How to create a personal financial plan?
Money isn’t everything. It’s not just a saying, indeed, there are a lot of things more important than money in our lives. But, we cannot deny the fact that we live in a society that requires money for almost everything we do. In that sense, having a personal financial plan becomes extremely important.
Planning is the way human society has discovered to be prepared in advance for situations. Thus, when we have to face that situation, we know what to do. Thanks to those plans, we save time and future efforts. And naturally, the same goes for financial plans.
Definitely, keeping our personal finances in order will allow us to enjoy our present, but especially our future. So, since we already know we need it, let’s learn how to build a personal financial plan.
Starting your personal financial plan
A financial plan is the act of planning how we are going to manage a certain amount of money we have, with the aim of being able to afford everything we have or want to do. That management basically involves determining:
- How much money do we have
- How much we can afford to spend
- What percentage do we intend to save
- And how much we are going to allocate to emergencies – believe me, we have to deal with them quite often
So, in simple terms, that is what we need to keep in mind when designing a financial plan. When we add, as in the subject of this article, the word personal, it only varies in the fact that the money we are handling is our money and the subject of the plan is us.
However, if you are thinking: “I don’t have enough money to bother creating a personal financial plan”, you are making an extremely common and fatal mistake. We need to make plans because we need to manage scarce resources. For example, we make travel plans and choose where to go and, at the same time, where not to go, because our time is limited. The same happens with money, and that is why we need personal financial plans.
Consequently, we may draw the conclusion that creating a personal financial plan is similar to vacation planning. However, while making a financial plan, we can rely on specific instruments that are not available when making a time plan and that can be just as helpful as harmful. I am, of course, referring to credit and the possibility of spending now and paying later in return for interest.
But before we get into the actual planning, let’s first find out what we need to know – ourselves.
Knowing yourself, the most important detail
Psychology is everything. We are rational beings who act, in principle, irrationally. But behind this supposed irrationality lies our fears, past traumas, unconscious beliefs and repressed feelings. Therefore, when we spend our money, whether it’s doing our groceries or choosing what clothes to buy, there may be hidden reasons that move us in a particular direction.
Anyway, I am not recommending that we all should go to therapy or seek professional help to dive into these reasons. But I do think it is very important to know how we react to certain decisions or situations related to money and to plan accordingly.
In this sense, it is advisable not to make financial plans when we are in moments of extreme happiness, euphoria or sadness. Extreme emotions will lead to extreme decisions in both directions. And by creating a plan, it is precisely these kinds of decisions that we seek to reduce.
In short, a great exercise could be the following:
- Write down some financial situations that you might face, here try to be extreme
- Then try to imagine how you might feel when faced with them
- Afterwards, try to think of some solutions to those situations
- The ones that make you feel the worst are the ones you should avoid the most
- After that, you can write down some more realistic or likely financial situations
- And repeat it two or three more times
This exercise will not solve every problem that you have, but it can help you get to know yourself better and become more aware of the person for whom you are designing the financial plan and their needs.
Mapping out our personal financial plan
The most important fact is that it is never too late to start a personal financial plan. Also, we must never forget that we are managing scarce resources and that the first principle is not to spend more than we earn. As obvious as it may sound, this simple piece of advice is the basis of a healthy relationship with your financial side.
However, we are not here to learn principles, but to understand how to make a personal financial plan, so let’s get down to business.
What should our personal finance plan define?
Having drawn up our plan, we should know, with a high degree of accuracy:
- Personal income
- Fixed expenses
- An estimate of our one-off expenses
- How much we will set aside for savings
- The amount set aside for emergencies
- How much we will dedicate to passive income
Perfect, now that we know what we have to define, let’s see how we are going to do it.
1 – Define your financial objectives
When you begin with your personal financial plan, the question that you need to ask yourself is:
- What is the main purpose of my plan?
Are you trying to get out of debt? Do you feel the time has come to buy a house and need to save money? Are you interested in travelling? Do you simply want to be more conscious of how you spend your salary?
No matter what it is, each reason is valid. But, inevitably, you need to have a purpose. Because, around that purpose, your whole plan will be built and, of course, your motivation to fulfil it.
Once you have defined your financial target, it is important that you set a realistic timeframe within which you intend to achieve it. Remember that our goals must be SMART (Specific, Measurable, Achievable, Relevant, and Time-Bound)
2 – Analyse the current state of your finances
Once we have our objective, with its defined time frame, it is time to understand where we stand. This step can be one of the most difficult of the whole plan. Therefore, it is important that we are completely honest with ourselves. There is no point in fooling ourselves.
So what do we have to define? Our debts and our holdings. Basically, write down how much we owe and how much we have at the moment. By knowing our current situation, we will be able to know how much money we are going to spend on debts, how much we can take from our holdings to pay them off or, if there are no debts, to start from scratch.
3 – Develop a detailed budget
Finally, the time that many people dislike has come – outlining our budget. Here, we will get specific and determine:
- The amount we earn
- Setting aside our fixed expenses
- An emergency fund
- Our monthly savings amount
- And, if we still have some leftover, the “passive income” share
As obvious as it may sound, the most important thing about our budget is to be strict and stick to it. However, it is possible to set an order of priorities. In case we realise that we will not have enough money for all our initial specifications, we should make sure to:
- First, cover our fixed expenses like gas, electricity, water bills and food
- After that, try to pay anything that can generate interest
- If you have covered these primary expenses, the savings are as follows
- Only after this point come the sum for “passive income”, emergencies and sumptuous expenses (yes, we all need them from time to time)
Here I have to give a word of caution: this emergency and re-prioritisation plan must remain an emergency one. If it becomes the usual method of executing your budget, evidently you will have to reconsider it.
4 – The amount you set aside for savings is untouchable
Many people manage to accurately execute their own budgets but fail in this simple yet complex mission. It is extremely important that the amount we set aside for savings, as such, remains.
Again, a wise thing to do with this amount of money that we choose to set apart every time we get our salary is to relate it with a purpose. The purpose doesn’t really matter. It can be a long-awaited holiday, you can use it to take your family out for a nice meal, or even to buy that computer you’ve been dreaming about.
The important thing is to generate a savings culture as a habit. Once saving becomes a habit, reaching our financial targets will become simpler every day.
5 – Be careful with loans and debts
This point is related to the principle with which I started this section. Not spending more than you earn means that borrowing or taking on debt is unwise.
However, there are situations where borrowing is feasible. I am referring to those possibilities that we cannot afford to pass up.
Nowadays, it is very difficult to buy a house without a loan and perhaps this is the best example of when is viable to get a loan. But, in that case, we must be careful with the debt we contract and not lose sight of any deadline.
Throughout this article, my goal was to give you the reasons why you need a financial plan, and a simplified method for creating your own. Of course, there will be as many personal financial plans as people exist, but this article will certainly give you a good starting point.
Beyond my thoughts, it is vitally important to know ourselves and how we react to different financial situations. These types of scenarios, which we virtually present to ourselves, help us to anticipate our responses and also to think, coldly, about the best solutions and preventive actions.
The perfect balance lies in the art of sticking to the plan and at the same time having the flexibility to correct it on the move. In any case, if we create a detailed plan that is tailored to our conditions, there is no wiser decision than to stick to it.