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Financial Literacy

Personal Financial Planning: The 7 Step Guide

If you want to achieve financial freedom, you have to prepare a plan. Because without some personal financial planning, you’ll never know if you’re veering off course.

Why You Need Personal Financial Planning

Plans hold you accountable, which can improve your financial wellness. Moreover, having a plan can give your life structure and meaning, something anyone can benefit from.

And according to a survey from CNBC, 75% of Americans are winging it when it comes to their financial planning. If that doesn’t worry you, it should. Are you one of them?

By creating a personal financial plan, you are making an investment in yourself and your future. And you don’t need to consult an expensive certified financial planner either. In fact, you probably shouldn’t. If you diligently follow these seven steps, you can create your own custom personal financial plan in no time.

Personal financial planning is a puzzle.

The 7 Steps to Personal Financial Planning 

  1. Write down your goals
  2. Establish your net worth
  3. Create an emergency fund
  4. Determine a realistic budget
  5. Eliminate toxic debt
  6. Utilize tax breaks
  7. Start investing.

1. Write Down Your Goals

Personal financial planning is a lot like solving a puzzle. The pieces of the puzzle represent expenses, purchases, debts, investments and other aspects of your financial situation. The picture on the box represents your goals.

To solve a puzzle, you need the pieces to fit together precisely. 

When it comes to personal financial planning, that’s the mindset you need to have. That’s why it helps to use the acronym S.M.A.R.T. I’ve explained S.M.A.R.T. goals more extensively in an article about wealth creation, but let’s briefly break them down here:

S.M.A.R.T. Goals for Personal Financial Planning

  • S stands for Specific. The more specific your goals are, the more likely you are to achieve them. Don’t just say, “I want to be wealthier” or “I want to pay off my mortgage.” Say, “I need to increase my mortgage payments by x dollars per year to pay off my debt fully in five years.”
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  • M stands for Measurable. A measurable goal has a clear definition of success. You either solve the puzzle or you don’t. There is no in between. So whether you are trying to cut your expenses down by $1,000 per month or you want to find $5,000 in additional investment money next year, make sure you can numerically measure your progress.
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  • A stands for Agreed upon. When you include a partner or family member in your personal financial planning, you are more likely to stick to your goals. It creates a sense of accountability for you. It also gets buy-in from them. Both factors will help you in your personal financial quest.
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  • R stands for Realistic. If your goals aren’t realistic, then you’re setting yourself up for failure. The difference between a realistic and an unrealistic goal could be a small change. For example, if paying off your mortgage in the next 10 years is impossible, then make it 15 years. Be honest with yourself.
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  • T stands for Time frame. By setting a goal with a time frame you add a sense of urgency. Deadlines motivate people to use their time efficiently and effectively.

2. Establish Your Net Worth 

Personal financial planning is creating a road map to success. So you have to know where you are in order to get to where you want to go.

First make a list of all your assets – this includes the money in your bank account, money put to work in an investment portfolio, real estate and personal property. Even cars. Every asset counts when calculating your net worth.

Then make a list of your debts – this includes your mortgage, credit card balances and loans.

Subtract your debts from your assets and you have your net worth. If this is a positive number, then you’re in a better position than many Americans. If it is a negative number, don’t worry. That is not uncommon. It just means you have your work cut out for you and that you can’t take your personal financial planning lightly.

3. Create an Emergency Fund

Once you’ve established your net worth, it’s time to set aside some money for life’s many unexpected expenses. You don’t want a medical bill or a car repair to wipe out all of the financial planning you’ve done so far.

According to a survey from Bankrate, nearly 1 in 4 Americans don’t have any emergency savings. Not having an emergency fund is dangerous. When unplanned expenses like car troubles, home maintenance or hospital bills come up, you don’t want to have to go into debt.

Typically, an ideal emergency fund will cover three to six months’ worth of living expenses. Financial experts generally suggest you put away 20% of your paycheck every month toward a savings account.

Ideally, you’d be able to take another small percentage of your paycheck and put it toward this separate emergency fund. You don’t want to have to dip into your savings account, or worse, go into debt over an unplanned issue.

4. Determine a Realistic Budget

A realistic budget is crucial to personal financial planning. The de facto rule for budgeting is the 50/20/30 rule. Senator Elizabeth Warren (I know, I know, believe me) popularized it in her book “All Your Worth: The Ultimate Lifetime Money Plan.” Here’s the breakdown:

Needs

Half of your income should go toward your mortgage, rent, car payments, groceries, insurance, health care and other necessary expenses.

Savings

Twenty percent of your income should go toward your savings. Building your savings is the crux of your personal finances.

Wants

The remaining 30% of your income can be allocated toward all other nonessential items. This includes tickets to the movies, new clothing, tech gadgets and all other items that aren’t absolutely vital.

5. Manage and Eliminate Debt

Not all debt is bad debt. Some debt can work in your favor. Mortgages, for example. If you are able to pay off your mortgage on time it can boost your credit score. High-interest debt, like credit card debt, is what you need to avoid. 

When you have high-interest debt, the best thing you can do is to pay it off as quickly as possible. To manage your high-interest debt try following the 28/36 rule. Put up to 28% of your pretax income toward housing expenses, and avoid putting more than 36% of your income toward all other debt.

Mortgage lenders often use this rule to assess someone’s ability to pay off the mortgage. If you can abide by the 28/36 rule you are in a good position to be approved for a mortgage and other lines of credit.

6. Utilize Tax Breaks

The tax code is not only remarkably complicated, but it’s also always changing.

For example, the Tax Cuts and Jobs Act of 2017 changed the number of deductions, lowered tax rates and expanded credits for 2018 and beyond. That act altered the tax situations of many Americans.

To make sure you’re prepared for the new year’s tax season, check in with the IRS’s tax reform page. You can review your withholdings, estimated taxes and any tax credits that you may have qualified for this year. Also, taking advantage of tax-sheltered accounts like IRAs and 401(k)s can help you avoid Uncle Sam for a little longer.

To get the most in-depth perspective on your tax situation, checking in with an accountant is generally a smart decision.

7. Start Investing to Build Your Wealth through Personal Financial Planning

The point of personal financial planning is to build wealth and maybe even achieve financial independence. Another aspect of personal financial planning is avoiding losses. And when you’ve worked so hard to budget and save, the last thing you want to do is lose money in the market.

One investing strategy that has lower risk but provides steady income: investing in high-quality dividend stocks. Dividend companies usually pay their shareholders quarterly. So investors who build up a portfolio of dividend stocks can collect a steady income.

Our Chief Income Strategist, Marc Lichtenfeld, always provides great insight into the world of dividend investing. Click on his name to see some of his excellent work on dividends and income investing.

Final Thoughts on Personal Financial Planning

You don’t need a certified financial planner to start planning your finances. You have all the tools to do so your own. Investment U is one great resource you can use to start accomplishing your personal financial goals today. 

Increasing your financial know-how is crucial to effective at personal financial planning. To learn more about managing your money, as well as some fantastic investing ideas, sign up for our free e-letter below.


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