Overview of Financial Plan

Lesson 1: FIN101.

Nigel N. Silvestre.
Personal finance (also referred to as personal financial planning) is the process of planning your spending, financing,
and investing to optimize your financial situation. A personal financial plan specifies your financial goals and describes
the spending, financing, and investing plans that are intended to achieve those goals. Although the United States is one of
the wealthiest countries in the world, many Americans do not manage their financial situations well. Consequently, they
tend to rely too much on credit and have excessive debt.

Personal finance does not require a genius mind, but does require the use of common sense and discipline. If you make
proper personal finance decisions, you will spend your money more carefully, which can reduce the amount of funds you
need to borrow, or can increase your savings. Either result increases your wealth, and allows you to more easily afford
purchases of products or services in the future. Conversely, poor personal finance decisions can cause you to borrow
excessively, to the point at which you might not be capable of repaying your debt.
HOW PERSONAL FINANCE CAN ENHANCE YOUR JOB
MARKETABILITY

An understanding of personal finance may interest you in pursuing a career as a financial adviser. Financial advisers are in
demand, because many people lack an understanding of personal finance or are not interested in making their own financial
decisions.

A single course in personal finance is insufficient to start a career as a financial adviser, but it may interest you in taking
additional courses to obtain the necessary qualifications. However, even if you decide to work for a company in a different
capacity than as a financial adviser personal finance decisions are very similar to decisions that employees make within a
company.

You attempt to earn income so that you have money to spend or save. A company earns income so that it has money to spend or
save. You spend money to buy products. A company spends money to buy products (or supplies). If you spend more money
than the amount you have in savings, you need to finance your purchases by borrowing. When a company spends more money
than it has saved, it has to finance its purchases. Your spending decisions affect your savings and your financing decisions.
COMPONENTS OF A FINANCIAL PLAN

You can benefit from building your own financial plan, which consists of the following personal finance
components:

1. Budgeting and tax planning

Budget planning (also referred to as budgeting) is the process of forecasting future expenses and savings. That is, it
requires you to determine how you spend money, the amount of money to spend, and how much to save. Your
spending decisions are critical, because they determine how much of your income can be used for other purposes. 

The first step in budget planning is to evaluate your current financial position by assessing your income, your
expenses, your assets (what you own), and your liabilities (debt, or what you owe). Your net worth is the value of
what you own minus the value of what you owe. You can measure your wealth by your net worth. As you save
money, you increase your assets and therefore increase your net worth. Budget planning enables you to build your
net worth by setting aside part of your income to either invest in additional assets or reduce your liabilities.
• Your budget is influenced by your income, which in turn is influenced by your education and career
decisions. Individuals who pursue higher levels of education tend to have smaller budgets during their
education years. After obtaining their degrees, however, they typically are able to obtain jobs that pay higher
salaries, and therefore have larger budgets.

• A key part of budgeting is estimating the typical expenses that you will incur each month. If you
underestimate expenses, you will need more cash inflows (money that you receive) than you expected to
cover your cash outflows (money that you spend). Achieving a higher level of future wealth requires you to
maintain your spending at a lower level today.
PLAN TO MANAGE LIQUIDITY.
You should have a plan for how you will cover your daily purchases. Your expenses can range from your
morning cup of coffee to major car repairs. You need to have liquidity, or access to funds to cover any short-
term cash needs. You can enhance your liquidity by utilizing money management and credit management.

Money management involves decisions regarding how much money to retain in a liquid form and how to
allocate the funds among short-term investments. If you do not have access to money to cover your cash needs,
you may have insufficient liquidity. That is, you have the assets to cover your expenses, but the money is not
easily accessible. Finding an effective liquidity level involves deciding how to invest your money so that you
can earn a return, but also have easy access to cash if needed. At times, you may be unable to avoid cash
shortages because of unanticipated expenses.

Credit management involves decisions about how much credit you need to support your spending and which
sources of credit to use. Credit is commonly used to cover both large and small expenses when you are short on
cash, so it enhances your liquidity. Credit should be used only when necessary, however, as you will need to pay
back borrowed funds with interest (and the interest expenses may be very high)
 
PLAN FOR FINANCING LARGE PURCHASES

Loans are typically needed to finance large expenditures, such as the payment of college tuition or the purchase
of a car or a home. The amount of financing needed is the difference between the amount of the purchase and
the amount of money you have available, as illustrated in Exhibit 1.3. Managing loans includes determining
how much you can afford to borrow, deciding on the maturity (length of time) of the loan, and selecting a loan
that charges a competitive interest rate.
PLAN TO PROTECT YOUR ASSETS AND INCOME
To protect your assets, you can conduct insurance planning, which determines the types and amount of
insurance that you need. In particular, automobile insurance and homeowner’s insurance protect your assets, and
health insurance limits your potential medical expenses. Disability insurance and life insurance protect your
income.
PLAN FOR INVESTING YOUR MONEY.

Any funds that you have beyond what you need to maintain liquidity should be invested. Because these funds
normally are not used to satisfy your liquidity needs, they can be invested with the primary objective of earning
a high return. Potential investments include stocks, bonds, mutual funds, and real estate. You must determine
how much of your funds you wish to allocate toward investments and what types of investments you wish to
consider. Most investments are subject to risk (uncertainty surrounding their potential return), however, so you
need to manage them so that your risk is limited to a tolerable level.
PLAN FOR YOUR RETIREMENT AND ESTATE.

Retirement planning involves determining how much money you should set aside each year for retirement and
how you should invest those funds. Retirement planning must begin well before you retire, so that you can
accumulate sufficient money to invest and support yourself after you retire. Money contributed to various kinds
of retirement plans is protected from taxes until it is withdrawn from the retirement account. Estate planning is
the act of planning how your wealth will be distributed before or upon your death. Effective estate planning
protects your wealth against unnecessary taxes and ensures that your wealth is distributed in the manner that
you desire.
DEVELOPING YOUR FINANCIAL PLAN.

I. ESTABLISH YOUR FINANCIAL GOALS. - First, identify your general goals in life. These goals do not
have to be put in financial terms. For example, you may have goals such as a family, additional education,
or a vacation to a foreign country for one week every year. You may envision owning a five-bedroom
house, or having a new car every four years, or retiring when you reach age 55.

A. TYPES OF FINANCIAL GOALS

B. SET REALISTIC GOALS

C. TIMING OF GOALS
DEVELOPING YOUR FINANCIAL PLAN.

II. CONSIDER YOUR CURRENT FINANCIAL POSITION - Your decisions about how much money to
spend next month, how much money to place in your savings account, how often to use your credit card,
and how to invest your money depend on your financial position. A person with little debt and many assets
will clearly make different decisions than a person with mounting debt and few assets. And a single
individual without dependents will have different financial means than a couple with children, even if the
individual and the couple have the same income. The appropriate plan also varies with your age and wealth.
If you are 20 years old with zero funds in your bank account, your financial plan will be different than if
you are 65 years old and have saved much of your income over the last 40 years
DEVELOPING YOUR FINANCIAL PLAN.

III. IDENTIFY AND EVALUATE ALTERNATIVE PLANS THAT COULD ACHIEVE YOUR GOALS -
Given your financial goals (which you defined in Step 1), you need a financial plan that could help move
you from your existing financial position (which you assessed in Step 2) toward achieving your financial
goals. Your financial plan will require various types of decisions that will influence your career, income
level, and savings over the next several years.
a. Pursuing Additional Education
b. Selecting your Major
c. Selecting your college
d. Establish a strategy to accumulate wealth
DEVELOPING YOUR FINANCIAL PLAN.

IV. SELECT AND IMPLEMENT THE BEST PLAN FOR ACHIEVING YOUR GOALS - You need to
analyze and select the plan that will be most effective in achieving your goals. Many alternative plans that
could possibly achieve your goals involve trade-offs. For example, you may have a long-term financial goal
of accumulating a large amount of money by the time you are 50 years old, so that you can retire at that
time. One plan to achieve this goal may be to pursue a career that generates a higher income level, but this
type of career might first require you to pursue additional education to have the credentials you need.
Consequently, you may have to spend money and time in education over the next few years to achieve this
long-term goal. Alternatively, you may decide not to pursue additional education, but plan to save a very
high proportion of your income from your existing career to achieve your goal. However, this strategy may
require that you forgo some spending over the next several years to achieve your long-term financial goal of
early retirement. Many individuals do not meet their financial goals because they establish unrealistic
financial plans.
DEVELOPING YOUR FINANCIAL PLAN.

V. EVALUATE YOUR FINANCIAL PLAN - After you develop and implement each component of your
financial plan, you must monitor your progress to ensure that the plan is working as you intended. Keep
your financial plan easily accessible so that you can evaluate it over time.
VI. REVISE YOUR FINANCIAL PLAN - If you find that you are unable or unwilling to follow the financial
plan that you developed, you need to revise the plan to make it more realistic. Of course, your financial
goals may have to be modified as well if you are unable to maintain the plan for achieving a particular level
of wealth. As time passes, your financial position will change, especially with specific events such as
graduating from college, marriage, a career change, or the birth of a child. As your financial position
changes, your financial goals may change as well. You need to revise your financial plan to reflect such
changes in your means and priorities.