Budget vs Financial Plan

Financial freedom is something many Americans thrive for daily. Often people believe that the pathway to obtaining financial freedom is best achieved by earning high wages to support active, debt-free lifestyles. The sad reality is that many of these higher earners struggle financially due to their true lack of knowledge when it comes to money. Misunderstanding the overall concept of money will usually lead to financial challenges and problems, and will surely make it tough to acquire money, let alone keep it.

So why do so many people struggle when it comes to the managing of their finances? One reason may be a lack of financial knowledge combined with a lack of understanding about how to use financial tools effectively. Unfortunately, the basic concepts of money, finance, budgets, and financial plans are rarely taught at any level of education. For example, let’s take a look at college graduates. After years of higher-level education, and in some cases thousands of dollars in student loan debt, new grads are seldom fully prepared for the real world as they struggle to get jobs, produce an income, or have a practical understanding on how money and finances really work. Do you know the difference between income and cash flow? Good debt or bad debt? Assets vs. liabilities? Don’t worry, most people are challenged with these questions as well.

There are two tools available to investors that want to take control and plan for their financial future. The first tool—considered by us to be the most important— is a budgeting tool that quickly allows you to practice debt management. The second tool is a financial plan or savings goal planner.  Budgeting and debt management are crucial because if an individual can set and follow a reasonable spending plan, then they are more likely to be able to save. Setting a budget and following through is an easy process that takes a little work and lots of discipline. It involves setting spending goals, debt management goals, and savings goals. Many of these tools are easily available to the public in the form of a Microsoft Excel spreadsheet, Mint.com, or FC360 Advisors’ budgeting tool.

Of course, the financial planning process is also important; it allows investors to create a visual road map of what goals and dreams they wish to attain. Financial planning can alert an investor to changes that must be made to ensure a smooth transition through life’s financial phases, such as accumulating wealth while working, distributing wealth while retired, and transferring wealth after life. It is important to update your plan and be flexible when financial changes occur.

So how do a budget and a financial plan differ? Both include many of the same financial pieces, but a budget looks at historical and projected spending assumptions and financial plans look to variables to predict future cash flows, asset values, and withdrawal plans. Let’s dive a little deeper to better understand what the true purpose of each tool is.

Budgets are set by income and expenses. The goal of creating a budget is to manage the household money so expenses do not exceed the incoming earnings. With most households, the number one financial goal is to create solvency. Why is solvency important? Well, would you rather spend your life buried in bills or would you rather fund your dreams and goals? In fact, most businesses, marriages, and dreams fail when there is a lack of solvency. Therefore, a budget is a good tool to help you realize how much money you truly need to survive and what areas you can cut back on, all so that you create surpluses. So now that you have a surplus, what do you do now?

Well this is exactly when a financial plan comes into play. Essentially, your financial plan is your financial road map to your goals and dreams. It helps identify where you are going and what bumps you might hit along the way. A good financial plan will also help you identify good monetary goals, the outcomes of accomplishing these goals, and which activities and what amount of motivation is necessary to get there. Most importantly, your financial plan is a guide to keeping you on the right track to reaching your financial goals.

When I pose the following question to our clients: “How much do you really need to save so you can live your life the way you want?” most of them just stare at me with puzzled expressions. They cannot answer the question. This is where a financial plan truly differs from a budget. Whether you have dreams to own a vacation home in Maui, pay your grandkids’ college tuition, take a dream vacation each year, or just get by, your financial plan is going to detail the actions necessary to accomplish your goals.

So in just scratching the surface one can see how different a budget is compared to a financial plan and see how each plays an important role. Your budget is your foundation and the tool that is going to help you manage the storm. Your financial plan is your guide showing you what twists and turns to take to arrive at your end goals.

Seeing the need to help our clients better manage their money, FC360 has developed a budgeting tool for our clients which helps manage cash flow based on income and expenses. Our tool allows our clients to monitor progress on a monthly basis while helping them indentify opportunities for improvement. We offer this tool free of charge to our clients as a benefit to help them get one-step closer to achieving their financial goals and dreams. FC360 is also currently working to develop a financial planning solution for our clients in the near future.