You could spend thousands of dollars for a money manager to create a financial plan and invest your money on a commission base. Or, you could take these easy steps to DIY personal financial planning process. Being burnt by money managers in the past, I firmly believe only YOU can take care of your money the way it should be taken care of. Only with a little bit of education, you can become your own money manager for life. Here is a quick guide on where to start.
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9 Steps to DIY Personal Financial Planning Process
Creating your own financial plan not only saves you money, but also gives you a deeper understanding of your financial situation. By taking the steps to DIY personal financial planning process, you get down and dirty with your own numbers. And in my experience with my clients and students, you are more likely to keep up with your budgeting to reach your financial goals.
1- Set up your financial goals: Focus on needs versus wants.
You can also call this your mission statement. A mission statement is your reason for financial planning. For example to achieve financial dependence, or to avoid financial independence. Then you need to create a list of goals based on your needs. Finally you are going to take the steps necessary to manage your objectives. Examples of objectives can include:
– Debt Management
– Tax Management and Emergency Fund
– Savings and Investments
– Estate Planning
The details list of objectives are important because it will altogether help you accomplish the mission of your financial planning.
The strategic approach in steps to DIY personal financial planning process focuses on the need-driven versus the want-driven priorities. Needs are defined as necessary by law (e.g. auto insurance) or required to make a plan work (e.g. savings). Wants on the other hand, are somewhat discretionary (e.g. purchase a home).
2- Understand your life cycle phase.
Your life phase helps to understand your risks, and to establish goals. In the financial planning world, this is called the life cycle approach. For example, if you’re married with children, you should probably establish a goal to save for the college education of your children. Meanwhile, you should be concerned about certain risks such as an untimely death, or disability. Here are the three phases most people fall under.
– The asset accumulation phase usually occurs in early 20s to mid 50s. During this phase cash flow for investing is low, you may be in higher amount of debt while net worth is low.
– The conservation (risk management) phase usually occurs in the early 20s tothe early 70s, where cash flow, assets, and net worth have increased and debts have decreased somewhat. In addition, risk management of events like unemployment, disability due to illness or accident, and untimely death become a priority.
– The distribution (gifting) phase usually occurs from the mid 40s to the end of life and is characterized by your high cash flow, low debt, and high net worth.
Life Cycle Approach – Steps to DIY Personal Financial Planning Process
You can very well be at two or even three phases at once.
3- Know your net worth.
Your net worth is the calculation of your assets minus your current liabilities.
Current assets – Liabilities = Net Worth
Assets are anything you own like a car, a house, your stocks, bonds, or any other investment. Liabilities are what you owe like your mortgage, a car loan/lease, or debt like student loans or credit cards.
Though this might seem like a straightforward step, it can become emotional quickly. It’s just facts, but you’ve got to realize, every single line on that balance sheet tells a story. Your list of debts may include one for a failed venture, so you may think about what a dumb move that was, and your spouse might be tempted to nod his or her head in agreement.
Some people may even be so ashamed of their past actions they will feel like avoiding this step. For instance, one woman who borrowed $5,000 a few decades earlier for a student loan had spent years not facing it, and when she finally checked in on it, it had swelled to $30,000.
Knowing your net worth at all time helps you focus on learning from those mistakes and on moving forward. Now you’ve got three down, and 6 more steps to DIY personal financial planning process to go!
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4- Create an emergency fund.
Once you have set up your financial goals based on your life cycle, and have got an understanding about your net worth, you get to one of the most crucial steps to DIY personal financial planning process, which is setting up an emergency fund. This step is often ignored in favor of other goals that seem to be more dramatic, yet it is entirely a financial must have.
An emergency fund is basically a savings account or money market that represents your liquid cash. The idea is to have it available when either an unexpected expense hits, or when there is an income disruption. That will not only enable you to weather a short-term financial storm, but will also help you to avoid borrowing money for the same purpose.
The general rule on an emergency fund is it should contain sufficient cash to cover 3 to 6 months worth of living expenses.
Emergency Fund Formula – Steps to DIY Personal Financial Planning Process
5- Prioritize paying the bad, reasonable and good debt.
Once you have filled your emergency fund with a sufficient amount of cash, the next step will be to get out of debt. However, you need to keep in mind that there are three types of debt. Therefore, you must prioritize getting out of bad debt before any other.
– Good debt is the type where the interest rate is relatively low in comparison to expected inflation and expected investment returns, and the expected payback period is substantially less than the expected economic life of the asset. Example of good debt is a fixed 15-year mortgage on a home with an economic life of the home in excess of 40 years. Or a student load for professional studies.
– Reasonable debt is when the payback period is longer or the returns on the debt are no doubt positive, but less certain. For example a 30-year home mortgages at appropriate interest rates, or student loans that are for general education.
– Bad debt is the type you’d want to get rid of immediately. Bad debt has high-interest rates or the economic life of purchase is exceeded by the associated debt payback period. For example, a car loan with a small down payment and a term of 72 months when the economic life of the automobile is three to five years. The absolute worse type of debt is high-interest rate credit card.
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6- Compare your financial position versus benchmarks.
Also known as ratio analysis, this is one of my most favorite approaches to personal financial planning because it gives you a deep understanding of where you are today financially. We get into this in detail in our Make Your Money Work for You PowerCourse after you’ve prepared your financial statement, and will help you do a thorough analysis of your ratio approach to financial planning.
There are 4 types of ratios. Liquidity ratio, debt ratio, financial security ratio, and performance ratio. Here is the list of liquidity ratios you need to keep track of. To learn how to conduct these calculations, attend this free MasterClass.
Liquidity Ratio Analysis – Steps to DIY Personal Financial Planning Process
For example, the current liquidity ratio will give you an understanding of your ability to meet short-term obligations, if current liabilities all come due immediately. For this to be helpful, you obviously have to have an appropriate emergency fund. Current liabilities are those liabilities that will be paid within the next year, and you can find the number in your Balance sheet. Cash is the same number you used for the emergency fund ratio. The result must be between 1 to 2.
7- Set up a budget.
Learning about budgeting is super necessary for anyone at any stage of their lives and with any financial situation. If you are ok now, you’d want to make sure you continue to be ok and get even better, right?
That is why you need to explore your current financial behavior and habits. Believe it or not, we make 6-10 money decisions every day. These decisions are guided by habits both conscious and unconscious, both good and bad. We all have money habits we’d like to change. But we have to be aware of what those bad habits are if we’re going to change them.
For example, most of us have a store where we habitually overspend. Mines are Amazon Pantry and Target. I think stuff is cheap so I continue to shop and shop and shop until I get one big ole receipt without even realizing it. Sadly, things add up!
Our financial present isn’t shaped by any one big thing. It’s a result of a series of many micro decisions, driven by our own money personalities. If you can figure out why you’re making the micro-choices you are, you can figure out how to rewire yourself to make better ones. When it comes to steps to a DIY personal financial planning process, there are three important tips you need to keep in mind for budgeting:
– Be realistic with your spending behavior.
– Budget a line item expense for miscellaneous expenses and unforeseen expenses.
– Being successful with a budget takes practice.
Over time, budgeting becomes easier and more accurate. Don’t sweat the small stuff. It doesn’t initially have to be 100% accurate. You may not be able to prepare for unexpected expenses. That is what we have the Emergency Fund for.
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Steps to DIY Personal Financial Planning Process – Free MasterClass
8- Calculate your risk tolerance.
In order to get on track with your financial plan, you are probably thinking of investing your money on the financial markets to help it grow. While investing can be an incredibly attractive tool for making your money work for you, many newbie investors lose their money, solely because they don’t know their personal risk tolerance. They treat investing as a get-rich-quick scheme and dive heads in without a plan.
The overall return investors expect is primarily a function of the riskiness of the investment. However, to achieve the investment goals, you are expected to invest at a risk level consistent with an assessment of your risk tolerance.
Risk tolerance or the ability to take on investment risk is a function of objective measures such as:
▹ Investment goals
▹ The time horizon for each goal
▹ Need for Liquidity
▹ Your tax situation
▹ Unique circumstances
In the Make Your Money Work for You PowerCourse we help you calculate your risk tolerance at any stage of your life so that you can develop the right investment strategy and portfolio for you.
9- Create an investment portfolio based on your goals and risk tolerance.
Once you have calculated your risk tolerance, it is time to design your investment portfolio. According to Forbes, if an investor contributes just 10% of her salary a year, beginning at age 25 with a starting salary of $50,000, she will have socked away $916,618 by the time she retires at 65. This is just one of the reasons why having your own investment account, free of money managers’ commission fees is crucial to your personal financial planning process. Your investment return will depend on your basic mix of stocks and more conservative investments. To get some guidance on what mix you ought to hold, join our Investing Group or attend this free MasterClass to learn about our Make Your Money Work for You PowerCourse.
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Related:
– Steps to Save for Home Down Payment.
– Online Risk Management for Traders & Investors.
