Part 2 Create a Personal Financial Plan

We live in the wealthiest country in the world, yet people struggle with money for a lot of reasons. The way to avoid money problems is to create a personal financial plan (PFP) to take control of your financial future.

Don’t worry—it’s actually pretty easy to do and one or two pages long. Writing your own PFP makes it personal by reflecting your goals and priorities.

This is the second article in a series of three. You should read “Part 1 Personal Financial Plan Foundation” if you haven’t already.

Step 1: Start with a Proactive Mindset

Start this process with the right mindset:

Value your freedom of choice and the right to exercise that freedom.
You are a product of your decisions, not your conditions.
Choose thoughtful responses to opportunities and challenges you face.

This mindset will help assure you create a personal financial plan that you own and is specific to your circumstances and goals. It is the financial basis for your story.

Step 2: Determine Your Current Financial Situation

Your PFP will be the path from where you are today to where you want to go and defines the specific next steps and priorities to accomplish that.

Start with your current Net Worth. Instruction on how to prepare one is discussed in “How to Determine Your Net Worth.”

Also, in “Net Worth as a Lifelong Scorecard” we discuss Net Worth as the objective measure to monitor your progress over a lifetime.

Step 3: Setting Your Financial Goals

It is important to set goals that are realistic and achievable. That means goals that balance enjoying your current life while pursuing your vision of True Wealth.

The plan is not realistic without a “livable” balance. For example, the less you spend the more you can save and that is a good thing but only to a point. Mr. Scrooge miserly saved everything but missed out on enjoying life.

There are healthier and easier ways to do this! Goals should include provisions for things that make life worth living like having a family, children, friends, buying a home, vacations, and giving back. Make room for your life interests, hobbies, and just having fun.

Also, plan around what you know and don’t get bogged down worrying about the unknowns. Life happens and as things change your plan is adapted to reflect those changes.

A Financial Plan is not a Financial Budget

Plans and budgets are sometimes used interchangeably and even some of the “experts” get it wrong. There actually is an important distinction between the two.

A financial budget balances your weekly, monthly, or annual income with expenses and is frequently monitored. The financial plan is long term in nature and covers your expected lifespan.

Although separate tools, the financial budget, and the plan must be consistent. The budget should reflect provisions to accomplish your financial plan goals. For example, a financial plan may include the amount of money you plan to accumulate for a secure retirement. The budget could include the monthly payroll withdrawals to accumulate the retirement goal.

It’s important to keep the long-range goals separate from immediate expenditures (the end in mind) so your financial plan doesn’t revert into a budget, and you lose sight of your long term goals and dreams.

A one year review is usually sufficient for a financial plan unless there are major changes in your life (marriage or children, job loss, etc.).

Making it a SMART plan, which is Specific, Measurable, Attainable, Realistic and Time-based, provide the measures to monitor progress.

Setting Financial Goals

To create a personal financial plan start with the big-ticket items. Make sure they are consistent with your desired lifestyle and vision of True Wealth. They could include:

Buy a house
Buy a new car
Maintain the family standard of living in the event of death or disability
Pay off a mortgage early
Become debt free
Preserve your standard of living during retirement
College education for children
Become financially independent
Start your own business
Travel the world

Personal Financial Plan Worksheet

Use the worksheet below to list the big-ticket items in the Goal column for the first draft of your PFP.

Estimate the total cost or budget amount for the items and the time needed to pay them off. Break it down into the monthly amount for each and use the notes column for any reminder you wish to capture.

Let’s go through an example below to better illustrate this.

Working Through an Example

Let’s assume your net worth statement is done, and your initial set of goals are:

Save $4,000 for any unforeseen emergencies within two years
Pay off the $2,500 credit card balance because of the high-interest rate
Pay off the $25,000 student loan debt to free up credit to buy a house
Trade in your car for $10,000 toward a new car costing $27,000
Save a 20% down payment on a house costing about $250,000
Continue to save and invest for retirement

This is the first draft of your Personal Financial Plan and it looks like this:

A portion of the $2,088 per month is for current living expenses. Payments are made for the 401(k), the credit card payment, and a student loan. These are examples of big-ticket items that are already underway. Include them when you create a Personal Financial Plan.

Step 4: Identifying and Evaluating Alternatives Options

What if all your monthly income is used for current expenses and there is nothing to set aside for something else? This is not unusual, many live paycheck to paycheck. This is a pattern that a Personal Financial Plan can help break.

Listing your items or goals does not make them self-fulfilling. It is only a wish list until you evaluate and choose the options to make the plan realistic and achievable.

In this step, you will discover the ways to make your PFP doable or adjust the plan until it is. When you create a Personal Financial Plan it must be SMART (Specific, Measurable, Attainable, Realistic, and Time-based).

This requires thinking in different ways and changing priorities to get the biggest bang for the buck and doing first things first. There are generally three important areas to consider while doing this:

Rethinking Your Scripts and Financial Lifestyle

This is a good time to think long and hard about your money scripts and the financial lifestyle you are living.

Are they consistent with where you want to be? Are you measuring the true opportunity costs associated with your lifestyle? Have you considered the full value of deferred gratification?

Reallocation of Resources

Another option is to reassign resources to other uses. For example, you could move money from savings and investments to debt repayment if the long term financial benefit is greater.

It’s strongly recommended to save and invest early to gain the benefits of the eighth wonder of the world: compounding. But that makes no sense if you’re living under a pile of credit card debt and can get higher returns paying off the debt.

Generating New Resources

Another area to consider is generating new resources. Pay raises occur over time, but perhaps more aggressive actions like changing jobs to earn more. Some may work additional hours or find a second job for a while.

On a side note, accelerated debt payment is a reallocation of resources. Consequently, it is ultimately a new resource of income, or more accurately, a recapture of your existing resources for other uses. It’s like giving yourself a raise!

Evaluating the Options

The number of options available and the impact of timing may surprise you. Therefore the best way to determine this is by analyzing the economic benefit of each to your situation.

Finding the best path to your financial goals is an ongoing process as your financial position continues to evolve.

We’ll discuss some of these options in the next post “Making Your Personal Financial Plan SMART” and apply them to the rough draft plan above.

Step 5: Implementing Your Personal Financial Plan

Once you identify and evaluate your options for impact and cost, their priorities often become self-evident.

This doesn’t mean you can’t override the economic priority for something else. But if you choose to override it, you’ll understand the opportunity cost of doing so.

In this step, you will likely make decisions as to which goals to pursue now and how best to get there.

Step 6: Reviews and Revisions

Going forward, review your PFP once a year, unless an unanticipated event requires an earlier review.

Things like marriage and starting a family may increase the priority of buying a home or saving for college and eliminate that new car or boat.

A Simple Process

A key determinate of success in reaching your vision of True Wealth is to create a personal financial plan. The process is simple. However, investing time in Part 1 of this series to reflect on your money habits and attitudes will help make the plan realistic and maximize the chance for success.

Write your personal finance plan by working through these steps: