The first thing you need to do when beginning a financial plan is to take a ­financial inventory. List everything of value that you own (your assets) and then subtract from that total everything you owe (your debts), including any loans and credit card balances you might have. The remaining amount is your net worth. As Table M5.1 shows, determining your net worth is similar to a company preparing a balance sheet but just arranged somewhat differently. If you’re young and just starting out, there might not be much to write down at first. But it’s still a useful exercise. As time passes, you’ll have more to add to this statement. Recording and calculating what you own versus what you owe, even if done only once a year, will help you see where you stand financially at a given point in time. This can also help you determine if you need to revise your financial plan should your circumstances change.

Next you can begin to set financial goals. These can be both short-term and long-term goals. Short-term goals should be measurable and realistic goals that can be completed in a time frame of less than a year. “I need to replace my car next year” is an example of a short-term goal. Long-term goals can be more motivational, such as “I would like to have $250,000 in investment assets before I turn 40.” Now break down the long-term goals into smaller, more manageable short-term goals. This increases your chance of achieving them. For example, “I would like to have $250,000 in investment assets before I turn 40” could be broken down as follows: “I would like to save $5,000 each year and invest it so it earns approximately 8 percent interest annually.”

Finally, prioritize your goals by identifying them as wants and needs. Put your needs above your wants and your short-term goals above your long-term goals. Make your short-term needs (buying a new car) a top priority and your long-term wants (installing a swimming pool in the backyard) a lower priority. Choose goals that you’re excited about and are determined to see come to fruition. Write these goals down in a place that you can refer to periodically to remind yourself of what you’re working toward.

If this all seems a tad overwhelming, remember that there are financial planners who will work with you to chart a course to financial stability. Look for a person who is qualified as a certified financial planner, which means they are licensed and regulated to ensure you are working with a professional.

You’ve figured out what you have and what you owe, and you’ve set financial goals. Now you need to know what you’re currently spending. Begin by listing all the expenses you incur in a month, similar to the list shown in Table M5.2. It’s easy to figure out your fixed expenses—expenditures that don’t change from month to month, such as your rent and car payments. The harder part is tracking variable expenses—monthly payments you have to make that may change from month to month. Gas, food, clothing, entertainment, utility, and cell phone charges are examples of variable expenses.

You’ll also need to include periodic expenses—items such as taxes or donations that you make but not on a monthly basis. Also, note the category of unexpected expenses shown in Table M5.2. You may not be able to determine the exact amount to fill in for this category. For example, will you get a speeding ticket this year that must be paid? It may be hard to tell. Nonetheless, set aside a modest amount of money to cover unexpected events such as this. Not doing so can throw a monkey wrench into the best-laid financial plans.

As you create your list, you may need to track “invisible” expenses—items you don’t realize you buy, such as daily lattes, chips from the vending machine, or gadgets for your car. The best way to determine your invisible expenses is to create a “penny journal” that tracks your daily spending habits to the last penny. The penny journal will also help you define your variable expenses. As you continue to work with your plan, you’ll be able to refine these numbers as well as establish limits for some of the expenses.

Analyze the penny journal and expenses list and identify the expenses you must cover (fixed expenses) and those that you might be able to cut back on (variable and invisible expenses). Now you’re ready to develop a budget.

A budget, or a spending plan, should be realistic in terms of the expenses you must pay. It should also include savings as a regular fixed expense. Every month, whether you think you can afford to or not, save a certain amount of money. Many financial planning experts suggest setting aside at least 10 percent of every paycheck. Don’t fall into the trap of depositing into your savings account whatever is left over. Instead, make a conscious effort to “pay yourself first” so that once you have paid your bills and the rest of the money is spent, you are left with some money. No matter what, you should not miss making the payment to yourself. The secret to success is not so much the amount of money you save as the persistence with which you do it.

Initially, your savings should accumulate so that you have a “rainy day fund” that is equal to at least one month’s worth of bills. Eventually, this fund should be built up to cover three to six months of fixed expenses. This fund will cover your expenses should the unexpected happen, such as a job loss or an injury. Once you’ve established a rainy day fund, your savings should go into an interest-bearing account—whether it is a CD, a money market fund, a mutual fund, or stocks and bonds.

Tracking your expenses and setting up a budget can be tedious and time consuming. Software packages, such as the one shown in Figure M5.2, are available to help you. The real challenge is sticking to your plan, which requires discipline and perseverance. Just cutting out one cup of designer coffee a week saves over $200 a year. Here are a few other tips for plugging leaks in your budget:

• Pay off all unpaid credit card debt. Carrying a balance on your credit cards is financial suicide. Most credit card companies charge more than 18 percent on unpaid balances. Therefore, pay down your credit card debt before depositing money into a savings or investment account. Also, pay your credit card bill on time. Late fees are a waste of money!

  

• If you have outstanding loans, see if you can reduce the interest rate or consolidate into a more manageable payment. Call your bank and ask! You might be surprised at the response you get.

• To reduce impulse buying, try using cash only. When you use cash instead of credit, you can immediately see the effects of your spending.

Figure M5.2

Sample Budget Template

Revisit your plan periodically and make adjustments as necessary. Look at your budget every month and make adjustments every year.