How much do I need to save for retirement? How can I ensure I won’t outlive my savings? What about saving for college with the escalating costs? These are questions you probably ask yourself and hope that what you are doing will be enough. You have probably gone online and used one of the many calculators designed to answer these questions, but do you really feel comfortable seeing what a simple calculator tells you? For the best chance of success, you need to be proactive and have a plan. Having a plan will help you stay focused, organized, and worry less about your finances. There are specific elements that a good financial plan includes.
Assumptions
A financial plan will often stretch over decades depending on the age of the individual. Because of this, assumptions are often made. Common assumptions in financial plans include interest and inflation rates, life expectancy, future income, and rates of return on investments. Did you know that average life expectancies for both men and women are well into their 80s? This means that half will live much longer, perhaps into their 90s. Make sure the assumptions used in your plan are realistic.
Goals
A comprehensive financial plan will include short, intermediate, and long-term goals. Make certain your goals are specific. Some examples of short-term goals include setting up an emergency fund or paying for a kitchen renovation. A common intermediate goal is saving for college tuition. The future cost of a public in-state 4-year college education could total as much as $170,000 or more in 10 years. Compare that to the cost of a private school totaling $380,000 or more. This illustrates why you need to make sure your goals are not vague. In addition, when considering your goals, include dream items such as a vacation home or extensive traveling. Finally, everyone’s long-term goal is saving so you can retire, without running out of money. For some people it may include retiring early or maintaining a specific standard of living during retirement.
Net Worth / Cash / Debt
In this section of the plan, your net worth, which is your total assets minus your liabilities or debt, is evaluated. Maybe you have credit card debt or student loans that need to be paid off. Or perhaps your emergency savings could be yielding a higher interest rate. A common savings account interest rate at a traditional bank is only .01%. Switching to an online bank could increase this rate by 2% or greater. Sometimes even small changes can have a big impact on your financial future, especially for those with a longer time horizon.
Investments
Your investment portfolio should be reviewed for the appropriate asset allocation between equity, fixed income, and cash. This review should include consideration of your stage in life and your investment risk tolerance. In addition, it should consider portfolio diversification, expenses, and tax efficiency with respect to your investments. Knowing that your portfolio is where it should be provides peace of mind when the market is volatile, as it has been with the recent trade war between China and the US.
Risk Management / Insurance
Some things in life are uncontrollable, which is why risk management is an essential component of a good financial plan. Many people overlook one of their greatest assets – their ability to continue to earn income. What will happen to your family if you are no longer able to work due to illness or injury? On the flip side, there is also the risk that unexpected expenses will negatively impact your personal finances. Many people don’t know what umbrella insurance is, or that coverage is recommended to be maintained in an amount not less than your net worth. Making sure your insurance coverages are adequate will help mitigate and protect you and your family when life throws you a curve ball.
Tax Planning
A good financial plan would be amiss without incorporating tax planning. This usually means decreasing the amount of taxes you pay but could also mean shifting the timing of when you pay taxes. Strategies used to manage taxes include: what investments you are making and in which accounts; tax loss harvesting techniques; managing capital gains taxes; and for retirees, it includes managing distributions.
Estate Planning
A lot of people think estate planning is only for the wealthy or retired, but that is not true. Since you plan to leave assets, you need to decide what will happen to those assets when you are gone. An estate plan outlines which assets will go to whom and the timing. In addition, it helps to minimize the amount of taxes, legal costs, and court fees paid during this process. Other issues estate planning addresses are stipulating who will take care of any minor children if you were to pass away prematurely, and who would make financial and medical decisions on your behalf if you were unable to. A well-thought-out estate plan will provide comfort that your family will be taken care of if you were gone tomorrow. Documents include wills, power of attorneys, revocable living trusts, and medical directives.
Recommendations / Implementation
The financial plan will conclude with recommendations, which will vary depending on the complexity of the individual’s situation and how many areas need attention. The plan cannot be useful unless it is implemented, so it should also indicate who is responsible for the various tasks, provide an estimated timeline for completion of each task, and specify the order in which to perform them (if necessary).
A sound financial plan has many components and is something that everyone can benefit from. Even if you think you are on track, it can provide peace of mind. On the other hand, maybe the results of your plan indicate that you aren’t on track. If so, the plan will provide you the steps needed to get on course. Whether you are 22 and just entering the workforce, or 65 and already retired, having a financial plan created is a worthwhile investment for your future.
Deborah Hobart, CPA is a Financial Advisor at Blue Water Capital Management, LLC, a fee-only financial advisory firm in Apex, NC.
