Why Is Financial Planning Important?
Without a financial plan, it's hard to know whether you're sinking or swimming when it comes to your finances. If you aren't tracking your cash flow, your debt could be growing without you even realizing it. "If you are digging yourself further in the hole every month, nothing else matters," says Brian Frederick, a certified financial planner practicing in Scottsdale, Arizona. "Having negative cash flow is analogous to having a leaky boat -- it's hard to go forward when you're busy bailing water to make sure you don't sink."
Understanding Where Your Money Goes
Without a financial plan, you don't know where your money is going, much less how you can make adjustments if you want to set new financial goals. "The biggest problem that I've seen with setting spending guidelines is that often, the numbers are just plucked out of the air," notes Frederick. "Rather than looking at prior spending as a starting point, people will frequently make up a number based on what they think it should be or what they want it to be." And, even though you might think you know what you spend on certain categories, it's not uncommon for people to be way off. "A classic example of this is that I had a client who was spending about $120/month at Starbucks on a $30,000/year income," recalls Frederick. "He was engaged and they wanted to have children as soon as possible after getting married but he realized that this wasn't financially possible with a coffee habit that took up 5 percent of take-home pay!"
Setting Long-Range Financial Goals
Building your financial plan allows you to incorporate long-term goals rather than living paycheck-to-paycheck and waking up five years later and realizing you're no closer to your financial aspirations. After you've gotten your cash flow into the black, Frederick recommends setting aside money for future emergencies and boosting your retirement funds. Ideally, Frederick suggests putting between 10 and 25 percent of your income, including any employer matches, into retirement savings. "Once you do these things, you can start thinking about things like saving for a home down payment or putting money away for your children's education," says Frederick.
Setting an Example for Children
Your little ones are watching how you live your life, including how you manage your money. "The best ways to pass good financial habits to your children is to take time to talk with them about money matters and also to set a good example with your own financial habits," says Frederick. In addition, your financial plan can include how you might provide for your children, such as with a life insurance policy, if something happens to you. Of course, no single policy is perfect for everyone, so talking with a financial planner can help you understand your options.