Many people think that a financial plan is only for people with money. Studies show however that a comprehensive financial plan benefits everyone, regardless of income, age, and net worth. In fact having a financial plan is one of the sure ways to get into a higher income bracket!
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Unfortunately, only 31% of American families have a financial plan, just 35% have a plan in place in case of a financial emergency, and only 18% are confident they can retire. When asked about the six most common financial goals: saving for emergencies, retirement, a child’s education, down payment on a house, major expense, and medical expenses, only two-thirds have a plan to meet any of them.
Those with a financial plan are 70% more likely to feel “very confident” about managing money, savings, and investments. Planners are also more likely to describe themselves as “living comfortably” compared to non-planners.
Though some make think you need money first before you create a financial plan, studies show that you need a financial plan to get more money. In this article I will cover the top reasons you need to get a financial plan today, and what you should look for in a financial plan.
What is a Financial Plan?
According to the Certified Financial Planner Board of Standards, a comprehensive financial plan covers savings and investments, planning for retirement, education, emergencies, major purchases, insurance needs, estate analysis, and other financial goals.
Your financial plan is your personal roadmap. It answers the three most important questions in regards to your finances and life: Where are you now? Where do you want to go? How will you get there?
- Where are you now? Having a spending plan or budget is important to track how much money you are bringing in and how much is going out. Surprisingly, more than 60 percent of Americans don’t do this! If you don’t know your inflow and outflow, you can’t properly spend, save, invest and reduce debt. In addition to setting up a budget, your plan will calculate your assets, liabilities and net worth. Answering this question will help you understand where you currently are financially, your spending habits and what you need to do to answer the second question.
- Where do you want to go? One of the primary purposes of your financial plan is to meet your financial goals, short-term and long-term. What do you want your lifestyle to be in the future? Your financial plan will help you prioritize your goals into needs, wants and wishes. It will reflect your true lifestyle goals and values you want to live by. If you have multiple goals, prioritize and rank them. Do the goals require one-time funding or ongoing? Do your goals involve acquiring an investment, asset, or service? Here are the most common and top financial goals people have.
- How will you get there? Now that you know where you are financially and where you want to go, a good financial plan will help you get there. Just like a road map, you want to find the optimal and best way to get to point B and achieve your goals. A good financial plan will calculate the total amount your goals will cost and how many resources you need to reach those goals. This includes a proper investment portfolio, the right amount of savings every year and not overspending.
A comprehensive financial plan answers these questions and keeps you on track to meet your goals. Without a plan, many people end up wasting precious time and resources.
A comprehensive financial plan also helps you determine when you can retire, when you should take Social Security, how much you need to save every year, how to maximize your hard-earned money, limit your risk, and help you grow, protect, enjoy, and give away your wealth!
Why Is It So Important?
We all want to be financially free, to be able to pursue our passion and goals in life without having to worry about money. If you look at people who are financially free, they have made SMART money decisions most of their life. A financial plan helps you make SMART decisions.
The sooner you start making smarter decisions, the more likely you are to achieve financial freedom. You can always get more money, but you can’t get more time. The best time to get a financial plan may have been in the past, but the second best time is today.
Even if the financial decisions are small and may seem insignificant, over time they add up. Just like investing and the magic of compound interest, the more time you have for investments to grow, the less money you need to save in order to achieve the same returns as someone who has less time.
This is why you want to get started on creating your financial plan today if you don’t have one! If you have already started a plan, it is important that you update and review it on a regular basis.
Maximizing Your Social Security Benefits
Studies have shown it is the primary way for people to feel confident about their money and retirement, especially when it comes to Social Security. With advances in online technology, a good financial plan can help you maximize your Social Security benefits and stress test the plan to address any concerns of Social Security solvency and the economy.
Social Security benefits can play a large role in the success of your financial plan and how you can meet your financial goals. In the past, analyzing and illustrating potential options to maximize potential benefits have been complex and difficult.
Online financial plans now can help you easily compare Social Security filing strategies and the plan results that follow. From our previous series on Social Security, we learned that some of the strategies you can use are taking benefits at full retirement age (FRA) at your retirement, as soon as possible, at age 70, file and suspending, maximizing spousal benefits and survivor benefits, and more (Click here for more information).
Since there are many options, a good financial plan will help you maximize your benefits for your plan. By calculating your Social Security strategy results, the total lifetime benefit, break-even points and the resulting probability of success, you can choose the optimal time to take Social Security, potentially earning tens of thousands more!
With advances in technology, you can easily analyze and compare different strategies and the results that follow. To get a free social security maximization plan, click here to sign-up and enter.
What a Good Financial Plan Has
Since the purpose of a financial plan is to discover and establish your financial goals and then develop a plan to achieve those goals, you need to make sure it takes a comprehensive approach. A good financial plan considers all aspects of your personal and financial positions. It encompasses the core financial planning topics:
- General Financial Principles – Are you managing your cash flow and budget?
- Risk and Insurance Planning – Do you have the right amount and right type of insurance?
- Employee/Employer Benefits Planning – Are you taking advantage of your employee benefits?
- Tax Planning – Are you paying unnecessary taxes?
- Investment Planning – Are you invested in the right things in the right amount?
- Retirement Planning – When and how much money do you need for retirement?
- Estate Planning – Do you want to leave an inheritance?
Besides retirement, funding health care costs is one of the most important goals that many do not take into account. According to the Employee Benefits Research Institute (EBRI), Medicare covers about 62% of an individual’s current medical expenses. Unfortunately the percentage covered could go down with retirees’ health care costs rising.
According to a study by Fidelity, a 65-year-old couple retiring this year will need an average of $220,000 (today’s dollars) to cover their medical expenses throughout retirement. This amount doesn’t include nursing-home or long-term care and only applies to those with traditional Medicare.
Currently, the average annual out-of-pocket expenses for someone on Medicare is approximately $5,000 for individuals and $10,000 for couples. If you expect to retire before age 65, you will have to purchase private insurance until you’re eligible for Medicare.
Health care expenses in retirement are primarily made up from your Medicare Part B and D, Medigap, and any out-of-pocket expenses. The premiums you pay for Medicare Part B (medical insurance) and Part D (prescription drug coverage) are dependent on your Modified Adjusted Gross Income (MAGI) which is the total of your adjusted gross income and tax-exempt interest income. Another study by the federal Agency for Healthcare Research and Quality found that an average hospital stay cost $9,200.
Given that health care costs are one of the largest expenses in retirement, a good financial plan can help you cover them without infringing on other goals. Click here to learn more about long-term care costs and how to pay less for more benefits!
Your plan will be able to show the annual costs for your goals. Based on your current financial situation, it will tell you the probability of success of reaching these goals and what you need to do to reach them.
Managing Risk
Your financial plan will also help you manage your risk. Many people overlook this step and do not have a plan that adequately reflects their risk tolerance. Your goal is to choose investments that are suitable to your risk tolerance and get the most return for the amount of risk you are willing to take.
Risk is measured by your financial ability to withstand losses. Investments have different levels of risk and potential return. The more you risk you take, the greater the reward should be, and vice versa.
While many equate risk to just finances, there is a large emotional component of risk tolerance. Emotions can be more powerful than logic and drive investors to make decisions without regard to their finances.
Why is understanding both your financial and emotional risk so important? If you take too little risk when you are younger, you may be leaving a lot of money on the table by not taking advantage of time’s effect on compound interest.
If you take too much risk during your later years in life, you may not be able to recover the losses in time. This unfortunately happened to many people who were close to retirement during the 2008 crisis.
Your risk is determined usually by your time horizon, financial resources, demographics, experiences, and personality. There are generally three different types of people when reacting to risk.
- Risk Seeking – Risk tolerant individuals and prefer uncertainty over certainty
- Risk Aversion – Risk rejecters and prefer certainty over uncertainty
- Risk Indifference – In the middle, willingness to make an investment based on it expected return without regard to its risk
How do you find your risk tolerance level? The most common techniques are through a risk tolerance questionnaire, examining your investment objectives, your preferences for various investment products, attitudes towards risk, and real-life choices involving risks.
Once you know the level of risk you are willing to take, then you are able to pick the right type of investments and your asset allocation. Unfortunately many people adapt their risk tolerance to investment products rather than have the correct mix of investment products to fit their risk tolerance.
Generally, investors who focus on the performance of their investments without regard to their risk tolerance will experience a roller coaster of emotions and potentially miss their goals. As a result, their confidence is tied to the stock market.
But those with a financial plan that stay focused on their strategy will only need to have confidence in their strategy. A good financial plan with your optimal investment portfolio adjusted with your risk tolerance will help you be more secure in your confidence!