For the novice investor, financial planning can be difficult to understand. It's an ongoing process that involves a great deal of work, including plenty of maintenance and attention to make sure you stay on track toward meeting your goals. Although some people will feel more comfortable working with a professional to meet those goals, those who prefer to do things on their own can guide themselves through the process in the same way many professionals work with their clients.
The basic planning process
If you choose to work with a financial professional, the first thing that person should do is to get to know you better. And that means more than just gathering your financial data, although having the professional know your income, expenses, assets, and debts is an important part of his or her understanding your financial situation. It also means talking with you on a personal level to find out what motivates you, what's most important to you, and what your goals are.
The personal element of financial planning is far more important than many people believe. Because personal decisions inform and guide the entire planning process, starting out without a firm understanding of how you make those decisions is likely to produce a plan that won't work for you. For instance, if a planner knows you're 40 years old and make $200,000 per year, it's relatively easy to run through a variety of financial projections to tell you when you can retire and how much money you'll have. Yet if you don't like your job and would prefer to do something else that might not pay as well but would give you far more personal satisfaction, then creating projections that rely on your current salary level for the next 25 years probably won't reflect what your actual situation will be.
Although you may have a vague sense of your motivations and personal goals, some people find it extremely challenging to analyze their feelings about money in detail. If you have trouble being specific about your goals, you may find it helpful to have conversations with family members or close friends. By forcing yourself to put your thoughts into words, you can make it easier to figure out what's really important to you.
Covering all the bases
Once you've figured out what your goals and concerns are, then it's time to dig more deeply into them. To begin, it's helpful to establish a baseline that you can use for future reference in comparing possible alternatives. Typically, a baseline plan incorporates your most likely course of action. For example, if you're 55 years old and have no dependents, then a baseline plan might assume that you'll keep working for 10 more years. After you've established this baseline, you can then compare it against alternative plans that involve early retirement or continuing to work beyond age 65.
One of the reasons financial planning gets complicated is it has to deal with all sorts of contingencies and evaluate risks to determine their potential impact on your finances. In particular, your plan has to account for many common and potential setbacks, such as the loss of your job, an injury or illness that keeps you from working, or unexpected large expenses such as medical costs. A good financial plan will include not only projections about your finances under typical conditions but also methods of reducing risks such as these that can keep you from reaching your goals.
You also have to consider that your financial plan probably isn't just about you. If you have other people depending on you, then you need to figure out how you'll provide for them no matter what happens to you.
Therefore, a comprehensive financial plan includes several elements. Basic information about income, expenses, and net worth provides the basis for understanding your current situation and your prospects for the future. Risk evaluation will help you determine your need for insurance and other tools you can use to manage risk. Looking at the needs of your dependents leads to considering estate and gift planning. And tax issues can highlight things you can do to reduce your tax burden and maximize the amount of your money available for your own goals.
After taking the time to consider these issues and gather all of your financial and personal information, you'll be ready to start taking definitive action to reach your goals. The second part of this article gives you some guidelines for taking your financial planning to the next level.
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Financial planning can be a daunting task to take on by yourself, so it's nice to have a helping hand in your corner. The Fool's personal-finance service, Motley Fool Green Light, can give you the strength you need to face your financial challenges confidently and effectively. See how the service can help you with a free 30-day trial.
Fool contributor Dan Caplinger has done financial plans both for himself and for clients. The Fool's disclosure policy helps you plan.
