Financial planning is one of the things every person will sooner or later encounter in his life. Naturally there are many people that ignore the importance of it and never do the effort to plan for their finances but I bet that if you have ever saved money to buy something you are not one of them. In this post I will share some of the most basic principles one can follow when doing his own financial planning and make sure he or she is on track to achieve his goals.
In the next following steps I will lay down the framework I would usually use to plan for my finances regardless if it is to save money for a vacation or for buying a house.
- Define your goal – it is helpful to be as specific as possible about the nonfinancial aspect of your goal or what would you really like to do. I will define several goals now to create a sample scenario and go through each of the following steps. My goals are to save enough money to support my family in case of emergencies or the event of death in the family, to buy a house in the next 1 to 2 years, to plan for my newborn kid college expenses and to think about my retirement with my life partner. These are all very common goals that many families will face.
- Quantify your goals – once you have identified your goals you can think about what they mean in terms of numerical expressions. Many people confuse these first two steps and start thinking about the numerical goals before defining what they really want to happen. It is important to start with defining the goal because thinking about money might bring too many emotions and blur our rational considerations. For example the retirement goal can be identified as a way of living (size of residence, travel, entertainment) instead of 1M in the bank when 65. Only after a picture of retirement standard of living is drawn a quantitative assessment can be performed.
- Look at current resources and expected future cash flows so that a plan can be prepared – at this point the goals should have been assessed and decided. In addition they should have been quantified and numerical goals calculated. Once the end goal is known a calculation of the cash flows needed can be performed. This will involve calculating initial capital and periodic payments needed. Also assumption about growth rate or interest on the capital needs to be factored in.
- Reassess the first three steps in case the estimated cash flows are unreasonably high or additional capital can be allocated for the goals. This step stresses on the fact that this is not a linear process. Once the first three steps are done the cash flows might be out of reach or too easy to be accomplished meaning that adjustment of the plan is warranted.
- Execute the plan – once the plan is set up it needs to be executed diligently by allocating the decided amounts on a regular basis. Being able to follow a well-developed plan is critical for its success.
- Monitor and Control – During the execution of the plan emergencies can happen and life events can change one’s financial situation requiring readjustment of the goals. This is not as scary as it sounds. Early readjustment of the plan can ensure that it will be followed for longer and will provide for the envisioned goal.
By following this simple framework one can ensure that he or she is taking a structured approach to plan for his future goals and his/her finances. It is not exact science and even though I will provide some calculation examples in the following posts I believe that it is much more important the person who the plan is created for, believes that it will help him improve his life and improve his/her finances.
Stay tuned for specific examples and calculations.