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Six Financial Planning Principles

Life is full of changes: some good and some bad and some planned and some unexpected. Developing a long-term financial plan to accommodate life's changes is essential to realizing your personal/family goals. A recent T. Rowe Price Investor article outlined the following six principles of long-term investing to help create realistic and effective financial plans:

1. Prioritize your financial goals. You will always have competing demands for your money (new car, vacation, home, funding a child's education, investing for retirement, etc.). The development of a financial plan should start with setting goals and priorities and recognizing the tradeoffs of each. For example, realizing that the attainment of long-term objectives will likely require deferring some short-term desires. After all, if you're saving money for the future, you can't be spending it today. Be sure to revisit your list of goals and priorities periodically. You will also want to periodically reposition your investments to match your changing personal circumstances (i.e., marriage, birth of child, graduation from college, job promotion, etc.).


2. Be disciplined with your investing and spending patterns. Create a plan that will ensure that you contribute as regularly as possible to various investment accounts (401(k), 403(b), Roth IRA, etc.). Even if you're not in a position to contribute large amounts, some "no load" mutual fund companies like T. Rowe Price (www.troweprice.com) and TIAA-CREF (www.tiaa-cref.org) will allow you to forego a large initial investment (often $1,000 to $2,500) to start a Roth IRA. In order to do so, you establish an automatic investment plan that debits your bank account periodically to purchase fund shares for plan deposits. Automatic investment plans are a great way to establish financial discipline and to dollar-cost average (invest regular sums of money at regular time intervals). Money for savings deposits can generally be found in most budgets just by reducing some discretionary expenses (e.g., food, clothing, and entertainment).


3. Allocate your assets appropriately. There is no "perfect" investment that can both keep your principal safe and provide growth. Stocks have strong growth potential but have the greatest volatility (i.e., changes in value) and investment risk. Bonds are more stable, but returns are typically modest, and bonds will lose value when interest rates rise. Cash equivalents, such as money market mutual funds and CDs, may barely keep pace with inflation. To achieve an appropriate balance of growth and stability, have a mix of different types of investments.


4. Benefit from tax-advantaged accounts and investments. Participate in your employer's 401(k) or other retirement plan and take full advantage of any employer matches. For 2004, you can invest up to $13,000 ($16,000 for those aged 50 and older, including a $3,000 catch-up contribution) in tax-deferred employer plans. A pre-tax contribution, combined with tax-deferred growth, make employer plans a great way to save for retirement. The Roth IRA is another tremendous way to save for retirement. You pay taxes up front on the amount contributed but all the growth on accounts open at least five years is tax free at withdrawal after age 59½.


5. Protect yourself from the unexpected. Be certain to have adequate insurance. Safeguarding your finances from the unexpected, such as illnesses, auto accidents, natural disasters, death, etc., is essential. Review your coverage from time to time. Insurance isn't the easiest thing in the world to fully understand, so be sure to consult a professional financial advisor when needed.


6. Review your strategy. As time passes, your circumstances and goals will change. Your financial plans should evolve along with you. A change in income or marital status may even call for an entirely new set of goals. To manage life's inevitable changes, conduct an annual review of goals, priorities, and progress to date and calculate your net worth (assets minus debts) and household cash flow (income minus expenses).