Structure is the key to growth. Without a solid foundation – and a road map for the future – it’s easy to spin your wheels and float through life without making any headway. Planning allows you to prioritize your time, plot your future and measure the progress you’ve made.
That’s especially true for your finances. A good financial plan allows you to grow and improve without any wasted effort, so you can focus on what’s most important to you. As long as your plan is solid, your money will do the work for you.
Thankfully, a good financial plan doesn’t have to be complicated. Here’s a step-by-step guide to creating your first one.
Evaluate Where You Stand
Building a financial plan is like creating a fitness program. If you just start doing random exercises, you could end up injuring yourself without making any actual progress. You need to get an accurate assessment of where you stand, devise a strategy to address any weak points and construct specific goals to work on.
There are a few ways to determine your current financial status. The first is your net worth, or what’s left over after you subtract your liabilities from your assets.
Liabilities are debts, like your student loan balance, mortgage or revolving credit card debt. Even the $1,500 you owe your parents is a liability. Assets are what you own, such as the money in your bank account, retirement account or the equity in your home. Your assets and liabilities will change over time, especially if you pay off debt and grow your savings.
A recent college graduate might have a negative net worth if they carry a high student loan balance and have only $500 in the bank. After paying down that debt and increasing their income, that same person may have a high positive net worth.
You should track your net worth on a regular basis. If it goes up, you’re making progress. If it decreases, you’re probably doing something wrong. It’s that simple.
Track Your Spending
Another way to evaluate your finances is to measure your cash flow, or how much you spend compared to how much you earn. While net worth gives you a clear idea of where you stand financially, cash flow is a great way to determine where you’re headed.
Negative cash flow means you spend more money than you make, which could lead to a growing credit card balance and eventual bankruptcy. Positive cash flow means you spend less than you earn. This leads to a surplus, which you can add towards any financial goals you have.
Once you have an idea of your cash flow, it’s time to set up a budget. Budgeting will help you sort out your priorities and filter your money into the right areas.
Now that you have a clear picture of your finances, it’s time to put your money to work. The question is, what do you actually want it to do? Do you want to pay off your loans? Do you want to buy a rental property? Do you want to retire at 45?
Make a list of your goals and dreams, like running a doggy daycare or living part-time in Paris. A financial plan should incorporate what you want most in life, even if it sounds outrageous.
Goals keep you motivated to spend less money, stick to your budget and make difficult choices. Goals remind you why you’re not going on vacation or why you’re driving a beater. Living a financially responsible lifestyle can be a slog at times, so it’s important to have a clear reminder of why you’re doing it in the first place.
When I graduated from college, my goal was to pay off my student loans in three years. Once I did that, my next goal was to become self-employed. After that was accomplished, my husband and I decided we wanted to save for a home. Six months ago, we bought our first house. Our next goal is to increase our income and save more for retirement.
Goals aren’t static things, so expect them to change over time. When that happens, your financial plan should change with them.
Create a SMART Plan
Follow the acronym SMART to help you make an actionable and useful plan:
Specific: Your plan needs to be concrete and detailed. Don’t say, “I want to retire early.” Say, “I want to retire at age 50 with $2 million in my IRA.”
Measurable: They say you can’t manage what you don’t measure. Create a system to track your progress, whether it’s a spreadsheet, budgeting app or bullet journal. Check in once a month to monitor your plan and update it if necessary.
Achievable: Every plan should be achievable. It doesn’t have to be easy, but it should be possible and realistic. Saving $100,000 in three years isn’t doable if you’re earning $25,000 a year and have $50,000 in student loans.
Relevant: This is your financial plan, so make sure you’re planning for something you actually care about. For example, a lot of my fellow personal finance writers are on the early retirement bandwagon. That’s not something I want to reach, so creating a plan to retire at 40 wouldn’t be relevant.
Time-bound: A successful plan should have a timeline, which keeps you on track and helps you know if you’re veering off-course.
It’s always a good idea to reevaluate your plan if you get married, have kids or quit your job. Every few months or so, take some time to look at your progress and assess problem areas. Take the time to celebrate milestones – it will help motivate you going forward.
Ask for feedback on your plan from people who know you. Your best friend might point out some things you’d forgotten about, like your desire to get a dog or live in a downtown loft. You can also run it by a professional financial planner, who can provide some objective insight and professional wisdom.