(Tiny Tips) – Financial planning is a broad framework covering a range of topics including:
- Budgeting
- Spending
- Saving
- Retirement planning
- Credit and debt
- College planning
- Insurance
In order to build a solid financial foundation, you need to understand how issues interact and impact each other. Here you’ll find a brief crash course on the most important aspects of financial planning.
Introduction to Financial Planning
Budgeting
At a basic level of personal finance, a budget is one of the most important tools you can use. A budget is a plan for how to spend your money.
By creating a detailed written budget, you can see exactly where your money is going and make better decisions about how to spend it. When you are intentional about your budget decisions, you have more control over how you spend your money.
One of the biggest challenges of not having a detailed budget is facing so many financial decisions and trying to keep track of them. This lack of understanding can lead to overspending and debt, not to mention making future financial planning more difficult.
Creating a budget gives you a clear idea of how much money you have. You know what you spend your money on and how much, if any, is left over. Once you see money coming in and out, you can optimize your spending to reduce things you don’t really need.
Tracking Expenses
Tracking your spending is an important part of budgeting. This tracking includes closely monitoring your non-essential expenses, such as clothing, dining out, travel or entertainment.
If you spend too much on non-essential items, you may have nothing to save each month. Savings is important, especially when building an emergency fund.
Your emergency fund is a pool of cash you can rely on in the event of an emergency or unexpected expense. Having emergency savings can help you avoid going into debt. If you don’t monitor your spending carefully, you may end up missing out on money you could be saving.
Credit and Debt
Financial leverage or simply using credit and taking on debt is not necessarily a bad thing. However, there are two types of debt: good debt and bad debt.
When you borrow money to buy a home, you may take on a lot of debt, but lower interest rates and buying an asset that will increase in value are considered acceptable forms of debt. The same goes for student loans, since you can use them to fund your degree, which can increase your earning potential and often come with lower interest rates.
On the other hand, if you use a credit card with an annual interest rate of 24% to go shopping at the mall and don’t pay it off in full immediately, that’s a bad debt. The items you buy don’t increase in value, and you’ll pay high interest on them while you have a balance on your card.
Getting out of debt doesn’t have to be difficult, but it is crucial to achieving financial independence. If you have debt, the first thing you should do is pay more than your minimum monthly payment. If you make just the minimum payment every month, it often takes decades to pay off the debt and costs you a fortune in interest.
If you pay more than the minimum, try lowering your interest rate. You can do this by transferring your credit card debt to a card with a lower APR or by refinancing your student or other loans at a lower interest rate. In the long run, high interest rates will make it more difficult to get out of debt.
Saving for Retirement
With fewer companies offering full retirement plans and uncertainty surrounding Social Security, savings and retirement planning are more important than ever. Unfortunately, many people feel they don’t have enough money to save each month.
Saving for retirement needs to be a priority, not just an afterthought. The IRS makes retirement savings more attractive through special tax-advantaged accounts such as employer 401(k) plans, IRAs, and special self-employed retirement accounts. These allow for tax deductions, credits, and even tax-free income for retirement savings.
Whether you’re fresh out of college, 40 years away from retirement, or planning to retire next year, it’s never too late to plan and maximize your retirement savings. Ideally, you should save 10% to 15% of your income each year for retirement. But if that’s not possible for you, try saving at least enough money in your employer’s retirement plan to qualify for matching contributions, if any. Then work toward increasing your contribution rate each year.
Insurance
You’ve created a budget, cut back on spending, eliminated credit card debt, and are now saving for retirement. You should be ready. These are all smart money moves, but there’s another important aspect of your finances you need to consider.
Insurance is important because you are working to build a solid financial foundation for yourself and your family and need to be protected. Accidents and disasters can and do happen, and not having the right insurance can lead to financial ruin.
Some insurance is required and everyone should have it. But there are many other types of insurance policies that you may not need, and you could be wasting valuable money that could be spent elsewhere. There is a fine line between being adequately insured and overinsured.
Assess your financial situation and ask yourself what gaps exist in coverage. For example, do you have life insurance? If not, is this what you need? If so, is your insurance coverage adequate? Also consider your home, vehicle, disability and health insurance. If necessary, adjust your insurance coverage to ensure you are protected against all risks.