A financial plan is a roadmap that helps you achieve your financial goals and secure your future. It covers various aspects of your personal finances, such as budgeting, saving, investing, insurance, taxes, and estate planning. But where do you start when creating a financial plan? What is the first key component that you need to consider?
The answer is: your financial goals.
Your financial goals are the foundation of your financial plan. They define what you want to accomplish with your money and when you want to achieve it. Without clear and realistic goals, you will have no direction or motivation to manage your finances effectively.
In this article, we will explain why setting financial goals is the first key component of a successful financial plan. We will also show you how to set SMART financial goals and how to prioritize them according to your needs and preferences. Finally, we will provide some examples of common financial goals and how to measure your progress towards them.
Key Takeaways
- Setting financial goals is the first key component of a successful financial plan because it gives you a clear vision of what you want to achieve with your money and when you want to achieve it.
- SMART financial goals are specific, measurable, attainable, relevant, and time-bound. They help you create a realistic and actionable plan for your finances.
- You can prioritize your financial goals by categorizing them into short-term, medium-term, and long-term goals. You can also rank them by importance and urgency using the Eisenhower matrix.
- Some examples of common financial goals are paying off debt, building an emergency fund, saving for retirement, buying a home, starting a business, or traveling the world. You can measure your progress towards your goals by tracking your income, expenses, savings, investments, net worth, and debt-to-income ratio.
Why Setting Financial Goals is the First Key Component of a Successful Financial Plan
Setting financial goals is the first key component of a successful financial plan because it gives you a clear vision of what you want to achieve with your money and when you want to achieve it. Without financial goals, you will have no purpose or direction for your money management.
Financial goals help you:
- Align your spending and saving habits with your values and priorities
- Motivate yourself to take action and stay focused on your desired outcomes
- Track your progress and celebrate your achievements
- Adjust your plan as your circumstances and needs change
- Avoid unnecessary stress and anxiety about money
According to Schwab’s 2021 Modern Wealth Survey¹, those with a written financial plan are more likely than those without one to pay their bills on time (87% vs. 69%), save each month (82% vs. 68%), have an emergency fund (65% vs. 39%), have life insurance (62% vs. 39%), and feel financially stable (62% vs. 32%).
Therefore, setting financial goals is the first step towards creating a written financial plan that can help you improve your financial well-being and achieve your dreams.
How to Set SMART Financial Goals
To set effective financial goals, you need to make sure they are SMART. SMART stands for specific, measurable, attainable, relevant, and time-bound. These criteria help you create realistic and actionable goals that can guide your financial decisions.
Here is what each criterion means and how to apply it to your financial goals:
Specific
Your financial goals should be clear and detailed. You should state exactly what you want to accomplish, how much money you need, and why it matters to you.
For example, instead of saying “I want to save more money”, say “I want to save $10,000 for a down payment on a house in three years because I want to own my own home”.
Measurable
Your financial goals should be quantifiable and trackable. You should be able to measure your progress and success using numbers and indicators.
For example, instead of saying “I want to pay off my debt”, say “I want to pay off $20,000 of credit card debt in two years by making monthly payments of $833”.
Attainable
Your financial goals should be realistic and achievable. You should set goals that challenge you but also consider your current situation and resources.
For example, instead of saying “I want to retire at 40 with $10 million”, say “I want to retire at 60 with $1 million by saving 15% of my income every month and investing it in a diversified portfolio”.
Relevant
Your financial goals should be meaningful and important to you. You should set goals that align with your values, priorities, and aspirations.
For example, instead of saying “I want to buy a Ferrari”, say “I want to buy a reliable car that meets my needs and budget”.
Time-bound
Your financial goals should have a specific deadline or timeframe. You should set goals that create a sense of urgency and accountability.
For example, instead of saying “I want to travel the world”, say “I want to travel to Europe for two weeks next summer by saving $5,000 by June”.
How to Prioritize Your Financial Goals
Once you have set your SMART financial goals, you need to prioritize them according to your needs and preferences. Prioritizing your financial goals helps you allocate your resources and focus your efforts on the most important and urgent ones.
There are different ways to prioritize your financial goals, but here are two common methods that you can use:
Categorize Your Financial Goals by Time Horizon
One way to prioritize your financial goals is to categorize them by time horizon. Time horizon refers to how long it will take you to achieve your goals. You can divide your financial goals into three categories: short-term, medium-term, and long-term.
- Short-term financial goals are those that you want to achieve in the next year or less. Examples of short-term financial goals are paying off a small debt, building an emergency fund, or saving for a vacation.
- Medium-term financial goals are those that you want to achieve in the next one to five years. Examples of medium-term financial goals are saving for a down payment on a house, starting a business, or paying off a large debt.
- Long-term financial goals are those that you want to achieve in more than five years. Examples of long-term financial goals are saving for retirement, paying off a mortgage, or funding your children’s education.
You can use the following table to categorize your financial goals by time horizon:
| Time Horizon | Financial Goals |
|---|---|
| Short-term | – Pay off $2,000 of credit card debt in six months – Build a $5,000 emergency fund in one year – Save $3,000 for a vacation in nine months |
| Medium-term | – Save $10,000 for a down payment on a house in three years – Start a side hustle and earn $1,000 per month in two years – Pay off $20,000 of student loans in four years |
| Long-term | – Save $500,000 for retirement by age 65 – Pay off $200,000 of mortgage in 15 years – Save $100,000 for your children’s college education in 18 years |
Categorizing your financial goals by time horizon helps you plan your budget and cash flow accordingly. You can allocate a certain percentage of your income to each category and adjust it as your situation changes. For example, you can follow the 50/30/20 rule², which suggests that you spend 50% of your income on needs, 30% on wants, and 20% on savings. You can then split the 20% savings into 10% for short-term goals, 5% for medium-term goals, and 5% for long-term goals.
Rank Your Financial Goals by Importance and Urgency
Another way to prioritize your financial goals is to rank them by importance and urgency. Importance refers to how much value and impact a goal has on your life. Urgency refers to how soon a goal needs to be accomplished or how severe the consequences are if it is not.
You can use the Eisenhower matrix³, also known as the urgent-important matrix, to rank your financial goals by importance and urgency. The Eisenhower matrix is a tool that helps you decide what tasks to do first based on four quadrants:
- Quadrant 1: Important and urgent. These are the tasks that you need to do immediately and have high priority. Examples of important and urgent financial goals are paying off high-interest debt, building an emergency fund, or saving for an upcoming expense.
- Quadrant 2: Important but not urgent. These are the tasks that you need to plan and schedule and have medium priority. Examples of important but not urgent financial goals are saving for retirement, investing in your education or career, or buying life insurance.
- Quadrant 3: Not important but urgent. These are the tasks that you need to delegate or minimize and have low priority. Examples of not important but urgent financial goals are buying unnecessary items on sale, paying for subscriptions or memberships that you don’t use, or lending money to friends or family.
- Quadrant 4: Not important and not urgent. These are the tasks that you need to eliminate or avoid and have no priority. Examples of not important and not urgent financial goals are gambling, buying lottery tickets, or spending money on things that don’t align with your values.
You can use the following table to rank your financial goals by importance and urgency:
| Importance/Urgency | Financial Goals |
|---|---|
| Important and urgent | – Pay off $2,000 of credit card debt in six months – Build a $5,000 emergency fund in one year |
| Important but not urgent | – Save $10,000 for a down payment on a house in |