What is a Financial Plan?

Becoming wealthy is simple, but it is not easy. It doesn’t matter if you are a multi-millionaire or someone living paycheck to paycheck and deeply in debt, everyone can be more efficient with their money and a customized Personal Financial Plan is the best way to start. A Personal Financial Plan is the ultimate financial road map that identifies three very important financial issues:

  1. Where am I now?
  2. Where do I want to be?
  3. How do I get there?

Think about it, if you become lost in the woods and need to get back to where you started to go home, the very first thing you need to identify is where you actually are right now versus where you think or assume you might be. You already know the goal of getting back to where you started, so once you know where you are, you are now free to choose the best path to get there.

So exactly what is a Financial Plan? A Personal Financial Plan is a present-day reality check as it will force you to inventory what you have in assets (Net Worth Analysis) and your current net income levels (Cash Flow Analysis). Too many people avoid this because they are afraid of the results while others just don’t care and take the head in the sand approach. Please, don’t be either of those people! If you are over 18, it is not the job of another person or the government to take care of you.

A Cash Flow Analysis is nothing more than completing an itemized personal budget by adding up your total monthly income from all sources and subtracting all of your recurring monthly expenses. This might be the single most important financial exercise you ever do because having a positive net cash flow is the single most important financial measure for an individual’s personal financial life. If you have a positive net cash flow then you will be able to cover all the ordinary costs of daily living with money left over to save or invest as you choose. However, a negative net cash flow means that you are spending more than you are earning and are forced to cover the difference by taking money out of savings. Depending on our amount of savings, this can become a problem quickly.

Once you have addressed your monthly net cash flow the next most important financial measure you need to monitor is your net worth. This is done by adding up the current sellable value of everything you own minus the total balances of all debts that you have. Just like net cash flow, the more positive the number the better. Many people will find that they have a negative net worth, however, if they can maintain a strong POSITIVE net cash flow, then it is only a matter of time until their net worth turns positive. On the flip side, if a person has a positive net worth and a negative net cash flow, then it is only a matter of time until their net worth turns negative. This is why net cash flow is priority #1 for individual personal finance.

After you know your current financial reality you have set the foundation for getting to wherever you want to be. Written goals carry more significance. They provide clarity to you and everyone else who views it which increases your accountability to get it done. Goals might include retiring at a specific age and/or having a certain dollar amount in your retirement accounts, paying for your children’s college, or making a significant purchase in the future (new home, car, boat, etc.).

Once your goals have been established a financial advisor can now work with you in developing a comprehensive and customized Personal Financial Plan based on your input and the advice and experience of a trained professional to help you achieve those goals. Remember, the only difference between a dream and a goal is a plan to make it happen. Do not underestimate the power of having a written plan that can show you the way.

Keep in mind that your Personal Financial Plan may require that you need to make some changes such as work a couple years longer than expected, increase your savings rate, or reallocate some investments to increase your expected rate of return to achieve the goals. Sacrifices today are often necessary to get you where you want to be in the future. However, a good Personal Financial Plan is flexible and can be customized to your wants, needs, and preferences so that you are not forced to take any current actions without your consent.

While, there is no definitive template for a Personal Financial Plan, in general, it should include the following components:

  • Investment Portfolio Analysis
  • Savings Analysis for Retirement and/or other goals
  • Tax Planning Considerations
  • Cash Flow and Budgeting Analysis
  • Disability Insurance Needs Analysis
  • Debt Management
  • Net Worth Analysis

Depending on your level of wealth and what stage of life you are in other common components might also include:

  • Retirement Spending and Distribution Analysis
  • Estate Planning
  • College Funding
  • Long Term Care Analysis
  • Life Insurance Needs Analysis
  • Social Security Analysis

Depending on the financial advisor and what software they may use, Personal Financial Plans can be a few pages long or well over 100. Personally, I like to keep it simple and prefer that each analysis only be a couple of pages long. I love personal finance and am a financial nerd, however, if I had to go through 100 pages to view my financial state of affairs I would probably get a headache.

What is a Financial Plan- is it worth the cost?

The average cost for a Personal Financial Plan can vary. In 2017 Bob Veres conducted a survey in which he found that 55% of all advisors that charged an Assets Under Management fee (AUM) for holding and investing client money, also charged a separate fee to prepare a Personal Financial Plan for their clients. In a 2018 survey from Michael Kitces, it was shown that the average financial advisor charged $231 per hour or a set fee of $2,361 to produce a Personal Financial Plan for a client. This is certainly not cheap, but the price of making personal financial mistakes due to a lack of financial understanding can be VERY costly.

Research studies from Morningstar, Vanguard, and Envestnet have estimated that the value of good financial advice to be worth, on average, about 2.5% per year. This may not sound like a lot, but over a working lifetime can add up to a significant amount of money. I’ll give you an example. The median household income in the United States is about $60,000 or about $3,800 income per month after taxes. For the past 100 years the stock market has an annualized return of 10.5%. If a person consulted with a financial advisor and started with zero savings and received a 3% annual increase in their income over a 40-year working period they would have $3.27 million dollars saved. If another person decided to go without professional financial advice and made some mistakes along the way and averaged 2.5% less annual return on their investments, how much would they have after 40 years? The answer is $1.76 million, a difference of $1.5 million! Rare is the person who will achieve superior financial results by going it alone with no financial consultation from any professionals. Even the great Warren Buffet has not grown his company, Berkshire Hathaway, by himself. In Buffett’s case, Charlie Munger has been a trusted partner for over 40 years of unprecedented business and stock market success.

So, whether you prefer to handle your own finances or turn everything over to a financial advisor, a Personal Financial Plan should be done as a form of an annual financial checkup on how your financial life is going.

FinancialPlanGuy can help you start the process and hold you accountable to staying the course when things get complicated or difficult. It’s never too late to start. Let’s do this together!