For true financial happiness, it’s important to approach your money holistically. That’s where financial planning comes in.

Americans with a more detailed financial plan are about three times as likely to report greater happiness in money matters, including goal setting, debt, net worth, and financial allies.

Financial planning is the process of looking at your entire financial picture and putting together a comprehensive plan where each area works together and helps you reach your financial goals. Financial planning can be done at any time in your life, but it’s especially helpful in preparing for major life milestones, such as marriage, a new job, a new child, or the loss of a loved one.

A financial plan should be dynamic in nature. You should consider revisiting and adjusting your plan over time in response to life changes. That way, your financial plan grows with you.

What is financial planning?

Financial planning is the process of assessing each area of your personal finances and making a plan for it. Financial planning is designed to help you reach both your short-term and long-term goals. Each area of your financial plan is designed to get you closer to those goals.

A comprehensive financial plan directs your cash flow, insurance, investments, retirement, taxes, and estate plan. However, an emphasis will be placed on those areas of significant need or those directly related to your biggest financial goals.

An important part of financial planning is finding a balance between short-term and long-term goals. In the short term, financial planning seeks to help you:

• Manage your cash flow
• Minimize your tax burden
• Protect your assets through risk management

In the long term, financial planning seeks to help you prepare a nest egg for retirement.

Read more: Financial planning for young adults

Why is financial planning important?

Financial planning, whether done yourself or with the help of a professional, is important for several key reasons. Let’s talk here about some of the benefits financial planning can provide.

1. Providing financial confidence: Having a written financial plan can increase your confidence. Not only have you gained valuable insight into your finances through the creation of the plan, but you also know that your goals are achievable if you take the steps outlined in the plan.
2. Navigating economic challenges: Changes in the economy, such as recessions, inflation, and rising interest rates, can wreak havoc on a family’s finances. Having a financial plan in place will help prepare you better to handle those undesirable but completely normal economic events.
3. Ensures a financial safety net: A financial plan isn’t just about building assets, but also about protecting them. Your financial plan will include financial safety nets such as an emergency fund and the proper insurance policies to help you navigate any emergencies and unforeseen events.
4. Meeting short-term needs: A financial plan can help you meet your basic and immediate needs by helping you manage your cash flow. It can also help you accomplish short-term goals — anything from a family vacation to the down payment on a home.
5. Achieving long-term goals: Another important function of a financial plan is helping you reach your long-term goals. One of the primary long-term goals a financial plan helps you meet is a comfortable retirement. However, it can also help you create a plan for building and transferring generational wealth to your loved ones.

Components of a comprehensive financial plan

A financial plan should be a comprehensive and holistic approach to your personal finances. It addresses each area of your finances and ensures they work together seamlessly. Here are the steps generally involved with creating a financial plan.

Step 1: Setting financial goals

Before you can complete your full financial plan, it’s important to have specific financial goals you’re striving for. A good financial plan should balance both short-term and long-term goals.

Here’s a tip: If you aren’t sure what financial goals to strive for, picture yourself in five, ten, or twenty years. What does your life look like? Do you have a family? What kind of home do you live in? What do you do with your spare time? Picturing your future self can help you identify your goals.

Consider using the framework of SMART goals, meaning those that are specific, measurable, achievable, relevant, and time-bound.

Step 2: Track your money

One of the first steps in creating a financial plan is getting your cash flow under control. To do that, it can be helpful to start tracking your spending to figure out where your money is going. Once you know where your money is going, you can put an intentional budget in place.

There are many different budget methods you can use, but one of the most popular is the 50-30-20 budget. It prescribes you to put 50% of your income toward needs, 30% toward wants, and 20% toward savings and debt.

Remember that your budget should account for your current spending and short-term goals, but also your long-term goals. If you don’t make room for your long-term goals in your budget today, you won’t make the necessary progress to meet them eventually.

Step 3: Budget for emergencies

Part of creating your financial plan is planning for things to go wrong, and that includes building an emergency fund. It’s a sum of money you’ve set aside to help pay for unplanned expenses and financial emergencies. It could be something as small as unexpected car repairs or something as big as a job loss.

There’s no set amount you should have in your emergency fund. However, financial experts generally recommend setting aside between three and six months of expenses.

Building an emergency fund isn’t something that can be done in just a month or two. However, once you determine how much you need to save, you can start setting aside a small amount each month until you’ve fully funded your emergency fund.

Step 4: Tackle high-interest debt

Debt repayment is an important part of progressing in your finances. Not only can debt create a large emotional burden, but it can also be expensive due to the interest associated with it.

When you start paying down debt, you have a couple of options. Two of the most popular debt repayment strategies are the debt snowball and debt avalanche. The debt snowball has you prioritize your smallest debts first, while the debt avalanche has you prioritize the debts with the smallest interest rates. You should choose the plan that works best for you – but know that the debt avalanche is the most cost-effective, as it eliminates your high-interest debt first.

Finally, if your debt is unmanageable as it is, consider debt consolidation to help you get fewer monthly payments, a lower interest rate, and/or a lower monthly payment.

Step 5: Plan for retirement

Retirement is the most expensive financial goal most of us will ever save for, so it’s no surprise that it’s also one of the most important parts of financial planning.

Planning for retirement has a few different elements, and it starts with envisioning what retirement looks like for you. That means identifying two things: when you want to retire and what your monthly income will be during retirement. Using these two factors, you can get a good idea of what you need to do to prepare for retirement.

When it comes to savings, you have plenty of options. Most traditionally employed individuals have access to a 401(k) plan sponsored by their employers. You can also save in an individual retirement account (IRA) alongside the 401(k). If you’re self-employed, your options include a solo 401(k), SEP IRA, or SIMPLE IRA.

Each of these accounts has different eligibility requirements, contribution limits, and other unique characteristics, so it’s important to research each plan to determine which is right for you.

Step 6: Optimize your finances with tax planning

Many people think of taxes as a necessary fact of life that they have little control over. The good news is there are steps you can take to reduce your tax burden. You can do this through a few ways:

1. Take advantage of deductions and credits: This is the simplest way to reduce your tax burden. Tax software will automatically help you take advantage of any deductions and credits you’re eligible for.
2. Use retirement accounts: Retirement accounts are tax-advantaged. They either allow you to reduce your tax burden upfront or reduce your tax burden during retirement. A financial professional can help determine which tax advantage is best for you — or maybe whether you should use a combination of both.
3. Tax-efficient investing: Investing in a taxable brokerage account can result in both income and capital gains taxes. You can save money on taxes by engaging in more tax-efficient investing and allocating your investments strategically between your taxable brokerage and retirement accounts.

Step 7: Invest to build your future goals

Investing is one of the most important steps in building wealth and reaching your financial goals. There are many ways to build wealth, both through taxable brokerage accounts and tax-advantaged retirement accounts.

When you’re investing, some of the most important considerations to keep in mind are risk tolerance, diversification, and asset allocation. Each person’s investment strategy may look different depending on their financial goals, so it’s important to build a portfolio based on your unique situation and goals.

Step 8: Protect your financial well-being

Financial planning isn’t just about building wealth, but also about protecting it. That’s where risk management comes in. Risk management is the process of buying the necessary insurance policies to protect your finances. Depending on your situation, you may need one or more of the following types of insurance:

• Health insurance
• Life insurance
• Homeowners insurance
• Renters insurance
• Auto insurance
• Umbrella insurance
• Disability insurance
• Long-term care insurance

It can be tempting to skip insurance because it’s an added cost in your budget. However, a small additional monthly cost for insurance can save you thousands — or even hundreds of thousands — of dollars if there’s an emergency.

Step 9: Estate planning for future generations

Estate planning is the process of planning for your assets after you pass away. For most people, it means creating a plan for how your assets will pass to your loved ones with the least amount of time, cost, and taxes.

The most basic type of estate plan is a will, which is a document that prescribes how your assets will pass after your death. Everyone should have a will but, depending on your situation, a will may not be enough. For that reason, many people also use a trust and other estate planning documents.

Read more: Seven essential steps for retirement planning

Do-it-yourself vs. professional financial planning

When it comes to establishing an estate plan, you can enlist the help of a professional or go the DIY route. Both options have some pros and cons.

Hiring a professional financial planner will result in the most comprehensive plan created by someone with expertise in the field. However, it also comes with a price tag. A DIY financial plan, on the other hand, is cheaper but may not be as comprehensive or effective as one made by a professional.

If you decide to hire a professional, it’s important to find the right fit for your situation and goals. There’s not necessarily a set definition of a financial advisor, nor are there many requirements for being considered a financial advisor. However, you can hire a  financial planning professional who is certified to get an additional level of professionalism and expertise.

The other thing to consider when choosing a financial professional is the cost. Some planners charge a fee — this can either be an hourly fee, a per-project fee, or a fee as a percentage of assets under management — while others earn a commission for recommending certain financial products.

Finally, when hiring a financial professional, make sure to choose one that offers the services you need. While many financial planners offer comprehensive planning services, others focus on just one or a few areas, such as insurance or investing.

The role of robo-advisors

A robo-advisor is a digital service that builds a portfolio on your behalf using an algorithm and information about your personal finances. A robo-advisor doesn’t build a custom portfolio in the same way a financial professional might, but it does build one that is suited to your financial situation and goals.

A robo-advisor can be a good compromise between hiring a financial professional and going the DIY route. It is more cost-effective than a financial advisor and still offers services like automated portfolio monitoring, rebalancing, tax-loss harvesting, and more.

One thing to consider, however, is that robo-advisors typically only offer investing services and can’t help you with other areas of your financial plan.

Read more: AI in financial planning

How to choose the right help for you

Before you proceed with your financial plan, you’ll have to first decide between hiring a professional, going the DIY route, or using a robo-advisor while doing other parts of your financial plan yourself.

The right answer may be different for everyone. Someone without financial knowledge or the time to manage their own finances may prefer to hire a professional financial planner. On the other hand, if you feel comfortable managing your own finances and feel confident in your ability to do so, you might decide to create your own financial plan.

A robo-advisor can be a happy medium for those who feel comfortable planning certain areas of their finances, but who want a less hands-on approach for their investments.

Implementing and monitoring your financial plan

Creating your financial plan is only one step of the process. Once your plan is created, you must also implement and monitor it to ensure you stay on track with your plan and see that your goals come to fruition.

If you hire a financial planner, they may help you through the implementation and monitoring process. You can also use a robo-advisor to help you with at least the investing portion, as we mentioned previously.

It’s also important to remember that your financial plan shouldn’t be a static document – your financial plan at 25 will reasonably look very different from your plan at 35, 45, 55, and 65. While your long-term goals may look similar, your current financial situation and short-term goals are likely to change drastically over the years, and your financial plan should change with you.

The bottom line

A financial plan may seem like a large undertaking — and it is — but it’s also a valuable one to help you get on the right track with your finances. A financial plan takes a comprehensive and holistic approach to assessing and outlining a direction for each area of your finances. It’s a critical step in managing your cash flow, protecting your assets, and reaching your short-term and long-term goals.

 

 

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