best education money can buy, the 3% with written plans for the future were worth more, in financial terms, than the other 97% combined. Step 4. Get it all together Inventory time. You have to know where you are financially—your net worth—before you can know where you can go. You may cringe at the thought of listing what little you own and the lot that you owe. “But without a plan you don't know," which can create anxiety, says Danica Goshert, vice president of product development for Successful Money Management Seminars, Inc., in Portland, Oregon. Inventory “Most people have no idea of where they stand," says Goshert. “Many do the inventory and are surprised to find out they are worth more than they thought." Inventory A net worth statement is more than just an inventory. It also gives you a clear picture of how your assets and liabilities are divided. This may expose, for example, areas of overspending or oversights in retirement planning. Inventory To give you an idea of a simple net worth statement, see the chart below. How your net worth statement comes in handy (sidebar) Net worth statements are not only critical to financial planning, they can also be used in other financial situations, such as:
Step 5. Follow the money Managing your cash flow is often called budgeting. But for many people, budgeting has become the “B" word and has, in effect, become another word for can't. However, this step should be about can, and the term spending plan suggests making choices on spending that can help you reach your goals. So let's use spending plan. Cash is liquid, and it may seem that cash flows out of your household with amazingly little resistance. A spending plan done weekly, monthly, quarterly, or annually can slow the flow. It provides funds to cover immediate needs, and it sets aside money to invest in long-term goals. A spending plan is also a record of spending, which helps you monitor how expenses are affecting progress toward goals. A spending plan is a fundamental part of any financial plan, so make your spending plan solid. If you have never developed a spending plan, the idea is to determine household income and expenses. To do this, get out your recent pay stubs, tax returns, checkbook register, and credit card bills. Then divide your expenses into categories (entertainment, food, medical, etc.), which become useful for periodic comparison. You may also want to keep a spending diary for 60 days to track where your money goes. A spending plan should be personal, fit to you, and designed by you. The simpler and more realistic the spending plan, the more you are likely to use it. And the more you use it, the less you will agonize over how you are going to keep up with expenses, pay for the unexpected, and invest for the long-term. By the way, savings should be part of your spending plan. Experts are in unison that financial success originates from the amount you save, not the amount you earn. So put savings at the top of your list of expenses. This “pay yourself first" approach makes savings a reality; saving what is left over after all other bills are paid usually doesn't work. Experts recommend saving 5 to 10 percent of your take-home pay. Initially, savings should go toward a safety net fund, which is a cash reserve of two to six months income set aside in to meet sudden expenses, such as unexpected repairs or medical bills. Then save for future goals such as a house, college tuition, investments, and retirement. Small change, big savings (sidebar) There are many ways of finding money for savings. To name a few: Save any money you get from gifts, bonuses, or extra jobs. Quit buying books; use your library card instead. Pay off your credit cards, and then save the money you are no longer spending on interest charges. Here are two others, what Root and Mortensen, in their book The Seven Secrets of Financial Success, call “Fun Savings Schemes."
Trust time with your money (sidebar) Compound interest happens when earnings on savings or investments are added back to the principal. This re-investment in turn generates additional earnings that are reinvested again to create more earnings, and so on. Einstein once called compound interest the eighth wonder of the world. Here's one example why: Ann and Margaret were 21-year-old twin sisters. Ann puts $2,000 a year into her IRA but stops after 10 years. She never saves another cent in her life. Margaret lives it up in her 20s, but, starting at age 30, invests $2,000 a year in her IRA for 20 years. When the twins turn 50, who has more money (assuming both IRAs earn 8%)*? Is it Ann, who started early and invested $20,000, or Margaret, who started late but invested $40,000? The answer: Ann has $145,841 in her account. Margaret has $98,846. * Income tax on IRA withdrawals is not considered in this example. The above illustration is hypothetical and does not represent any particular investment. Step 6. Get the red out Sometimes even a good spending plan cannot save you from being awash in red ink. Since overspending and debt put financial planning on hold, this step is about changing the red to black. There are many reasons why people overspend. Spending is fun, and it can provide instant gratification. Let's also admit that advertising is powerful, as is the quest to keep current and keep up with peers. However, experts agree that while credit cards can be useful, they—or rather our misuse of them—are the major contributor to short-term debt. According to the Federal Reserve Board, consumers on average owe more than 20 percent of their income, not counting what they owe in mortgages and home equity loans. Getting out of this kind of debt may not be easy and will take time, but one solution recommended by financial planners is to cut up credit cards, or keep one for emergency use. This forces you to limit what you spend. Also, you will not have to pay the interest on outstanding balances, which is usually more than you pay for most loans. If you feel you absolutely need to carry a card, carry a debit card, which looks like a credit card but is really a check replacement card. Any purchase you make is immediately subtracted from your bank account. One last point: all debt is not bad. In fact, without credit most of us would not own houses or cars, and many students would not be able to attend college. These are examples of good debt, meaning it is “used to purchase appreciating assets, to make investments in materials or equipment where an economic gain will result, or when the borrowed money can be invested to produce a gain which exceeds the interest rate." Bad debt, on the other hand, is “used to purchase items with depreciating value and no income-producing potential." Unlike good debt, which is future-oriented, bad debt is covering past expenses, such as vacations or entertainment costs. Step 7. Answer the “what-if" questions These are the questions that are hard to face because they involve death, disability, aging, illness, and catastrophes. Such topics may not brighten your day, but they must be covered in your financial plan. Therefore, this is the insurance-coverage step of your financial plan. This step will safeguard your future and help free you up from worry about unpredictable events. Briefly, life insurance is used to replace income lost as the result of your death. If you support a family, keep a household running, have a mortgage, or expect the children to attend college, life insurance can fill the financial gap left by your death. In addition to life insurance, there are many other kinds of insurance that your financial planner can explain. One is disability insurance, which pays you a percentage of your salary during the time you are unable to work. Another is long-term health care insurance, which refers to a broad range of health care, rehabilitative services, personal care, and social services for people who, due to illness or disability, need special assistance with their daily activities. You can get bogged down in the details of insurance policies, but if you find yourself thinking insurance is not all that interesting, “consider for a moment how interesting life could be trying to survive without 15 months of income if your were injured in an accident," write Root and Mortensen. Step 8. Muscle up OK, by the time you reach this step, you have your spending plan set, “bad" debts cleared away, an emergency fund in place, and you have the appropriate amount of insurance coverage. Congratulations! Now, to meet the goals you have defined in Step 3, your financial plan probably needs more muscle, more of the earning power that only investments have. Investing means putting your money to work to earn more money. You have decisions to make about how much you want to invest and where to invest it. There are three basic investment categories: stocks, bonds, and cash. These categories involve scores of products, including mutual funds, individual retirement accounts (IRA), 401 (k) plans, certificate of deposits (CD), U.S. Treasury bills, etc. Sorting through these products to determine which ones suit your needs usually requires the expertise of your financial planner. You and your planner will choose your investments based on liquidity, risk, and return. Liquidity means how easily you can convert you investment to cash. If you want high liquidity investments, you probably will put your money in something like CDs or a money market fund. Lower liquidity investments are for growth toward long-range goals and would include stocks and bonds. Risk is personal. Some people shiver at the thought of losing any money investing, so they look for investments they consider safe, like U.S. Treasuries. But safety can have its price. Safe investments often promise a specific, though limited, rate of return. That rate may not yield enough growth or income to reach your goals. In fact, it may just be enough to offset the impact of inflation, which is the gradual increase in the cost of living. Investments that involve more risk—stocks and mutual funds, for example—give you a chance to beat inflation and reach your goals. With these investments you can make—and lose—a great deal of money. The rate of return on investments varies, as the chart below illustrates. The rate of return is important in reaching your financial goals. A 12 percent return on your IRA, mutual fund, and 401 (k) plan may allow you to meet your goals, whereas an 8 percent rate could put you considerably short. It is important to do paper-and-pencil projecting with your financial planner. The numbers can bring home the realities of your financial plan like nothing else can. You see the type of investing you have to do to reach your goals. “You know how much you have to put away each year," says Gold. “That should give you peace of mind. You are then free to spend the extra on yourself, your family, a vacation—enjoy life—and not feel guilty about it." Step 9. Pass it on Your financial plan should help you and your loved ones live in prosperity. This step, which is about estate planning, will help you die in peace. It is another safeguard-your-future step when it is less your future that is planned for and more the future of your surviving loved ones. The higher your net worth, the more important it is to have an estate plan that includes a will. With poor planning, you could lose up to 55 percent of the value of your estate to federal and state estate taxes. Wouldn't you prefer that your money went to people you select? However, even if your estate is modest, there are other reasons for estate planning:
You may find you have an aversion to doing this step. You are not alone; 2 of 3 Americans die intestate (without a will). Maybe it is the thought of your own death that makes you resistive to estate planning, or maybe you underestimate your estate. However, experts say this step can be one of the most rewarding acts of a lifetime, a summation of your deepest personal wishes and an act of love for those who will inherit your final gifts. Make every effort to do this step. You have come too far in your financial plan to not complete it with estate planning. Step 10. Be a player This is the last of our steps, but financial planners believe this step may really be the beginning for you. Your financial plan is now set, but “it not something you do once and say, ‘Well, I'm done with that,'" says Goshert. She advises reviewing the plan at least once a year and with every major change in economic conditions and your life. “The first time you do financial planning is the least valuable," says Mortensen. “Only when you do it again and compare do things start coming together." Beyond reviewing you plan, stay involved in your finances. Financial planning is not about turning everything over to professionals. Yes, you probably will need their help, but you also need to remain knowledgeable and active in your financial affairs. Read about your money in books and magazines. Attend seminars. Monitor your investments. Personal finance is a fascinating world once you are into it. It is a world based in reality but built on your dreams. Contact us for financial planning information This brochure can help you understand the basic steps of financial planning. This understanding should make you aware of the freedom that comes with having control over your money versus having your money control you. But to go beyond the basics you must develop your own financial plan—and then carry it out. As we have said, you will probably need professional help. We invite you to contact us at ReliaStar for information on all aspects of financial planning. We have detailed informational brochures on topics ranging from insurance, annuities, retirement planning strategies, mutual funds, college savings, and managing investments during retirement. Call the ReliaStar Line at 1-888-757-5757—or your agent—to request these free brochures. A company you can count on ReliaStar Financial Corp. is a Minneapolis-based diversified holding company whose subsidiaries provide individual life insurance and annuities; employee benefits; reinsurance; retirement plans; mutual funds; bank, mortgage, and trust services; and personal financial education. All securities products and investment advisory services are offered through ReliaStar's wholly owned subsidiary, Washington Square Securities, Inc., 20 Washington Avenue South, Minneapolis, MN 55401, 612/372-5507, a registered broker dealer. Member, NASD and SIPC. RELIASTAR ReliaStar Financial Corp. Washington Square Securities, Inc. This booklet, as well as any recommended reading and reference materials mentioned, is for general information only. It is issued as a public service and is not a substitute for obtaining professional advice from a qualified person, firm or corporation. ReliaStar is not rendering tax, legal, accounting or consulting advice. © 1998 ReliaStar Financial Corp. Form: 000000 0/98 Printed in the U.S.A.
© Copyright 2004 Gary Legwold and Conrad Henry Press. All rights reserved. |
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