The whole idea of making a personal financial plan my seem a bit daunting. Well it really isn’t. It’s like anything new, you approach it step by step. Start with making a simple One Year Budget with Income, Expense and Cash Flow. Also take a snapshot of your Net Worth including Assets and Liabilities. Here is how.
One Year Budget
You could start without getting a RealMoneyPlan template and just use some simple budget template, there are lots to be found. The thing is that no other non-trivial template or program is easier than RealMoneyPlan and you will just have to move it over later which means it will actually be more work. In fact some simple budget templates actually make things harder by expecting you to enter too much detail and keep it up relentlessly. From experience I know that is likely to be problematic, discouraging and likely you will give up with little value realized. So I highly recommend getting and starting with a RealMoneyPlan Template. That’s not a sales pitch, just good advice.
Use the RealMoneyPlan User Guide, it is very helpful. Initially it is not necessary to enter exact amounts, just ball park the numbers if you like and then later go back and refine them. Enter your income, for example if your income is employment income use a pay stub to estimate your gross and net income for each pay period and enter it for the year.
Enter your expenses. I do not recommend using a bottom up approach. That is, do not try to think of all the expenses you have and add them up. It is too much work and you will miss a lot of stuff and the number in the end will be wrong. This approach is how so many people fail in trying to create a budget. Instead work backwards by looking at last year’s income, subtract what you saved or transferred or used to purchase major assets or pay down debt. The remainder is what you actually spent on stuff, that is, your total expenses. Now take that total expense amount and start breaking it down by taking out the large expenses that you would like to identify individually such as rent, utilities, insurance, etc. Most people have records of these large expense items and there is only a few that actually matter. After taking out the large expenses what is left is just miscellaneous expense made up of many small items you really don’t want to have to keep track of. You can make your best guess at dividing up this pool of many small expenses into a few categories or items such as food, clothing, etc. and then spread that over the year. You can do this to whatever granularity you wish. There, that is how to handle expenses, it’s not very hard at all. Later, if you wish to analyze and optimize your spending habits you can refine it further. And the important thing is that the total expense amount is realistic and represents what you actually spent last year. Use this as a basis for this years expense, making adjustment for any major differences from last year to this year that you expect.
Now that you have the income and the expense figured out you are now ready to complete the cash flow part. What exactly is meant by cash flow. It can be described by a simple formula: Income less expense equals savings available to transfer to or from assets or liabilities. Fundamental to this formula is recognizing the difference between expenses and assets and liabilities. Expenses are things you buy after which they have no significant value such as rent, food and insurance. Assets are things you own such as a house, a car, bank accounts or investments. Liabilities are things you owe such as a car loan. To make it easy to understand think of expense purchases as your money spent and gone. Think of asset (or liability) purchases as your money transferred to or from something you own (or owe). With this in mind go ahead and complete the cash flow section.
You now have a simple one year budget with income, expense and cash flow.
Net Worth
The other really important thing to do is a Net Worth. To be quite frank, you need to know your Net Worth. Use the template and simply enter all your assets as of the start of the year as well as any liabilities as of the start of the year. For example, if you own a house with a mortgage, the house is an asset and the mortgage is a liability. Your Net Worth at the start of the year is simply your total assets less your liabilities. Your Net Worth is basically how much you own and hopefully it is a positive number, the bigger the better.
Now what you want to know is how much your Net Worth is going to change over the year. Look back at your cash flow and take any amounts that were transferred to or from assets and liabilities and enter them on the Net Worth page. If your end of year Net Worth has increased then you are “getting ahead”. It’s then up to you to decide if your balance between spending on expenses (living for today) versus growing your net worth (saving for the future) is reasonable. Now you have the numbers to think about that.