Financial Planning 101: How To Start

You may not think you make enough money to start building wealth or planning for retirement, but it’s never too early to have a financial plan for achieving your life’s goals, regardless of your current income and expenses. In addition to a secure retirement, your goals might include getting married, buying a house, having children or putting your children through college, and traveling abroad.

The initial stage of your financial journey can significantly influence the rest of your life. By diligently saving a portion of your hard-earned money and investing wisely, you can more easily achieve your financial goals as you navigate life’s progression. Remember, building wealth is a consistent and long-term endeavor. Your future self will thank you for setting yourself up for success.

A financial plan addresses more than budgeting. It has these benefits:

1. Helps you set clear objectives and make informed decisions for preparing to fund significant events
2. Assists with reducing tax bills, sometimes overlooked when you don’t yet own a lot of assets
3. Serves as a roadmap that can change and adapt to unexpected events and challenges
4. Helps give you the confidence for maintaining financial independence

Where do I start?

There are several components of a financial plan, including investing, saving, estate planning, tax strategies, and insurance coverage. The plan will evolve along with your life. It includes taking steps to help ensure you have financial security now and in the future.

Here are some examples of how financial planning could assist with your finances:

• Cash flow: It can be daunting to look over credit card, school loan, and bank statements, but there are a lot of websites and apps that make it easier than ever to view the money that’s coming in and going out, like Quicken Simplifi, PocketGuard, and Rocket Money.If you can master your cash flow, a process of assigning resources to specific priorities that help with moving closer to goals, you can make decisions on where to cut overspending or what amount to save each month. This amount being saved could be invested with a long-term horizon in mind that generally allows for a more aggressive strategy, which means taking on higher risk in pursuit of higher returns. You might also put some of those savings toward paying down school loan debt, if applicable. Maybe you’re saving to buy a house or plan a big trip.

• Investing: While being more aggressive with investments at a younger age can make sense, there is a difference between investing and gambling. Typically, there are no shortcuts to investing successfully. Consider employer-sponsored 401(k) plans and Thrift Savings Plans (TSPs) or individual retirement accounts (IRAs), which are tax-advantaged opportunities as one of the ways you can invest and save.

  Example 1: Fictitious investor Jane started an investment account with $5,000 and put it all in one stock she really liked. If that stock had a bad year and lost 20% of its value, Jane could start the second year with an account value of $4,000. On the other hand, if the stock has a great rebound year and returns 30%, Jane could potentially see an increase in her account balance after two years of investing.

  Example 2: Looking simply at just the interest, if Jane invested $5,000 at an annual interest rate of 5%, after one year she would have $5,250. In the second year, she would earn interest on $5,250, not just the original $5,000, leading to $5,512.50. This is known as compound growth.

• Saving: Decide how much you will contribute to your retirement account to achieve compound growth over many years and help sustain financial security in retirement. Many employers offer matching contributions — this is considered “free money” which can potentially enhance an employee’s retirement savings. Avoid taking money out before you reach age 59 ½ or you’ll lose out on potential growth of the funds and likely incur a tax penalty.

As part of your financial plan, save about six months of living expenses for coverage in case of an emergency, such as a layoff or significant medical issue that limits or halts income. Ideally, this would go into a high-yield savings account, separate from your checking account.

It’s also important that you understand the difference between good debt and bad debt. For instance, if you want to borrow more money to pay for a master’s degree but aren’t sure the higher degree will lead to a job that generates enough income to pay the interest and principal on the loan, you may not want to accumulate the debt. Additionally, credit card debt can get out of control with high, compounded interest.

If you’re part of a couple, talk about how you want to handle making big purchases and communicate often about your combined finances. Since you may be combining two sources of income, consider each saving three months of living expenses into an account.

What does success look like?

By creating and following a financial plan, you can achieve your goals as well as avoid financial challenges in later years, whether it’s in middle age or retirement. Also consider that, generally, the more your income and assets grow, the more complex your taxes become. There are strategies for reducing taxes, such as taking advantage of deductions for various purchases such as energy-efficient appliances.

• Investing: If our fictitious investor Jane started contributing 6% of her $70,000 salary at age 27 into her employer-sponsored 401(k) retirement savings plan, with a conservative 4% return on investments and 3% annual raise each year, she’s potentially on track to retire at age 65 with a potential balance of around $585,000.¹ If you add in an employer matching 50% of up to 6% of her contribution, her potential balance would be about $878,000. If she had begun contributing 11% of her salary, with the same conditions, she would have nearly $1.4 million at retirement including employer matching.If Jane didn’t start contributing to her 401(k) plan until age 39, with 11% of her $100,000 salary, at the same return and annual raise rate, she would retire at age 65 with a potential balance of about $692,000. With the additional employer match it would be around $880,000.

  These two scenarios illustrate the value of Jane starting early with the potential of being able to save much more for retirement if she stays consistent with contributions for the long-term. They also show how much more of your salary it can take to catch up if you start investing later, but that it’s still possible to save and grow the funds in your account. In both cases, there are multiple factors that can change the ending value’s potential, including age of targeted retirement, contribution and return rates, income increases, and employer-matching amounts, which should be included in a financial plan.

• Saving: Let’s say you were part of a layoff by your employer and unemployed for three months. If you have a savings account for emergencies that included six months of coverage for your living expenses, plus had paid off your student loans and didn’t have any credit card debt, you could likely weather the storm of unemployment better.

  When you change jobs, you may be able to transfer your 401(k) plan balance from a previous employer into the plan offered at your new job without tax penalties. However, you can also keep the account with your former employer’s plan or, if it fits into your financial plan, roll over the funds into a Roth IRA. There would be taxes incurred on the rollover amount, but the conversion can help with keeping taxes lower in the future for distributions.

• Taxes: By contributing to retirement savings accounts, you can get a tax deduction that lowers your taxable income and could put you into a lower income tax bracket (and tax rate). You can also use charitable giving to reduce your taxable income while donating to causes that you’re passionate about. There are other strategies that can be included in your financial plan to help minimize taxes.

Summary

The bottom line is that the earlier you start with a financial plan, the better your chances can be for achieving your goals in both the short- and long-term. Depending on your objectives, success could mean being financially independent in your thirties and continuing to build wealth, while setting yourself up for financial security in retirement. There are many financial decisions that can affect your future success. A financial plan isn’t meant to limit you, rather, think of it as a way to help achieve your life’s goals.

Keep in mind that the information in this article is general and doesn’t cover all the areas of a comprehensive wealth management plan. If you want to build wealth, and avoid potentially making long-term mistakes, connect with your family member’s wealth advisor at Mercer Advisors.

If you don’t have a family member that is a client of Mercer Advisors, consider hiring a fiduciary financial partner to collaborate with on creating your financial plan. We’d be happy to partner with you. Let’s talk.