How to Create a Personal Financial Plan

Bottom Line Up Front (BLUF): Creating a financial plan for your family is a crucial step in creating and protecting future wealth. Without a plan, you can’t know whether you are headed towards success. Also, it is harder to stick to your investing plan if you haven’t solidified why you made those choices.

For the first 80% of my military career, I thoroughly ignored my financial situation. I put myself in debt, only invested a little in the Thrift Savings Plan each month, and basically plodded along without any goal or aim in mind. As a result, our family is behind where we needed to be financially.

“If you aim at nothing you will hit it every time.” - Zig Ziglar

A couple years ago, I finally began to take our finances seriously. I decided that I wanted to be debt-free in the short term. I also decided that I didn’t want to rely on just my military retirement and social security to pay the bills when I finally retire for good. After realizing that I needed to step up my investments to get there, I decided that I would start investing at least 15% of my income. I began learning more and realized that I could increase my returns by using tax-advantaged retirement accounts to reduce my future tax burden.

Though I was moving in the right direction, I still needed a plan. I needed to understand our end goal, and how best to get there. Here are the steps that I followed:

Step 1. Figure out your financial situation.

Start by making a list of all the financial parts of your life. This list should include:

• Your income (how much you get paid each month, and if you are expecting any changes in income)
• List your bills (house, cars, utilities, internet, streaming services, insurance, etc.)
• List your assets (your house’s value, amount in your bank accounts & investment accounts, etc.)
• List your debts (home loan, car loans, credit cards, etc.)

This information will be important for planning. However, once you are done, move on to step 2.

Step 2. Figure out your financial goals.

Planning your finances requires starting with the end in mind. Ask yourself:

• Long-Term: How do I want to retire?
• Short-Term: How do I want my finances to look in the next 2-3 years?

Long Term: For example, I wanted to ensure we accumulated enough investments by retirement age (~30 years) to receive $40,000/year in today’s dollars. My goal is modest, but reasonable since I started very late. Also, because I should have my military retirement, our family should be comfortable with this amount. This is assuming that we stay in our current home and

Short Term: For example, about 9 months ago, I decided that I wanted our family to be debt-free (except our mortgage), and to sell our money-losing rental property (which we did). I wanted to ensure that I had the investing accounts setup and be on the right path towards our retirement goals.

Step 2A. Find your “magic number” (i.e. how much you need to live off 3% of your investments per year)

The Math: Figuring out your goal number requires a little math. Here are the steps:

1. How much money do you need each year to live on?
2. Multiply by 33 (to find your magic number, or how much you need to accumulate by retirement).
3. Adjust your magic number for inflation (by adding a compounding 3%/year, or estimating with the Rule of 72)

For example, for my $40,000 goal:

1. I needed $40,000 (in today’s dollars)
2. I multiplied by 33x, giving me a total of $1,320,000
3. If I plan to retire by 65 years old, I have 25 years to retire. At 3%/year, I’d expect the amount I need to double in 27 years. If I’m retiring in 25 years, I’d say we’d need about $2,600,000 to retire.

Based on my goals, my magic number is $2,600,000. I need to accumulate this much in tax-free investments/assets before I’m ready to fully retire.

Step 3. How much do I need to invest each month to meet my goal?

The next step is to figure out how to get to your magic number. This starts by figuring out how much you must invest each month to reach your goals.

With my magic number of $2,600,000 I can use Smart Asset’s investing calculator to determine how much I need to invest each month to meet my goal. If I was starting from $0, it would take investing $3,300/month (assuming a 7% return) to reach this goal in 25 years. Because I’m starting with about $100,000 invested, I will need to invest ~$2,600/month to reach my “magic number” (i.e. accumulate $2,600,000) in 25 years.

Step 3A. What accounts should I use to get there?

To ensure that you have the maximum tax-free returns, you must also think about what types of accounts (like Roth IRAs, TSP, or 401Ks) you will use for your investments.

If you are eligible (based on income), I’d start with maxing out a Roth IRA for you and your spouse (if applicable) with $6,000/year for each of you. Then, if eligible, put the rest in your Roth TSP (or Roth 401K) up to your total monthly investment goal.

Why? Because, these tax-advantaged accounts will help you keep more of your investment gains over the long-term. In addition, Roth IRAs have the neat feature of allowing you to pull out the money you put in (contributions) at any time (but not the investment gains), if needed.

For example, my wife and I are able to invest $12,000/year in Roth IRAs (using a Spousal IRA for her) and put the rest of our investments in our Roth TSP (while I’m still in the military). However, this is only $1,000 of the $2,600/month I need to invest.

Next, you can invest up to $1,708/month (or, $20,500/year) in either the traditional TSP or Roth TSP. Since I need to invest another $1,600/month to reach my “magic number”, I will invest that amount in the Roth TSP. (I’m not quite meeting this amount, but I’m working on it.)

Based on all of that, my family plans to invest:

• $1,000/month ($12,000/year) in 2x Roth IRAs (one for me and one for wifey)
• $1,600/month ($19,200/year) in Roth TSP*

Step 3B. What types of investments should I use to get there?

Besides the types of accounts you use, the types of investments you buy will greatly determine your outcome. To get the long term growth from investing, the majority of your investments should be in low-cost, total market index funds. However, you’ll also want to diversify across other market segments.

For more details on how to pick your investments, please see our post entitled, “Step 6: Diversify”.

Step 4. Find Ways to Increase Your Investments

At this point, I’m still investing less than I need to each month. Though my income should increase in the future (and allow me to easily invest more), I still need to look at my monthly bills and debts to see if I can eliminate anything. I already did some of these steps before, and found lots of areas were I could save money each month while not affecting our lives very much.

We reevaluated the following:

• Debts: This is always the first step. For most households, eliminating debts is the best way to make room in their monthly budgets for investing. It also removes the extra money that they are spending in interest on their loans and debts. For more on why to start here and how to use the debt snowball to pay down debts, check out our previous post titled, “How Debt is Holding You Back, and How to Fix It”.

• Car Insurance: It pays to shop around. Though I wouldn’t suggest going with just any company, it might surprise you how different the quotes are between major companies. I saved around 30% by swapping our car insurance to another company (in our case, Allstate, but your mileage may vary)

• Home Insurance: It also pays to shop around on home insurance as well. We saved a ton by shopping around on this as well, without it really impacting out lives. For most people, the savings won’t be felt right away (as your mortgage company usually pays this), but swapping should eventually save us a few hundred a year.

• Internet Service: Though you usually only have 1-2 good options for high-speed internet, we did save $10/month by switching from one to another.

• Cell Phone Service: Cell phone service prices vary widely. The cheapest service I’ve found is $15/month with T-Mobile prepaid. It only allows 3GB/month of data, but is vastly cheaper than the alternatives. We save at least $50/month on this.

• Miscellaneous Internet Services: For almost every pay-for-service online, there is a free version on the internet. I’ve worked hard to eliminate any services that we wouldn’t miss when they are gone.

Conclusion

Ultimately, your personal financial plan will be unique to you and your family. The goal is to understand your financial situation, decide where you are trying to go, and then how you are going to get there.