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When youre young and dont have many financial responsibilities, you may be able to live comfortably from paycheck to paycheck without a lot of advance planning. But at some point in your life, the things that you want or need will outdistance what you have in the bank. And if you dont have a strategy in place for accumulating the assets you need, you may find that you have to postpone or abandon some of the things you were counting on. A financial plan is about looking ahead, so the money is there when you need it, for as long as youll need. While everyones specific goals and circumstances may be different, a financial plan should help you: Identify your short-, medium-, and long-term financial goals Choose strategies to help you meet the ones to which you give highest priority Provide for an emergency fund Identifying your goals, selecting the most important ones, and deciding how to achieve them are the crux of your plan. Building an emergency fund will help prevent you from being thrown off track by an unplanned loss of income or unexpected expenses. And practicing good financial habits such as having a spending plan, investing regularly, and using credit wisely can help you find yourself where you want to be within the time frame youve set.
that returns on your investment assets arent guaranteed, and your account could lose value, especially in the short term.
Inflation
Inflation is another reason you may want to invest rather than use a savings account to meet your long-term financial goals. Because the rate of return you realize on savings accounts is generally fairly low, you risk falling victim to inflation, or the gradual decline in the purchasing power of the dollar. Inflation has averaged 3% annually since 1926. For example, if you put $10,000 in a money market account earning 2.5% interest, your account would have $15,676 after 18 years. If inflation averaged 3% per year, your account value would have approximately $8,500 worth of buying power. But if youd invested the money in a portfolio of stocks with an average annual return of 8% for 18 years a realistic historical long-term return for stocks, though not a guaranteed rate youd have $40,000. After accounting for 3% inflation that would produce more than $21,500 worth of buying power. However, a savings account isnt the only way to save for short-term goals: The best strategy depends on your time frame. For instance, if you know youll need the money on a specific date say two years from now you may decide to invest the money in a 24-month certificate of deposit (CD). That way, the money is out of reach while it earns more interest than it probably would in a regular savings account. And if some of your goals are still a few years off, you can invest a percentage of your savings say 25% in a lower-volatility balanced fund, short-term bond fund, or even a blue-chip stock fund, so that your savings have the opportunity to grow without as much risk to your principal as some other investment opportunities. As the date you need the money approaches, you can gradually shift more of your money into a savings account.
long-term goals
The more time you have to reach a financial goal, the more investment risk you can usually afford to take. That means allocating most of the principal you set aside for long-term goals to equities either individually or through exchange-traded funds (ETFs), mutual funds, or managed accounts that invest in stocks. Although the value of an investment portfolio may fluctuate dramatically over the course of a month or year, over periods of 15 or 20 years or more, stocks as an asset class usually a fairly volatile type of investment over the short term have historically increased in value, though there is no assurance that what has happened in the past will happen in the future. Despite the fact that a return on your investment isnt guaranteed, it is true that when you invest for the long term, your earnings have the opportunity to compound. Compounding is what happens when your investment earnings are reinvested and in turn generate earnings. The longer you have to invest the more you stand to benefit from the power of compounding.
DEVELOPING A FINANCIAL PLAN How many times have you thought about developing a financial plan, but have never known where to start. It is important that you get started now because your financial plan will help you achieve your goals more easily and attain the lifestyle you want in the future. Here are steps to following to create your own plan. 1. Start by writing down each of your goals on a 3" x 5" card. 2. Create two stacks - goals you want to accomplish within the next five years or less and goals that will take longer than five years (you'll save for these goals differently). 3. Sort the cards within each stack in order of priority, based on how hard you are willing to work or save to reach each goal. Make retirement a priority. 4. Write on each card what you need to do to accomplish that goal, plus when, what it will cost and how much you'll need to save each month to reach your goal. 5. Prioritize again, creating a "dream" stack and a "reality" stack to guide your saving and spending. 6. Create a snapshot of your finances by calculating your net worth - the total value of what you own minus what you owe. Include in this snapshot of your financial resources items such as personal possessions, vehicles, home and other real estate, checking and savings accounts, insurance policies, stocks and retirement plans. On the liabilities side, consider your home mortgage, credit card debt, student or auto loans and taxes/capital gains owed. 7. Envision your retirement and the monthly resources you'll need in retirement, along with when you want to retire. 8. Estimate how large your nest egg will need to be to "buy" your retirement goal. 9. Use a worksheet or software program to help calculate how much you'll need to save every month and the return on investment you'll need to reach your goal. Some useful financial calculator Web sites have been provided in the Department of Labor's new booklet on page 20. 10. Create a spending plan for your monthly income that starts with your "payment" to your retirement savings plan designed to build the resources you'll need for the retirement you desire.
Your net worth is the difference between all the things of value that you own, and all the debts you owe. In financial terms, your net worth is your assets minus your liabilities. If you have more assets than liabilities, you have a positive net worth. This is a good thing. If you have more liabilities than assets, you have a negative net worth. This is not such a good thing, but it's information you need to know. For a general idea of what your net worth should be, based on your age and income, the authors of "The Millionaire Next Door" recommend that you multiply your annual income times your age and divide by ten. While the results are interesting, take this information with a grain of salt, since it's simply an average and doesn't take specific personal situations into account. Calculating your net worth is fairly simple in concept. (See the Net Worth Worksheet for a sample form to use). First, list the things of value that you own, starting with:
cash and cash equivalents, such as Certificates of Deposit, money market accounts, bank accounts investments, such as stocks, bonds, mutual funds, savings bonds retirement funds, such as 401(k) or 403(b) plans, Individual Retirement Accounts (IRAs), company pension plans, including only the amounts you are fully vested in real estate, including your home, if you own it, and any other real estate or personal property such as boats, cars, RVs, planes household goods, such as furnishings, jewelry, furs, collectibles, antiques. Use the estimated fair market value, which may be more or less than what you paid for the item. Fair market value is "the price a willing, rational, and knowledgeable buyer would pay." For cars, use the blue book value. When you've listed everything you can think of, total your assets. Next, list your liabilities, or amounts you owe others, starting with your
loans, including your mortgage, if you have one, student loans, bank loans, car loans credit card balances, including major bank cards like Visa or Mastercard; department store cards, gas cards taxes owed, such as real estate taxes or income taxes any miscellaneous amounts that you owe When you've listed everything you can think of, total your liabilities. Now subtract your liabilities from your assets. Is the number positive (you have more assets than liabilities)? If so, give yourself a pat on the back and start planning on how to increase your net worth. If the number is negative (more liabilities than assets), don't despair. Read the following articles to get on the road to financial health: