2020 is almost over!
Taking the hard lessons learnt this year, now is the perfect opportunity to start making decisions and putting things in place in navigate the next year with some degree of security.
One of those decisions can be effective financial planning.
What is the importance of financial planning for the New Year?
This year because of the global pandemic, many companies laid off workers, job hunting has become more challenging and the labour demands of various sectors have changed. A financial plan can secure your current funds and ensure they uphold you during unemployment.
If you are working, having a plan helps avoid overspending, builds your cash reserves and places you in a stable financial condition, should career interruptions come your way in 2021.
To start building your best financial future however, the critical questions remains – what is financial planning?
What is financial planning?
Financial planning is a long-term, ongoing process. It establishes income goals that would build and maintain wealth. What are the things that are important to you? Where do you see yourself in a year’s time? Or five years? What kind of financial situation would you like to be in at those stages of your life?
To answer these questions, a financial plan brings together your assets, liabilities, income, taxes, insurance and other available resources to achieve your financial goals.
How do I start a financial plan?
What is your income, fixed assets, other assets – savings, 401k, retirement funds, bonds and other investments? Include outstanding payments that you will likely receive. List your short-term liabilities – money owned to creditors or the figure on your credit card statement, long-term liabilities – loans, mortgages etc.
If you can closely estimate at least these figures, you can compute your net worth statement. This can be done by your assets – liabilities.
After identifying your current financial situation looks like and your net worth, you can choose to create your own financial plan yourself, or seek the services of a professional. Assistance from a financial planner will acquaint you with the technicalities of finance, assess your finances objectively and build a suitable plan.
You can also add a retirement plan by identifying a possible age to retire, and the kind of financial stability you would need to do so. Your financial planner can assist in retirement plans as well as management of your estate.
Setting up a living trust/estate plan
As your financial planner will tell you, establishing a trust helps avoid a pitfall of wills – the probation process. A person’s will can take months or even years to probate in the judicial system.
A living trust is a revocable document which ensures that assets are distributed as specified. Your financial planner will advise on what assets should be placed in your trust and how property should be divided.
Tips on how to start saving money
Budget
You can create a personal budget where you can allocate a specific sum on a monthly basis towards savings.
Separate your savings
It is advised that your savings should be kept in a separate account that you designate, away from your usual transactional accounts. You should not have immediate access to this account to avoid the temptation of withdrawing funds for frivolous purchases.
Let technology do the work for you.
Once your salary is deposited into your account, the automatic withdrawals transfers a specific amount to your designated savings account. This keeps a steady momentum of building your savings going. Additionally, you technically never see this money being transferred, so the temptation to spend is gone.
How to manage debt
Many people may be unaware, but there is good debt, and bad debt. Good debt is individuals borrowing money to generate additional revenue. Prime examples would be taking a loan to start a business or purchase real estate. Bad debt is money loaned that does not generate revenue – bad investments, unnecessary purchases and credit cards.
A debt repayment strategy
To manage good debt, set up a debt repayment strategy. Seek ways to increase incoming cash flow. This can be done through increasing business sales or generating rental income from your real estate. With a healthy cash flow, you can allocate revenue to pay off loans.
Pay off the important debt first
An effective part of your debt repayment strategy would be to pay off the loan that is most psychologically burdensome. This can either be the one with the highest principal, interest rate or deadline. Once you eradicate the burdensome loans off your plate, it makes repayment of other liabilities easier.
Automate payments
Like your savings, you can also automate your debt repayment strategy. You can set up standing orders with your bank to transfer funds from your account to creditors on a timed basis.
Debt consolidation
If you have significant amounts of bad debt from various creditors, you can choose to consolidate as an option. If your credit rating allows or if you have collateral as security, you can obtain a loan to pay off your various creditors and consolidate your debt to one institution.
Establish a budget.
Often, many people find themselves with loads of bad debts due to excessive spending on credit facilities, poor financial choices and bad investments. It is critical that you, or your financial planner establishes a budget. This optimises the most resourceful use of your income and helps prevent excessive spending and poor financial decision-making.
Tips on creating a budget.
One budget template divides income based on the following ratio:
- 50% of income for essential expenses – food, clothing, health & transport
- 20% of income – savings & paying off debt
- 10% of income – lifestyle purchases & entertainment
Your financial planner can create your budget ratio, according to your income. However there are some steps to consider:
- Track your income and expenses – how much you make vs. how much you spend? You can use online tools, spreadsheets or simple pen and paper.
- Identify all sources of income – Salary, savings, gifts, additional revenues. Credit cards should not be included.
- Categorise expenses – What do you buy on a monthly basis? Use your bank statements to determine your frequent purchases. Which expenses are essential and which are non-essential?
- Are your spending more than you earn or vice versa? Ideally you should be earning more than you spend.
- Allocate your money towards the essentials first, followed by rainy day funds for unforeseen expenses.
What should I read next?
- Read our article about Budget for Holidays
- Read our article about Financial plan
