Developing a Financial Plan

The prospect of developing and adhering to a financial strategy can be overwhelming. However, it does not have to be so complicated. Consider these steps:

• Measure your current financial status with a personal balance sheet.
• Identify and quantify your financial objectives, such as retirement, college funding, reducing taxes and accumulating an estate to pass to heirs.
• Identify the steps needed to help you reach those objectives.  

Additional things to consider include:

• Sensible spending. Prepare a household spending worksheet to see where you spend and where you may be able to save.
• Prudent borrowing. Loans for things that provide lasting value (for education, homes or autos) are smarter than borrowing for short-term gratification (extravagant vacations or expensive jewelry). Prudent borrowing includes getting attractive rates and terms. Before borrowing (whether it is a credit card, auto loan, mortgage or other loan), make sure you understand all the terms including the interest rate, length of loan and method of calculating interest. 
• Consistent saving. Use a payroll deduction or automatic savings program. They are convenient and usually more successful than trying to save on a less regular basis. Find one that fits your budget and meets your long-term needs. 
• Wise investing. Investments come with risks, and hopefully higher returns to compensate for those risks. Diversification, asset allocation (dividing funds into stock, bond and cash investments) and investment costs should all be considered as part of a wise investment strategy. 
• Adequate protection. Review your insurance coverage periodically (homeowners/renters, health, disability, auto and umbrella policies). Make sure you have the right combination of coverage and deductibles. If you use insurance primarily for "catastrophic" coverage, remember that higher deductibles mean lower premiums.
• Evaluate how much life insurance you really need. If your family would need significant funds to replace your income, a larger policy may make sense. If you are single, perhaps a smaller policy (and smaller premiums) will be sufficient. Also, compare the benefits and costs of term and whole life policies. For younger, healthy individuals without a need for permanent protection, a term policy may be a better choice. 
• Use a qualified advisor, if you need one. If you want or need help, find an investment professional, insurance agent, financial planner, credit counselor or trusted family friend that is knowledgeable, trustworthy and someone you can comfortably work with them. Do your homework. The more knowledgeable you are, the better you will be able to evaluate recommendations. 
• Use Automatic Savings Programs to Reach Your Financial Goals. One of the simplest and most effective tools you can use for almost any saving goal is an automatic savings plan. Automatic saving programs generally come in two forms – either your employer deducts a certain amount from each paycheck and deposits it into a specific account or your financial institution moves a certain amount from your checking account into a savings account on a regular basis. Either way, these automatic transfers add a discipline to your saving. Once people use them, they often find they do not even notice the smaller amount they have to spend each month.

Putting automatic savings plans to work

• Fund your yearly IRA contribution. Decide which type of IRA you want to fund, open the IRA account and then have the maximum that is allowed automatically transferred each month into the IRA account.
• Fund an even larger amount for your retirement. If you are already taking advantage of your employer’s retirement plan and an IRA, you can transfer even more into a savings account each month.
• Save for your children’s college educations. Determine the amount you want to set aside for each child, establish a custodial account for the child and have that amount transferred each month. Transferring $250 each month will accumulate to almost $39,000 over 10 years at a 4% earnings rate. The earnings on the child’s account will be taxed to the child.
• Combine an automatic savings plan with a Section 529 college savings plan. This would work similar to transferring the funds into a custodial account, but would also have the benefit of the earnings not being subject to current taxes. Earnings within a Section 529 plan are tax deferred and can be withdrawn tax free if used for qualified educational expenses.
• Combine an automatic savings plan with your investment strategy. Dollar cost averaging is a method of buying a constant dollar amount of an investment on a regular basis that works very well with mutual funds. Dollar cost averaging eliminates the risk of “buying at the top of the market” and over time reduces the average price you pay for the mutual funds purchased. Most mutual funds and brokerage firms can establish these plans very easily.
• Use an automatic savings plan for estate planning purposes. Older and wealthier individuals often want to transfer funds to their heirs during their lifetimes to reduce their ultimate taxable estate and to provide their heirs with more immediate funds. Up to $12,000 per year (for 2006) can be transferred to an individual without triggering gift taxes. If both a husband and wife want to make gifts, the total can be up to $24,000 per person. If this is something you want to consider, be sure to talk to your tax advisor. Over a relatively short period, one couple can transfer a great deal of money to their children (and grandchildren) to help manage their estate.  

Taking actions to regularly save or transfer money can be easily delayed or forgotten. Using a little bit of automation by having your financial institution do it for you can make the process easier and more effective.