Financial Planning Basics Explained: Wealth 101

Most of us could benefit from a few financial planning basics, even if some of it involves stuff we already know – or, knew at one time. Like so many things, we get busy, and life gets complicated. Things start to slip through the cracks because there are only so many hours in the day and we only have so much energy to figure out so many things, it seems.

Well, take a breath. Relax. Nothing here is going to be about how you’re doing everything wrong or how you’ll never be able to retire or whatever. We’re just going to look at a few rather straightforward, non-threatening financial planning basics. Maybe you’ll find one or two of them helpful, or encouraging. If something catches your attention and you’ve simply gotta gotta know more, that’s certainly doable as well.

What Is Financial Management?

Financial management can cover a range of things. For most of us, the first images which leap into our minds when we hear the term are probably accountants or investment professionals talking about “rounding out our portfolio” or “diversifying our long-term dividends.”

They’re the financial equivalent of the sci-fi-speak we grew up hearing on Star Trek or Battlestar Galactica. “If I can’t remodulate these dilithium crystals, we’ll lose warp engines!” We feel like we get the general idea, but if we were asked to really start explaining what’s going on, we’d probably be in serious trouble. “Dammit, Jim – I’m an assistant inventory manager, not a stock broker!”

But, see… financial management means more than high dollar investment strategies. Financial management simply means the planning, monitoring, directing, and organizing of your financial resources. Yes, companies have these internally for their organizations – sometimes an entire department of folks with this title on the door. But it’s also what you do when you decide how to keep money coming in during difficult times. It’s what you do when you make a household budget and prioritize some items over others. And it’s what you do when you decide how you plan on paying for your daily needs down the road – upon retirement, or in your golden years.

If you have substantial resources on hand and need advice on how to best preserve and multiply your small fortune to best take care of your extended family and multiple properties, you should seek one-on-one professional financial planning advice. Maybe you already do. That’s great – you’re doing well. Keep up the good work!

For the rest of us, however, let’s back up a few steps to those financial planning basics I mentioned above and start a bit more slowly.

The Past, the Present, and the Future

If you haven’t done so already, you absolutely must create a household budget. If you live alone, this is your personal budget; if you’re responsible for others, it includes all of their income, debts, and recurring needs as well.

Start by taking a realistic look at the past few months. How much money have you made as a household, in total? That part shouldn’t be too hard. Create a spreadsheet or write the numbers down on a legal pad. Where’s the income coming from? How predictable is it? Is it mostly the same every month, or does it vary substantially with how many hours you work or how busy things are? Are there additional sources of periodic income you’ve overlooked? Other sources of potential additional income you could pursue, if it became necessary?

Now for the harder part. Where did it all go? Dollar for dollar, what did you spend it on? This isn’t intended to start any fights or make you feel guilty about how you spend your money. But unless we’re honest with ourselves about where our money goes each month, we’re not making adult decisions about spending so much as living in denial and hoping the fun parts outweigh the stress. Try to cover every normal expense – rent, car payment, credit card bills, utilities, cell phones, online subscriptions, groceries, eating out, entertainment, drinking money, etc. Whatever you spend money on, let’s hammer out those numbers.

If you’re new to an honest adult budget, you should know that the first time you do this two things are likely to happen. The first is that you’re going to end up unable to account for hundreds of dollars. That’s OK – you weren’t keeping track when you spent that money; you’ll be more aware now. The second thing is that your first month’s summary of what you spent on which things is going to be wrong. You’ll discover you spend way more on groceries than you thought, or way less on gasoline, or something. So you’ll adjust and see how the next month lines up with your anticipated budget – then compare again.

The foundation of all money handling skills is honesty with yourself. This usually requires being thorough and somewhat anal about keeping track of every dollar until you have a better idea of where your money is going. Financial planning basics don’t have to be complicated, but they can be emotionally difficult – especially at first.

Once you’ve got a pretty good idea of what each month looks like – enough that you can predict the month ahead with reasonable accuracy (and you turn out to be right) – it’s time to think about the future.

What If I Don’t Want to Think About the Future?

I know, I hear you – me, either. Today is complicated enough. But whether you’re thirty, fifty, or sixty-nine-and-a-half, the future is coming faster than we’d like and not always the way we’d planned. So, here are some foundational questions you should ask yourself (or discuss with your significant other) before we move on.

  • Best-case scenario, how long can I keep doing what I’m doing professionally (the source of my current income)?

  • What’s the minimum I’m likely to need to live on after I’m no longer working? (Will your house be paid for? How will you get around? What is your health care situation most likely going to look like?)

  • Are there major expenses coming in the future for which I’d like to be prepared? (Kids going to college? A loved one with escalating care-giving needs? A wedding you’d hoped to make possible?)

  • What am I currently doing to make sure I can still take care of myself and those for whom I’m responsible ten years from now? Twenty years from now? Forty?

If you don’t find those daunting enough, here are a few more you can throw into the mix:

  • What happens if I lose my job in ten years? Or have an accident and can no longer work? Or I die? Who pays for things then?

  • What about those I love? What’s the plan if something happens to one of them? Can I handle their education expenses? Medical care? Other needs?

I’m not trying to freak you out. There are only so many things we can control, and there’s a point at which we simply have to make like Elsa and “let it go.” But too often we ignore what we could be doing, things we could influence or control, because we simply don’t like to think about scary unknowns. That approach is NOT acceptable. We can certainly do better with our financial planning basics than THAT!

Where Do I Begin?

Let’s assume that you have at least some general ideas about what you’d like to have available when you retire. Also, for now, let’s take unexpected events off the table – no tragedies, no company closings, no Chinese takeover of the entire economy. On the flip side, let’s assume you don’t have years of comfortable living already invested. Maybe you’re living more or less paycheck to paycheck – not usually too behind, but rarely very far ahead.

What are the most basic ways you can begin preparing for the future more effectively? In other words, let’s look at how to be better with money starting from right here, right now.

What Current Expenses Can You Cut or Consolidate?

How much could you save by refinancing your mortgage? How much would it help to take out a bill consolidation loan and pay off high interest credit cards and other debt and replace them with a lower interest, more manageable monthly payment? What could you shave from your cable package? Your cell phone plans? Your monthly subscriptions or services?

You don’t necessarily have to live like a hermit to cut expenses. We live in consumer-driven times, and “More! More! More!” is our national anthem. (Maybe a better choice would be “I Want It Now!” from that horrible child in the Willy Wonka movie!) We talked about this in much greater detail when we covered Money Management Basics recently, if you’d like to check it out.

A Savings Account

I know, right? This is financial planning basics, after all. If you don’t have a savings account, open one. If you have one, let’s figure out right now how you can contribute to it regularly.

The nice thing about savings accounts is that they’re so darned accessible. You usually have them at the same bank or credit union where you do your checking and maybe a few other financial management things. They’re easy to tap into if you need the funds, and easy to add to when you have the cash. And they should be paying you SOME sort of interest, even if it’s pretty minuscule. Something is better than nothing, yes?

So why not just work out of your checking account? Besides that token interest, there’s something psychologically different about money in a savings account. You can access it, sure – but it’s different than using your debit card or writing a check. It requires a certain… intentionality to draw from it, perhaps giving you a simple moment of pause before you pull the trigger. Are you SURE you want to do this? Will you be HAPPY you made this choice in a few days or next month? If so, go right ahead – it’s your money. If not, well… maybe think on it another day. We don’t want to go all crazy and start tapping into our SAVINGS unless it’s absolutely necessary, do we?

That same convenience is the biggest disadvantage as well, of course. You’re a bit behind on a few bills, and you figure you can transfer $500 from savings to help cover everything. You’ll “pay it back” when you get paid, right? Only you don’t, then you do it again a few months later, and before you know it, you don’t actually have anything in savings.

Plus that interest rate is rather sad, isn’t it? Still, having a savings account is better than not having a way to save. It’s a step in the right direction, and we’re all about steps in the right direction around here.

Your Employer's Plan

Most of us at some point have sat down with someone from HR or with a rep from a financial organization chosen by our employer to fill out some forms and check some boxes and figure out what sort of life insurance we want, whether or not we need accident coverage, and probably how much we want to contribute to… something above and beyond whatever our employer already pays on our behalf.

If you know all about these options and pay close attention at these meetings, you’re wondering why I’m making it all sound so vague and confusing. The rest of you are thinking, “Wait – so I’m not the only one not entirely sure what I signed up for or whether or not I should have done the, you know… thing?!”

Even if you’re not quite THAT confused, take a few moments to revisit your options through your employer. Start by going through whatever paperwork they sent you home with and write down any questions you have. Look at your various options, keeping in mind that some might travel with you while others go away if you leave that employer. Don’t be afraid to schedule a sit-down with HR or that rep from the financial company and ask your questions. Lay out your situation and ask about your options. It’s even OK to ask exactly what a “401(k)” is.

What’s a 401(k)?

See, that wasn’t so hard, was it?

A 401(k) is a retirement plan chosen by an employer to offer to their employees. Some employers pay into their employees’ 401(k) plans as part of the overall benefits of working for the company, but it’s not required that they do so. You, as the employee, choose how much you want deducted from your check each month to go into the 401(k). The amount you choose is pre-tax, meaning when you contribute to a 401(k), you’re lowering your taxable income.

You often have some input on how these retirement savings are invested on your behalf, choosing either specific investments or selecting general categories like “high risk (high payoff),” “medium risk (average payoff),” or “low risk (low payoff).” Some plans allow limited borrowing against the total or other options, but keep in mind this isn’t a savings account – it’s a retirement account. The idea is that you don’t touch the money until you retire.

See a representative from whatever financial organization your employer chose to manage their 401(k) plans for the details.

Is That The Same As A 403(b)?

These are very similar retirement savings programs to the 401(k), but they’re specifically designed for employees of public schools or other tax-exempt organizations – teachers, government employees, nurses, librarians, preachers, etc.

There are some technical differences from the 401(k), but we’re not going to try to unravel those at the moment. For now, it’s the non-profit version of a 401(k) plan. Remember, we’re just trying to cover some financial planning basics at the moment. It’s always OK to ask your financial advisor or financial institution more detailed questions or to research specific plans on your own once you have a foundation.

What’s an IRA?

IRA stands for “Individual Retirement Account.” As the name suggests, it’s something you initiate rather than something your employer has to offer. While they don’t require that you have a 401(k), it’s often the case that an employee establishes an IRA to supplement the plan offered by their employer. Like with most things, there are endless variations on this theme, but most basically there are three types of IRA:

1. The Traditional IRA

You set this up with a local or online financial institution and make contributions each pay period. In many cases, the money you contribute can be deducted on your tax return, and your earnings are not taxed until you withdraw them after you retire.

2. The Roth IRA

You set this up with a local or online financial institution and make contributions each pay period. There’s no up-front tax break for these contributions; they’re considered income just like everything else you bring home. (You might choose to put money in a savings account every month, but it’s still taxed normally before you even receive it.) As long as you follow some of the guidelines your financial institution can explain, you don’t have to pay taxes on these funds again when you withdraw them upon retiring.

3. The Rollover IRA

This is an IRA into which you “roll over” funds from another retirement plan, like a 401(k). This makes sense if the tax conditions or interest rates that come with your IRA are better than those associated with your other retirement plan. You might also have more control over how the funds are invested, if you like the “hands-on” approach. In other words, this one’s all about the details.

What Other Options Are There For, You Know, NORMAL People?

Here are several other straightforward options for saving for the future without devoting hours each week to complicated decision-making or deciphering the financial news. Keep in mind that generally, the higher the risk, the higher the potential reward. The safer the investment, the lower the payoff. Then again, safer investments are, well... safer.

CDs

I don’ t mean your “Best of Loverboy” disc that’s still at the bottom of your closet somewhere. CDs are “Certificates of Deposit.” You agree to leave a certain amount of money in one of these accounts for a specific amount of time. The shortest time period is typically three months, but commitments of one to five years are far more common. The longer you agree to leave your money in the account, the better interest rate you’ll be offered.

CDs are insured by the FDIC and one of the safest ways to invest. The interest rates are higher than a simple savings account and many other investment options. The down side, of course, is that you’re committed for the time period of the deposit. You don’t have access to those funds in an emergency unless you’re willing to pay substantial penalties.

Some investors practice what they call “CD Laddering.” They invest in CDs throughout the year and for different time periods, so that once things are rolling, they have CDs maturing regularly and can choose to either use those funds or reinvest them.

There are, of course, endless varieties of CDs available with different benefits and quirks. Part of what makes financial planning basics seem so complicated is that nothing comes in a single flavor any more. Don’t get too freaked out by all the variations; pick something you think will work for you and try it for a while. See what happens, then adjust as necessary.

It’s not about getting it “right” or “wrong”; it’s about having a plan for the future and pursuing it. Cut yourself some slack if you’re not always 100% sure of every option and every choice you make.

The Stock Market

If there’s an “opposite” to CDs, it’s the stock market. There are few limits on how much stock you can buy, or when, or when you can turn around and sell that stock. It can be high risk and high reward, high risk and huge loss, low risk and pretty much any possible outcome, or anything in between.

When you buy stock, you essentially own a small piece of the company whose stock you’ve purchased. If the value of that company goes up, the value of your stock goes up in the same proportion. If the value goes down, so does the value of your investment. Then again, you don’t really profit or lose until you choose to sell – as long as you hold onto the stock, all of your gains or losses are on paper. They’re theoretical.

Some investors love the excitement and risk and hands-on approach. Others find it stressful and confusing. A good rule of thumb is to never invest more than you could afford to lose when it comes to the stock market. Otherwise, the risk is simply too great. There are all sorts of subtle ways people play the market which you can explore if you have the interest.

Bonds

When you purchase bonds, you’re essentially loaning the issuing company (or the government) a set amount of money for an extended time period. When the bonds mature, you receive your investment back with interest. If you’ve ever given or received “savings bonds” or “treasury bonds,” they’re a common form of this. Sometimes corporations issues bonds to raise capital, so they have funds on hand to invest in hopes of increasing growth.

Bonds are not that different from CDs, but they’re issued by companies or the government rather than your local financial institution.They tend to be longer-term than CDs, with ten, twenty, or even fifty years not uncommon. They’re far more reliable than stocks or other forms of investment, and the interest rates tend to be decent (although the cost of living can change dramatically over a fifty-year window, so there’s that). On the other hand, cashing in bonds before the maturity date usually results in substantial penalties.

Mutual Funds

Mutual funds are not something you can do directly on your own. They’re a financial arrangement managed by various professionals which allow investors to combine their funds and invest in pieces of many different companies.

Think of it this way. Let’s say there are ten of you at work, each of you wanting to invest in the stock market in hopes of improving your retirement. Each of you chooses a solid stock and invests your individual money in that stock. What’s the most likely outcome?

If you all did your research, maybe four of you make substantial profits, three of you do OK over time, two of you lose a small amount, and one of you loses everything they invested. That sucks for the last guy, and it’s not great for the two who lost a little, but overall, this was a success!

Now imagine the ten of you taking the same amounts you were investing and instead combine them together. You use that money to buy pieces from all ten of those same companies. What happens over time?

If the majority of those companies were successful, as they were in the first example, then you’ll all come out ahead over time. The top investors from the first example won’t make quite as much, but no one will lose money, despite the one company that crashed-and-burned. That’s because you’ve packaged your investment in such a way as to spread out the risk.

Besides reducing risk, you don’t have to have a huge amount of money to try out mutual funds. You do have to find a financial expert who offers these, since they’re the ones actually putting together those packages like we described in the example.

Actual mutual funds are a bit more involved than that, of course, and you still have some decisions to make about the type of mutual funds in which you wish to invest, but in terms of financial planning basics, that’s the general idea. Dave Ramsey dives into mutual funds in a bit more detail if you’re interested.

Commodities

One of the easiest types of investment to understand, but one of the hardest to predict over time, is commodities. Commodities are tangible items of value which come from the earth in some fashion – soybeans, coffee, cotton, wheat, cattle, oranges, aluminum, copper, uranium, or oil, for example.. Commodities also include two of the most popular precious metals you’ve no doubt heard pushed as must-buys towards your future security – silver and gold.

You can, of course, simply buy stocks in companies built primarily around commodities. This puts you in the same position as any other stock purchase.

Another way to invest in commodities is through “future contracts.” These are a promise to sell a specific amount of a particular commodity at a set time in the future for a price you agree upon NOW. You don’t have to physically take ownership of the commodity, but the dynamics are the same. You’re essentially playing a very messy guessing game about what will happen to the price of your chosen commodities over time..

Then, of course, there’s the most basic way to deal in commodities – to buy them and store them yourself. This is most common with gold and silver, since most of us don’t have a convenient way to manage 100 tons of soybeans or 750 alpaca ourselves. Not that you’re not welcome to give it a try, but... let’s be realistic. Gold and silver are tricky in that, while they each have a few practical applications, their value is largely a function of agreed-upon longing. They’re valuable because they’re relatively rare and because we’ve all agreed to consider them valuable.

It’s all but impossible to predict what gold or silver prices will do, but some people feel batter having the physical metal there in their secret wall safe in the basement with their rifle and all those canned beans.

Conclusion

Financial planning basics don’t require you to be an expert on every possible option, and they certainly don’t require you to be rich. They do require us to take some time each month to look at where we are and where we’re going, and what we can do to improve our odds of a comfortable, full life when we get there.

Any of us can do that. Any of us can start now. Any of us can make a few steps. What are YOU going to do first?