An effective financial planning process help you to identify the most important financial goals in your life and work towards achieving these goals. Of course, what is important to me may be different from what is important to you, however we all need to prioritize our financial goals. If you are not sure how to set the priority of your financial goals, a financial advisor could help. Don’t forget you are still responsible for your goals and everything in your life. This week on personal finance, we discuss about 5 key components of an effective financial plan.
1. Financial plan is all about budget
Budget is a financial plan. If you want to prepare a basic budget, you will simply list out all your incomes and how you intend to distribute them. Economists will tell you that we have unlimited wants which are chasing limited resources. Budgeting clearly shows you how to allocate your limited finance among your unlimited wants and needs.
In order to successfully manage your finance you have to set a budget for each month. I mean, plan how to spend your money on monthly basis. Budget helps you to track and measure cost and income.
As the saying goes with budgeting, you control your money and not your money controls you.
Although budgeting may seem like a lot of hard work or too basic for most people but it is the key to a lasting financial success.
2. Eliminate Non-Value Added Debts
According to Urban Institute in Washington, roughly 77 million Americans, or 35 percent of adults with a credit file, have a report of debt in collections. These 77 million are not paying their debts on time because most of these debts are expenses instead of investment.
Yes, it is true, you have to eliminate non-value added debts and minimize value-added debts. Value added debt is the debt you take and invest the proceeds into something that adds value beyond the debt.
In fact you should not save money, when you have a non-value added debt. This is because it does not make sense to save money (1-5% interest) when you are paying a higher interest rate on your debts. Like every serious plan in life, debt elimination requires discipline or else you will not achieved it. If you have lot of debts you will need to seriously cut your spending and increase your earnings to pay the debt off quickly.
3. Build an Emergency Fund
Once you are out of debt you should build an emergency fund. This fund can serve as a cushion during hard times without touching your investments or going into debt. Most experts believes that three to six months living expenses should be okay for emergency fund. Emergency fund can be invested in highly liquid assets such as Treasury bill or certificate of deposit, at least to earn some returns that could cover inflation. As the name implies emergency fund should only be used for real emergencies such as a job loss. If anytime you used part of your emergency fund, you should quickly try to bringing it back up to the full amount.
4. Save for Retirement
Another important reason people save money is for the retirement. Do not think that it is too early or you are too young to start saving for retirement. Whether you are self-employed or working as an employee, you should plan for retirement now.
If you do not think about retirement planning, you are ignoring part of the future.
How much should you save? This depends on number of factors such as your age, retirement goals etc. Example, if you want to retire in my village, then life is cheap but if you plan to stay in Lagos or flying all over the world; you have to save a lot.
However, most experts agreed that saving 10 to 15 percent of your gross salary for retirement should be okay. You should talk to a financial planner who can help you determine the amount you need to be able to retire comfortably.
5. Invest and Diversify
Retirement is a long-term plan, therefore the savings for retirement can be invested into a long-term asset. You can invest into many of the retirement investment tools such as mutual funds, bonds, annuities or real estate to increase your investment portfolio. If you do not have access to these investment products in your country, you can consider using 1 year treasury bill and rollover it over on an annual basis.
It is important to you do not put all your eggs in one or two baskets.
You need to diversify by investing into different types of assets. If you carefully managed your investment portfolio it will generate more income for you. However, it important you understand any financial product before you put your retirement fund in it.
What is your own financial plan? Mike Tyson didn’t plan for retirement. He made about $300 million in his career, but filed for bankruptcy in 2003. This is only possible without a solid financial plan. It does not matter whether you are an executive or a higher paying footballer, it is how you plan your finance that determine the success of your financial goals.