Walking Through the 6 Steps of Financial Planning

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You don’t need to be a Certified Financial Planner to use and benefit from the same steps the CFPs follow themselves in all areas of financial planning, including investing. Therefore, regardless of your knowledge and skill level, it is wise to follow the basic steps of financial planning.

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Why not plan for yourself like the professionals do it? Check out the 6 steps of financial planning.

Step 1: Establish the Goal / Relationship

This step is where the CFP will introduce themselves and the planning process to the prospective client at the beginning of the relationship. But this need not be an interpersonal exchange. Do-it-yourselfers can fulfill this step by simply getting to know themselves and defining their goals a bit better.

The purpose of establishing the goal or relationship is to form the foundation or purpose of your money. Hopefully you’ve already clarified this. However, too many people save and invest money with no specific goal in mind other than just having more money later.

Financial planners begin establishing goals by asking open-ended questions, which are questions that cannot be answered by a simple yes or no:

  • What do you want your money to do for you?
  • When do you plan to begin taking money from your investments? 1-2 years? 3-5 years? More than 10 years?
  • What are your financial strengths? Where are your financial weaknesses?

Once you clarify the financial goal, you will have formed the guiding philosophy to direct investment objectives, cash management, insurance needs, and to find the best financial instruments to help achieve those goals.

Step 2: Gather the Relevant Data

Some of the information acquired in Step 1 can be used in Step 2, where you are gathering the appropriate data needed to make the best financial decisions to accomplish the goal you’ve established.

In the financial planning area of investing, there are useful risk tolerance questionnaires and profiles available. For do-it-yourselfers, I like Vanguard’s Investor Questionnaire. It asks some standard questions that can help guide you in making the right investment choices:

  • What is your experience level with investing?
  • Are you willing to accept high relative market risk to achieve your investment goals?
  • What would you do if the value of your investment account declined significantly in three months?

In related planning areas, such as retirement, you’ll need to know your savings rate, years until proposed retirement, age when you are eligible to receive Social Security or a pension, how much you’ve saved to date, how much you will save in the future, expected rate of return and more.

Although you may already know this information, it is wise to have it all written down so you can visualize all of the necessary data required to give yourself the best “advice.”

Step 3: Analyze the Data

You’ve gathered the relevant data, now you can analyze it and begin to make certain assumptions about it. Following the investing for retirement planning example, let’s say you know that you have $100,000 in savings, you can save $500 per month, and you have an expected rate of return of 8%.

But now how much more money and how much time you will need to reach your goal?

If you don’t have a financial calculator, there are some good ones online, such as Kiplinger’s Retirement Savings Calculator, where you can plug in the numbers and see if your retirement nest egg will be just right for you.

Often the initial assumptions about savings rates and time horizons are not quite enough to obtain the goal. In the next step, you can begin devising alternative solutions.

Step 4: Develop the Plan

Let’s say you need $1 million to reach your goal and you want to do it in 20 years. The data you’ve gathered and analyzed in Step 2 and Step 3 say you can’t reach your goal unless you can put away $500 more per month. Or, if you you can handle taking more market risk, you could increase your exposure to stocks and reasonably assume a 9% rate of return to get to your goal a little quicker.

Plugging in the data into my own financial calculator, I can tell you that the present value of $100,000 plus $1,000 per month with a 8% rate of return, would hit your $1 million goal within 20 years. Assuming a 9% rate of return, you could shave off about 2 years and hit your goal in about 18 years.

You can see why this step’s key word is “develop.” With so many different variables to consider, your plan needs to evolve with your needs while remaining within your capabilities and risk tolerance.

Step 5: Implement the Plan

Now you simply put your plan to work! But, ironically, this step is among the most difficult for many people because there is a significant behavioral element to it.

As simple as this sounds, many people find that implementation is the most difficult step in financial planning. Although the plan is developed, it takes discipline to put it into action. Saving more money each month can be difficult as it is without behavioral barriers such as procrastination getting in the way. Or you may tell yourself that the goal isn’t attainable and you’d rather just take a Caribbean cruise instead.

Successful investors will tell you that just getting started is the most important aspect of success. If you can’t quite pull off all of the aspects of your plan right away, just implement whatever is achievable now. Doing too much too fast is a common reason for failure.

Step 6: Monitor the Plan

Every assumption made in your plan can change as a result of many uncontrollable factors, such as tax laws, inflation, market fluctuations and economic recessions. But life also changes. People get married, get divorced, have children, get promotions and move to other cities.

Once a plan is created, it’s already history. It’s called financial planning because it is an ongoing process, just like life.

Therefore remember to keep referring back to the steps as significant life or financial changes occur. If you need an easy way to remember the 6 steps, you can memorize the acronym, EGADIM, like I did when studying for the CFP Board Exam:

Establish the goal/relationship
Gather data
Analyze data
Develop a plan
Implement the plan
Monitor the plan

Now that you know the 6 steps of financial planning, you can apply them to any area of personal finance, including insurance planning, tax planning, cash flow (budgeting), estate planning, investing and retirement.

Kent Thune shares this information for general discussion purposes and it should not be interpreted as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/02/financial-planning-steps/.

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