Blog

[Prefer to listen? You can find a podcast version of this article here: E228: What Does a Solid Financial Plan Look Like?] 

The word "financial plan" can be ambiguous and confusing sometimes. And it can be defined in different ways depending on who you ask.

To some, a financial plan is a complex document full of charts, graphs, and projections. It might be lengthy and detailed. Others may see it as a simple outline that can fit on one page.

So what is a "proper" financial plan?

As you might expect, there is no one correct answer. Most importantly, it guides you toward your goals and provides a solid financial foundation for your life.

So what does the typical financial plan contain, and what should it cover?

Liquidity

One of the most essential components of your financial plan is your liquidity, or Liquid Term. Your liquidity measures how much cash runway you have or how long you could operate your household if your income was interrupted and you had to live on savings.

The "correct" liquid term won't be the same for everyone. If you are a dual-income household and both of you have very stable jobs, you may be comfortable with a lower amount. On the other hand, if you are a single-income household and your income is not very stable, you may need a larger cash reserve to handle the risk associated with your situation.

The liquidity number defined in your financial plan determines the minimum level of cash you need to maintain to protect against unexpected cash flow issues.

A solid financial plan includes a cash reserve that is appropriate for your situation.

Insurance

One of the less exciting areas of a financial plan is insurance. Insurance is designed to protect you and your household against unexpected events. It manages risk.

There are many different types of insurance you may need, including:

• Life insurance
• Disability insurance
• Home & auto insurance
• Umbrella insurance
• Long-term care insurance
• Health insurance

A solid financial plan includes adequate insurance coverage that protects you and your household against the unexpected.

Investments

Many people see investments as the "core" of a financial plan. After all, this is how we build wealth and move closer toward financial independence.

There are many different investment vehicles available, including:

• IRA / Roth IRA
• 401(k) / Roth 401(k)
• Taxable brokerage account
• HSA
• Defined benefit plan
• College savings plan (such as a 529)

Within these accounts, you have options for investing your money. How you invest depends on your specific situation and objectives.

A solid financial plan includes an investment portfolio that is appropriate for your situation and a regular schedule of contributions to your investments. The amount and frequency of contributions should be enough to meet your goals.

Estate planning

Estate planning is one of the most neglected components of a financial plan. There is a core set of basic estate planning documents that everyone should have.

Everyone has an estate plan; by default, it's the one that your state decides for you. However, if you want to have a say in it, you need to create your own estate plan.

Your estate plan defines things like:

• Who receives assets upon your death
• Who will be a guardian for minor children
• How assets are distributed
• Who is responsible for managing the distribution of your assets
• Who can make financial or healthcare decisions for you if you are unable to
• What are your wishes for end-of-life care

While these things are not necessarily pleasant to think about, they are important for loved ones left behind when you pass. By creating an estate plan, you are showing love and consideration to the important people in your life and making things easier for them.

A solid financial plan includes a well-defined estate plan. Estate planning is an act of love.

Taxes

How could we forget taxes? Everyone loves taxes, right?

A solid financial plan includes an intentional plan for how you handle taxes.

Are you investing in Roth accounts or pre-tax?

What is your philosophy on taxes?

How much effort are you willing to put into reducing taxes?

Are you taking advantage of tax opportunities?

There are various opinions on taxes ranging from "paying taxes is fine because it supports social services that are good for everyone" to "taxation is theft."

The important thing is that you understand your approach to tax management and that you have an intentional plan for how you approach taxes in your financial plan.

Cash flow

Cash flow is the keystone of any financial plan. Without cash flow, none of it works.

Cash flow planning includes managing the inflow and outflow of your money. It can include a formal budgeting process that helps you track and direct your money with intention.

Understanding your cash flow is essential for any financial plan to work. If you manage this well, everything else falls into place.

Maintaining a solid financial plan

Like anything else worth doing, a financial plan takes effort to establish and maintain. It's not set-it-and-forget-it.

It's important to update your plan periodically, course-correct as you go, and adapt to changes in your life.

Once you get in the habit of paying attention, however, maintaining a solid financial plan becomes second nature.

Knowing you have a solid financial plan helps you reach your goals faster and lower stress in the process.