Financial planning - Bogleheads

I Need A Plan?
If you don't know where you are going, you'll end up someplace else.
Yogi Berra

A financial plan is not about acquiring piles of money. It's a long-term process of managing your finances so you can achieve your goals and dreams, while at the same time negotiating the financial barriers that inevitably arise in every stage of life. Remember, financial planning is a process, not a product.^[1]

A sound financial plan incorporates these steps:^[1]

1. Establish Goals
2. Gather Data
3. Analyze & Evaluate Your Financial Status
4. Develop a Plan
5. Implement the Plan
6. Monitor the Plan & Make Necessary Adjustments

Note the distinction between an investment plan and a financial plan. Although the terms are frequently interchanged, they have a very different purpose.

Financial plan

Establish goals and gather data

A financial plan usually begins with a summary of the current financial situation; including net worth, a list of income and expenditures, and a budget. Following this snapshot, the plan may address issues and make recommendations in seven key areas:^[2]

• Day to day finances (budgeting, expense control, mortgages, other debt, emergency funds, etc.)
• Insurance ( life, health, disability, property)
• Education (529 Plans)
• Taxes (exemptions, deferrals, income splitting)
• Investments ( asset allocation, security selection, risk management)
• Retirement ( pensions, 401(k), Social Security, annuities, etc.)
• Estate (wills, powers of attorney, use of trusts, planned giving, etc.)

Not all financial plans include recommendations for all of these topics. For example, a retired person with a mortgage-free residence and a pension that covers day to day expenses may want and need advice only with respect to investments, taxes, and estate planning.

Analyze and evaluate your financial status

Main article: Household budgeting

Main article: Emergency fund

Are you ready to invest, household budget - Day to day finances

Develop a Plan

Both financial as stated above, and investments (below)

Implement the plan

financial as stated above (get estate matters in order, acquire insurance. Investments as below - save for education, watch taxes. Monitor day-to-day finances by tracking your budget and adjusting as necessary.

Monitor the Plan & Make Necessary Adjustments

Once a year, reevaluate your goals and compare to your time horizon. Adjust your insurance, estate matters, rebalance portfolio.

Investment plan

(This is the investments part of a financial plan)

Recognizing that every store of value, even a mattress, is an investment with potential risks and rewards, then anyone who possesses something of value is an investor. A natural first question, then, is, "How should I invest?" That is, into what asset classes should I place my funds and in what proportions? Or, what should my asset allocation be and how do I determine it and adjust it over time? The discussion below attempts to provide guidance in addressing that question using the canonical example of saving for retirement. However, some (not all) of the techniques and tools presented below can be applied to other savings goals.

Investment is risk. It is not possible to separate the two. So a natural place to begin is an assessment of one's appetite for risk.

The first step on your investing journey should be to settle on an investment plan that includes your desired asset allocation. Your investment plan should look out into the future and include things like a new car or home purchase in a few years, education expenses for children, and retirement, just to name a few. All of these goals require money in different time frames, and the money should be invested accordingly. Studies have shown that your asset allocation will determine more than 90% of the variation in your portfolio return, so you should focus on your asset allocation first rather than on fund selection.^[3]

Since risk and return are directly related, your asset allocation should balance your NEED to take risk with your ABILITY to withstand the ups and downs of the market. NEED can be determined in many different ways. If you are young, you have the benefit of many years of compounding, so in one respect your NEED to take risk is low. On the other hand, your portfolio size is probably small, leaving you with a long way to go to reach your retirement goals. As a result, you could argue that your NEED to take risk is high.

For people closer to retirement, it may be possible to more closely determine NEED. First, estimate approximately how much income you will need annually after retirement. For this example, we?ll assume you need $100,000 per year. Next, look at any pensions or social security benefits that will provide a source of income. If a pension provides $30,000 per year and social security provides an additional $20,000 per year, then your portfolio would need to provide an extra $50,000 each year. To prevent running out of money, you should probably start by withdrawing 4% a year or less with an annual inflation adjustment. To generate $50,000 per year at 4% requires a minimum portfolio size of $1,250,000. How close are you to your goal?

Turning to ABILITY, this relates to your ability to withstand the ups and downs of the market without getting nervous and making changes to your asset allocation. Selling in the face of a decline is about the worst thing you can do. Here is a table offered by author Larry Swedroe, based on the 1970s bear market, showing the amount of decline for various stock/bond allocations:

Asset Allocation?% (Stock/Bond)	Exposure to Maximum Loss
20/80	5%
30/70	10%
40/60	15%
50/50	20%
60/40	25%
70/30	30%
80/20	35%
90/10	40%
100/0	50%

For example, you would be willing to accept a loss of 35% in your portfolio if you held an allocation of (80% stocks / 20% bonds). This table is from the 1970's; performance during other time periods will have different results. The general idea is to select an asset allocation you are comfortable with.

Notes

References

1. ? ^1.01.1What is Financial Planning?, by the Financial Planning Association
2. ? Creating a Financial Plan from finiki, the Canadian financial Wiki. Modified for US.
3. ? Investment Planning, forum discussion.

External links

1. Establish Goals - What Is The Purpose Of Your Investments? Gather Data, Determine how much you need to save to meet your goals

a. Define your goals

i. Retirement

ii. Owning vs Renting

iii. Children and their College Savings

b. Determine the time needed to reach goals: short, medium, and long term

c. Set priorities

2. Gather Data - Before you start- organize, net worth, debt situation, current insurance, current budget, current emergency reserves. Analyze & Evaluate Your Financial Status

3. Analyze & Evaluate Your Financial Status

a. Are you ready to invest?

i. Emergency fund established

ii. Household budgeting - do you have enough left over for investing?

4. Develop a Plan

a. Create a realistic budget with adequate insurance

b. Plan for paying off existing credit card debts and other loans

c. Plan for building an adequate emergency fund

d. Understand your need, willingness and ability to take investment risk

e. Plan for saving to meet your goals

i. The time horizon will define your investing strategy (dream home, retirement, college)

ii. Design a disciplined savings program

f. Write an Investment Policy Statement (IPS) or Investing plan

5. Implement the Plan: Stay focused so you can keep your plans on track

a. Track your expenses and stay within your budget

b. Pay off credit card debt and loans

c. Complete saving for the emergency fund

d. Buy a home if that is in your plan

e. Execute the IPS

6. Monitor the Plan & Make Necessary Adjustments

Source: http://www.bogleheads.org/wiki/Scratch_Pad%3A_Investment_planning

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