Those with a financial plan are more likely than those without one to pay their bills on time and save each month. So, what does a good financial plan look like?
While there are many ways to go about developing a plan—do it yourself, use a robo-advisor, work with a financial planner, or a combination thereof—Schwab has identified the eight critical components every plan should include, regardless of the method used to create it.
1. Financial goals
You can’t make a plan until you know what you want to accomplish with your money—so whether you’re creating it yourself or working with a professional, your plan should start with a list of your goals, both big and small. It can help to organize them by how soon you’ll need the money:
- Short-term goals are those you hope to achieve in the next five years—such as paying off debt or buying a new car.
- Medium-term goals are those you hope to achieve in the next five to 10 years—such as the down payment on a home or starting your own business.
- Long-term goals are those that are 10 or more years away—including college and, of course, retirement.
For each goal, specify a dollar figure and a target date. “The more specific your goals, the easier it is to measure your progress toward them,” says Rob Williams, vice president of financial planning at the Schwab Center for Financial Research.
A host of online tools can help you run the numbers, weigh competing priorities, and determine the best course of action for you. And if you have multiple goals to work toward, a robo-advisor, or automated investing platform, can help you weigh the importance of each goal, ranking them by needs, wants, and wishes.
Any time is a good time to establish a financial plan.
Ideally, you start investing for financial goals early in life, but any time is a good time to check in on your current financial situation and assess how you’re doing—Are you still on track? Do you have other goals you hadn’t previously considered? Having a financial plan helps you assess where you are today and where you want to go next.
2. Net worth statement
Every plan needs a baseline, so next you should determine your net worth. Make a list of all your assets (bank and investment accounts, real estate, valuable personal property) and another one of all your debts (credit cards, mortgages, student loans). Your assets minus your liabilities equals your net worth.
“Don’t be discouraged if your liabilities outweigh your assets,” Rob says. “That’s not uncommon when you’re just starting out—especially if you have a mortgage and student loans.”
3. Budget and cash flow planning
Your budget is really where the rubber meets the road, planning-wise. It can help you determine where your money is going and where you can cut back in order to meet your goals.
A budget calculator can help ensure you don’t overlook irregular but important expenses, such as car repairs, out-of-pocket health care costs, and real estate taxes. As you’re compiling your list, separate your expenses into two buckets: must-have items such as groceries and rent, and nice-to-haves such as eating out and gym memberships.
When considering how your goals fit into your budget, you may want to pressure-test it using “what if” scenarios: What if you want or need to retire earlier? What if you downsized your mortgage? Some robo-advisors offer tools that allow you to adjust certain assumptions to see how they could affect your savings strategy.
4. Debt management plan
Debt is sometimes treated like a four-letter word, but not all debt is bad debt. A mortgage, for example, can help build equity—and boost your credit score in the bargain. High-interest consumer debt like credit cards, on the other hand, weighs heavily on your credit score. Plus, every dollar you pay in finance charges and interest is one you can’t put toward other goals.
If you have high-interest debt, make sure you create a plan that can help you pay it off as quickly as possible. If you’re not sure where to start, a financial advisor can help you prioritize, then determine how much of your budget should go toward your debts each month.
5. Retirement plan
An old rule of thumb says you’ll need approximately 80% of your present income in retirement. However, this assumes that retiring will free you from any work-related expenses and taxes, that you’ve paid off your mortgage, and that your children will be financially independent.
It’s also important to keep in mind that Medicare doesn’t cover everything, and health care expenses that Medicare doesn’t cover—such as long-term care—can add up quickly. You also might spend more on other things in retirement, like travel, dining out, gifts, or financial support to a relative or friend.
Plugging in different scenarios into a retirement savings calculator can help you figure out what you may need in retirement.
Don’t count on the 80% rule
If you’re saving 20–30% of your pre-retirement income, then the 80% income-replacement rule is a good place to start. Otherwise, it’s safer to aim at covering 100% of your pre-retirement income, less whatever you’re saving for retirement. As with any general rule, there are plenty of exceptions. So be sure to sit down and fine-tune your retirement budget as the time draws near. This should be your top priority, since you can borrow for most other goals but not for retirement.
6. Emergency funds
When something unexpected happens—you lose your job, for example, or get hit with an unexpected medical bill—an emergency fund can help you avoid tapping your long-term savings to make ends meet.
It’s generally a good idea to save enough to cover at least three months’—but ideally six months’—worth of essential living expenses (e.g., groceries, housing, transportation, and utilities). Save this money in a highly liquid checking or savings account so you can access it in a hurry should the need arise.
7. Insurance coverage
Insurance is an important part of protecting your financial downside—but neither should you overpay for coverage you don’t need. In general:
- Health insurance: Without it, even routine care can cost a pretty penny, while a serious injury or hospital stay could set you back tens of thousands of dollars. As you get older, you may want to consider long-term care insurance, as well.
- Disability insurance: This coverage protects you and your family in the event you’re unable to work. Employer-provided disability insurance typically replaces about 60% of your salary.
- Auto and homeowners’/renters’ insurance: If you own a car or home—or rent and can’t afford to replace possessions out of pocket—make sure you’re adequately protected.
- Life insurance: This is generally a good idea for those with dependents. Work with an insurance agent to understand what type of—and how much—coverage makes the most sense for you.
8. Estate plan
At a minimum, you should have a will, which states your final wishes with regards to your assets, dependents, and who you want to administer your estate. You should also keep the beneficiaries of your insurance policies and retirement accounts up to date. Also consider establishing powers of attorney for financial and health care decisions, in the case you become incapacitated.
For help getting started or tackling more complex estate-planning tasks, consider working with an estate attorney or a qualified financial planner.
