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Many people tend to be indecisive about how they handle their money. A passive approach like this can hinder sustainable growth in their income. It can also lead to great losses should they fail to take their finances seriously. This particular problem usually arises from the lack of a financial plan.
A financial plan involves plotting out one’s financial goals and devising a strategy to achieve them. This is most often most useful for investors and those trying to create passive income by investing in one or more asset classes. For example, a crypto investor with a Monero wallet may have a financial plan that revolves around investing in XMR coins and other security innovations.
To avoid falling into bad spending habits, everyone should know about these four key components in creating an effective financial plan.
Finding Out Your Net Worth
By finding out your net worth, you can see where exactly you stand in terms of your financial situation. For this, you do not necessarily need to account for income sources. The focus for calculating your net worth is on how much you actually have at the moment. This requires listing down all your assets and liabilities.
Assets refer to anything in your possession that has value. Aside from money in the bank, this also includes properties, vehicles, retirement savings plans, investment assets, and everything else that you own. Opposite to that, liabilities are all of your outstanding payments or debts such as student debts, loans, mortgages, and whatever else you have to pay over time.
Your net worth is essentially the total value of your assets subtracted by the sum of your liabilities. This calculation basically results in how much you are worth at present, giving you a good idea of where you stand financially.
Recognizing Your Cash Flow
In simple terms, cash flow determines how your money comes in and out of your pocket. For this, you should take into account all your sources of income from current jobs and other revenue streams. It is also a good idea to note when and how frequently these income sources flow in. That said, the more crucial part of cash flow is where your money is spent.
You should first note down all of your regular expenses such as bills, utilities, and necessities since these are the easiest to find out. Then, you should account for your overall spending habits. This can be complicated if your spending varies from per month. The best way to address this is to look back on your checking accounts, credit card statements, and anything with your expenses recorded within the past year.
Ideally, you should note down your cash flow on a monthly basis. But if your spending behavior is somewhat unpredictable, you can actually compute it on a yearly basis instead. You can then get an average monthly expense by dividing the result by twelve, just to make sure that you include your monthly bills.
Setting Your Goals
Contrary to popular belief, there is no single, all-encompassing set of financial goals that fits everyone. It all depends on your personal circumstances, which is why this component may need a little more thought.
Ideally, your goals should be concrete, realistic, and time-bound. To begin, it is important to visualize a timeline for your financial plan. Your goals may be in the short or long term, depending on what you want to achieve.
Furthermore, you should have a grasp of your risk tolerance. This varies from levels of conservative, moderate, and aggressive—determined by your willingness to take on risks for potentially substantial gains. This is why it helps to know your net worth and cash flow. This allows you to narrow down your options as to how you will achieve the goals you set. Whether this includes growing your long-term wealth by investing in various asset classes or lowering your expenses after computing your monthly cash flow, these goals will form the basis of your overall financial plan.
Working on a Strategy
There is no point to having the whole financial plan without a strategy to progress through it. Depending on your goals, there are many options and factors to consider that can influence your approach. For instance, many people stick to the basic retirement strategy—which is simply setting aside a fixed amount from their income to save enough for life after work.
Others like to strategize based on risk management by accounting for what-if scenarios, accidents, and potential setbacks in life. On the other hand, there are a growing number of people that prefer to look into long-term investment strategies. These individuals build up savings through a diverse portfolio of assets rather than insurances or liquid savings.
And of course, some people like to combine these strategies to fit their needs and their personal situation. Again, it all depends on the different components of your financial plan and for what you want to save up.
Hopefully, this article has been useful for crafting an effective financial plan. Addressing some of these components may seem overwhelming at first, but it does eventually help in figuring out the rest. What matters most is that you are no longer haphazardly spending your money by creating a financial plan and sticking to it. You will find yourself saving and likely earning more with a plan to guide you.
This article does not necessarily reflect the opinions of the editors or management of EconoTimes
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