In “Part 1 Personal Plan Foundation” and “Part 2 Create a Personal Financial Plan” we went over key points to start your Personal Finance Plan (PFP). In addition, we need to identify and evaluate the options to make it a SMART Personal Financial Plan (Specific, Measurable, Attainable, Realistic and Time-based).
The easiest way to explain this is to walk through the logic with an example.
Let’s assume the example plan below belongs to a fictitious couple, Mr. and Mrs. Median. We start with the draft used in Part 2, that contains our best guesses at associated costs.
More About the Medians
Their net worth statement shows they have $3,000 in a savings account. And, their financial budget has a $376 per month surplus set aside for payments on a new car. They are spending the rest of their regular take-home pay.
Some of the goals on their Personal Financial Plan (PFP) are already underway and included (funded) in the monthly budget. They’re the shaded items below.
They’re already contributing a maximum $500 per month to their 401(k) plans at work and making the regular, minimum payments on the credit card and student loans.
If you look at the “Monthly Budget, $/Month” chart, you see they start with their take-home pay and subtract out what they are already using. Then, they subtract the remaining funds needed for their PFP to figure out if they have enough to fund this plan as-is.
Oops, there’s a problem with the plan; there is a shortage of $861 per month. It doesn’t pass the SMART Personal Financial Plan test (Specific, Measurable, Attainable, Realistic and Time-based). It’s specific, measurable, and time-based, but not yet attainable and realistic.
Reluctant to give up on their dreams so quickly, Mr. and Mrs. Median roll up their sleeves with a proactive mindset to consider the three essential areas discussed in Part 1 and Part 2 of this series.
Looking at Options
Rethinking Scripts and Financial Lifestyle
After this initial disappointment, they look at their discretionary spending. Discretionary spending is taken for granted because their spending habits developed over time. These include eating out, coffee shop visits, and spontaneous purchases, and others.
More disciplined spending is needed to make the Personal Financial Plan viable and they agree $350 per month is available to free up. They agree to do that. Although significant, it is also a small price to pay for fulfilling their life dreams.
They also decide to keep their used cars, because the maintenance on these paid-for vehicles is a lot less than the cost of a new car at $376 per month.
Besides, a new car is an expensive asset that loses value quicker over time and faster than a used car. This is inconsistent with efforts to increase net worth. The can purchase a used car if needed at a lower price.
With a new mindset, they question the purpose of the $3,000 savings. They could convert it from “extra money” and commit it to the emergency fund.
Through open and honest communication, their money scripts begin to shift from mostly consumption to include more of an accumulation mentality.
In this discussion, they identified $726 per month that could be freed up by prioritizing longer-term goals overspending ($350 + $376 = $726).
Now how best can they use this money?
Reallocation of Resources
They discuss using the $3,000 savings for either paying down debt or starting the Emergency Fund. Paying debt has a lot of appeal and will produce a good return. However, no one likes to think about unexpected emergencies happening to them, but what if something does?
They decide to reduce the unknown risk and allocate the savings to the Emergency Fund.
That reduces the need for emergency funds in their PFP to $1,000. They agree to keep the Emergency Fund a high priority and set aside $167 per month to fund in six months ($1,000/$167 per month = 6 Months).
The updated worksheet of the Personal Financial Plan with changes highlighted in yellow is below. The impact of the Emergency Fund, no new car, and the budget savings reduce the PFP deficit from $861 to $135 per month.
That’s good progress, but there’s still a $135 PFP Deficit.
Funding the Personal Financial Plan Deficit
They contribute the remaining discretionary money to the 401(k) and house savings. Most importantly, the employer matches some of the 401(k) contributions, dollar for dollar. That yields a 100% guaranteed return on the matched dollars. Where else can we get that kind of return?
Unmatched dollars are still income tax deductible. Also, the money invested in the 401(k) will increase due to the eighth wonder of the world: compounded returns.
Comparing the 401(k) benefits against the 2% interest rate the bank pays on saving’s accounts makes this a no brainer. The deficit is made up by reducing house savings.
They don’t give up on the house – just delay it a little.
Early debt payment is a fertile place to make a SMART Personal Financial Plan because of the interest on the credit line. The interest rate the Medians pay on the credit card is 18%, compared to the 2% rate the bank pays them on savings.
Common sense tells us paying 18% on the credit card to receive only 2% interest on savings doesn’t make sense.
Using the online credit card calculator at Bankrate and inputting the credit card balance, interest rate, and minimum payment, we see it will take 204 months (17 Years!) to pay off the credit card. This also assumes no new purchases made on the card. Moreover, a total of $3,173 (including interest) is needed to pay off the $2,500 principle balance.
Adding insult to injury the interest over this minimum payment period shows you will pay 27% more for those purchases than you thought ($3173/$2500 = 1.269).
There is $559 remaining from the house savings ($694 – $135 for the deficit = $559). Using it to pay off of the credit card increases the monthly payment from the minimum $63 per month to $622 per month ($63 + $559 = $622).
Using another online credit card payoff calculator we see that it would take about four months instead of 204 months to pay off the credit card. As a result, a total of $2,598 (including interest) is needed to pay off the $2,500 balance.
That’s a savings of $575 in interest and 200 months of aggravating credit card payments!
With their new disciplined spending lifestyle, they pay the credit card balance in full each month and incur no interest. In addition, they agree to undergo “plastic surgery” and cut up the credit cards if they don’t pay the credit card bill off each month.
The Emergency Fund and the credit card are paid for in six months:
This is real progress let’s see how to put the $789 budget surplus to good use!
They could apply all or part of it to the student loan or savings for the house. It doesn’t have to be an either or answer. However, the student loan is at 6.8% interest and savings pays only 2%. Let’s look at paying off the loan.
Another option to make a SMART Personal Financial Plan is to add the $789 to the minimum $288 per month payment the student loan.
The LendingTree student loan calculator shows the results of applying the loan balance, interest rate, and required $288 minimum monthly payment. As a result, over the ten years, a total of $34,524 (including interest) is needed to pay off the $25,000 balance.
Adding the $789 per month surplus to the $288 per month loan payment raises the payment to $1,077 per month. The student loan calculator shows the loan paid off in just 25 months. In other words that is about eight years sooner at the cost of $26,943 for a savings of $7,581 in interest payments.
After that, there will be $1,077 per month available for other uses. Things like saving for the house or investing to get the benefits of compounded returns.
For now, applying it to the $50,000 house down payment shows it will take 47 months ($50,000/$1,077 per month = 46.4 months). That’s less than four years!
Add that 47 months to the 31 months elapsed to save for the Emergency Fund, and paying the loans gives a total of 77 months.
Not far off of the original six years planned (72 months). The early payoff of the credit card and student loan also boosts borrowing capacity and raises the credit rating. It also provides an additional $351 per month ($63 + $288 = $351).
Your Optimized One Page Personal Financial Plan:
Is it The Perfect Plan?
Probably not, but it doesn’t matter, it is a SMART Personal Financial Plan. Think of it as a living plan that will evolve with you as you change, learn and your situation changes. You will have decades to revise it.
Practical now is more important than perfect someday. We need to make informed decisions, based on our best assumptions at the time and consistent with your vision of True Wealth.
Even an imperfect plan shows you “about” where you are now and “about” where you are going. Without that, how will you ever know what path to take, let alone the best way, to get you there?
Without the perspective of a SMART Personal Financial Plan, people tend to do nothing, fearing they don’t have enough, or all the right, information.
Doing nothing is a waste of your greatest resource: Time. So act now before you no longer have the luxury of procrastination or acting at all.
Note: You can print this PFP Template Form for your use.