A question we've heard countless times is "What are the most common mistakes people make when managing their finances?" One of our leading answers: making spending and investment decisions apart from a personalized financial plan. No matter how good your particular investing choices may be, if they're made outside the framework of a larger plan, you're inviting trouble.

Read on to discover the "best practices" you'll want to follow at each phase of life as you construct a solid financial plan of your own.

Imagine you're preparing to build your dream home. Over the years, you've accumulated scores of ideas that you'd like to incorporate into it. Before construction begins, you sit down with your builder to review your design goals. You ask him how long before the blueprints will be ready, but to your surprise, he tells you he doesn't work that way. Rather than planning everything ahead of time, he prefers to develop the design as he goes along. He'll keep your ideas in mind, but "blueprints are so restricting," he says — he wants to have the freedom to be spontaneously creative as the house is being built.

Most of us would be reluctant to hire a builder like that! When building a house, we recognize it's a good thing to have a carefully considered blueprint for action before taking on a challenging task. In fact, the more important the project (e.g., having open-heart surgery), the more emphasis we place on careful planning.

Unfortunately, too many people use the "we'll work out the details as we go along" approach when it comes to one of the most important projects they'll ever take on — building a secure financial future. Yet, in much the same way that we live in a physical home, we each "live" in a financial home as well, one that has been created by our past decisions. Just as our dream house could end up poorly designed due to a lack of planning, many people reach retirement and find their financial home isn't what they hoped for. That disappointing outcome results from a lifetime of making financial decisions independent of a master blueprint.

The good news is this doesn't have to happen to you. Get 2014 off to a good start by setting aside time this month to create a personalized financial plan aimed at building the kind of future financial home you'll enjoy living in.

In a moment, we'll look at typical planning situations for people at three stages of life. Before we do, let's examine two basics common to every financial plan. The first is the necessity of developing a clearly defined set of God-given goals. Clearly defined goals establish your financial priorities.

In his book, Storm Shelter, Ron Blue lists the following five steps for setting good goals: List your goals, consolidate and refine them, prioritize them, make them measurable, and keep them visible. The monthly surplus established by your budget (which I'll get to in a moment) is the wind in your sails, but your goals are the compass you navigate with. Set good goals and keep them in front of you — you'll be surprised at how much more productive and focused you'll feel as you start living with a clearer purpose.

The second common denominator of all good financial blueprints is a spending plan (i.e., a budget). You may not like it, but it's an essential tool for everyone who hasn't yet received a seven-figure inheritance! Without a spending plan, you can't intelligently implement saving and investing strategies because you don't know if you have any extra money to save or invest. Even if you seem to have extra money left over each month, without a budget you won't know if that money should be saved for those once-a-year items (such as insurance premiums and summer vacations) or if it truly represents a surplus. Also, it's unlikely you'll be in a position to give generously to God's work if you don't plan for it.

As you work through your goal-setting and spending plan, remember that this is a spiritual endeavor, not merely a mental one. Your financial goals and budget will reflect how you view and use money. Since, as Christians, we recognize that we are managers rather than owners, it's vital that you allow God to speak to you regarding your plans for His money. Married couples should make these planning decisions together, not just because it ensures "buy-in" from both parties, but because it establishes you as a team rather than opponents. We're told that one-half of new marriages end in divorce, and 80% of those divorces are due, in part, to money problems. Jointly establishing a financial plan may have farther reaching implications than you think.

While there are no "one-size-fits-all" financial plans, certain experiences are common to particular phases of life. As you read the following scenarios, don't get discouraged if you feel "behind." The point is not to provide benchmarks for how far along you should be, but rather to provide guardrails to keep you on track and to help you think through issues common to each phase. Your situation probably will differ somewhat from what's here, so make sure to personalize these to your individual circumstances.

The young person/couple

For many young people these days, youth translates financially into "easy credit and lots of debt." For many, the first decade (at least) out of school is spent paying off school loans, car loans, and credit-card bills. Outfitting an apartment or first home can really pack on the debt, especially if you aren't following a spending plan in those early years. Throw in trying to save for a wedding, the down payment on a first home, building a savings reserve, and paying for the arrival and growing up of your little bundle(s) of joy. And just about the time your education is paid off, it's time to start saving for college for the kids.

Sound bleak? It doesn't have to be. Unfortunately, many young couples waste the most productive financial years they'll have for a while: those early marriage years when both spouses may be working and there are no kids in the picture yet. This is a golden opportunity to make serious headway financially, but all too often it isn't seized due to lack of planning (and because there's so much fun stuff to buy!). The sense of urgency that arrives with those two exciting words — "I'm pregnant" — often comes too late. Here's what's needed before that happens:

  1. Make a budget, relying on your current spending to establish realistic initial estimates in each category. Establish your short- and medium-term financial goals. Then look at your budget again. Does your available surplus put you in position to realize your goals? If not, it's not unusual to go through several rounds of belt-tightening before finally settling on a workable budget. Consider these to be normal growing pains — chances are, it's your first experience setting and living on a real budget.
     
  2. Attack your debt, while avoiding further debt. This is tougher than it sounds, since most young people have yet to establish a savings reserve from which to absorb unexpected expenses. Couples considering having children are wise to attempt budgeting all living expenses from one income, while applying the other entirely to debt reduction and saving. Sure that may reduce the money you have for "fun stuff" now, but you'll appreciate the flexibility later when your expenses soar and income (potentially) drops in half.

    List all of your debts, including balances and interest rates. There are two debt-payment strategies to choose between. If you are highly disciplined, you will save the most money in interest by paying off your highest rate debts first. A more motivating strategy for many is the "debt snowball" approach, in which you pay off the debt with the lowest balance first, then the next lowest, and so forth. Don't underestimate the value of this psychologically; if seeing your debts fall one after another keeps you motivated, it's worth paying a little extra interest.

    Our Accelerated Debt Payoff Calculator shows how much faster your debt will be eliminated based on various additional payment amounts — a powerful motivator.

  3. Start building your emergency fund by opening a money-market account at an online bank and having money automatically deposited into it each month. For most people, we suggest establishing at least a small fund — $1,000 is a good target for most people — before focusing hard on debt reduction. Having a savings reserve will help keep you from slipping back to your credit cards when unexpected expenses arise. Once your debts are largely eliminated, you can turn your attention toward building a larger emergency savings fund. Most financial planners recommend a fund of three-to-six months' worth of living expenses. That may seem like a lot, but you'll have plenty of use for it if an unexpected repair, purchase, or job loss arises.
     
  4. Take advantage of "free money" at work by contributing to your retirement plan up to the amount your company matches. This is slightly controversial if you are in a deep debt hole, in which case you should skip this step for now. But if your debt is manageable, meaning you have a clear plan to pay it off reasonably soon, take advantage of employer matching in your 401(k) or other retirement plan if it's available. Contributions beyond the amount being matched take a lower priority.
     
  5. Fund a Roth IRA. A Roth IRA, funded in your 20s or 30s, is an incredible deal. You'll earn 30+ years of compound growth, then get to take that money out tax-free! Roths can also double as (imperfect) college-savings accounts, as well as last-resort emergency-savings vehicles. Because they are so potent yet flexible, you should make a serious effort to start funneling money into one as soon as you get your debt under control and emergency savings up to a reasonable level. (Consider purchasing The Sound Mind Investing Handbook for more information about Roth IRA's and many other topics covered in this article.)
     
  6. Choose your investing strategy. Whether you're investing at work or in a Roth IRA, you need a clearly defined strategy. SMI offers three strategies suitable for the bulk of one's portfolio: Just-the-Basics, Upgrading, and the relatively new Dynamic Asset Allocation. All three are founded on core principles that should be a part of any investing plan, and any can be adapted to your situation. You can read more about these strategies, as well as how to match them to your investment temperament here on our website. Once you get your long-term strategy (or combination of strategies) up and running, continue to follow through no matter what the markets may be doing. In other words, don't let current events (and the emotions surrounding them) keep you from making your monthly contributions.
     
  7. Be conservative when buying/upgrading homes. This is likely to be the single biggest expense a young person or couple faces, and is a driver of many other expenses. The home and neighborhood you choose will have far reaching financial implications, both direct (insurance, taxes, furnishings) and indirect (school decisions, vehicle purchases, vacation plans). An affordable home is one that consumes no more than 25% of monthly gross income in mortgage/tax/insurance payments. Control the housing decision and you'll likely be able to find money to save for the future. Failure to control this decision will likely result in it controlling you.
     
  8. Start saving for college. If you already have a child, the clock is ticking on his or her education saving. There is definitely a right way and a wrong way to do this, so educate yourself. It's easier than it seems. If you aren't already fully funding a Roth IRA for both yourself and your spouse, do so as the first step of your college saving. If you're fortunate enough to be saving beyond the Roth IRA maximums, use Coverdell Education Savings Accounts and/or Section 529 Plans.

    Avoid old tools you may have heard about: EE bonds, custodial accounts, and so on. And don't buy into the idea that you need to save a gazillion dollars for college either. There will likely be part-time jobs available and (to be avoided if possible) student loans to make sure Junior can still go to college. Don't be paralyzed by the huge numbers you read about; just start saving as much as you can, as early as you can.

The middle-aged couple

Traditionally, the kids leaving the nest has been the turning point for many couples financially. With those expenses reduced, the wind-sprint toward retirement would start and saving for that rapidly approaching reality would take over. Now, with many couples marrying later than in the past, things aren't as cut and dried.

Still, while the age at which this happens may be more fluid, most couples will transition at some point in the middle-age range from their peak spending years to peak saving years. Child-related expenses decline (at some point), which often coincides with the highest earning years for most workers. In rare cases, the mortgage may be close to paid off. Details may vary, but there's probably more surplus money available now than ever before, and it's a good thing. The day-to-day expenses of child-rearing can leave you feeling a little behind regarding your retirement plan. Middle-age is catch-up time on that task. Your priority list includes:

  1. Revise your budget to reflect your new level of income and expenses. This budget revision should be an annual event anyway, but I'll include it in case you haven't adjusted your budget in a while. Take a new look at your short- and medium-term goals as well. It's getting down to crunch time, so if you're serious about meeting those goals, you don't have as much of a time cushion as you once did. Use that as motivation rather than letting it discourage you.
     
  2. Take a financial inventory of your household. What debt do you have outstanding? What needs are coming up — additional school payments, cars that need replacing, home repairs you've put off? At this stage of life, debt should be pared back to bare minimums. If you haven't already done so, pay off those credit-card balances, car loans, and other consumer debts. You likely have the cash flow now, so you can eliminate or reduce interest expense on big-ticket items (such as car purchases) through advance planning and saving. If it's not there yet, build your emergency saving-account balance up to where it should be. Consider additional mortgage payments in order to have it paid off by the time your anticipated retirement date arrives.
     
  3. Get realistic estimates of how much money you'll need to retire. A retirement-planning calculator can help you with this task. Having specific figures in mind will help motivate you if you need to start saving more, or potentially keep you off the austerity budget if you're doing better than you realize.
     
  4. Review your investing strategy. For many people, this will be happening regularly already as a result of managing retirement plan money at work or in IRAs they've established. But how you divide your money between stocks and bonds (which affects your risk level) changes as you move closer to retirement, so it's important to make sure your allocations are still appropriate. (See point #6 for young couples for more on this.)
     
  5. Maximize your retirement plan at work. Your 401(k) or other retirement plan at work probably represents your best opportunity to quickly save large amounts for retirement. The tax advantages of such accounts, which typically include pre-tax contributions (some 401k plans now include the option of Roth treatment as well) coupled with employer matching or other contributions, make it tough to beat. This isn't true in every case though, so investigate the details of your plan as well as the investment options offered within it. The maximum 401(k) contribution in 2014 is unchanged from 2013: $17,500 and an additional $5,500 if you're at least 50 years old.
     
  6. Take advantage of IRA opportunities. If you're married and your gross income is over $115,000, you probably won't gain an immediate tax benefit from contributing to a deductible IRA. But that doesn't mean it's not worth contributing. Or you may qualify for a Roth IRA, which can provide years of valuable tax-free growth. Remember, your time horizon isn't just until you retire, it's through your retirement, which these days often extends another 20-30 years. So if you've maxed out your retirement plans at work, definitely consider an IRA. For 2014, the maximum investment amount is $5,500, and if you're at least 50 years old you can add an additional $1,000 per year.
     
  7. Consider obtaining long-term care insurance. This can be an involved decision, so do your homework (our article Long-Term Care Insurance: To Buy or Not to Buy is a great place to start). But age 60 is considered by many to be the sweet-spot for obtaining this type of coverage.

The retirement couple

The big day has finally arrived! Freedom! But with the freedom from your job comes the unsettling loss of that familiar friend: a regular paycheck. That loss of steady income makes many retirees feel they're at the mercy of the financial markets to a much greater extent than they prefer. Don't panic, you can have peace of mind despite this adjustment. But it's definitely time to make sure your personal financial plan reflects these major changes. Here are some key points:

  1. Re-create your budget to reflect the realities of your retirement income. This doesn't just mean the changing amounts; it means the change in the timing of these payments as well. Match your living expenses to the amount and timing of your income, obviously remembering to include things such as Social Security income, pension benefits you receive, and so on.
     
  2. Maximize your Social Security benefits. This is one of the bigger decisions you have at the onset of retirement, as the timing of when you (and your spouse if applicable) begin drawing benefits will lock in a significant component of retirement income for the rest of your life. Our May 2013 article, Maximizing Your Social Security Benefits, offers a primer on this extremely important decision.
     
  3. Decide whether to take your company retirement plan money in a lump sum or an annuity. This is an extremely important decision and should be made with great care (and perhaps with outside counsel).
     
  4. Determine your strategy for withdrawing money from your retirement plans. This is a major decision, one you should make with a firm grasp of your income needs (from your newly revised budget).

    Let's review a few options. Taking a fixed amount out at regular intervals is simple enough, but it exposes you to market declines and increases your risk of outliving your money more than other methods. A slight variation involves taking out a fixed percentage at regular intervals. This improves your odds of not outliving your money, as you take less out if your account balance declines. As long as you are still able to meet your expenses, this can work well.

    Another option that greatly insulates you from market fluctuations is to set aside three-to-five years of living expenses in a savings account, and pay all current expenses from that account rather than directly from your market-based investments. History shows that the stock market has made money a majority of the time when looking at five-year periods. This is a good way to extend your time horizon, allowing you to be slightly more aggressive in your asset allocation, by insuring that you won't be taking money out of your plan disproportionately during down markets.
     
  5. Consider the implications of which accounts you withdraw from when. Traditional IRAs, including IRAs you may have rolled over from your company retirement plan, have mandatory distribution rules that require you to start withdrawing from these accounts at age 70 1/2. Roth IRAs, by contrast, have no mandatory distribution rules, and in fact, get favorable tax treatment should you die and leave them to your heirs. While this order-of-withdrawal decision requires individualized number crunching and thought, taking money out of your traditional IRAs rather than your Roth IRAs early in retirement generally will leave you with more flexibility in later years than vice versa (due to the smaller mandatory distributions you'll incur).

    An even more aggressive way to leverage this difference in the IRA rules is to consider delaying the start of your Social Security benefits initially when you retire. You'll have an extremely low taxable income as a result, which you can use to your advantage by converting chunks of your Traditional IRA into a Roth at rock-bottom tax rates. Having more Roth and less Traditional IRA assets will increase the flexibility of your future withdrawals, perhaps lower the overall tax rate paid on those IRA assets, and boost the amount of your monthly Social Security payments once they do begin. This sort of maneuver is complex enough that it's likely wise to enlist the help of a good CPA to evaluate its effectiveness in your specific situation.

  6. Reconsider your asset allocation and risk threshold. Retirement is a time to reduce risk, taking only as much as is necessary to meet your financial needs. Even if you've been an "all stocks, all the time" investor throughout your life, it's foolish to take that added risk if you can live comfortably on the income provided from less-aggressive investments. So look closely at what your specific income needs are, and reduce your risk (by lowering your stock allocation) if you're able.

    Our relatively new Dynamic Asset Allocation strategy is likely to be a useful tool for the stock allocation of those at this stage. Its emphasis on "winning by not losing" is a good philosophical match for most retirees. In the past, this approach would have provided significantly more downside protection than either Upgrading or Just-the-Basics, while still producing long-term returns that were just as strong.

Conclusion

I've merely touched on some of the most important aspects of creating your personal financial plan: identifying your season of life and risk temperament, determining your ideal asset allocation, applying our model portfolios, and so on. But much of this information is explained in greater detail in material available to SMI web members. If you need any of the materials mentioned in this article, please visit the SMI website or call us toll-free at 877-736-3764. The website offers more information on these and a whole host of other specific topics. It's our desire to provide you with any resource we can to aid you in the pursuit of your goals.

While the action steps listed above aren't comprehensive, they do highlight key items to address in your personal financial plan at each stage of life. Ultimately, your financial priorities and plan of attack can be decided by only one person: you. But having a step-by-step plan can help you stay on track when the inevitable financial temptations grab your eye. Your goals are worth sacrificing to achieve, and taking time to establish a comprehensive plan is the first step. This year, replace your good intentions with action by creating — and faithfully following — a personal financial plan. You'll be glad you did when it comes time to move into the financial home you've built for yourself.