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The 6 Steps to Basic Financial Planning

Keys to Financial Planning | Importance of Financial Planning

It’s been said that the average person spends more time planning a vacation than they do their finances. Basic financial planning can be the key to not only getting you out of debt but setting you up to build wealth.

When you are dealing with something as important and potentially complicated as your finances you need to take some time to figure out what you want, set some goals and plan to achieve those goals.

You might also think that you need to use a financial planner for basic financial planning. I have used several financial planners in the past and my experience has been that they focus on two things: investments and insurance.


Because they make money on commissions by selling you investments and insurance…

This might not always be a bad thing because after all you can benefit from some of these products and I have made quite a bit of money on the investments I made with my financial planner. But my point is that you might not get a comprehensive enough financial plan just relying on a financial planner.

Are they going to get into your groceries budget or tell you if you are spending too much on shoes?... Probably not...

The keys to financial planning lies in you taking a look at your financial picture and putting together a basic plan to get you where you want to go.

Basic Financial Planning Step 1: What do you want?

This first step of basic financial planning requires you to look deep and far. Sit down with a piece of paper and write everything you want to achieve in terms of money and wealth. No limits on this list. Just think deeply about the life you want and start writing.

Whether it is to get out and stay out of debt, pay for your kids college in cash, buy your first home, pay off your home, buy a Ferrari, become financially independent by your 40th birthday, etc...Just make sure you connect with what you truly want.

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Once you have your list you are going to prioritize it. You are going to narrow down to your top 20 goals from then to your top 15 then down to your top 10 and then top 5 or so. You are then going to be left with your top 5 financial goals for your life.

In case you are wondering, yes I have done this exact same exercise…more than once too. I keep coming back above all that my main financial goal is to build wealth and create financial independence. To me all the other goals will fall into place if I can achieve this one.

This single goal has numerous implications. It means I have to be debt free, it decides how much I need to save every month, how I invest my money, how much income I need per year and more.

The reason you want to narrow to about 5 goals or less is so that you can focus. So that you can keep those few goals front and center the whole time and have something to guide your financial decisions.

Basic Financial Planning Step 2: Where are you at?

Put that goal list aside for a minute and now take an assessment of where you are financially. Gulp…

basic financial planning

Calculate your net worth – look at our page on simple net worth calculation to see how to go about doing this, what to include and what not. Basically you are going to round up everything you own that has financial value (bank accounts, real estate, stocks, bonds, other investments, etc.) and deduct from it what you owe (credit card, mortgage, car loans, etc). What you are left with is a fair assessment of your financial net worth. This is important because from now on one way to measure if you are making progress in building wealth is by an increasing net worth over time.

How much debt do you have – Is it too much? Are you struggling with it? Most importantly, when are you going to pay it off? If the answer is never then you need to face your debt situation head on and put together a plan solely for getting out of debt. See our Debt to Wealth section and credit card debt solutionsfor more help.

Your income – How much do you and/or your spouse bring in on a monthly basis. If you are on an irregular income then look back over a year and get a monthly average. Your income is the #1 tool you have for building wealth IF you own it. You give it away by giving it to Visa, Mastercard and American Express…

Basic Financial Planning Step 3: How are you going to get there?

First (sorry for the cliché) this is a marathon and not a sprint race. It will be slow and steady and will require planning, executing, planning again, executing again and so forth.

The value of basic financial planning is not doing it one time but doing it consistently year after year. That is how millionaires are made. If you think about it that is how success is achieved in any field whether financial or not.

The following basic financial planning tools are going to help you chart your course:

Budget and Spending Plan – with a spending plan you decide where you are going to spend your monthly income. With a budget you track your spending to make sure you are on track with your spending plan. For putting these together read our articles on personal budgeting and putting together a spending plan to learn more.

Create an emergency fund – it is typically recommended that you have about 6 months of expenses in an emergency account but one year would be super. The purpose of the emergency fund is that you don’t have to resort to borrowing when (not if) an emergency rolls around.

Get out of debt – Other than the mortgage if you have overwhelming debt in the form of student loans, credit card debt, excessive car debt, etc. you need to face this head on. Create a plan specifically to deal with your debt. Debt is the #1 thing that will keep you from building wealth. Check out our extensive articles on credit card debt solutions and going from debt to wealth.

Saving and Investing By paying yourself first at the very leastyou need to save 10% of EVERYTHING you make. More is better. Some of the wealthiest people I have known save as much as 50% of their income. Once you start setting apart this amount for savings here is what you are going to do with it…

Basic Financial Planning Step 4: Put Your Money to Work

Now that you have set apart AT LEAST 10% of everything you make you need to put that money to work by investing it. First, I suggest you take some of the money you save and put it in a regular savings account month after month and this is how you save for “stuff”.

Want to go on vacation? This is how you pay for it…

Want to buy a big screen TV…a new wardrobe…an iPhone…anything that is not a necessity? This is how you pay for it…with money that you have saved not with money that you don’t have (aka credit cards).

Then…take the rest of the money you set apart for saving/investing and put it to work in investments. So if you save 10% of your income then you can put 3-5% into a savings account and the remaining 5-7% can be invested.

Understand that there are many ways to invest, the stock market just being one of them. But, these guidelines can help you get started in your basic financial planning:

Learn Investing 101 – KISS (keep it simple stupid). Educate yourself on how to create a sensible portofolio that you understand of conservative, growth mutual funds that have a good track record. Then put money in it every month for the next 10, 20, 30 years or whatever your time horizon. This habit alone with the power of compound interest can make you a millionaire.

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Open a Roth IRA – you need to do this the moment you start generating income regardless how young you are. This is one of the most efficient savings vehicles there is because you get to shield your money from the tax man. A Roth IRA can be used in many ways whether it be to purchase stocks, bonds, real estate, mutual funds or as a savings account and much more.

Use a 401K – if you have one at work AND there is a matching contribution from your employer this is another great tool. I suggest that you invest only that amount that your employer will match. Once you meet that any quantity above what your employer matches is better off in a Roth IRA or some other investment.

Consider Real Estate – God knows I love real estate as an investment and if you have been reading this site for any time you probably have noticed. Real estate is a proven wealth builder and can be done in numerous ways. However if you are just getting started with basic financial planning or have a large amount of debt to take care of first then it might have to wait.

The most important thing about real estate is not money, like many think, but education. Check out our Real Estate Investing Guide and our House Flipping projects and see if real estate is for you.

Make it Automatic – set up through your bank, your employer or whatever financial company you use for investing, automatic withdrawals from your paycheck and/or checking account. Have these automatic withdrawals go straight into your investments. This one little habit has made me tens of thousands of dollars…it works.

Basic Financial Planning Step 5: Protect Yourself

So far we have focused on money – how much you want, how to make it, keep it and grow it. Now you want to consider how you can protect yourself from those situations that can take it away.

When you think about protecting yourself and your family there are the three main things you want to consider in basic financial planning: savings, insurance and taxes.

We already talked about savings and an emergency fund above and how they can protect you. Let’s look at the others:

There are a thousand insurance options out there. But I want you to consider at least the following:

Health Insurance – If you are in the USA the costs of health care can be staggering and the cost of one medical emergency can bankrupt you if you are not prepared. Whether you have health insurance through your employer or you have to purchase on your own you should consider some form of this coverage.

Home/Renters Insurance – if you own a home and have a mortgage this will pretty much be mandatory but even if it’s not it’s a good idea to have given that a home is one of the most expensive assets you might own. If you rent instead then renters insurance is cheap and is the only way of insuring your belongings if something happens to the home.

Life Insurance – Not everyone is going to need this. If you are single, and have no dependents then you probably don’t. Or, you might have a family but have $500,000 in savings then you might not either. Otherwise if you are at least married and certainly if you have children, some form of life insurance is good. The younger you are the cheaper it is. Term life insurance is usually the most appropriate choice for most of us needing life insurance. Remember one thing, insurance is not an investment regardless of what the insurance salesman says…

Auto Insurance – Again, this is mandatory almost everywhere in the USA but it’s still a good idea. A car accident can not only be catastrophic to your car but can also affect the health of those involved and other property.

A great deal of your income goes towards paying taxes. So I suggest to you that you make an effort to be tax savy and avoid giving the government a penny more than they deserve. Covering taxes would take 1,000 more pages but I want you thinking of at least the following:

Big Refunds = BAD – if you get a big refund at tax time this means you are having too much taken out of your paycheck. All this means is you are letting the government keep your money for a year and then they give it back to you without interest…not good. So go ahead and decrease the amount of taxes they take out of your paycheck so that you bring more money home every month.

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Keep track of your deductions – There are many, many deductions and credits out there. Whether is a child tax credit or a deduction for the miles you drove while visiting your rental properties or deducting a business lunch. First, if you don’t know it’s a deduction and second if you don’t track it then you will not remember them at tax time.

Tax Deferred Savings – like the Roth IRA, a 401k, 403b and others allow you to save and invest while reducing the amount of taxes you pay. For example, did you know that if you buy and sell a house within a self-directed IRA the profits from that deal would be tax free? Pretty cool…

Hire Someone – Filing your own tax returns can be fairly straightforward for some. However, once you start getting into investments, multiple deduction/credits, businesses, etc. it can get complicated. A tax professional (not necessarily an accountant) can actually help you keep more of your money and stay safely away from the IRS. I once balked at paying $300-$400 for these services but I know I have already gotten my money back and then some. Think about it…

Basic Financial Planning Step 6: Review Your Plan

Every plan consists of planning, executing, evaluation and reassessment. Once you put together your basic financial planning effort and put it in motion you have to periodically review and see what works, what doesn’t and why and see if you need to modify it.

I recommend that you consider doing the following reviews:

Weekly Review your budget. This is the only way to know that you are not overspending. If you put together a simple budget that is easy to update this could be 15-30 minutes per week. This ensures you don’t overspend.

Monthly – at the end of the month look back and see how you did with your budget and spending. Did you spend more money this month than what you made? Use the budget from the previous month for planning expenses for the next month.

Also make sure you have met your saving and investing goals for that month. If applicable, see if you can put more money towards getting debts paid off. Also, check your emergency fund to make sure that it is fully funded or on the way there.

Quarterly review your net worth and your investment portfolio. Tally up what you have saved and invested and what you owe. Look at your investments and see how much they have grown since last quarter. Are there any bad performing investments? Try to figure out why - understand them.

Annually – review your entire financial plan. Are you making progress on your goals?... Have your goals changed?... Do you need to do more, less or something different?... What are your goals for next year?...Did you spend more money than you made this year?...etc.

Other things you might want to check in your periodic basic financial planning are to make sure your insurance coverages are still appropriate, make sure you are maxing out the contributions to your IRA and see if you can increase the amounts you contribute towards saving and investing.

Doing your own basic financial planning will give you direction, peace of mind and a plan of action for achieving your financial goals.

Whether you do your basic financial planning by yourself or with your spouse this is a sure step to get control of your finances, get out of debt and ensure your financial future.

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