Getting There From Here Requires a Plan

The late Sylvia Porter likened preparing a financial plan to planning a long car trip. First determine where you want to go. Then figure out how to get there and where you want to stop along the way.

Advisers agree that a comprehensive financial plan is the key to getting where you want to go financially without getting sidetracked or lost. So why do so many people fail to plan?

For one thing, it can be expensive. Fee-based financial advisers typically charge upward of $1,000 to draw up financial road maps for you. It’s cheaper--at least upfront--to have a stock broker or a commission-based planner help. But many people distrust advisers who make money by recommending products they themselves sell.

Fortunately, anyone with the time can draw up their own financial plan. All it takes is a pencil and paper, a calculator, some straight talk with your spouse or significant other and, most of all, patience.

The first step is setting goals. Do you want a house, a new car, a million-dollar investment portfolio or simply schooling for your kids and a comfortable retirement?

So make a list. Include every thing you think you may want, from the ridiculously obvious to the obviously ridiculous. You want to retire, right? Put it down. You want a castle on the Rhine? Put that down too. There’ll be plenty of time to eliminate things later.

Next to each goal, put down an estimated price and a date. For example, if you’re 30 and want to retire at age 50 with $500,000 in your pocket, write: Retirement, $500,000, 20 years.

For many people, the list begins with financial security. To accomplish this, you’ll probably need savings and insurance. Your cash cushion should be sufficient to see you through until you find another job or until you can sell other assets. It’s also worthwhile to draw up a mental list of assets you could sell in an emergency, and how long it would take to unload them. It’s unrealistic, for example, to believe that you could sell real estate in less than 60 days.

Another source of financial security is insurance. If you are single, you may need only a disability policy. If you’re married and have children, consider life insurance too. How much you need depends on the size of your family, your spouse’s employment status, the ages of your children and your financial obligations.

A rule of thumb is that you’ll need a death benefit equivalent to between four and 10 times annual earnings. The more debts and young children you have, the higher the multiple.

Other common goals include buying a home and building up nest eggs for retirement or children’s higher education.

All these goals are the destinations on your financial road trip. Now all you need is a map. In finance, that means a budget.

Setting up a budget is simple but time-consuming. The first step is plotting out how much you earn both monthly and annually. Include wages, tips, interest, dividends, commissions, trust funds and any other regular source of income.

Then make a list of your assets--equity in a house, a car, savings accounts, retirement funds, money you may have invested in mutual funds, stocks or bonds.

Finally, write down how much you spend monthly and annually. This includes your rent or mortgage; utilities; taxes on property and income; insurance on your life, house and car; meals; clothing; debt payments; transportation costs; luxuries, and entertainment.

All too often, a couple’s budget shows they are spending every dime they earn. That leaves nothing to save or invest. You can’t meet your financial goals that way.

But only a few of your expenses are truly fixed. Most people will find they can economize on virtually every item if they make the effort.

Go back and look for things you can trim. Some should be simple. You can eat out less, for example. But at some point, you’ll have to decide how much you are willing to sacrifice today to get what you want tomorrow.

Now return to your list of financial goals and look at the price tags and dates. For this part of the plan, you’ll need a present-value calculator. (They sell for about $25; many personal computer programs will also do the job.)

The idea is to calculate how much you need to save now to reach each goal in the given amount of time.

For that, you must assume some anticipated return on your money. Generally speaking, the more time you have to save and invest, the greater risks you can take with your money. So it’s logical to calculate lower rates of return for short-term goals than long-term.

Assuming again that you want to have $500,000 saved in 20 years, it’s probably fair to expect that, invested in a mix of stocks, bonds and deposits, you’ll earn 8%.

OK, key in $500,000 on your calculator and punch FV (future value). Now assume you can earn 8% on your money. So hit 8, divide by 12 (months), to get .666 and hit the “%i” (percentage interest) key. You have 20 years, so key in 20 times 12 (months) to get 240 and hit “N” for number of payments. Plug in 0 for the PV (present value), since we’re starting with no money saved. Now hit CPT (compute), PMT (payment), and you’ll find you must save nearly $850 a month to meet your goal.

Do the same calculation with each goal to determine how much of your monthly income you need to save.

Now comes some of the hard part. You may have noticed that you have to save more than you earn to meet all your goals. Clearly, they’re not entirely realistic.

You may decide, for example, that saving $850 a month is too hard. You may opt to retire in 30 years instead. (Use the same calculation, but plug in 360 N, instead of 240.) The monthly set-aside required to meet this goal is a much more relaxed $335.

The final step in preparing your financial plan is putting together an investment strategy.

Your specific strategy will depend on your age, income, marital status and financial goals. Generally speaking, families should divide their savings and investments into three categories to meet short-, medium- and long-term goals.

Short-term savings should be in safer and more liquid investments such as certificates of deposit, Treasury securities and money market accounts. Medium-term investments should be divided between safe, short-term investments and somewhat riskier longer-term investments. You might want to put some of these funds in equity and income mutual funds, for example.

Finally, long-term savings should be divided among low-, medium- and higher-risk investments. Some of your retirement money might go into Treasuries, some into growth stock mutual funds, and some might go into real estate.

A cliche is important here: Don’t put all your eggs in one basket. In other words, diversify.

That’s it. You’ve got financial goals, a budget and a savings and investment plan designed to attain them.

But don’t get too comfortable. It’s important to review your financial plan and revise it periodically, particularly if you’ve had some major shift--a promotion, marriage, divorce or the birth of a child.

It’s crucial to have a plan. Just don’t write it in stone.

Kathy M. Kristof welcomes readers’ comments and suggestions for columns but regrets that she cannot respond individually to letters and phone calls. Write to Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.