What is a Financial Plan?

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A financial plan is a roadmap for understanding your current financial situation, as well as your goals and strategies to achieve them.

🤔 Understanding financial plans

A financial plan is a detailed guide that outlines your current financial situation, your goals, and strategies for growing your wealth. A financial plan generally covers topics like budgeting, debt, saving, retirement planning, insurance, and more. Budgets — a breakdown of how much you make and spend — can help you stay on track with your goals. Financial plans also often outline strategies for growing your wealth, such as saving and investing. With a detailed financial plan, you can figure out not only where you are today, but where you want to go and how to get there.


Imagine your friend Jim is in a bad spot financially. He has outstanding student loans, credit card debt, a low credit score, and very little saved for retirement.

Jim knows things need to change, so he makes a financial plan. It details his current financial situation, as well as goals for paying down debt and hitting savings targets.

Jim realizes he spends too much eating out and not enough taking advantage of his employer’s 401(k) plan. After setting a budget and eating at home more often, Jim begins saving and investing, and his wealth slowly increases.


A financial plan is like a GPS…

Set a destination, and your GPS can help you navigate winding country roads and busy cities. Things may not always go as planned, but if there’s construction or an accident on the way, a GPS can advise another route. Likewise, a financial plan can help you lay out your goals and the strategies that could make them a reality. Just like a GPS, your financial plan has an initial goal but can adjust to changing conditions, such as increased income or a new dependent.

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What is a financial plan?

A financial plan is a detailed review of your current finances, as well as your goals and the strategies you can use to reach them. A financial plan usually considers your income, debt, assets, liabilities, and other factors that could impact your finances.

A thorough plan will also typically cover insurance, retirement planning, investments, and anything else that could impact your financial security.

What are the objectives of financial planning?

Making a financial plan can help you understand where you stand today and get clear on where you want to go. Everyone’s financial plan will look different — It depends on your individual circumstances and what you want out of life.

Sound financial planning can improve your financial security. That could mean building up an emergency fund to cover unexpected costs or diversifying investments to reduce risk.

Saving for retirement is also a vital objective for most people. When you retire, you lose an important source of income. People who don't save for retirement may not have enough money to cover living expenses and may have to keep working longer than they’d like.

Ultimately, a financial plan can help you achieve the goals that you set for yourself. This might mean building a diversified stock portfolio, retiring by age 55, getting out of debt, or whatever else you desire.

No matter your specific goals, the overall objective of financial planning is to build wealth and financial security. Things don’t always go exactly as planned. Financial plans are meant to be flexible and adjust along with your circumstances.

How do I make a financial plan?

These are some of the key steps in financial planning:

Outline your goals

When you use a GPS, the first thing you probably do is set a destination. Similarly, the initial step in making a financial plan is setting goals.

"Becoming wealthy" is a good start, but specifics are better. Where do you want to be in five years? How about in 10 or 20? Do you want to own a home, pay off your car loan, and have $100,000 in your 401(k)? Have children and pay for their education? Fund a trip around the world or retire early? Figuring out when you want to retire, and how much money you need to save and invest to afford your lifestyle, is something every plan should include.

As you build the rest of your financial plan, you may end up adjusting your goals based on what’s realistic. Your goals are likely to change over time, too.

Figure out your net worth

Now that you know where you want to go, determine your current situation. First, figure out your net worth, which is all of your assets minus all of your liabilities.

Assets include real estate, stock portfolios, valuable jewelry, cash, and anything else of substantial value that you own.

Liabilities include mortgages, student loans, credit card debt, car loans, and any other debts. Subtract what you owe from your assets, and you'll have your net worth.

Having a negative net worth is common, especially for younger people. Ideally, net worth increases as you age and approach retirement.

Understand your cash flow

Figure out how much you bring home every month after taxes through your job and any side gigs. If you have other income, like rental properties, child support, or stock dividends, include that as well.

You also want to put together a detailed account of your spending. Figuring out how much goes toward fixed expenses, like rent, utilities, and loan payments, is pretty straightforward. Also determine how much you spend on restaurants, groceries, coffee, entertainment, and other variable expenses.

Set a spending plan that will support your goals Next, you need to assemble a spending plan that aligns with your financial goals. If you're not on track to meet your goals, you may need to put together a budget that limits spending or find ways to grow your income.

One common budget strategy is the 50/30/20 rule. You spend half of your income on necessities, such as mortgage payments, car loans, insurance, required debt payments (like the minimum payment for your credit card), and student loans. You can spend 30 percent of your income on things you want, including entertainment, vacations, and dining out. The last 20 percent goes towards savings, debt payments beyond the minimums, retirement accounts, and investments.

This method is a good starting point. But you may find that following this budget won't allow you to reach your goals. If that's the case, you may have to cut spending by renting a smaller apartment, not going out as much, or finding other ways to save. On the other hand, this strategy may not be realistic given the cost of living in your area or your current finances. The key is to make a budget that works for you and stick to it.

Identify and reduce costly debt

Not all debt is bad. For example, many people can't afford to buy a house all in cash and have to take out a mortgage. While interest will accrue, it's usually reasonable, and your home may increase in value over time.

High-interest debt, on the other hand, is usually detrimental to your long-term financial health. It's smart to pay down credit card balances and other high-interest debt quickly. If not, the interest payments, along with fees and penalties, can balloon over time. Missing payments or having too much debt relative to your income may also lower your credit score, making it harder to qualify for good terms on loans down the line.

Paying down debt might mean adjusting your budget and spending less on things you want but don’t need. Some people tackle their highest-interest debt first, while paying the minimum on other debts, to reduce the amount of interest they pay overall. Others choose to pay off their smallest balance first to earn a “win” that helps them stay motivated.

Consider your investments

Investing is an important part of financial planning — It allows your money to work for you. If you invest in assets like stocks and bonds, you may earn returns on your money. On the other hand, cash typically loses value over time due to inflation. It’s important to remember, however, that all investing comes with risks.

While building your financial plan, you may want to consider investment opportunities and how they could help you reach your goals. Investing is especially crucial for long-term goals, like retirement. Generally, the earlier you start saving and investing for retirement, the better, thanks to the power of compound interest — or interest earned on your interest.

One way to save for retirement is through an employer-sponsored plan called a 401(k). Some employers match contributions to these accounts up to a certain limit — essentially giving you free money.

A 401(k) also usually provides tax advantages. Contributions are withheld from your paycheck and not subject to income taxes, up to the limit. However, you will pay taxes on the funds you withdraw in retirement.

You can also set up a traditional individual retirement account (IRA). Contributions might be tax-deductible, depending on your income and company benefits. If you make below a certain income threshold, you can contribute post-tax dollars to a Roth IRA, which generally lets you withdraw money tax-free in retirement.

Understand your tax situation

Paying taxes is necessary, but it cuts into your wealth. Income taxes, capital gains tax (which applies to profits on certain investments), and other taxes all impact your finances. Understanding how to reduce your tax burden can be an important part of your financial plan.

Using tax-deferred retirement accounts is one way to save on taxes. Deductions, such as qualifying charitable contributions, and tax credits can also help reduce you short-term tax burden.

Save for rainy days

It's a good idea to build a rainy day or emergency fund. This fund should consist of liquid assets, such as cash, that you can access in a pinch.

Maybe you’ll have to pay for an expensive car repair, an unexpected medical bill, or living costs after losing a job. Generally speaking, most experts recommend that an emergency fund be able to cover your necessary expenses for three to six months, or more.

You can calculate your living expenses by using your budget. Add up the bare minimum you need to cover rent, car insurance, automobile payments, food, and other necessities. Then multiply by three or six to find out your goal for your emergency fund.

You can park your rainy day fund in a relatively safe place, such as an interest-earning savings account. It’s generally not a great idea to invest this money in stocks or otherwise put it at risk.

Most stocks are liquid, meaning you can sell them quickly. However, stocks can drop in value, depleting your emergency fund.

Mitigate risks

It's smart to consider risk throughout your financial planning process.

Part of risk mitigation involves diversifying your investment portfolio and ensuring that some assets are lower risk. For those with longer term goals, many advisors recommend investing in a portfolio that includes stocks in many different kinds of companies, as well as bonds and other assets. Bear in mind this general approach varies depending on your risk tolerance, age, and investing goals.

Diversification doesn’t guarantee positive returns, but should mitigate the effect of losses in some parts of your portfolio. If you invest in a single company’s stock, on the other hand, you could lose a lot of money if its value declines.

Life insurance is also important to consider, especially if you have dependents. Estate planning and a written will are also essential for peace of mind, as they can help protect your family should you pass away.

Meanwhile, health insurance may help you avoid expensive medical bills, and disability insurance covers you in the event that you can’t work because of a serious injury or illness.

Check assumptions

Things won't always go according to plan, and you may need to adjust your strategies to protect your financial security.

Keep in mind that financial plans are built on assumptions. You might have assumed that your home would increase in value over time when planning for retirement. However, the real estate market could suffer a downturn.

It can be hard to predict how much value investments will gain or lose in the future. If your projections are off, it could make your calculations inaccurate. Fortunately, you can adjust your financial plan to reflect new data.

What is the importance of financial planning?

Follow the above steps, and you'll have an informative financial plan in hand. Financial planning isn’t something you do just once. Instead, your plan is a “living” document that will evolve as your income, net worth, and goals change.

Financial planning helps you understand your current situation, as well as your long-term goals and whether you’re on track to meet them.

It can motivate you to improve your current financial situation. If you're having trouble paying rent or are always worried about bills, cutting costs and redirecting money could help.

By listing out your expenses, for example, you may find that you spend a lot on gym memberships you don’t use. By exercising outdoors or at home, you could reduce unnecessary spending.

Financial planning is also vital for long-term financial goals. If you don't understand your current situation and long-term needs, it'll be hard to plan for retirement, for example.

With proper planning, you'll have an easier time figuring out whether you can afford that trip to Europe or a new car. You can have a better idea of whether you need to cut down on spending or find ways to increase your income. And you can take steps to protect yourself in the face of unexpected emergencies or economic downturns.

Ready to start investing?
Sign up for Robinhood and get your first stock on us.Certain limitations apply

The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.


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