How to build a personal financial plan: A 10-step guide

Think of your financial plan as a map that helps you navigate to your financial goals. Just as it is difficult to get to one’s travel destination without a map, similarly it is hard to achieve financial goals without a plan.

Here is a step=by-step guide to building your financial plan.

1.     Assess your current financial situation

Start by reviewing all your finances comprehensively. This includes:

Income: A full picture of your gross family income and monthly take home pay. Remember to include your company stock compensation, if applicable.

Assets: Make a full list of all your assets: This includes retirement assets in 401Ks or IRAs, investments you may have in various brokerages, cash from bank accounts, and any other assets.

Debt: Collate all your debt – credit card debt, student loans, mortgages or car loans. 

2.     Get a full picture of your expenses

Ideally, look at your expenses for the past one year to get a full picture and to account for seasonality. For example, you may spend more during certain times of the year like the holidays or travel seasons. Summer expenses could be higher due to kids’ summer activities.

Next, break down expenses by fixed and variable.

Fixed expenses include rent/ mortgage, loan payments, utility payments, daycare or school fees. It is very difficult to change these expenses, and these often determine the type of lifestyle you have.

Variable expenses consist of things like food, groceries, entertainment, clothing and Netflix subscriptions. These vary month-by-month. In a crunch these expenses can be changed or reduced.

Discretionary Expenses: Finally, there are discretionary expenses. These are things like travel, or other major lifestyle expenses. These can be scaled down quickly if needed.

3.     Plan your goals and desired lifestyle

a) What are your goals?

Think hard and make a list of all the things you’d like to accomplish and enjoy – both in the short and long term. Would you like to retire with a nice nest egg? Do you plan to put kids through college? Do you want to remodel your home in 1 year? In some households, one parent may want to take time off or go part-time to care for kids.

b) What lifestyle do you want? 

Would you like a big house with a yard? Would you like to travel every year to exotic places?

c) What tradeoffs would you be willing to make?

While we’d like to have everything, it is important to remember that we won’t likely be able to do everything we want. So it is important to think about what is really important vs what is something you can live without.

Some tradeoffs that people may consider:

Can you delay retirement a few years to fully pay for kids’ college?

If you want to buy a bigger house with a larger mortgage for kids, you may not be able to spend money on travel or other expensive hobbies.

Do you want to remodel your home in an expensive area or move to a low cost of living (LCOL) area?

4.     Build your plan

Now that you have outlined your most important goals, figure out how much savings you need to achieve each short-term and long-term goal. Then set aside a budget for each goal

For each goal (home buying, kids’ college, remodeling, retirement, etc), calculate how much you need to save every month/ year. For eg, how much savings do you need for down payment for a new home, or to retire in the time period you wanted?

You can use our retirement and college calculators to help you do this analysis.

Then set aside this amount every month (or periodically) to save towards each goal.

5.     Set aside emergency funds

You need to make sure you have enough money set aside as emergency funds. Typically, the recommended amount is 3 to 6 months’ worth of expenses, but this should be personalized based on how much risk you can handle, whether it is a one-earner vs two-earner household, and how much savings you already have that you could dip into, should there be an emergency.

6.     Look for opportunities to boost savings

Revisit your expenses to evaluate which expenses you can cut. It is probably not going to be easy to change fixed costs, but look at variable and especially discretionary costs.

Alternatively, can you boost your income? This may be hard to do in the short term, but is worth pursuing for the medium to long term.

 7.     Debt management

If you have high interest rate debt like credit card loans, make a plan to pay these off as soon as possible, before allocating money elsewhere. For low interest rate loans such as mortgages, you may be better off investing the money instead rather than paying down low-cost loans. But you need to do the math to figure out the best strategy.

8.     Optimize your savings and investments

Take a close look at your savings and investments and find out ways to make them more productive. Always remember to also take into account risk while looking at investing.

 Some important considerations while thinking about your investments:

Asset allocations: It is important to determine your ideal asset allocations based on your risk profile, age and goals.

Investment fees: Investment returns can underperform due to high fees. It is important to correctly assess the fees you are paying on investments.

9.     Planning for uncertainties

No matter how well you have planned your budgets and investments, life can come at you fast. It is therefore important to plan for uncertainties and things that could go wrong. Therefore, insurance and estate planning should be an integral part of your financial plan.  

Life and Disability Insurance: You may need life insurance in the following situations:

If you or earning members of your household have dependents

You want your dependents to have a good lifestyle in the event of the unthinkable happening and your assets may not cover their lifestyle.

Figure out which expenses need to be covered, such as mortgage, lifestyle expenses, college tuition, kids’ activities, etc, and plan for life insurance accordingly. Also, make sure to factor in post-death expenses such as funeral, estate taxes etc.

10.  Will and estate planning

Ensure that you have a will and estate plan that cover the following:

Asset distribution per your wishes, in the event of death.

Designate beneficiaries

Guardianship of minor children

Estate administrator: Decide who will administer the estate and assets on your behalf in the case of death.