Morning note taking and planning Retirement

How to Make a Financial Plan

Everyone needs a financial plan, but where do you start? We break it down for you in four simple steps.

While preparing for your financial future can seem overwhelming—so much can happen and there is a lot to consider—learning how to make a financial plan doesn’t have to be stressful when approached in the right way. Like any life-sized topic, planning for your financial goals is easier to tackle in pieces—and with help. As with many finance-related matters, a dollar saved or earned earlier is better than later, due to the law of compounding. So while it may seem comfortable to wait until “tomorrow,” the earlier you implement your plan, the better. The longer you have to invest—and adjust—the greater the probability of meeting your financial goals.

Where to Start?

The first phase of learning how to make a financial plan: Identify your financial goals (what you want to accomplish with your money) and your investment time horizon (the length of time you need your assets to work for you, your family or bequest). A common pitfall at this stage is that many investors with a goal of funding retirement think their time horizon stops at retirement. While retirement is an important life event, an investor aiming to fund retirement has a time horizon of at least their lifespan. The next step—identify your income sources and expenses—is what many think is the most onerous part of financial planning.

To help get you going, here’s a preview of what you should try to compile for your income and expense report and why it’s needed to prepare your financial plan.

What’s Going Out?

Getting a handle on your expenses (day-to-day, less frequent, one-off, anticipated and even aspirational) provides an idea of how much retirement will cost when you make your financial plan. That way you’ll know what it takes to maintain life quality—from the “must have” to the “would like to get there” levels. To do that, it’s best to group expenses into non-discretionary spending (living expenses, debt payments, taxes, insurance and health-care costs) and discretionary spending (travel, entertainment and gifts for friends and family).

When accounting for non-discretionary spending, consider whether you plan on relocating in retirement. If so, explore living costs in the new area. Also count on health-care costs taking a bigger chunk of change the older you get. When it comes to health, it’s better to overestimate cost of health-care then underestimate.

Think about discretionary spending this way when figuring out how to make a financial plan: Are you able and willing to reduce or even eliminate it if times get tough? Discretionary spending is for the fun stuff—what would you like to spend on you and yours? It may also be things like that expanded-cable package. Are you willing to make do with less?

In addition to normal outlays, you must factor in inflation—the erosion of purchasing power over time. Although inflation has averaged roughly 3% a year for US consumers as a whole, retirees can face substantially higher expenses that historically have grown faster than inflation.

What’s Coming In?

Cataloging all your income sources shows you how much money you’ll have to pay for retirement expenses when considering how to make a financial plan. Start by tallying your non-investment income: Social Security, any pension, residual business income, and earned income from a family member or yourself—if you plan to work part time, for example. The gap between this and your expenses is what your investments must fill.

A few cautionary points: If the gap between your income and expenses is too large, the risk you’ll run out of money is high. For example, some folks think 10% annual withdrawals from an all-stock portfolio are sustainable because stocks have returned roughly 10% over timei. We believe this is dangerous thinking! The average isn’t assured to repeat in your retirement years, and either way, it results from a large mix of years above and below it—including down years. Withdrawing heavily in those down or low-returning years can spell problems later, even if stocks do return their long-run average through your retirement years.

Additionally, Social Security comes with the twist of deciding whether to keep working or start receiving benefits. The longer you can delay taking Social Security—up until age 70—the greater your benefit payments will be, often substantially so. Make sure you weigh the decision carefully when thinking about how to make your financial plan, as the early strain on your portfolio can increase the likelihood your withdrawals deplete the assets. It’s a balance.

Your Guide to Retirement

Before you get started, don’t fret about getting everything exactly right. Projected financial information need not be completely accurate early on, but the more information is available, the more realistic the assessment you can make when deciding how to make a financial plan work for you. We understand that none of this is set in stone. Circumstances change—that’s life. But it’s also why financial plans require periodic review and updates.

Once you have a plan, the challenges aren’t over. You still must implement and then stick to the plan—both in budgeting and investment-strategy terms. Adjusting as circumstances change becomes a continual process, requiring ongoing attention and discipline to implement. But in crafting a retirement income and expense profile, you have taken a crucial first step towards a more comfortable retirement.

iS&P 500 Total Return 12/31/1925-12/31/2016 = 9.92%, Source: Global Financial Data, Inc., 1/5/17. The S&P 500 Total Return Index is based upon GFD calculations of total returns before 1973. These are estimates by GFD to calculate the values of the S&P Composite before 1971 and are not official values. GFD used data from the Cowles Commission and from S&P itself to calculate total returns for the S&P Composite Price Index and dividend yields through 1970, officially monthly numbers are from 1971 to 1987 and official data from 1988 on.

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