09 May Financial planning Essentials: How to build your financial plan in 5 simple steps
A lot of us have the tendency to think that financial planning is something only for high-networth individuals, or those with complex financial situations or worse those with messy financial situations. However nothing can be further from the truth.
According to Investopedia, A financial plan is “a comprehensive evaluation of an investor’s current and future financial state … to determine if a person’s financial goals can be met in the future, or what steps need to be taken to ensure that they are.”
By giving a direction to your financial life, financial planning can not only help you secure your future but also make you more comfortable with what you are spending today.
In this article, we detail 5 simple steps to making your very own financial plan. You can also check out our infographic for a short summary
1. Assess your current situation
The first step of financial planning is to find out where you stand today with respect to you income, expenses, assets and any outstanding liabilities. You can think of this exercise as making your personal balance sheet.
A professional financial planner will next proceed to analyse your balance sheet through multiple standard ratios. However as a DIY financial planner, you can work with less formalisation and focus on three main aspects of your balance sheet ( which is what the ratios measure in any case):
a. Savings: What are your annual savings and also your accumulated savings relative to your annual income
b. Debt position: How does your debt stand relative to your assets and how do the interest payments stack up against your income
c. Liquidity: What is the composition of your assets, liquid vs. illiquid, financial (typically more liquid) vs real assets
It is always important to evaluate your balance sheet relative to your age (as a proxy for your current stage in life). When you are young, in your 20s and early 30s it is natural to have higher expenses relative to income and low accumulated savings.
Also a significant portion of income is likely going towards servicing a home loan on a house which is a significant percentage of your assets. However the ratios should improve as you get older.