Everywhere people are talking about money. When it comes to handling your finances, are you an explorer, someone who is always searching through uncharted areas? Are you a passenger, just along for the ride on the money decision-making trip of life? Or are you a researcher, seeking answers to the inevitable money questions of life?

Most people want to handle their finances so that they get full satisfaction from each available dollar. Typical financial goals include such things as a new car, a larger home, advanced career training, contributions to charity, extended travel, and self-sufficiency during working and retirement years. To achieve these and other goals, people need to identify and set priorities. Financial and personal satisfaction are the result of an organized process that is commonly referred to as personal money management or personal financial planning.

Personal financial planningThe process of managing your money to achieve personal economic satisfaction is the process of managing your money to achieve personal economic satisfaction. This planning process allows you to control your financial situation. Every person, family, or household has a unique financial position, and any financial activity therefore must also be carefully planned to meet specific needs and goals.

A comprehensive financial plan can enhance the quality of your life and increase your satisfaction by reducing uncertainty about your future needs and resources. The specific advantages of personal financial planning include

• Increased effectiveness in obtaining, using, and protecting your financial resources throughout your lifetime.
• Increased control of your financial affairs by avoiding excessive debt, bankruptcy, and dependence on others for economic security.
• Improved personal relationships resulting from well-planned and effectively communicated financial decisions.
• A sense of freedom from financial worries obtained by looking to the future, anticipating expenses, and achieving your personal economic goals.

We all make hundreds of decisions each day. Most of these decisions are quite simple and have few consequences. Some are complex and have long-term effects on our personal and financial situations. While everyone makes decisions, few people consider how to make better decisions. As Exhibit 1-1 shows, the financial planning process is a logical, six-step procedure: (1) determining your current financial situation, (2) developing financial goals, (3) identifying alternative courses of action, (4) evaluating alternatives, (5) creating and implementing a financial action plan, and (6) reviewing and revising the plan.

Exhibit 1-1   The financial planning process

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Sheet 1
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STEP 1: DETERMINE YOUR CURRENT FINANCIAL SITUATION

In this first step, you will determine your current financial situation regarding income, savings, living expenses, and debts. Preparing a list of current asset and debt balances and amounts spent for various items gives you a foundation for financial planning activities. The personal financial statements discussed in Chapter 3 will provide the information needed to match your goals with your current income and potential earning power.

STEP 2: DEVELOP YOUR FINANCIAL GOALS

You should periodically analyze your financial values and goals. This activity involves identifying how you feel about money and why you feel that way. Are your feelings about money based on factual knowledge or on the influence of others? Are your financial priorities based on social pressures, household needs, or desires for luxury items? How will economic conditions affect your goals and priorities? The purpose of this analysis is to differentiate your needs from your wants.

Specific financial goals are vital to financial planning. Others can suggest financial goals for you; however, you must decide which goals to pursue. Your financial goals can range from spending all of your current income to developing an extensive savings and investment program for your future financial security.

STEP 3: IDENTIFY ALTERNATIVE COURSES OF ACTION

Not all of these categories will apply to every decision; however, they do represent possible courses of action. For example, if you want to stop working full time to go to school, you must generate several alternatives under the category “Take a new course of action.”

Creativity in decision making is vital to effective choices. Considering all of the possible alternatives will help you make more effective and satisfying decisions. For instance, most people believe they must own a car to get to work or school. However, they should consider other alternatives such as public transportation, carpooling, renting a car, shared ownership of a car, or a company car.

Remember, when you decide not to take action, you elect to “do nothing,” which can be a dangerous alternative.

STEP 4: EVALUATE YOUR ALTERNATIVES

You need to evaluate possible courses of action, taking into consideration your life situation, personal values, and current economic conditions. How will the ages of dependents affect your saving goals? How do you like to spend leisure time? How will changes in interest rates affect your financial situation?

CONSEQUENCES OF CHOICES   Every decision closes off alternatives. For example, a decision to invest in stock may mean you cannot take a vacation. A decision to go to school full time may mean you cannot work full time. Opportunity costWhat a person gives up by making a choice is what you give up by making a choice. This cost, commonly referred to as the trade-off of a decision, cannot always be measured in dollars. It may refer to the money you forgo by attending school rather than working, but it may also refer to the time you spend shopping around to compare brands for a major purchase. In either case, the resources you give up (money or time) have a value that is lost.

Decision making will be an ongoing part of your personal and financial situation. Thus, you will need to consider the lost opportunities that will result from your decisions. Since decisions vary based on each person’s situation and values, opportunity costs will differ for each person.

EVALUATING RISK   Uncertainty is a part of every decision. Selecting a college major and choosing a career field involve risk. What if you don’t like working in this field or cannot obtain employment in it? Other decisions involve a very low degree of risk, such as putting money in an insured savings account or purchasing items that cost only a few dollars. Your chances of losing something of great value are low in these situations. In many financial decisions, identifying and evaluating risk is difficult (see Exhibit 1-2). The best way to consider risk is to gather information based on your experience and the experiences of others and to use financial planning information sources.

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Exhibit 1-2   Types of risk

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FINANCIAL PLANNING INFORMATION SOURCES   When you travel, you often need a road map. Traveling the path of financial planning requires a different kind of map. Relevant information is required at each stage of the decision-making process. This book provides the foundation you need to make appropriate personal financial planning decisions. Changing personal, social, and economic conditions will require that you continually supplement and update your knowledge. Exhibit 1-3 offers an overview of the informational resources available when making personal financial decisions.

Exhibit 1-3   Financial planning information sources

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STEP 5: CREATE AND IMPLEMENT YOUR FINANCIAL ACTION PLAN

This step of the financial planning process involves developing an action plan that identifies ways to achieve your goals. For example, you can increase your savings by reducing your spending or by increasing your income through extra time on the job. If you are concerned about year-end tax payments, you may increase the amount withheld from each paycheck, file quarterly tax payments, or shelter current income in a tax-deferred retirement program. As you achieve your short-term or immediate goals, the goals next in priority will come into focus.

To implement your financial action plan, you may need assistance from others. For example, you may use the services of an insurance agent to purchase property insurance or the services of an investment broker to purchase stocks, bonds, or mutual funds.

Sheet 2
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STEP 6: REVIEW AND REVISE YOUR PLAN

Financial planning is a dynamic process that does not end when you take a particular action. You need to regularly assess your financial decisions. You should do a complete review of your finances at least once a year. Changing personal, social, and economic factors may require more frequent assessments.

When life events affect your financial needs, this financial planning process will provide a vehicle for adapting to those changes. Regularly reviewing this decision-making process will help you make priority adjustments that will bring your financial goals and activities in line with your current life situation.