Chapter 1 - The Financial Planning Process

The financial planning process is the taking of conscientious and systematic steps toward fulfilling your financial goals. Conscientious means we've thought about it. We are not just stumbling from one pay check to the next without stopping to consider what we want to accomplish with our money. Systematic means we have a plan in place and we follow the plan carefully and intentionally, our eye fixed on our goals.

The purpose of building a financial plan is to maximize our lifetime happiness. This is very different from maximizing our lifetime wealth. We want to use the money that we are able to obtain to build the happiest life possible, and that means that we will often pay for things that do NOT produce additional wealth for use, but instead they buy additional satisfaction or happiness.

For example, did you eat a meal today? You probably did. Was that meal a waste of money? After all, how much profit will you gain from paying for your food? None at all. Spending money on food does not increase your wealth - it decreases it! Does that mean you should not spend money on food? Obviously not. Food is essential for life. Getting life in return for money ios not a waste. I would argue that you can find no greater reward for money than the continuance of life itself.

Money matters, yes, but only as a means to an end. Money matters because it can become other things - and THOSE things have value. We'll explore this train of thought more in chapter 2.

The core of a financial plan is to decide three key things.

1. WHAT will I buy? Which goods, services, or experiences are most valuable to me? Which will bring me the life that I most want to live? Almost as important, we need to understand what will NOT bring us happiness. A good budget helps us focus on what’s most important to us. We’ll talk more about budgets in Chapter 4.

2. WHEN will I buy it? Changing when you buy something changes how much it might cost and how likely you are to succeed. For example, buying a house might be impossible when you are 18, but much more attainable when you are 30.

3. HOW will I pay for it? Did you know that the method you use to pay for things can affect how much they will cost? Examples of buying methods include: debit card, credit card, mortgage, student loan, and existing assets. These options all have different advantages and disadvantages as well as different costs, which we will discuss later in the book.

The financial planning process consists of five steps that are focused on answering these three questions.

First, you must define the goals you wish to reach. This is the “WHAT” of financial planning. Next, you need to determine what resource you have available to you. This is the “HOW” of financial planning. Once you know what resources you have available, you need to develop the details of your plan. This is the “WHEN” of your plan. This plan needs to include information about how you are going to generate money, when, why, and how much money you are going to borrow, how you are going to build your wealth, and how you are going to protect your resources.

Once the plan is created, you need to implement the plan. Implementing the plan will require the use of a spending plan (called a budget) and a way to monitor your progress. Finally, your goals and resources and constraints will change as circumstances change, so be sure to reevaluate your financial plan on a regular basis.

The Five Steps of the Financial Planning Process 1. Define goals (ie WHAT should I buy?) 2. Identify available resources (ie HOW can I pay for it?) 3. Develop plan details (ie WHEN will I pay for it?) 4. Implement the plan 5. Monitor and revise the plan over time

We’ll be focusing on each step at various times throughout this book. For this chapter, we are focused on step 1 - defining goals.

There are three approaches to managing your finances: you can do it yourself, you can hire someone else to do it for you, or you can have it done to you. If you have ever heard someone say that they don’t know where their money goes each month, then that person is having their financial plan happen to them. In other words, they aren’t really in control of their money. People in such situations are rarely happy with the results of such an approach to financial management.

We often struggle to reach our financial goals. Often (but not always), the financial goals that we struggle to reach are doomed from the beginning because they have not been properly defined. A financial plan cannot exist without goals, and goals are unlikely to be reached if there is no plan. There are two steps to properly define a financial goal that we can build a plan to achieve.

Step 1 – Define your life goals.

It is essential that we do not set financial goals until we have first established our life goals. This helps us be motivated to reach our financial goals and helps us ensure that reaching our financial goals will provide us with the life we most want to live.

Life goals refer to the way you want to live your life. They are the picture you have in your head of how you would like to live your ideal life. These are NOT financial in nature. Rather, they are personal in nature. It’s the “who, what, where, and when” of how you would like to spend the precious hours and days of your life.

People often feel overwhelmed when trying to define life goals, particularly when they are young. Don’t overthink it! It’s important to remember that your life goals CAN CHANGE over time. In fact, it’s almost inevitable that they will change. What matters here and now is defining the overall tone of your life so you can get started on a healthy path. You can adjust your course as your life progresses and your goals change.

Examples of life goals “I want to be an involved parent.” “I want to see Europe.” “I want to be President of the United States.” “I want a quiet life at home with my spouse.” “I want to be a famous actor.”

Step 2 – Define a plannable financial goal.

Stop dreaming, start planning! People often let themselves dream about their ideal life. The perfect car, the perfect house, with the perfect clothes, etc. The trouble is this often leads us to feel dissatisfied with the world as it actually is, because the real world can never live up to a dream. Instead of dreaming about the future or what could be, instead try to focus your mind on your plannable goals, because these are the goals that you can actually make a reality.

Many goals lack the inherent characteristics necessary to build a plan to achieve them. It is almost impossible to reach a goal that is unplannable. In order for us to build a plan to meet our financial goal, the goal itself must have two critical characteristics – they must be measurable and timed.

Measurable goals

A financial goal must have a specific dollar amount, or you need to be able to make a reasonable approximation of the cost of the goal. For example, the goal “I want to buy a car” is not specific, because there is no way to measure how much this will cost or if you are on track towards your goal. A measurable version of this goal would be “I want to buy my dream car for $70,000.” Now that you have a clear dollar amount, you can develop a plan to pay for this goal and measure your progress toward your goal.

Timed goals

A timed financial goal has a specific timeframe attached to it. We cannot make a plan to achieve a financial goal unless we know how long we have to reach that goal! For example, the goal “I want to retire early” is not timed because we don’t know what counts as “early”. A timed version of this goal would be “I want to retire on my 45th birthday.” This gives us a solid timeline that we can use to calculate how much we must save each month to reach the goal. The timeline of a goal can also affect it’s attainability. For example, the goal to “retire at the age of 19” is far less attainable than the goal to “retire at age 45”.

Example:

“I would love to pay off my $300,000 mortgage in 15 years.” This is a plannable financial goal. It is specific – we need to repay the $300,000 balance of mortgage – and it is timed – we have 15 years to accomplish this goal.

Financial goals are monetary in nature, and, if set properly, should come entirely from your life goals. Look at your life goals one at a time and ask yourself this question, “will I need any money to reach this goal?” If the answer to this question is “yes”, then you have found a financial goal for yourself.

You will find that almost every life goal has some kind of financial aspect to it. This is why it can be so difficult to answer the question “does money buy happiness?” - because money buys the things that enable us to live the lives we want to live! For example, we cannot share a meal with our loved ones if we have no money to buy food. For another example, consider how can we find peace of mind when we know we are facing eviction? See Chapter 2 for more discussion on the relationship between money and happiness.

In short, a well-defined financial goal is simply an aspect or prerequisite of the life that you want to live.

Setting your life goals first and using those to define your financial goals is important because it helps you find motivation to reach your financial goal. If you have a life goal of spending time with your future grandchildren, then you can think of saving for retirement as buying time with your grandchildren. It is far more appealing to “buy” treasured time with the grandchildren than it is to save for some abstract, distant, and unknown future. You wind up taking the same actions towards that goal, but for very different reasons. It is the difference in these reasons that makes up a good bit of the difference in your motivation to reach the financial goal.

Examples of life goals and associated financial goals

People often set a goal for their income. “I want to earn $X per year!” While there is nothing inherently wrong with this goal, setting such a goal without considering your life goals is a recipe for unhappiness. Some people have very high incomes but are quite unhappy because they did not consider the tradeoffs required to obtain that income. The job demands a lifestyle that is inconsistent with the life they wanted to live. People in this situation complain that their job demands long work hours and causes them a lot of stress. They have money but little time to spend time with their family. This is a problem for them because they have failed to recognize that their more important life goal is to spend time with their family. This is a great example of how setting financial goals before setting life goals can lead to a life of dissatisfaction – which is the opposite of our purpose of financial planning!

Definitions:

Budget: a way of monitoring our spending progress through a financial plan

Measurable goal: a goal that has a defined amount of money needed to achieve it

Timed goal: a goal that has a defined amount of time until it is ready to be achieved

Life goals: a goal that relates to how you want to live your life

Financial goals: a goal that relates to the money that is needed to achieve a life goal