Financial planning
Financial planning is a crucial aspect of securing your future and achieving your financial goals. It involves managing your money, making informed decisions, and creating a strategic plan to effectively use your financial resources. In this article, we will explore the concept of financial planning, its importance, and provide you with practical steps to create a robust financial plan.
Definition
Financial planning is a process, not a product. It is the long-term method of wisely managing your finances so you can achieve your goals and dreams, while at the same time negotiating the financial barriers that inevitably arise in every stage of life. In order to create a sound financial plan, goals must first be established. Data is then gathered to analyze and evaluate your financial status. Once complete, your plan can be developed and implemented. Monitoring the plan on an ongoing basis is essential in order to make necessary adjustments to reach your goals.
Financial planning involves looking at a client's entire financial picture and advising them on how to achieve their short- and long-term financial goals. From saving for education and planning for retirement to effectively managing taxes and insurance, financial planners develop valuable relationships with their clients to provide them with confidence today and a more secure tomorrow.
The financial planning process includes multiple tasks, including:
- Confirming the vision and objectives of the business
- Assessing the business environment and company priorities
- Identifying which resources the business needs to achieve its objectives
- Assigning costs business costs centers included in the plan
- Quantifying the amount of equipment, labor, materials, and other resources needed
- Creating and setting a budget
- Identifying any issues and risks with the budget
- Establishing the time period of the plan or planning horizon, either short-term (typically 12 months) or long-term (2 to 5 years)
- Preparing a full financial plan summarizing all key investments, budgets and departmental costs
Generally, the financial partner role includes three areas:
- Strategic financial management;
- Determining financial management objectives; and
- Managing the planning cycle itself.
- Connecting business partners and teams to financial plan
Benefits of using financial planner
How do you know if you could benefit from the services of a financial planner? You may not have the expertise, the time or the desire to actively plan and manage certain financial aspects of your life. You may want help getting started. Some reasons for seeking professional financial planning guidance might include:
- Making sure your money will last during retirement or rolling over a retirement plan
- Handling the inheritance of a large sum of money or other unexpected financial windfall
- Preparing for a marriage or divorce
- Planning for the birth or adoption of a child
- Facing a financial crisis such as a serious illness, layoff or natural disaster
- Caring for aging parents or a disabled child
- Coping financially with the death of a spouse or close family member
- Funding education
- Buying, selling or passing on a family business
Procrastination is the greatest enemy of financial independence, and using a financial planner will keep you on track.
Financial Planning Types
Financial planning is done to achieve your future goals, including investment, tax saving, retirement, education, etc. The basis on these, some of the common types of financial planning are:
- Investment Planning: Under investment planning, strategies are made for future investments. You can plan for the type of investment and the proportion of investment you want. You can allocate your funds to various investment vehicles such as mutual funds, NPS, ELSS, etc.
- Tax Planning: Financial planning also helps in solving your tax issues. Under tax planning, financial strategies are made to decrease tax liability. For maximum tax savings, you can plan to invest in fixed deposits, NPS, PPF, ELSS, etc.
- Retirement Planning: Under retirement planning, strategies are made to ensure you retire rich. At the time of retirement, you need a huge corpus to fund your lifestyle for 20-30 years, and retirement planning helps achieve it. It will help you estimate the amount you would need to retire and how much you should invest in making it possible.
- Budgeting: Under budgeting, your income and expenses are analyzed, and on the basis of that, financial plans are made. It is focused on minimizing costs and debts and increasing your disposable income.
- Insurance Planning: Insurance provides financial assistance in times of emergency. Insurance planning helps you identify the type of insurance you require and how much your insurance should cover.
Education funding planning: Financial Planning for education has become increasingly important as the expense of higher education in India has skyrocketed over the years. Financial Planning in advance for education expenses ensures that you don’t compromise on your goals.
Whether it’s for a child’s college education or your own academic aspirations, education funding planning helps you to accumulate funds for future education.
Estate planning: Estate planning is basically a financial plan that helps you pass on your assets smoothly to your loved ones after your death. It helps to avoid family feuds and disagreements about who gets what.
Making a will is an important part of estate planning, as it helps in avoiding family feuds regarding the property or assets. It gives the roadmap regarding the distribution of assets among the family members after your death.
Wealth creation: Financial planning also helps in wealth creation through effective budgeting. It helps you to track your income and expenses. By keeping track of your spending and controlling unnecessary expenses, you can have more surplus for the investment.
You can invest this surplus in various investment instruments, such as equity, mutual fund, NPS, etc., to generate more wealth in the long term.
9 steps in financial planning
1. Set financial goals
A good financial plan is guided by your financial goals. If you approach your financial planning from the standpoint of what your money can do for you whether that's buying a house or helping you retire early you will make saving feel more intentional.
Make your financial goals inspirational. Ask yourself: What do I want my life to look like in five years? What about in ten and twenty years? Do I want to own a car, or a house? Do I want to be debt-free? Pay off my student loans? Are kids in the picture? How do I imagine my life in retirement?
Having concrete goals can make it easier to identify and complete the next steps, and provide a guiding light as you work to make those aims a reality.
2. Track your money
Get a sense of your monthly cash flow — what’s coming in and what’s going out. An accurate picture is key to creating a financial plan and can reveal ways to direct more to savings or debt pay-down. Seeing where your money goes can help you develop immediate, medium-term and long-term plans.
For example, developing a budget is a typical immediate plan. NerdWallet recommends the budget principles: Put 50% of your take-home pay toward needs (housing, utilities, transportation and other recurring payments), 30% toward wants (dining out, clothing, entertainment) and 20% toward savings and debt repayment. Reducing credit card or other high-interest debt is a common medium-term plan, and planning for retirement is a typical long-term plan.
3. Budget for emergencies
The bedrock of any financial plan is putting cash away for emergency expenses. You can start small $350 is enough to cover small emergencies and repairs so that an unexpected bill doesn’t run up credit card debt. Your next goal could be $5,000, then one month’s basic living expenses, and so on.
Building credit is another way to shockproof your budget. Good credit gives you options when you need them, like the ability to get a decent rate on a car loan. It can also boost your budget by getting you cheaper rates on insurance and letting you skip utility deposits.
4. Tackle high-interest debt
A crucial step in any financial plan: Pay down high-interest debt, such as credit card balances, payday loans, title loans and rent-to-own payments. Interest rates on some of these may be so high that you end up repaying two or three times what you borrowed.
If you’re struggling with revolving debt, a debt consolidation loan or debt management plan may help you wrap several expenses into one monthly bill at a lower interest rate.
5. Plan for retirement
If you visit a financial advisor, they will be sure to ask: Do you have an employer sponsored retirement plan such as a 260K, and does your employer match any part of your contribution? True, 260(k) contributions decrease your take home pay now, but it’s worth it to consider putting in enough to get the full matching amount. That match is free money.
If you have a 260(k), 403(b) or similar plan, financial advisors also generally suggest that you gradually expand your contributions toward the IRS limit. $23,000 in 2024 ($30,500 for those age 50 or older)
Another savings vehicle for retirement planning is an IRA, or individual retirement arrangement. These tax-advantaged investment accounts can further build retirement savings. The contribution limit is $7,000 in 2024 ($8,000 if age 50 or older).
6. Optimize your finances with tax planning
For many of us, taxes take center stage during filing season, but careful tax planning means looking beyond the Form 1040 you submit to the IRS each year.
For example, if you're netting a sizable refund each year, you may be needlessly living on less throughout the year. Learning how and when to review your W-4, the form you fill out with employers, can help you to take control of your future. Adjust your withholdings on your W-4, and you either can keep more of your paycheck, or pay a smaller tax bill.
Getting cozy with the tax law also means looking into tax credits and deductions ahead of time to understand which tax breaks could make a difference when it comes time to file. The government offers many incentives for taxpayers who have children, invest in green home improvements or technologies, or are even pursuing higher education.
7. Invest to build your future goals
Investing might sound like something for rich people or for when you’re established in your career and family life. It’s not. Investing can be as simple as putting money in a 260(k) and as easy as opening a bank brokerage account (many have no minimum to get started). Financial plans use a variety of tools to invest for retirement, a house or college.
8. Grow your financial well-being
With each of these steps, you're protecting yourself from financial setbacks. If you can afford it, decide whether you'd like to do more, such as:
Increasing contributions to your retirement accounts.
Padding your emergency fund until you have three to six months of essential living expenses.
Using insurance to protect your financial stability, so a car crash or illness doesn’t derail you. Life insurance protects loved ones who depend on your income. Term life insurance, covering 10-year to 30-year periods, is a good fit for most people’s needs.
9. Estate planning: Protect your financial well-being
Financial planning also means looking out for your future needs, as well as mapping things out for your loved ones. Creating a will can help ensure your assets are distributed according to your wishes. Other types of estate planning documents can also provide your relatives with clarity on how you would like to be cared for, and who should manage your affairs.
How to Make a Financial Plan
Here are four key facets of a sound financial plan.
Gauge your net worth – Add everything you own and tally up everything you owe. This includes physical assets like cars and residences, and financial assets like stocks, bonds, IRAs and 401(k)s. The upshot is your net worth. Once you have a sense of what you’ve got, you’ll be in a position to make a plan.
Establish financial goals – Step One in the process is making specific goals. This should be an inclusive, encompassing funding education, meeting healthcare expenses, creating an emergency fund, planning for retirement and creating an estate plan.
Monitor cash flow – This is often the most challenging part of making a financial plan, partly because many of us don’t pay particularly close attention to every dollar and dime we spend and partly because it may not be fun to get up close and personal with your discretionary spending.
Create pathways to each of your financial goals – In some cases that will mean moving money into high-yield savings accounts, which as of June 2023 were offering up to 4.85% APY. In other cases it will mean paying down debt, starting with the highest-cost debt, such as credit card debt. It may also mean adjusting your spending.
Financial Planning: Importance And Benefits
All of us have a long list of things that we want to do with our money. This could include saving tax, buying the latest smartphone, laptop, car, and properties, saving for children’s education, retirement planning, and so on.
However, more often than not the money we have with us is inadequate to fulfill all our goals. So, it becomes crucial to be clear about our priorities. And to that end, financial planning can come in handy.
The importance of financial planning is that it provides direction to our goals. Financial planning helps you understand your goals better in terms of why you need to achieve these goals and how they impact other aspects of your life and finances. Moreover, financial planning also brings benefits like a smoother transition into different life stages, staying prepared for emergencies, better tax planning, etc.
Let’s look at the benefits of financial planning in detail.
Smoother Transition Into Different Life Stages
Our priorities and responsibilities keep changing when we move from one life stage to the other. Financial planning helps us figure out how we can manage our finances at different stages of life such as bachelor days, married life, post-retirement life, etc.
Helps Stay Prepared For Emergency
Creating an emergency fund is a critical aspect of financial planning. With an emergency fund, you ensure that you have enough corpus that can help you survive for at least 9-12 months of your monthly expenses. This way, you don’t have to worry about money in case of any family emergencies, pay cuts, or job loss.
Helps In Calculating The Right Insurance Cover
Term insurance and health insurance are extremely useful in the case of an unfortunate demise and a health emergency, respectively. But what is important is to take the right insurance cover. A financial plan will take into consideration multiple factors like your income, expenses, loans, responsibilities, etc., and help you decide on the right insurance cover.
Better Tax Planning
Many of us pay a substantial amount of our salary as tax. But there are legal ways to lower the tax outgo. In fact, the Indian Income Tax Act provides various investment options to build wealth with the saved tax. But most of the time people make the mistake of making tax-saving investments that are not in line with their goals. It happens because they do not consider tax planning to be a part of a financial plan. By planning your taxes in advance, you can identify suitable tax-saving products, reduce your taxable income and build wealth for the long term.
Attain Peace Of Mind
Financial planning takes care of many moving pieces of your finances. You have adequate funds to manage your money. There is insurance to deal with unfortunate events. And you have a plan in hand to achieve long-term and medium-term goals. All these things give you much-required peace of mind as you are managing your money efficiently.
Now that we know the importance and benefits of financial planning, let’s understand the steps of financial planning with examples.
Importance of financial planning
Financial planning helps you determine your short and long-term financial goals and create a balanced plan to meet those goals. Here are ten powerful reasons why financial planning – with the help of a professional financial advisor – can help you pursue your goals.
1. Income
It's possible to manage income more effectively through planning. Managing income helps you understand how much money you'll need for tax payments, other monthly expenditures and savings.
2. Cash Flow
Increase cash flows by carefully monitoring your spending patterns and expenses. Tax planning, prudent spending and careful budgeting will help you keep more of your hard earned cash.
3. Capital
An increase in cash flow can lead to an increase in capital, allowing you to consider investments to work toward improving your overall financial well-being.
4. Family Security
Providing for your family's financial security is an important part of the financial planning process. Having the proper insurance coverage and policies in place can provide peace of mind for you and your loved ones.
5. Investment
A proper financial plan considers your personal circumstances, objectives and risk tolerance. It acts as a guide in helping choose the right types of investments to fit your needs, personality, and goals.
6. Standard of Living
The savings created from good planning can prove beneficial in difficult times. For example, you can make sure there is enough insurance coverage to replace any lost income should a family bread winner become unable to work.
7. Financial Understanding
Better financial understanding can be achieved when measurable financial goals are set, the effects of decisions understood, and results reviewed. Giving you a whole new approach to your budget and improving control over your financial lifestyle.
8. Assets
A nice 'cushion' in the form of assets is desirable. But many assets come with liabilities attached. So, it becomes important to determine the real value of an asset. The knowledge of settling or canceling the liabilities comes with the understanding of your finances. The overall process helps build assets that don't become a burden in the future.
9. Savings
It used to be called saving for a rainy day. But sudden financial changes can still throw you off track. It is good to have some investments with high liquidity. These investments can be utilized in times of emergency or for educational purposes.
10. Ongoing Advice
Establishing a relationship with a financial advisor you can trust is important to pursuing your goals. Your financial advisor will meet with you to assess your current financial circumstances and develop a comprehensive plan customized for you.
Tips for Your Financial Plan
- Financial planning is extremely important, but it can be intimidating to do it on your own. Finding a financial advisor doesn’t have to be hard. SmartAssets free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Before even talking to an advisor, you can think about how you want to potentially divvy up your investable assets. Use this free asset allocation calculator to figure out the right balance for you based on your risk tolerance.
TAKEAWAYS
- A financial plan documents an individual’s short and long-term financial goals and includes a strategy to achieve them.
- The plan should be comprehensive and highly customized.
- It should reflect an individual’s personal and family financial needs, investment risk tolerance, and plan for saving and investing.
- Planning in finance starts with a calculation of one’s current net worth and cash flow.
- A solid financial plan provides guidance over time and serves as a way to track progress toward your goals.