By Anh Thu Tran, MBA
What is a financial plan?
Most people wouldn’t think twice about pulling up Google Maps to get directions to unfamiliar destinations, yet few seek out guidance to help reach life’s biggest destinations: home purchase, children’s education, retirement incomes. Generally speaking, a financial plan is a roadmap that helps you better understand your current financial situation (your location) and gets you to your biggest personal / financial destinations. It does this by showing you where you are, factoring in where you want to go and suggesting how to get there. Given the importance and breadth of a financial plan, it often requires a good deal of upfront work from both the client and advisor.
Financial Plan – Question 1: Where are you?
The answers to three questions make up the backbone of the planning process: 1) Where are you? 2) Where do you want to go? 3) What’s the best way for you to get there? (See exhibit 1 for details.) To help answer question 1, a good advisor will ask you a number of qualitative questions concerning your background, family, lifestyle, work, and retirement preferences. (Read Good advisors ask questions.) Building on this, she will also ask for your quantitative financial information (e.g., 401k statements, IRA statements, insurance policy, checking and savings accounts, tax return). Combined, this information helps provide a comprehensive picture of where you are – personally and financially. A good, initial barometer for gauging where you are is your net worth (your total assets minus your liabilities). A positive net worth suggests that you are heading in the right direction as you own (assets) more than you owe (liabilities). Meanwhile, a negative net worth suggests that there’s room for you to improve your saving and spending habits.
Exhibit 1: Key Questions in Financial Planning
|Where are you?||Personal, professional and financial assessments = net worth:
|Where do you want to go?||Big goals:
|What’s the best way to get there?||Recommendations:
Financial Plan – Question 2: Where do you want to go?
Once a financial advisor has a good grasp of where you are, she will work with you to help pinpoint your destinations. Typically, answers to question 2 take more time and require you to reflect more deeply on your values and preferred lifestyle. While destinations may take more time to identify, they are critical components of a financial plan. They serve as powerful motivators for developing and then following through on the recommendations in a plan. This is important as life’s biggest destinations are often further on the horizon and require patience in terms of working, saving and investing.
Financial Plan – Question 3: What is the best way to get there?
Based on your responses and input to questions 1 and 2, a financial advisor can then assess how far your current resources can get you to your destinations. Depending on your circumstance, your advisor could suggest ways to change some areas in your life ̶ budgeting, saving, debt management, investing, insurance, estate planning (via wills and trusts). Collectively, these recommendations can help you: a) preserve your resources (e.g., budgeting) b) maximize your resources (e.g., investing in tax-deferred retirement accounts) c) address ways that you might be wasting your resources (e.g., debt management). The ultimate goal is to help get you to where you want to go ̶ in the most effective way. The financial plan should identify the probability that your goals (dollar-wise and timeline-wise) can be achieved given your assets and expected future contributions toward those goals. Once you understand the probability of achieving your goals, you can move forward with “what if?” scenarios that either help you enhance the path to the goals or identify risks that may put stress on your ability to fund the goals.
Who needs a financial plan?
Most people assume that those in late-career (50 and 60-year-olds) are the best candidates for a financial plan. Our current clientele reflects this assumption. Many have spent a lifetime saving for retirement and now want a professional gut check to make sure they are on track for success. While a financial plan is an important affirmation for those in late-career, it could be most beneficial to those in early-career (30-year-olds). Many young savers’ destinations are far away (years, if not, decades). A sound financial plan helps chart the best route for them to reach their destinations. Moreover, it can help young professionals harness their greatest assets ̶ time and talent.
A sound financial plan is an invaluable roadmap for those intent on successfully reaching life’s biggest destinations. Geographically, the quickest path between two points is a straight line. Realistically, life is rarely that accommodating as most people’s journeys are filled with detours. Similar to Google Maps, a good financial plan can’t anticipate road conditions. However, it can factor in the latest developments and propose an alternative route. The next time you utilize Google Maps to find the best route to a grocery store or a friend’s house, you may also want to (re)consider developing a financial plan to help map out the best routes to your life’s biggest destinations.
Subscribe to our monthly newsletter for insights on money, markets, and personal finance.