Financial planning

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Financial planning is the long-term process of managing your finances so you can achieve your goals and dreams, while at the same time negotiating the financial barriers that inevitably arise in every stage of life.[1] The financial plan is the written reflection of this planning process.

Financial planning covers day-to-day finances, budgeting, insurance, loan management, education, taxes, estate planning, investments, charitable giving, and retirement planning. As such, an investment plan is considered part of the financial plan.

If you don't know where you are going, you'll end up someplace else.

— Yogi Berra

The first and most important step is identifying objectives and their timelines.

'Financial planning then proceeds methodically to lay out how to achieve these objectives.[1]

Basic steps

There are a few basic financial steps that are important to get correct early:

  1. Finance planning starts with a sound financial lifestyle (Video).
  2. Track your expenses and stay within your budget. (Household budgeting).
  3. Is your needed insurance coverage up to date?
  4. Pay down bad debt (credit cards, other high interest debt). Paying off a 20% interest rate credit card debt will free up your money far faster than purchasing a stock fund. With very low interest rate loans, it is often better to make minimum loan payments while investing the rest.
  5. Start saving for the emergency fund. Once you have debt under control, create an emergency fund. Don't skip this step! An established emergency fund can provide an individual with needed funds whenever an unforeseen event occurs so that one does not need to tap investments held for long term goals.
  6. Take advantage of any employer match on a retirement savings plan even as you work towards the above goals.

With these basics initiated, you are ready for the next steps and to create a full finance plan, which will also revisit each of the above topics.

Introduction : Elements of a financial plan

A financial plan usually begins with a summary of the current financial situation; including net worth, a list of income and expenditures, and a budget.

Following this snapshot, the plan may address issues and make recommendations in seven key areas:[2]

Not all financial plans include recommendations for all of these topics. For example, a retired person with a mortgage-free residence and a pension that covers day to day expenses may want and need advice only with respect to investments, taxes, and estate planning.

Step 1+2: Establish goals and gather data

The initial and most important step is identifying objectives (in a family, agreeing on shared objectives), e.g. buying a house, retiring early, ensuring that children get an excellent education, and so on. Determining what the objectives are, and when you would like to meet them, is primary. Since what usually requires money in the modern world, financial planning then proceeds methodically to lay out how.[2]

Planning includes significant financial life events, such as:

  • When your pension and employer retirement plan contributions become vested.
  • When a mortgage will be paid off.
  • When children will be in college.
  • When kids move out and become financially independent.
  • A child's wedding as a possible large expense.
  • The death of a spouse; one's future incapacity.

Step 3: Analyze and evaluate your financial status

After establishing goals and organizing data, one can now evaluate personal finances. What areas need focus? Consider as a minimum:

  • Evaluate your day-to-day finances. Are you living below your means?
  • Have you established an emergency fund?
  • Are taxes under control?
  • Do you have adequate insurance; such as life, health, disability, property?
  • Is your estate planning up to date? Proper estate planning is essential to ensure that your finances don't get derailed due to unforeseen circumstances. Do you have: a will or living trust, living will, Power of Attorney, medical Power of Attorney? Have you established guardians for minor children? Some situations may also need asset protection.
  • Is your retirement planning; 401(k), pension, Social Security, IRA on track?

Step 4: Develop a plan

Make a list of things to do:

  1. Create a realistic budget with adequate insurance
  2. Plan for paying off existing credit card debts and other loans
  3. Plan for building an adequate emergency fund
  4. Plan for saving to meet your goals, develop the investment plan
    1. The time horizon will define your investing strategy (dream home, retirement, college)
    2. Understand your need, willingness and ability to take investment risk
    3. Design a disciplined savings program
    4. Document this in your Investment Policy Statement (IPS) or in the simpler Investment plan
  5. Create an estate plan

In retirement, the focus changes from saving to spending. The above items still apply, but with an objective to ensure that funds last as long as possible ("capital preservation").

Professional assistance may be required in the following areas:

  • See a Certified Public Account to help with your taxes, if needed.
  • See an estate planning attorney. Be sure the attorney is qualified to practice Elder Law and is experienced with the laws of your state.

Step 5: Implement the plan

Prepare to invest

  1. Track your expenses and stay within your budget. Investing starts with a sound financial lifestyle. The first step to decide if you are able to invest. Do you have enough left over, after living expenses for investing? Have you updated needed insurance coverage? In order to invest, budget a certain portion of your income for investing.
  2. Pay off credit card debt and loans. If you discover that you have no funds available for investing, remember that investing is what you do after you have paid off credit card debts and other high interest loans. Paying off a 20% interest rate credit card debt will free up your money far faster than purchasing a stock fund. With very low interest rate loans, it is often better to make minimum loan payments while continuing to invest.
  3. Complete saving for the emergency fund. Once you have debt under control, create an emergency fund. A minimum of six months of living expenses (preferably more) is recommended, especially for non-retired individuals. Don't skip this step! An established emergency fund can provide an individual with needed funds whenever an unforeseen event occurs. Examples of unfortunate events include loss of employment, temporary health impairments, large ticket repair items, and any other unforeseen financial contingency. An emergency fund allows one to meet such expense obligations with liquid funds, so that one does not need to tap investments held for long term goals. Once this is in place, you are ready to invest.

Implement the investment plan

The following five items are the components of an investment plan.
a. Investment goals. The investment objectives (what the money is for) and time horizon (when you will need it) define the securities used to create the investment portfolio. For example, when investing with a medium-term timeline you should not purchase a 5 year CD when you need the money in 3 years. [note 1]
b. For long term financial goals, such as funding college costs for young children and funding a retirement, devise a suitable investment plan. For long term investments, the key decisions will involve what asset classes should be selected; in what proportions (asset allocation); and how these should be adjusted over time.
c. Since many asset classes can rise and fall in value, you must understand your need, willingness, and ability to take investment risk. Since risk and return are directly related, your asset allocation should balance your NEED to take risk with your ABILITY to withstand the ups and downs of the market. NEED can be determined in many different ways. If you are young, you have the benefit of many years of compounding, so in one respect your NEED to take risk is low. On the other hand, your portfolio size is probably small, leaving you with a long way to go to reach your retirement goals. As a result, you could argue that your NEED to take risk is high.[3]
For people closer to retirement, it may be possible to more closely determine NEED. First, estimate approximately how much income you will need annually after retirement. For this example, we’ll assume you need $100,000 per year. Next, look at any pensions or social security benefits that will provide a source of income. If a pension provides $30,000 per year and social security provides an additional $20,000 per year, then your portfolio would need to provide an extra $50,000 each year. To prevent running out of money, you should probably start by withdrawing 4% a year or less with an annual inflation adjustment. To generate $50,000 per year at 4% requires a minimum portfolio size of $1,250,000. How close are you to your goal?
Turning to ABILITY, this relates to your ability to withstand the ups and downs of the market without getting nervous and making changes to your asset allocation. Selling in the face of a decline is about the worst thing you can do. Here is a table offered by author Larry Swedroe,[3][4] based on the 1970s bear market, showing the amount of decline for various stock/bond allocations:
Asset Allocation %
Exposure to
Maximum Loss
20/80 5%
30/70 10%
40/60 15%
50/50 20%
60/40 25%
70/30 30%
80/20 35%
90/10 40%
100/0 50%
For example, you would be willing to accept a loss of 35% in your portfolio if you held an allocation of (80% stocks / 20% bonds). This table is from the 1970's; performance during other time periods will have different results. The general idea is to select an asset allocation you are comfortable with.
d. After designing an appropriate asset allocation for an investment portfolio, one needs to execute a disciplined savings program (if one is accumulating wealth) for continually funding the investment plan, or a reasonable spending program (if one is drawing from the portfolio during retirement).[note 2]
e. All of these investment decisions should be formalized in an Investment Policy Statement (IPS) or Investment plan.

Execute needed estate planning documents

Step 6: Monitor the plan & make necessary adjustments

Once a year, reevaluate your goals and compare to your time horizon. Adjust your insurance, estate matters, and rebalance your portfolio.


  1. Investment authorities commonly advise investors with goals coming due within five years to restrict investments to short term instruments such as bank CDs, money market funds, and short term treasury securities that all mature by the time the funds are needed. Longer term goals can include asset classes that fluctuate in price.
  2. This table from the Phau paper provides guidance on savings rates for accumulating adequate retirement savings. Pfau, Wade D. Safe Savings Rates: A New Approach to Retirement Planning over the Life Cycle, Journal of Financial Planning, May 2011. Retrieved 5 August, 2012.
    See Replacement rate models of retirement spending for more information about replacement rate.

See also


  1. 1.0 1.1 What is Financial Planning?, by the Financial Planning Association
  2. 2.0 2.1 Creating a Financial Plan from finiki, the Canadian financial Wiki. Modified for US.
  3. 3.0 3.1 Bogleheads® forum post: Investment Planning, Laura.
  4. Bogleheads® forum post: Asset Allocation/Swedroe chartLarry Swedroe, viewed August 13, 2018.

External links