When it comes to my financial life, every year I sit down and work through a financial planning framework that I have developed over time. This framework allows me to review the past year, evaluate where I am relative to my goals, develop additional goals and planning for the upcoming year, and then execute. Execution can often seem like one of the more difficult steps in financial planning. However, I think this is likely due to a lack of clarity. Execution becomes easy if you have a plan. Planning becomes easy if you evaluate and define/refine your goals. Evaluating and defining/refining your goals becomes easy if you review your progress and understand where you are in current state. It is all a progressive cycle, and cycles become MUCH easier with a clear framework.
For these reasons, I thought I’d share my 10 Step Financial Planning Framework that I use each year to plan for the upcoming year.
HTF 10 Step Financial Planning Framework:
Step 1: Update and review your net worth, savings rate, and spending for the year.
I track my net worth monthly. I recommend you do so at least quarterly which makes this step easier when entering a new year. I also track my spending utilizing YNAB (no affiliation – I just like the program). There are a lot of different ways you can track your net worth and spending. The key is to do what works for you. If you choose to set up systems to track regularly (which is my approach), this exercise because easier. Otherwise, this is one of the most time-consuming steps of the process. However, it is necessary because it is the foundation for all remaining steps.
Step 2: Evaluate your net worth, savings/investing rate, and spending relative to your overall goals both in short-term and long-term.
Your saving/investing rate is personal, and your targets should be dependent upon your goals. As noted in my previous post, The Eighth Wonder of the World, your savings/investing rate impacts your timeline to FI, and of course your savings/investing rate is inversely correlated to your spending whereby increasing one decreases the other.
Step 3: Review your recurring expenses (monthly, quarterly, and annual) to determine if changes need to occur. This can include elimination/reduction of existing recurring expenses, intentional addition of new recurring expenses, or transition of expenses to a different cadence to save money.
It is important to not focus on the just cutting recurring expenses in this step. There are many recurring expenses you want to or must keep. For these expenses, the intent is to understand where you can maximize efficiency and reduce costs. For instance, you can often pay many of your recurring costs (think insurance, entertainment, etc.) on a bi-annual or annual basis. In doing so, you receive a discount for something you were going to pay for anyway.
In addition to existing recurring expenses, this step is the opportunity to thoughtfully add recurring expenses. Again – the intent is to perform a thoughtful analysis of your recurring expenses to ensure they align with your values and goals – both in the short-term and long-term.
Step 4: Review your sinking funds to determine what sinking funds need to be added or eliminated based upon new goals. Also determine progress with existing sinking funds to determine if revisions should be made to increase/decrease recurring contributions.
If you don’t currently have a framework around sinking funds, you should. As a reminder, sinking funds are money you intentionally set aside each month for specific savings goals. Think infrequent, large expenses you can proactively plan for over time. This proactive planning can smooth your cashflow when large expenses arise and eliminate the need for you to tap your emergency fund or go into debt when paying for large expenses. Core sinkings fund examples could be a car fund, car maintenance fund, home maintenance fund (i.e. new roof, significant maintenance), home renovation fund (as applicable), and/or other large expenses that need pre-funding including large expenses for children, investments, etc. This is personal to you and your goals.
I recommend keeping your sinking funds in a high yield savings account or other FDIC insured account. This will ensure you have quick access when needed, financial protection, and allow you to earn more interest than a traditional brick-and-mortar bank. As a HENRY, I also recommend you consider eliminating sinking funds that can be covered easily utilizing monthly free cash flow. For instance, if you have $3,000 extra a month after saving, investing, and spending, you likely don’t need to have a $2,500 sinking fund for annual car repair expenses since you could cover an unexpected expense with your monthly free cashflow. Again, this is personal, so do what makes the most sense for you, and allows you to sleep at night.
Step 5: Review your credit card rewards earned for prior year to determine the effectiveness of your strategy. Determine if changes need to be made to include new credit cards, different utilization strategy, etc.
Skip this step if credit cards aren’t your thing (looking at you hard core Dave Ramsey followers) or if you can’t manage credit cards responsibly. However, if you can, credit cards are just another tool in your financial toolbox. Utilized correctly, the average HENRY can likely earn $3K – $5K in rewards annually just based upon what you were planning to spend already. You can earn much more than this if you are a business owner or want to spend the time to truly maximize your outcomes in this area. In the end, this is your time to review the previous year and determine if you want to close cards, add cards, or change your spending habits to maximize credit card reward points and cash back.
Step 6: Review your current investment/financial account structure to determine if changes need to occur to simplify your financial life and/or track to long term goals. Also review your current framework regarding bill payment, savings and investing, etc. The intent is to leverage systems, automation, and a defined framework to achieve goals.
I personally subscribe to a version of Ramit Sethi’s framework here. For this reason, I recommend automating your savings and investing to occur the 1st – 3rd of each month. I then recommend aligning all your recurring bills to pay the 5th – 7th of each month. All credit cards should be automatically set to pay the balance in full.
As you probably could have guessed from my comments in Step 5, I recommend all possible expenses be paid on credit cards. One important note here. If you need to ensure your credit score is high, I would pay your balances weekly or bi-weekly noting you should still be setting your credit cards to automatically pay the balance in full each month to avoid any unplanned issues. More regular payments will ensure your credit utilization stays relatively low on a month-to-month basis – especially when you’re putting most spending on your credit cards.
Step 7: Determine your travel and leisure/fun spending goals for the upcoming year noting your review of the prior year occurred in Step 1. Then you should determine how each goal will be funded (i.e. cash-flowed, sinking fund, etc.)
I recommend that you have a monthly budgeted amount allocated to fun/leisure/local travel (i.e. weekend trips, entertainment, etc.). I then recommend you have a sinking fund for travel that is funded monthly to support more substantial/expensive travel (i.e. large family vacations, out-of-country, travel, etc.) Any money that you don’t spend on a given month can then also be transferred into the sinking fund.
Step 8: Determine emergency fund, saving, spending, investing goals for upcoming year to include allocation of monthly free cash flow (savings, sinking fund, taxable, pre-tax, etc.)
I recommend that your monthly spending be pre-funded in a checking account each month (i.e. keep 1X monthly spend or 1X monthly income in primary checking account to cover spending in upcoming month). For example, if you spend/save/invest approximately $15K a month, I recommend having approximately $15K in your checking account to start the month so that you are “pre-funding” the upcoming month. The number is specific to you. The point is to operate from a position of strength each month from a cashflow perspective.
For your emergency fund, I recommend 3 – 12 months of expenses in a high yield savings account, money market, or similar account. This again is highly personal based upon your income, occupation, overall net worth to include taxable account, etc. You can also have multiple tiers to your emergency fund to include bonds and other cash equivalents.
Note: I personally would consider shrinking your emergency fund toward the lower end (~ 3 – 6 months) as your sinking funds begin to build and/or when your taxable account is more significant relative to your annual income/spending.
Step 9: Review your Investment Policy Statement (IPS) to include your asset allocation, investment mix, etc. Propose changes for upcoming year noting I recommend you follow the waiting period defined within IPS to make changes.
If you are unfamiliar with an IPS or don’t have one, you can check out my previous post, Do You Have An IPS, to understand the mechanics of creating one. This is an opportunity to propose revisions for those with an existing IPS. Again, I recommend sticking to your defined waiting period in your IPS when making changes so you ensure they are thoughtful and in alignment with your long term goals.
Step 10: Rebalance your portfolio based upon desired asset allocation and ISP. Determine a cadence to review progress over the upcoming year to ensure you are on track.
The Transition from Checkers to Chess
The framework above allows you to methodically work through your financial life in a very structured way. In doing so, you should have accomplished the following:
You should now understand your prior year saving, investing, spending/expenses, and overall progress relative to your goals both in the short-term and long-term.
You should now have a tactical financial framework for the upcoming year to include monthly spending, recurring expenses, sinking funds, savings, and investing. You should also have a goal-oriented financial framework to include annual targets for savings rate, sinking funds, emergency fund, other savings, and investing both pre-tax and taxable.
You should have a defined time to revisit ISP changes that require changes to portfolio, as well as a defined cadence to review progress and ensure you are on track.
With the above, execution is no longer the hard part. You have graduated from playing checkers in your financial life to playing chess. This transition from reactive to proactive positions you to systematically execute on your plan and drive toward your goals – both short-term and long-term.
Regards,
Henry
*** Images: Unsplash.com ***