The four pillars of basic financial planning include budgeting, saving and investing strategically, managing debt effectively, and ensuring comprehensive risk coverage.
Budgeting and Expense Management
Effective budgeting and expense management are fundamental to maintaining financial stability and achieving your financial goals. This process starts with a clear understanding of your income and expenses and involves strategic planning to optimize your financial resources.
Create a complete budget
Create an itemized budget that reflects your income sources and tracks each of your expenses. First, write down your monthly take-home pay and other income sources, then track your monthly expenses, including fixed expenses (such as rent and car payments), variable expenses (such as groceries and entertainment), and irregular expenses (such as annual insurance premiums or holiday gifts). For example, if you make $3,500 per month, make sure to categorize your expenses so that your needs are paid before discretionary expenses and your discretionary expenses do not exceed 30% of your income.
Track your expenses religiously
Use a budgeting app or spreadsheet – track every dollar spent. This not only helps you stick to your budget, but it can also show spending patterns. For example: if you find yourself regularly exceeding your spending on dining out (e.g., $500 per month when you budgeted $300), it’s a sign that you need to reevaluate your budget or adjust your dining expenses.
Set spending limits
Budget-shift spending: You can always overspend on discretionary expenses, so set limits. For example, limiting entertainment to $200 per month will keep you from overspending, which could end up eating into your savings or fixed expenses.
Review and adjust regularly
Review your budget in detail at least once a quarter to make sure it’s still in line with your financial goals and your life. Check your dashboard regularly and make adjustments to better reflect your income, life changes, and financial goals. When you get a pay raise, determine how much of the extra income will go toward savings versus spending.
Leverage financial tools
Take advantage of financial tools and technology to automate your budget. So many apps that fall into this category track your spending and cross-check it with your budget numbers in real time, sending you alerts and reports to make sure you’re staying on track.
Savings and Investment Strategies
An effective savings and investment strategy is essential to building wealth and securing your financial future. It’s not just about saving, it’s about investing wisely to ensure long-term growth and security.
Set a savings goal
Determine your savings goal in quantifiable terms. For example, saving for an emergency fund, a down payment on a house, or retirement. Simply determine how much to save and when to save. If you need $15,000 for an emergency fund, saving $500 a month for 30 months will accomplish that goal.
Diversify your investments
Spread your portfolio across a variety of asset classes to reduce risk and earn a solid return. Depending on your risk tolerance, investment horizon, or both, you may want a combination of stocks, bonds, mutual funds, or even real estate. For example, a younger investor may decide to hold an aggressive portfolio with a ratio of 80% stocks and 20% bonds (although these may change as you age or your financial goals change).
Use tax-advantaged accounts
Save as much money as possible into tax-advantaged accounts such as IRAs, 401(k)s, or HSAs. Using these accounts can greatly accelerate the growth of your investments because they have tax advantages. For example, putting more money into an IRA, $6,000 a year can grow tax-free and turn into a fortune over a few decades.
Optimize your portfolio frequently
At least once a year, review and rebalance your investments to ensure that the percentage of each asset in your portfolio is in line with your established strategic asset allocation. Rebalancing is the act of buying or selling certain assets to keep them in line with your original investment strategy. If your stock allocation increases to 85% due to market gains and your goal is 70%, you need to sell stocks and buy bonds to rebalance.
Monitor and adjust
Monitor the performance of your investments and change your strategy based on success and dynamics. Any time a particular investment fails miserably, it may be time to move more or all of your investments into better performing assets.
Debt Management and Credit Planning
Taking control of your debt and strategically planning it is the secret to a healthy financial lifestyle and achieving financial flexibility. Helpful practices regarding credit card debt include: knowing your rights, maximizing debt repayment, and using your credit effectively to improve your financial situation.
Assess Your Debt Burden
Compile a comprehensive list of all the debts you owe: credit card balances, student loans, mortgages, and any other loans. The interest rates, monthly payments, and current balances of each debt. For example, if you have a $20,000 student loan with a 6% interest rate and a $350 monthly payment, understand that you may have to make that the first item to manage because it is a more expensive item compared to other, potentially low-interest debts.
Create a Repayment Plan
Write out a plan to pay off your debts, pay the least interest, and get out of debt the fastest. Use strategies such as the snowball method (pay off the debt with the smallest balance first) and the avalanche method (pay off the debt with the highest interest) to pay off your debts. If you use the avalanche method, if you have extra payments to make, absolutely use 20% of your credit card payments instead of paying off 6% of your student loan.
Improve Your Credit Score
Keep an eye on your credit score, which can help you get good rates and loans. Pay your bills on time, keep your credit utilization below 30%, and don’t open multiple new credit accounts at once. It can save you hundreds or even thousands of cents on your loan interest rates in the long run!
Review and adjust your plan regularly
Review your debt management and credit plans; they can be adjusted based on your personal financial situation or changing economic conditions. If you make more money, you may want to increase your debt payments to get out of debt faster. If interest rates drop, consider refinancing to save costs
Risk Management and Insurance
Risk management and insurance are important aspects of any financial plan because they are two ways to protect you from unexpected losses and secure your financial future. Individuals who manage these elements well can protect their assets and income and have peace of mind knowing that they are financially secure.
Identify Potential Risks
By conducting an extensive risk analysis, you can assess the full range of financial threats. Some examples of risks include illness, disability (and potential loss of income), property damage, legal liability, and major health emergencies. For example, if you own a home in an area prone to natural disasters, understanding the cost of flood or earthquake damage can help you prepare financially.
Choose the Right Insurance Policy
Choose insurance products that support significant risks within reasonable limits. It includes choosing health, life, disability, property and liability insurance and planning based on personal needs and financial circumstances. For example, if you are unable to return to work, a term life insurance policy worth 10 times your salary may be the right amount for your family.
Review Insurance Coverage Regularly
All aspects of your life change, just as they do every day, and your insurance coverage should change with it. You should adjust your insurance coverage as your marital status changes, family members grow, new properties are purchased, or new businesses are established. Update insurance limits to current values and needs to prevent over-insurance and under-insurance.
Diversify your investments
Further spread your financial risk with a properly diversified portfolio. A diversified portfolio that owns a variety of assets, such as stocks, bonds, real estate, etc., helps manage volatility and creates a more stable source of strength in various economic environments. That way, if the stock market crashes and the investments in bonds or real estate still perform well, the contributions from the good performance can offset the losses.
Build an emergency fund
Build and grow an emergency fund that is enough to cover three to six months of living expenses. An emergency fund is a financial buffer that can help you handle unexpected situations in life without having to cash out your investments too early (thereby locking in losses or penalties).
