Financial Planning Process

We will explain the financial planning process with a step-by-step approach. We will also talk about things that affect financial planning, such as investment time-frame, risk and investing style.

Learning about the financial planning process can be challenging if you are new to investing. In the old days, investing was simple: stocks, bonds and real estate. Today, the financial planning process has become much more complicated with hundreds of choices that may be very complicated to understand.

The good news is that your investment portfolio can be as simple or as complicated as you want it to be. In addition, you don’t have to be rich to begin investing. In this article we will lay out a clear, 5-step approach to the financial planning process you can use to organize how you invest.

Investment is defined as,

“the investing of money or capital in order to gain profitable returns, as interest, income, or appreciation in value.”

Summary of Financial Planning Process

  1.  Establish Goals
  2.  Assess Personal Finances
  3.  Determine Risk Tolerance
  4.  Develop Investing Timeline
  5.  Begin Allocating Funds for Investment

Step 1: Establish Goals

The first step in the financial planning process should be to determine what your financial goals are and what you wish to accomplish. Where do you see yourself in 10, 25 or even 50 years? The average life expectancy for Americans is around 78 years. However, you may have family members that live to be in their 90s and beyond. If you retire at 65 and live to be 95, will you have enough money invested to last through your retirement years?

Write Down Your Goals

If you want to retire at 65 and move to Portugal, then included this as part of your written goals. Begin by creating a journal, a spreadsheet or plan where you list exactly what you have planned for the future. This serves two purposes. First, writing down your goals makes what you want explicitly clear. It gives you a starting point and also provides you with the details that you will need to determine how you will reach your goals.

Second, the purpose of planning out your financial goals on paper (or electronically) is that you are signaling to yourself and others what you want. History has proven that the psychology of desire and intention is a powerful tool in accomplishing goals. Many wealthy investors credit their personal wealth and success to the philosophy outlined in the book, “Think and Grow Rich” by Napoleon Hill.

Step 2: Assess Personal Finances

Learn to Budget, Save, Pay Off Debt and Live Below Your Means

Budgeting is one of the critical steps that can help you take control of your life and control personal finances. In addition, preparing a budget allows you to not only know where your money goes, but also allows you to plan where your money will go in the future. Finally, it’s important that your money works for you, not against you in your financial planning process.

During the financial planning process, we also prepare ourselves for better quality of life by having more money. Having more money means that you have more power to dictate the kind of life you want, especially in retirement.

How Budgeting can help you:

  • Improve your credit score
  • Save for emergencies
  • Save and invest for retirement
  • Stop wasting money and curb bad habits
  • Promote a healthy, meaningful lifestyle
  • Buy a new home or upgrade your existing home
  • Obtain financial freedom

Pay Off All Debts

Before you can start the financial planning process, you must pay off all debts. Now that you’ve established your budget, cut personal spending to the bare minimum. You will take extra money that you have leftover in your budget and use it to pay down debts. Create a list or accounting of your debts, the corresponding balances and interest rates that you maintain. Use this information to help you keep track of your progress as you pay down debts.

If you are young and just starting out, hopefully your debts are minimal. Having minimal or no debt when you begin your journey toward wealth creation is a huge advantage. Paying off debt can take years and a great deal of sacrifice.

Living Below Your Means

While following a budget, you should be living below your means (hopefully). Unfortunately, living below your means is a philosophy that most people don’t follow these days. Living below your means requires that you spend less than what you make. For example, if your take home pay is $1500 per month, then living below your means is only spending $1,000 per month.

The extra money that you save from living below your means will serve two purposes. At first the extra money will be used to pay down debts quickly. Getting ahead requires that all debt be paid off first. Secondly, after the debt has been paid off, you will then use the positive cash flow to fund your emergency fund, savings and investments. Each of these is part of your net worth and the buffer between you and poverty. The more you can grow your savings and investment, the simpler and easier life gets.

Save Money Every Paycheck

Put Aside 10-15% of Your Regular Income for Investment

One of the habits that can help you reach your goals in the financial planning process is to start saving each paycheck. Make it a habit to take 10-15% of each paycheck and save it. After a short time, you will realize that you don’t even miss the money.

Make saving 10-15% of each paycheck easy by setting up an automatic money transfer, either to your investment account or to your savings account. For example, each time your paycheck is deposited into your checking account, have an automatic transfer set up that moves money into your savings account. Some people even have a savings account that is in a different bank to reduce the temptation of raiding the account.

Step 3: Determine Risk Tolerance

What is Your Level of Risk?

Active Versus Passive Investing; Aggressive Versus Conservative Investing

To start, you must determine what style of investor that you are. First, the major categories of investment include active management or passive management. For example, a portfolio manager can determine what investments are in your fund and make decision for you using passive management; however, active management means that you reserve more control of your investments and perhaps you even use online services to trade individual stocks on a daily basis.

Second, you must determine if you are an aggressive or a conservative investor. Aggressive investing is utilized by those who want to take more risk and capture greater returns. This type of investing is considered acceptable for younger investors and for savvy investors who want to dedicate a small portion of their portfolio to higher risk. Conservative investing is a lower risk style of investing. Returns tend to be lower than the aggressive style, but come with lower risk. This style is best for those that desire lower risk and those who are getting closer to retirement age.

Step 4: Develop Investing Timeline

Estimate Retirement Age and How Much Money You Need to Retire

How old will you be when you retire? This is one of the questions that you want to answer during the financial planning process so that you can gauge your progress toward retirement. In addition, you can set goals for how much money you need when you reach the milestones of 30, 40, 50 and 60 years old and so forth.

Retirement Age

First, if you live in the United States and were born after 1960, you may be eligible to retire at age 67. Second, if you were born earlier than 1960, then the age requirement is 66. These are the ages where you may be eligible for Social Security Benefits. Consequently, you can look at the United States Social Security Benefits Website for additional details. They also offer a retirement calculator and benefits planner there.

If you want to narrow down how much money you will need for retirement, there are four primary factors needed.

  • Current Age
  • Retirement Age
  • Monthly Cost of Living (Estimate)
  • Life Expectancy

First, if you take your current age and subtract your retirement age, then that gives you how many years you will have to save for retirement. For example, if you plan to retire at 67, and you are 40 years old, then you have 27 years to save (67-40 = 27).

Planning for 30 years of retirement is a typical timeframe that most investors use. However, life expectancy has been increasing for Americans and you should also consider that you may live to be 100 years old.

Determine How Much Money You Need to Live on

You Will Need 70-80% of Your Current Salary for Retirement Expenses

While thinking about budgeting, take a closer look at how much money you need to live on each month. For example, what basic amount of money do you need each month to cover expenses? You need enough money to pay for a place to stay, food, electricity, etc. Don’t include things like vacations, luxury items or entertainment. Once you determine how much you need to live on, you can then start to figure out what retirement expenses look like.

Another common rule of thumb for estimating how much money you need when you retire is the 70-80% Rule. In other words, many experts believe that you will need at least 70-80% of your current income to make ends meet. For example, if you bring home $3,000 each month, then you will likely need approximately $2,100-2400 each month in retirement. This is a realistic way of estimating what you need to retire if you don’t want to do complicated calculations or spend a lot of time on the topic.

Step 5: Begin Allocating Funds for Investment

This step is the final step in the financial planning process. You will begin depositing money into your investments. The easiest way to start is to allocate a percentage of your earnings each month. You will then review your investment portfolio each year with your investment advisor to determine whether it requires changes. Your investment advisor can help you through the financial planning process.

Ideally, your investments will be divided into groups, with a certain percentage of your total investment allocation going to each group. For example, you may have chosen to invest in stocks, real estate, precious metals and cryptocurrency. You may be investing 50% in stocks, 25% in real estate, 20% in precious metals and 5% in cryptocurrency. Obviously, the percentage allocated to each group you choose will be determined based upon your risk tolerance.

Dollar-Cost Averaging

Many wise investors use “dollar-cost averaging” as a part of their financial planning process. Dollar-cost averaging is simply dividing up the amount of money you have to invest over a longer time frame. For example, let’s say you have $1,200 to invest in the year 2021. Then each month, you will invest $100 ($1,200/12 months = $100/mo.). Your $1,200 investment would then be dollar-cost averaged over a one-year period.

This investment methodology means that you invest the same amount of money each week or month, no matter if the market goes higher or lower. Dollar-cost averaging takes the emotion out of the financial planning process and simplified investing. It also prevents investors from making bad decisions.

If you don’t know how much to invest, then start out simply. Every month, divert 10-15% of your earnings to investment(s). An example would be investing in a 401(k), Investment Retirement Account (IRA) and/or real estate. Year after year, your money will grow and work for you during the financial planning process to create wealth.

Diversify Investments

No one can predict the future to know what investments will do well and which ones will fail. As a result, we can improve our odds of success in investing my diversifying our investments. Diversification of investments means spreading your money over different investment sectors. For example, you may want to have some stocks, bonds, real estate and precious metals in your investment portfolio.

Tax Considerations

Some investments will inherently have higher tax implications than others. In many cases, timing is important when the asset is sold in determining how it is taxed. The level of taxation of an asset can impact your return on investment. For example, if you purchase a home, fix it up and flip it for a profit, it will be taxed at a higher rate than if you simply bought a home and lived in in for a few years.

Find a Good Financial Advisor

Many of the topics discussed regarding personal finance and investment complicated and you probably need the assistance of a financial advisor. A financial advisor can help you make better informed decisions about how to best invest your money. Be careful to select an advisor who is knowledgeable in their industry and who has a proven track record regarding investment.

Unfortunately, many “financial advisors” are simply sales people who know very little about investment and are simply trying to earn a commission by locking in your business. Do your research to find the best candidate. In some cases, good financial advisors charge an upfront fee for consultation because they do not earn a commission from helping you with investing.

Caveat on “Faux Investments”

Our list of investments did not include several financial products that some may consider investments. The reason we excluded these “faux investments” is because they don’t provide real returns on your investment and/or they may be risky. In addition, many of the faux investments may actually lose money on an annual basis, guaranteed.

For example, if you place your money in a savings account and nominally earn 0.1% interest on your savings, this might sound ok. However, if you consider that inflation is currently 1-3%, then your 0.1% rate of return at the bank is eaten up by inflation. In fact, you actually lost money from inflation, guaranteed.

List of Faux Investments

  • Savings Accounts – Money in savings earns very little interest and cannot withstand current inflation rates.
  • Options – Risky market plays that often expire worthless and are simply a hedge against other investments.
  • Futures – Risky market play that hedge against counter investments and require deeper level of investment and trading knowledge.
  • Initial Coin Offerings (ICOs) – Many of these are not available to investors in the United States and may have regulatory implications.

Types of Real Investments:

  • Stocks
  • Bonds
  • Mutual Funds
  • Retirement
  • Real Estate Trusts (REITs)
  • Real Estate (Land/Homes)
  • Annuities
  • Precious Metals (Gold, Silver, etc.)
  • Cryptocurrency (Bitcoin)
  • Insurance

Take Control of Personal Finances and Begin Investing

Now is a great time to begin getting your personal finances in order. Thinking and planning for the future are noble activities that we encourage at Piggy Bank Coins. Moreover, every adult should learn to budget, save money and invest at some time in their life. If you have a family, it is critical that you begin planning your financial future and develop a financial planning process.

Read More:

Wealth Building Cornerstones

How to Save a Million Dollars

Value Investing Books

10 Things to Know Before Starting a Budget

Is It a Good Time to Buy Stocks?

Disclaimer: It is important to note that Piggy Bank Coins does not provide financial advice. We don’t endorse or recommend any financial investments. Instead, we provide information for educational purposes to those seeking knowledge regarding personal finance. However, in the spirit of transparency, note that the author is an investor in cryptocurrencies, precious metals and some equities.

In addition, The Federal Trade Commission (FTC) requires that Piggy Bank Coins disclose to readers that we may receive commissions when you click our links and make purchases. However, this does not impact our reviews and comparisons. Moreover, we try our best to keep things fair and balanced, in order to help you make the best choice for you.

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