The financial planning process

Key topic

In this lesson we will discuss all the details of the financial planning process that will give you the necessary tools to design your financial game plan; a requirement for becoming a financially independent and hopefully a wealthy person!  At your age, the financial planning process starts by dividing your allowance and maybe some other income into three different categories:  spend, save, and give. Your allowance is the first step to understanding the written spending plans and budgets which form part of the financial planning process. Learning how to develop your financial plan will allow you to control your financial situation as you grow up, increasing your quality of life and reducing uncertainty about money-related issues and future needs. Just like any other decision-making process, financial planning includes the steps we will go through by using you, as an example. As you can see the bulk of the lesson is divided into seven sections. Each section (sections 3-8) corresponds to a step in the financial planning process and you should view each section as a section of the process and not as an individual part.

Learning objectives

• Understand the components of the financial planning process
• Learn how to set financial goals
• Learn how to achieve your financial goals
• Understand how to design your financial game plan

What is financial planning

In simple words, financial planning means figuring out where you are now financially, deciding where you want to be financially later in life (for example 5-10-20 years from now) and creating a plan on how to get there.

It may sound easy right now, because you are living with your parents and you don’t have to worry about much, but don’t forget that sooner or later, you will be living on your own and perhaps starting a family. At some point or another you will have to create a plan of your own, that will allow you to be financially successful; just like the game plan that your coach hands out, explaining how you will win the game, a financial plan takes into account several moves, which if you effectively follow and complete, it’s highly likely that you will succeed financially. It’s recommended that you start thinking about financial planning as soon as possible, of course having in mind that you have to be in control of your finances and earn some money, in order to execute your plan. Consider this an early exercise, where you will learn how to plan your financials and you can definitely experiment with financial planning through your allowance.

Financial resources are the combination of income and earnings you will have in life; these resources can be salaries, earnings from investments, sale/rental of assets and in general any other sources of revenue that come your way. Even though not always a good choice, a financial resource can also be money from a loan. Right now, your basic income is your weekly allowance and additional income may be cash from birthday or Christmas gifts, money paid by your parents for doing some chores around the house, or money earned by mowing your neighbor’s lawn which is actually income from work!

Determine where you are now financially

In this first step of the financial planning process, you will determine your current financial situation with regard to income, savings, living expenses, and debts; basically, all the sources of making money and spending money (financial obligations). Preparing a list with all items where you can make or spend money, will give you a foundation for financial planning activities.

Let’s say you have a weekly allowance of US$150 and the only financial obligation you have is to use money from your allowance to buy lunch at school.  Your school bus is paid for by your parents and pretty much all your basic needs are met by your parents.  Of course, you have to pay for your cell phone bill on a monthly basis, you like to go to the movies once a week, you like to buy your favorite Starbucks shake on your way to school, you want to buy the new iPhone within the next four months which costs US$800 and for which your parents will only contribute US$400, and you also have to pay for your guitar lessons.  In addition, you always donate $5 for the kids in need each Sunday.  Let’s list your current monthly revenues and expenses in what we call a Monthly Allowance and Spending Plan:

Decide where you want to be financially over a period of time (developing financial goals)

Specific financial goals are very important when it comes to financial planning. Your financial goals can be short term, medium term or long term. They can range not only in terms of duration, but also in terms of size. It’s okay to have financial goals that may seem too easy to reach or very unrealistic, as long as you are working towards them. You make the decision about these goals and it’s your responsibility to evaluate them, keep them or change them. To be successful, you should periodically analyze your financial values and goals.  You should evaluate if these goals are being met, if they are within your reach, or if they must be changed. The purpose of this analysis, among other things, is to differentiate your needs from your wants (as described in a previous lesson).

One of your short-term goals is to get that iPhone four months from now, so you are saving about $100 per month for it. Also, you want to go to a soccer camp in a year from now which costs $1,200 and your parents have told you that they cannot pay for that.

A long-term goal you have is to be able to buy a nice car (actually the car of your dreams) when you are 16 and you get your driver’s license. You know that your parents can only afford to pay about $2,500 towards the car and the particular car that you have in mind will cost about $6,300. Therefore, you need to figure out a way to save:

1. first the $400 you need for the iPhone within the next 4 months, (short-term)
2. the $1,200 for the soccer camp within the next 12 months and (medium-term)
3. the $3,800 for the car within the next 4 years (long-term)

Identify the way to achieve your financial goals, how to get there

Developing alternatives is critical for making good decisions. Although many factors will influence the available alternatives, possible courses of action usually fall under the categories of continuing the same course of action, expanding the current situation, changing the current situation, or taking a new course of action. Considering all of the possible alternatives will help you make more effective decisions.

In connection with your above goals, you realize that you will be able to save the money for the iPhone within the next 4 months since it is well within your budget. However, if you want to go to the soccer camp in twelve months, you will have to save another $100 per month for that as well.  In addition to that, you have the car savings to deal with which, even though long term (4 years from now), they require planning because the amount is quite large and you need a longer time period to come up with it.  So, what are your alternatives?  Perhaps you could increase your income by saving the money that you receive as Christmas and birthday gifts. You usually get about $200 for Christmas from your grandparents and family and another $150 for your birthday.  However, even if you save that money, it will not be enough for everything. Perhaps you could start a small business of mowing the neighbors’ lawns once a week, on Saturday, for some extra money. You know that a friend of yours does that and makes about $20 for each house lawn that he mows. Of course, instead of doing that or perhaps in addition to that, you could cut down on some of your expenses which are not absolutely necessary like your daily Starbucks shake or the weekly movies or even the guitar lesson and you could consider not making your weekly donation at the mall.

Consider the different ways of getting there, that is, achieving your financial goals

You need to evaluate possible courses of action, taking into consideration your life situation, personal values, and current economic conditions. You should remember that each alternative has its own consequence, its own possible cost and its own possible risk. You will undoubtedly need to sacrifice some things to gain others. In many financial decisions, identifying and evaluating risk is difficult.

You are simply overwhelmed with all of the alternatives you have identified in order to achieve all of your financial goals. You really want to count on the Christmas and birthday money but you are not really sure that you would get the whole $350 this year. It could be less for any reason. Also, you don’t want to spend your Saturday working as it is your fun day. You are thinking about the weekly donation and it does not feel right to stop making it, it does not agree with your values, you always want to help out those in need. Everything spins in your head and you are rather confused when evaluating your alternatives. It seems that for every alternative, you have to give up something so you need to prioritize according to your needs and your values.

Create your financial game plan

In this step of the financial planning process, you develop an action plan. This requires choosing ways to achieve your goals. Remember that, in order to implement your plan, you have to consider your needs and your values.

You have given everything a lot of thought and you have finally decided what to do.  You will concentrate on your short- and medium-term goals first and then deal with your long-term goal. Your short-term goals are:

1. Purchasing the iPhone in 4 months and you are already budgeting $100 per month for this
2. Saving the $1,200 within the next 12 months to go to the soccer camp which means that you need to save another $100 per month for the next 12 months.

How will you do that, given that your current monthly budget allows you to only spare $5 per month after of course your savings for the iPhone. You have decided that for the next 4 months you need to change things a bit since you have to save another $100 per month for the soccer camp while saving for the iPhone as well.  After the next four months, things will be easier because you will not have the $100 per month for the iPhone purchase and you can use that money towards the soccer camp savings.  You have decided that you will not count on the Christmas and birthday money because of the risks of not actually getting the money or not getting the amount you estimate you need. This way, you are minimizing the risk. Otherwise, you might face the risk of not actually coming up with the required amount.  Therefore, you will be cutting back on expenses: You will be going to the movies only twice a month so there is a $20 monthly saving there. In addition, you have decided that you will give up your Starbucks shake for the next 4 months so there is another $55 monthly saving there. You are short approximately $20 per month so you have talked to your neighbor and you will be mowing her lawn once a month for $20. 

Your monthly budget for the next four months will look like this:

After 4 months, when you will have purchased your iPhone, you will have the option to go back to your regular weekly movies and your daily Starbucks shake and save the $100 per month towards your soccer camp and the remaining $25 towards the purchase of your car.  After another 8 months, when you will be done with saving the soccer camp money, you can save $125 per month to buy your dream car. By then you will already have saved $200 for that and you have another 36 months to save $3,600 which is quite doable because you will be saving $100 a month quite easily. If you continue to mow your neighbor’s lawn you will also have the $20 extra per month which together with any extra cash you get for Christmas or for your birthday will give you the flexibility to save for something else you may want to buy, or spend it on other things.

Constantly check in and adapt your financial game plan if necessary

Remember that this is a process which changes very often and doesn’t necessarily have an end point. You need to regularly assess your financial decisions and your financial standing at that point. It is very normal to need to make changes and you should not be afraid to do so. It is a trial-and-error sort of process, after all. You should recognize that having the necessary discipline, consistency and flexibility to stick to your plan, without being afraid to change the things that don’t work, is the key to success.

Action steps – Exercise 1 (20 minutes)

• Below you see your current budget, which is very similar to the one we provided earlier. You have decided that next year you will travel with your team to the World Cup which is taking place in France. To travel there and attend the games you want, you need to come up with $1.500. Your parents are willing to give you $200 to help. Create your plan to achieve that over the next 12 months. Take into account your monthly savings, try to adjust your expenditures and try to think of additional sources of income to get your $1.300

Lesson wrap-up

Today we explored the technique of planning for your finances. We saw how you assess your current situation, how you set timeframes for your goals and how you can go about achieving them. Moreover, we saw how you can adjust your expenditure and even income by weighing alternative options in order to achieve your goals. Finally, we stressed how important it is to remain flexible and aware of your plan so as to make the changes when that is necessary.

At this point we will wrap up today’s lesson.  First, we will go over the learning objectives of this lesson and we want your feedback as to whether they have been achieved and then we will address any questions you may have.  Please feel free to ask anything you’d like in relation to today’s lesson and we would love to hear how the concepts we discussed today relate to you and your life!