Do you have a financial plan? Apparently, most people don’t according to an old friend who has spoken to thousands of retail banking clients over the past 15 years. Not only has he spoken to thousands of people about their finances, he’s also seen thousands of banking statements as well. Frank is a regional branch manager for one of the largest banks in the world.
“Sam, the middle class are just living paycheck to paycheck. They have no plan when it comes to their retirement. So many of them are in their 40s and 50s with just $10,000 or less to their name,” he explained to me.
He went on, “All they do is come into the branch, ask what the latest CD rates are, and move on if they aren’t high enough. They don’t bother to invest or learn about other ways to make their money grow. They just hope everything will be OK due to Social Security.”
Hope is a very strong feeling that helps us get through many obstacles. But when it comes to our finances, let’s not leave them up to chance. It’s important for every one of us to come up with a financial plan.
LET US FINANCIALLY PLAN
The reason why more people don’t plan is because people just don’t know where to start. There’s also a strong level of procrastination because there’s no clear immediate reward. Let’s go through three simple steps to help anybody get started with a financial plan.
1) First, make a list of financial goals by a certain age. It’s important to have the age in there because it provides a deadline. Without a deadline, there’s no sense of urgency.
Here are some examples of common financial goals for people at various ages:
- Graduate college by 22
- Buy a home with 20% down by age 28
- Save up $100,000 by age 30
- Pay off all student loans by age 33
- Get married by age 35
- Have children by age 38
- Achieve a $500,000 net worth excluding primary residence by age 40
- Develop three income streams making $50,000 a year before taxes by age 45
- Pay off mortgage by age 55
- Achieve a $1,500,000 net worth by age 60
2) Second, find out where you are on the progress meter by assessing your current financial situation compared to your goals.
Take a look at these examples from the examples above.
- You’re currently 21 years old and have one more year left of college after three years. Progress meter at 75%.
- You’re currently 25 and saved $30,000 in three years with $30,000 left to go by the age of 28. Progress meter at 50% for a 20% downpayment and a progress meter at 67% for a 20% downpayment plus a 10% buffer.
- You’re currently 28 years old with $25,000 left in student loans after paying off $5,000 after six years. Progress meter less than 15% with only five years left until your desired goal of being student loan free by 33.
- You’re currently 33 years old and are only casually dating someone. You’re definitely not on track to get married by age 35 or have children by age 38. Progress meter closer to 20%.
- You’re currently 45 years old and have $200,000 left of a $250,000 mortgage taken 15 years ago. There’s 15 years left of the 30-year fixed mortgage, but you want to pay off your mortgage in 10 years. Progress meter at 35% without further action.
- You’re currently 50 years old with 28 years of work experience and a net worth of $1 million. Progress meter at less than 40% because you only have 10 years left to make up half of what took 28 years to accumulate.
3) The final step of your financial plan is to prioritize the top three financial goals and come up with specific action steps to take to make up any shortfalls. Your top three financial goals can also be arranged as the top three financial goals with the greatest shortfalls.
Let’s say you’re the 25 year old with $30,000 in savings, and a $60,000 a year income in this example. Your priorities are buying a home, finding love, and achieving a $1,000,000 net worth by 45.
In order to buy a $300,000 home by age 28 with 20% down and a 10% cash buffer, you’ve got to save another $60,000 over the next three years to comply with my 30% rule for home buying. The math is therefore $20,000 a year in non-401k and non-IRA savings. You could continue to max out your 401k by $18,000 a year, leaving you with $42,000 a year in taxable income. But, in order to save $20,000 a year in non-tax advantageous accounts, you’ll probably have to reduce your 401k/IRA contributions. Sacrifices will need to be made if your income stays static at $60,000 a year!
In order to get married by 35, you’re probably going to have to meet someone by age 33 in eight years. You realize that ever since you started dating at age 20, you’ve only averaged one girlfriend a year, all of which ended in tears. To up your chances for finding the one, you’ve got to increase the volume of women you meet. Finding love is a numbers game. You create a game plan to meet at least one new woman a quarter, so that by the age of 33, you’ll have met 32 women as opposed to eight. You further read all you can about becoming a more charming individual who’s thoughtful and doesn’t bore women to death. You also start a new diet and exercise regime to look incrementally more attractive.
In order to achieve a $500,000 net worth by age 45 (20 years), you need to grow your net worth by $25,000 a year on average. With an existing $60,000 gross income salary and the desire to save $20,000 a year for a home, you’re not that far off. The solution is to create a pro forma spreadsheet of what happens to your income, savings rate, and investment returns after the age of 28 when more cash flow is freed up to invest. You should create three different scenarios (Blue Sky, Realistic, Bad Case) of your income level from ages 26-45 and adjust your savings rate and investment returns accordingly.
The Main Financial Goals
The most common financial goals will revolve around paying down debt and achieving a certain net worth by specific times. The ideal financial scenario is where you experience zero financial stress as soon as possible, and no later than your desired retirement date.
Zero financial stress always entails less debt, and larger amounts of cash flow. Therefore, one of the best goals everyone should strive for is to retire with zero debt and generate passive income equivalent to your average annual gross income during your working career. If you can do this, you’ll be absolutely safe from financial worry because you’ll have an extra income buffer since you no longer need to allocate part of your income for retirement.
Once you come up with a financial plan that includes specific goals by specific times, you can more easily begin to take action. Try to start with the end in mind and reverse engineer your way how to get there. The hardest part is getting started.
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