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 and map out what they hope to achieve financially over the next 12 months. Even if you feel fairly confident about how 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.

What Is an Annual Financial Plan?

An annual financial plan is a guidebook of sorts that tells you where you are right now financially, 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 that you need to be thinking about.

Life Events

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. A 20-something who has 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 are 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.

Retirement and Investing

Saving for retirement should be a top priority at any age, but unfortunately, it gets pushed to the back burner far too often. A 2020 Federal Reserve survey found that 25% of Americans have nothing saved toward their retirement, while less than 40% consider their retirement savings to be on track. Of course, those statistics also show that three-fourths 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 individual retirement account (IRA) or 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 of your investments are doing. This obviously includes both retirement accounts and other investment accounts that you may have.

Asset allocation and fees

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 2014 study from the Center for American Progress estimated 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. A 2019 study by the U.S. Department of Labor estimated that fees and expenses would reduce the total amount in a 401(k) by 28% over the course of 35 years. These studies make clear the critical importance of being mindful of what you’re paying for your investments.

It may be time to unload expensive mutual funds and substitute something that lets you keep more of your money. In addition, consider whether you need to rebalance your portfolio if your asset allocation has drifted off course. 

Taxes

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 the end of the year.

Additional income streams

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, look for ways now to maximize your income later.

Saving for Emergencies

While saving for retirement is a big part of financial planning, you can’t overlook your other savings goals. According to the 2020 Federal Reserve study mentioned above, 37% of Americans would struggle to come up with the cash to handle a $400 emergency.

If you don’t yet have an emergency savings buffer—or if yours isn’t as big as you would like it to be—then starting one or beefing it up should be added to your financial to-do list moving forward.

Financial Planning Tools

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.

There are plenty of budgeting apps out there, both free ones and those that come at a cost. In other words, you have lots of choices for finding the financial planning resources that are going to work best for you. 

Next Year’s Savings Goals

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 put that money.

Starting with the total amount that 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 currently to help you come up with more cash for your future.

The Bottom Line

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. You'll want to review all of the items that a financial advisor would look at during your annual review. Once your plan is completed, you can begin taking specific steps to ensure that your financial house is in order and running smoothly.