Comprehensive Financial Planning
Comprehensive Financial Planning
You might think you have a pretty good grasp on what financial planning is. In reality, though, on a day-to-day basis, financial planning is going to vary depending on where you are in your financial journey.
By this we mean that, for people just starting out with saving money or even building credit, financial planning might start with just getting a bank account and a credit card. But for those who are long past that stage in life, it gets a lot more complex.
For example, once real money starts coming in, a person might know they need to invest some of it, but they don’t know where to start.
Once people have a family, they might know they need life insurance, but they don’t know how much.
All of this falls under the category of financial planning. People are often comfortable handling some parts of it, and don’t have much of an idea how to handle other parts of it.
Regardless, there are certain things that should be included in all discussions of financial planning.
Get Started Investing
Hopefully this goes without saying, but we’ll say it anyway: You need to save and invest as large a portion of your income as possible. That’s not financial planning–that’s just a fact.
The financial planning part gets into the details of what that saving and investing should look like. It’s a lot more than putting money in the bank (though that should be a small piece of it).
For many people, the biggest question is going to have to do with what kind of investments they should make. Broadly speaking, this is asset allocation, and it–also broadly speaking–refers to stocks, bonds, and cash.
The way you allocate your investments across these asset types is usually based on how old you are, your ability to stomach the ups and downs of the stock market, and financial goals you have set for you and your family.
You already know what cash is, so let’s talk about the other two: stocks and bonds. These come in all flavors, and depending on the things mentioned in the previous paragraph, you’re going to invest in them somewhere on the spectrum from very conservative to very aggressive.
Conventional wisdom says that you’ll want to invest on the aggressive side when you’re younger and building up your wealth, and on the conservative side when you’re older.
And what do those words mean as they relate to investing? Aggressive stocks are the shares of companies that are growing like crazy and may not even be turning a profit. Think Amazon.com 20 or so years ago.
Conservative stocks are shares of companies that are large, profitable, and quite likely pay a dividend to their investors.
As for bonds, they’re best largely ignored when you’re young and building wealth.
Aggressive bonds are generally junk bonds, which pay big yields but have a higher risk of default, while conservative bonds might be the debt of one of the aforementioned companies that offer conservative stock investments, or, at the most conservative end, short-term US treasury bills and notes.
You don’t want to go out there and buy individual stocks and bonds, though. You want that handled by professionals.
Actually, that’s not entirely accurate–you generally don’t want people picking stocks and funds for you, including professionals. That’s called active management, and it will do worse than the overall stock market indexes the vast majority of the time.
Instead, you want passive management, also referred to as index investing. Index funds will track indexes (such as the S&P 500 and countless others) as best as possible, minus a small management fee. Keeping these fees low is one of the keys to successful investing.
Once you’ve chosen your investments, you’ll want to keep track of how they’re doing. You can use software like WealthTrace, which provides comprehensive financial and retirement planning software and also allows users to track their wealth.
Websites such as PersonalCapital allow users to track their investments and transactions while also providing investment management services for a fee.
It’s up to you how far down that path you want to go, but two things to consider: (1) Watching your investments too closely is a recipe for making yourself crazy, and (2) if you invest solely in index funds that match your goals and risk tolerance, you should not need to worry much about a rogue investment going wrong.
Funds will invest in some companies that do well and some companies that do poorly, but the chance of one of those companies’ stocks doing lasting damage to your investment portfolio is vanishingly slim.
In addition to asset classes, you also have to consider what kind of investment accounts you should be funding. Here, we’re referring mostly to how the accounts are taxed and when they can be used.
A 401(k) and a traditional IRA are going to be tax-deferred, meaning you won’t pay taxes on their growth until you take money out of them in retirement.
It’s normally best to fund these right off the top, especially with a 401(k), where the employer might match a portion of your contributions. That’s free money, and it should not be ignored.
But it also makes sense to get a taxable account going as well. If you can squirrel away a bit of money–even a small bit, just to get in the habit–into a taxable account each paycheck, you absolutely should do so. As your earnings increase, you can increase your contributions to it.
Where financial planning comes into play here relates to what kind of accounts to fund and in what order. And that’s largely going to depend on what you hope to achieve by saving and investing.
What Do You Want Out Of This?
In most cases, you’ll want to fund that 401(k) up to the matching amount, regardless of what your goals are. But beyond that, where you sock away your funds is going to have to do with when you’ll need the money, and what you’ll need it for.
Most people want to invest for retirement. That’s an easy one. Beyond that, though, the timing of when you’ll need the money should influence how you’re investing it.
For retirement, assuming it’s a long way off, you can afford to be aggressive–and that aggressiveness will pay off in higher returns. For something like a down payment on a home you anticipate buying soon, you don’t want to risk a market crash right when you need the money, so you’ll want to be conservative with it. This is all part of financial planning.
Don’t Forget About Insurance
Insuring your prized possessions is important and part of financial planning, but even more important is insuring yourself. That is, making sure health and life insurance are handled in some way, and at least considering long-term care insurance.
We’ll start with the last one. Nobody wants to think about it, but getting old will happen, and can be very expensive.
If you’re young, start saving for it now. For most people, ‘self-insuring,’ meaning making sure you have the resources yourself versus buying an insurance policy, will make sense.
The problem is nobody knows how much they’ll need, or if they’ll need it at all. The best we can do is make an educated guess based on heredity and health.
Health insurance and life insurance, however, are a bit more straightforward. You’ll want to be prepared to pay for supplemental Medicare insurance when the time comes; we hope we’re not the ones breaking it to you that basic Medicare won’t cover everything.
Putting money into a Health Savings Account (HSA), if you’re eligible for one, is a solid way to handle this issue.
Life insurance, too, is fairly cut and dried. Would your dependents be able to make ends meet (and then some) if something were to happen to you (or the family’s main breadwinner)? Life insurance can make sure they’ll be OK. Preparing for this is also financial planning.
As you get older and make money and maybe start a family, life will get more complicated. This rule definitely applies to personal financial issues too. Financial planning starts out pretty simply, but then gets more complex as you try to prioritize your goals, minimize your taxes, and prepare for retirement.