Our Multi-Step Financial Planning Process

1. Devise a Budget

A budget is essential to living within your means and saving enough to meet your long-term goals. The 50/30/20 budgeting method offers a great framework. It breaks down like this:

• 50% of your take-home pay or net income (after taxes, that is) goes toward living essentials, such as rent, utilities, groceries, and transport
• 30% is allocated to lifestyle expenses, such as dining out and shopping for clothes.
• 20% goes towards the future: paying down debt and saving both for retirement and for emergencies

2. Create an Emergency Fund

It’s important to “pay yourself first” to ensure money is set aside for unexpected expenses such as medical bills, a big car repair, rent if you get laid off, and more.

Between three and six months' worth of living expenses is the ideal safety net. Financial experts generally recommend putting away 20% of each paycheck every month (which of course, you’ve already budgeted for!). Once you’ve filled up your “rainy day” fund (for emergencies or sudden unemployment), don’t stop. Continue funneling the monthly 20% towards other financial goals such as a retirement fund.

3. Limit Debt

It sounds simple enough: To keep debt from getting out of hand, don’t spend more than you earn. Of course, most people do have to borrow from time to time—and sometimes going into debt can be advantageous, if it leads to acquiring an asset. Taking out a mortgage to buy a house is one good example. But leasing can sometimes be more economical than buying outright, whether you’re renting a property, leasing a car, or even getting a subscription to computer software.

4. Use Credit Cards Wisely

Credit cards can be major debt traps. But it's unrealistic not to own any in the contemporary world, and they have applications other than as a tool to buy things. Not only are they crucial to establishing your credit rating, but they’re also a great way to track spending, which can be a big budgeting aid.

Credit just needs to be managed correctly, which means the balance should ideally be paid off every month, or at least be kept at a credit utilization rate minimum (that is, keep your account balances below 30% of your total available credit). Given the extraordinary rewards incentives on offer these days (such as cash back), it makes sense to charge as many purchases as possible. Still, avoid maxing out credit cards at all costs, and always pay bills on time. One of the fastest ways to ruin your credit score is to constantly pay bills late—or even worse, miss payments. (See Tip No. 5.)

5. Monitor Your Credit Score

Credit cards are the main vehicle through which your credit score is built and maintained, so watching credit spending goes hand in hand with monitoring your credit score. If you ever want to obtain a lease, mortgage, or any other type of financing, you’ll need a solid credit history behind you. Factors that determine your score include how long you've had credit, your payment history, and your credit-to-debt ratio.

Credit scores are calculated between 300 and 850. Here's one rough way to look at it:

• 720 = good credit
• 650 = average credit
• 600 or less = poor credit

To pay bills, set up direct debiting where possible (so you never miss a payment) and subscribe to reporting agencies that provide regular credit score updates. By monitoring your report, you will be able to detect and address mistakes or fraudulent activity. Federal law allows you to obtain free credit reports from the three major credit bureaus: Equifax, Experian, and TransUnion. Reports can be obtained directly from each agency, or you can sign up at AnnualCreditReport, a site sponsored by the Big Three; you can also get a free credit score from sites such as Credit Karma, Credit Sesame, or Wallet Hub. Some credit card providers, such as Capital One, will provide customers with complimentary, regular credit score updates, too.

6. Consider Your Family

To protect the assets in your estate and ensure that your wishes are followed when you die, be sure you make a will and—depending on your needs—possibly set up one or more trusts. You also need to look into insurance: auto, home, life, disability and long term care insurance. And be sure to periodically review your policy to make sure it meets your family's needs through life's major milestones.

Other critical documents include a living will and healthcare power of attorney. While not all these documents directly affect you, all of them can save your next-of-kin considerable time and expense when you fall ill or become otherwise incapacitated.

And while they're young, take the time to teach your children about the value of money and how to save, invest, and spend wisely.

7. Pay Off Student Loans

There are myriad of loan-repayment plans and payment reduction strategies available to graduates. If you’re stuck with a high-interest rate, paying off the principal faster can make sense. On the other hand, minimizing repayments (to interest only, for instance), can free up other income to invest elsewhere or to put into retirement savings while you're young and will get the maximum benefit from compound interest (see Tip No. 8, below). Some federal and private loans are even eligible for a rate reduction if the borrower enrolls in auto pay. Flexible federal repayment programs worth checking out include:

• Graduated repayment—progressively increases the monthly payment over 10 years
• Extended repayment—stretches the loan out over a period that can be as long as 25 years

8. Plan (and Save) for Retirement

Retirement may seem like a lifetime away, but it arrives much sooner than you’d expect. Experts suggest that most people will need about 80% of their current salary in retirement. The younger you start, the more you benefit from what advisors like to call the magic of compounding interest—how small amounts grow over time. Setting aside money now for your retirement not only allows it to grow over the long term, but it can also reduce your current income taxes if funds are placed in a tax-advantaged plan fund like an Individual Retirement Account (IRA), a 401(k) or a 403(b). If your employer offers a 401(k) or 403(b) plan, start paying into it right away, especially if they match your contribution. By not doing so, you're giving up free money! Take time to learn the difference between a Roth 401(k) and a traditional 401(k), if your company offers both.

Investing is only one part of planning for retirement. Other strategies include waiting as long as possible before opting to receive Social Security benefits (which is smart for most people), and converting a term life insurance policy to a permanent life one.

9. Maximize Tax Breaks

Due to an overly complex tax code, many individuals leave hundreds or even thousands of dollars sitting on the table every year. By maximizing your tax savings, you'll free up money that can be invested in the reduction of past debts, your enjoyment of the present and your plans for the future.

You need to start each year saving receipts and tracking expenditures for all possible tax deductions and tax credits. Many business supply stores sell helpful "tax organizers" that have the main categories already pre-labeled. After you're organized, you'll then want to focus on taking advantage of every tax deduction and credit available, as well as for deciding between the two when necessary. In short, a tax deduction reduces the amount of income you are taxed on, whereas a tax credit actually reduces the amount of tax you owe. This means that a $1,000 tax credit will save you much more than a $1,000 deduction.