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Financial planning 101: What it is and how to do it

At a glance:

Personal finance is economics on the family and individual levels. Get a basic introduction to it in this tutorial. Learn about goal-setting, using savings and investments to match your goals, and building a simple financial action plan. This tutorial is ideal for those seeking a good foundation for more in-depth personal finance topics.

How to set personal financial goals

If you do not know where you are going, how will you know when you get there? This is very true about financial goals. You need to set financial goals to help you make wise financial decisions, and also as a reward for your efforts. Goals should be clear, concise, detailed, and written down.

Unwritten goals are just wishes. Those who set goals and fail often find that they didn't set realistic goals to begin with. So, the first step in setting any goal is to determine what is realistic and what is not. In this article, you will learn how to set realistic and achievable financial goals.

How you achieve your goals

You achieve your financial goals when you have the cash available to satisfy some immediate financial need, want, or desire. The key is to be prepared to have the required cash when the time comes to achieve the goal.

For example, suppose you want to buy a brand-new car costing $30,000 using cash five years from today. In five years and one day, you will know whether you achieved that goal. If you have the $30,000 five years from today, you have achieved your goal. That is all pretty definite, but is it realistic?

You will have more than one financial goal to achieve. Besides the new car, you might be considering buying a home, funding higher education, paying for a wedding, taking a vacation, or accumulating retirement nest savings. Each financial goal has its own price and time horizon—when you need the money.

You should have a plan

In order to achieve all your goals, you will need a plan. Starting from what you already have available, you will need to determine how much more you need to accumulate and when you will need it. Don't neglect to consider that the price of your goal items might actually increase as well. Depending upon how you invest your savings over time, you might receive interest, dividends, or gains to help you along—you should consider this as well.

Do you have the means to make additional investments necessary to accumulate the required wealth? Don't neglect to consider the effects of taxes on your savings. After considering the foregoing, you might determine that you can achieve some goals in less time. Or you might find that it could take longer. The time horizon is important to setting realistic goals.

Setting short-, intermediate-, and long-term financial goals

Consider the time element

Consider how important it is to achieve your goals on time. Some goals are so important that not achieving them would be not only disappointing but also disastrous. When a goal must be achieved by a specific date, you must plan conservatively, save more money, and take less investment risk to help ensure against loss. However, if the timing isn't as important or if you have discretionary assets and can take some investment risk, you might be able to invest more aggressively.

Let's say you needed to save an additional $15,000 in five years to buy the car mentioned above. After five years, you only manage to accumulate $27,000—you're $3,000 short of your goal. So, it will take you longer to buy the car. Had you invested more aggressively, you might have made the goal, but you might also be worse off. In this case, let your risk tolerance help you determine your time horizon.

Short-term, intermediate-term, and long-term

Goals should be grouped as short-term (three years or fewer), intermediate-term (three to seven years), and long-term (more than seven years). Generally, the longer the time horizon to achieving a goal, the more aggressive you can be in your investment approach.

However, you should never exceed your risk comfort level—the amount of risk you can take without abandoning your goal. This is your risk tolerance. If you approach setting financial goals in this way, you will make better financial decisions about setting goals and ways to invest to potentially achieve them.

You should always monitor your goals to be sure they are on track. Set up a way to measure your progress. If you see that you are lagging behind, you may need to make an adjustment in the amount or way you are investing. If you are way ahead, you may want to be more conservative, shorten your time horizon, or add a new goal.

How to use savings and investments to help meet your goals

Personal finance also helps you make better savings and investment decisions because it focuses on your goals. Your budget (or spending plan) should be built around your day-to-day expenses, including your short-range lifestyle and financial goals. These may include your goals for your family's well-being, shelter, food, clothing, and recreation. It should also provide for future personal lifestyle and financial goals as well.

Savings and investments can help you reach your goals

Savings and investments should be used to match your short-, intermediate-, and long-range financial goals. You save and invest for a purpose, not just to accumulate great wealth. In fact, you save and invest for many purposes, and how you save and invest depend upon the purpose.

For example, if you need to replace a household appliance costing a few hundred dollars in the next 12–18 months, you will save differently than you would if you were saving to pay for a child's education in 10–15 years. To make these decisions, you need to understand the relationship among investment risk, time horizon, and investment reward.

The reward for risk

Investors are often rewarded for taking investment risk. Higher-risk investments have potential for greater reward, as well as greater loss. You can spread investment risk over many different investments. This is called diversification. (There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk.)

You can use this relationship in making savings and investment decisions—low risk for short-term goals and higher risk for longer-term goals, based on your goals, time horizon, and risk tolerance.

Cash for the short term

Cash and equivalents are generally used for short-term financial goals because they are liquid and less vulnerable to market fluctuations. However, you can expect lower returns on them because they pose less investment risk.

Income investments for the mid-term

Income investments may offer higher returns than cash and equivalents, with a steady stream of income. This may make them suitable for those short-to-intermediate-range goals. While they have higher risk than cash and equivalents, they are generally considered less risky than equities. Bonds are subject to market and interest rate risk if sold prior to maturity. Generally, bond values will decline as interest rates rise and are subject to availability. Bond income is also subject to the paying ability of the issuer.

Equity for the long term

Equity class investments tend to be more volatile in nature than bonds. Just look at the daily Dow Jones averages, the S&P 500, NASDAQ, etc. However, if you look at how they perform over several years (seven-plus), you find they generally outperform the income and certainly the cash investments. This may make them a good choice for your long-range financial goals. Stock investing involves risk, including loss of principal.

How to help minimize volatility

Another interesting thing tends to happen when you combine different asset classes in your overall portfolio. Because the different asset classes typically do not go up and down together, the ups and downs eventually tend to smooth out so your portfolio is not as volatile as any one asset class.

By combining the asset classes based on your time frame, investment objectives and risk tolerance, you can help minimize the volatility while potentially optimizing your portfolio return for the amount of risk you are willing to take (risk aversion). This is called asset allocation. (Asset allocation does not ensure a profit or guarantee against a loss.)

In personal finance, you use your spending plan to help you decide how much you can save and invest each month, then save and invest that money according to your goals, taking advantage of asset allocation to help achieve those financial goals with less risk.

How to build a financial action plan

A note about writing your goals: it's not enough to say something like "I want to have some extra spending money." Goals like this fail because they are not specific; to really work, they should specify three things:

  • What the goal is

  • How much money is needed for it

  • When the goal is to be achieved

In our example, we should say, "I want to save an extra $40 at the end of every month to spend on what I want." That is not only specific, but it can be measured at the end of every month. Of course, it should also be realistic and attainable.

In this Friday, Aug. 21, 2015 photo, certified financial planners Aaron Munoz, left, and Gilbert Cerda, pose for a photo at their offices in Downey, Calif. Their company, Cerda Munoz Advisors, offers financial advice with a focus on the Hispanic population.  (AP Photo/Damian Dovarganes)
Certified financial planners Aaron Munoz, left, and Gilbert Cerda, pose for a photo at their offices in Downey, Calif. (Photo: AP Photo/Damian Dovarganes)

Here is a sample financial action plan:


  • Goal: Save $40 at the end of every month to spend on what I want.

    • Task 1: Make a budget.

    • Task 2: Look for less-expensive alternatives to existing expenses. For example, eat out 2 fewer times per week and save $10.

    • Task 3: Divert the amount of money saved into a separate place.

  • Goal: Save up $1000 for a different car by 10 months from now.

    • Task 1: Make a budget.

    • Task 2: Cut out unnecessary expenses; perhaps $100 per month.

    • Task 3: Take on a part-time or temporary job to raise the needed money.

    • Task 4: Divert the amount of money saved into a separate place.

  • Goal: Pay off a $1000 balance on a credit card in 12 months.

    • Task 1: Determine the amount that must be paid each month (online calculators can help with this).

    • Task 2: Set aside that amount each month by cutting out unnecessary expenses.

    • Task 3: Take on a part-time or temporary job to raise the needed money.

  • Goal: Create an emergency fund of $5,000 in 24 months.

    • Task 1: Reduce the phone bill, cable bill, eating out bill, and other bills by $208 per month.

    • Task 2: Divert the amount of money saved into a separate account, such as a savings account.

The owner of this plan should monitor it at the end of every month to make sure it is on track.

These examples are simple, but they are the kinds that millions of people struggle with. As long as you make your goals specific enough to be measurable and you set specific actions down in writing, you have a working financial action plan.

As the time frame of your plan goes on, you will want to review and revise it, based on how well you are sticking to it. If you are not sticking to it, perhaps you were unrealistic, or perhaps there were interruptions that prevented you from reaching your goals. In that case, you can revise your plan and continue with it.

Consider using the example above as a template. If you wish, you can and should embellish it to include how you will measure your progress. You can even add a reward at the end.

Summary of financial planning 101

Personal finance uses the process of personal financial planning to help you develop a spending plan around your lifestyle and financial goals. It helps you set realistic goals and budget to meet them while managing your savings and investments.

With this in mind, we'd like you to think about crafting a personal financial action plan.

Practical ideas you can start with today

  • List your financial goals, the date you want to accomplish each goal, and the dollar amount of each goal.

  • Match each of your short-, medium-, and long-term financial goals with a specific portion of your savings or investments.

  • Determine how much you should save to meet your goals.

  • See how you can allocate your assets.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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