The Importance of Making an Annual Financial Plan

Taking a strategic approach to managing your finances is a good way to keep tabs on how you’re doing, but even the most organized person doesn’t always take the time to make an annual financial plan. As fall approaches and students head back to school for a new year, it’s an excellent time to begin mapping out what you hope to achieve financially over the next 12 months. 

Even if you feel fairly confident about the way you’ve been handling your finances so far, understanding how you can use an annual financial plan to your advantage can help you make smarter decisions with your money going forward.

An annual financial plan is a guidebook of sorts that tells you where you’re at financially right now, what your goals are looking ahead and what areas or issues need to be addressed so that you can meet those goals. The plan covers every aspect of your financial life, from investing to taxes to your outlook for retirement. While your starting point in developing your plan may be different based on your age, income, debts, and assets, the most important components of an annual financial plan are the same. If you’re not sure what’s included, here are the things you need to be thinking about.

Reaching certain milestones, such as getting married or having a baby, are obvious reasons to reshape your financial plan. If, for example, you have younger children, you need to think about how saving for college fits into the picture. When your kids reach their teens, it's paying for college that needs to rise to the top. A twenty-something who’s recently gotten married, on the other hand, may be more focused on saving enough money for a down payment on a first home.

Looking at where you’re at in the context of any major life shifts that have happened over the past year – or are in the works – should influence your planning. Upcoming retirement is another obvious life change.

Actually, saving for retirement should be a top priority at any age, but it’s unfortunately something that gets pushed to the back burner far too often. A Northwestern Mutual survey published this year found that 21% of Americans have nothing saved towards their retirement. Of course, those statistics also show that more than two-thirds of Americans have been saving. However, saving isn’t a financial plan; it’s just the raw material for one.     

Your financial plan should review your retirement-savings options and determine how to use them to your best advantage. For example, if you have access to a 401(k) plan, ask yourself if you’re making the right level of contribution. 

If you’re not able to save in an employer-sponsored retirement account, you should be looking to save in a traditional IRA or a Roth IRA. If you already have one of these, the question is whether you're in the correct type.

Each year, inventory which types of accounts you have, what their balances are and how all your investments are doing. This obviously includes both retirement accounts and other investment accounts you may have.

Beyond just looking at where your money is being invested for retirement – and how much you're saving – you should also consider how your assets are allocated and what you’re paying in fees for those investments. A study from the Center for American Progress estimates that high fees can drain away more than $400,000 from the 401(k) of a high-income worker over the course of a lifetime, so it’s important to be mindful of what you’re paying. It may be time to unload expensive mutual funds and substitute something that lets you keep more of your money. In addition, see if it’s necessary to rebalance your portfolio if your asset allocation has drifted off course. 

Taxes are another consideration if you have investments in a taxable account. If you’ve sold any securities in the past year for a profit, you need to be prepared to pay capital gains tax when you file your return in April. Harvesting those losses by selling off holdings that have been on a downward slide can be an effective way to offset the impact of the gains, but you’ll have to make your move before year’s end.

Finally, you should be thinking about developing additional income streams for retirement beyond tax-advantaged and taxable investment accounts. For example, could buying a rental property fit into your plan? Would it be possible to boost your income through a side business or through investing in someone else's business? If you’re concerned about not saving enough for your later years, looking for ways now to maximize your income later is a must.

While saving for retirement is a big part of financial planning, you can’t overlook your other savings goals. According to another survey from the Federal Reserve, 46% of Americans would have trouble coming up with the cash to handle a $400 emergency.

If you don’t have an emergency savings buffer yet – or yours isn’t as big as you’d like it to be – then starting one or beefing it up are items you should add your financial to-do list moving forward.

The right financial-planning software can make managing your money easier and less stressful. If you’re using a software program now, consider whether it’s still meeting your needs. If you’re just flying by the seat of your pants, look into what the various software options are.

Between the scores of free budgeting apps that are out there and the premium programs for which you’ll have to pay a little more, you’ve got lots of choices for finding the financial planning resources that are going to work best for you. 

An annual financial plan takes into account your past and present, but it should also include your outlook for the future. By this point, you should be able to identify what you want to accomplish in the next 12 months, with regard to what you want to save and where you should be putting that money.

Starting with the total amount you want to save and then breaking it down on a monthly or weekly basis can make it easier to work toward your goal. This is also a good time to look at where you can save in your current life to help you come up with more cash for your future.

Creating an annual financial plan can be time-consuming and may require you to face up to some financial realities that you’ve been avoiding, but it’s well worth it in the end. Once your plan is completed, you can begin taking specific steps to ensure that your financial house is in order and running smoothly.