4 Key Elements of an Effective Financial Plan
Many people tend to be indecisive about how they manage their money. Such a passive approach can hinder sustainable revenue growth. It can also lead to heavy losses if they don’t take their finances seriously. This particular problem usually stems from the lack of a financial plan.
A financial plan consists of laying out your financial goals and devising a strategy to achieve them. This is most often most useful for investors and those trying to create passive income by investing in one or more asset classes. For example, a crypto investor with a Monero wallet may have a financial plan that revolves around investing in XMR coins and other security innovations.
To avoid falling into bad spending habits, everyone should know these four key elements in creating an effective financial plan.
Know your net worth
By finding out your net worth, you can see exactly where you stand financially. For this, you do not necessarily need to consider sources of income. Calculating your net worth focuses on how much you actually have right now. This requires listing all of your assets and liabilities.
Assets are anything in your possession that has value. Besides money in the bank, this also includes properties, vehicles, retirement savings plans, investment assets, and anything you own. Opposite this, liabilities are all your unpaid payments or debts such as student debts, loans, mortgages and anything else you have to pay over time.
Your net worth is basically the total value of your assets subtracted from the sum of your liabilities. This calculation basically gives how much you are currently worth, which gives you a good idea of your financial situation.
Recognize your cash flow
Simply put, cash flow determines how your money flows in and out of your pocket. For this, you need to consider all your sources of income from current jobs and other sources of income. It’s also a good idea to note when and how often these revenue streams come in. That said, the most crucial part of cash flow is where your money is spent.
You should first write down all of your regular expenses such as bills, utilities, and necessities, as these are the easiest to find. Next, you need to consider your overall spending habits. This can be complicated if your expenses vary from month to month. The best way to fix this is to check your checking accounts, credit card statements, and anything that has recorded your spending over the past year.
Ideally, you should track your cash flow on a monthly basis. But if your spending behavior is somewhat unpredictable, you can actually calculate it on a yearly basis instead. You can then get an average monthly expense by dividing the result by twelve, just to make sure you include your monthly bills.
Define your goals
Contrary to popular belief, there are no single, comprehensive financial goals that are right for everyone. It all depends on your personal situation, which is why this component may require a little more thought.
Ideally, your goals should be concrete, realistic and time-bound. To begin, it is important to visualize a timeline for your financial plan. Your goals can be short or long term, depending on what you want to achieve.
Additionally, you need to have an idea of your risk tolerance. It varies between conservative, moderate, and aggressive levels, determined by your willingness to take risks for potentially substantial gains. This is why it is useful to know your net worth and your cash flow. This allows you to narrow down your options as to how you will achieve the goals you have set for yourself. Whether it’s growing your long-term wealth by investing in various asset classes or reducing your expenses after calculating your monthly cash flow, these goals will form the basis of your overall financial plan.
Work on a strategy
There is no point in having the whole financial plan without a strategy to progress through it. Depending on your goals, there are many options and factors to consider that can influence your approach. For example, many people stick to the basic retirement strategy, which is simply to set aside a fixed amount of their income to save enough for life after work.
Others like to develop strategies based on risk management by considering what-if scenarios, accidents and potential setbacks in life. On the other hand, an increasing number of people prefer to look into long-term investment strategies. These people build savings through a diversified portfolio of assets rather than insurance or liquid savings.
And of course, some people like to combine these strategies depending on their needs and personal circumstances. Again, it all depends on the different components of your financial plan and what you want to save.
Hope this article has been helpful to you in developing an effective financial plan. Addressing some of these components may seem overwhelming at first, but it ultimately helps to understand the rest. What matters most is that you no longer spend your money haphazardly by creating a financial plan and sticking to it. You’ll find yourself saving and probably earning more with a plan to guide you.
This article does not necessarily reflect the views of the editors or management of EconoTimes
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