What is financial planning?
We will start with defining financial planning. According to Certified Financial Planners Board of Standards, financial planning is having a view of the complete financial state of affairs of a client and guiding them in achievement of their short-term and long-term financial goals.
This advice covers the whole spectrum of financial exposures like saving money for education and having enough money to retire. It also includes how to best manage taxation and which insurance to buy. The primary goal of financial planning is to live a confident life today with assurance that future is secured too.
Financial planning is a not a one-off exercise. Rather the process is an ongoing one to bring reduction in stress levels about money needs, supporting a long term stable financial outlook and a peaceful retirement.
If you are wondering why creating a financial plan is important, let me tell you that by having a plan in place, you not only will be able to earn the most on your assets but also you will be at your best place to achieve whatever future goals you may set for yourself.
More importantly, by having a financial plan, you will be able to weather any storms or bumpy roads that may come along the way. And lets agree that life is not a smooth affairs. We all are thrown financial challenges by life at one or more stages of our lives.
Taking steps to financial planning
As with everything meaningful in life, financial planning also requires you make effort and take steps towards putting in place a financial plan. While the circumstances may change from a person to person, the key steps for crafting a financial planning success remain the same.
1. Set your eyes on financial goals
Your own personalized financial goals are at the foundation of any good financial plan. When you start thinking in terms of what value you can derive from money – for example paying for a house mortgage or retiring to live on a beach – you will note that you will be more inclined towards saving money.
The goals should not be random. They should inspire you to achieve something. You can start by asking yourself questions like:
When you are setting your financial goals, try to make these sound as concrete as possible because this makes you more likely to clearly identify these goals and take steps to complete in the next few years.
Your goals will be the guiding torch of your financial plan. Keeping in mind the five principles of goal setting theory will help. These are: clarity, challenging, commitment, possibility of feedback and managed complexity.
2. Start tracking the money trail
Get on top of the cash flow statement of your expenses and income. Start to track how money is coming in and how much money you are spending.
Having a clear status of monthly cash flow is critical for creating a financial plan. Once you have that picture, it will provide you opportunities to better identify ways to save more or decrease debt.
By following trail of your money, you will be more informed in making decisions about your current, medium term and long term financial plans. You can make use of Financial Literary and Education Commission’s tools for budgeting and planning checklists.
You can then start by developing an immediate financial plan by creating a monthly budget. Generally it is recommended that at least 20 percent of your monthly take home salary should either to savings account or to pay of debt. About 40 to 50 percent should go to your basic needs like housing, paying utility charges etc and 30 to 40 percent may be reserved for wants like entertaining yourself, fashion and dining out.
A useful medium term plan would include paying off credit card or other high interest debt you might be having. And taking care of future retirement needs would be a long-term plan.
3. Get employer’s contribution to your retirement plan
One of the key questions that financial advisors would definitely ask is: Have you got a 401(k) retirement plan and does your employer match or contribute to your plan?
You might not like that initially because having a 401(k) means that you will contribute to it and this would decrease your take home pay but you should stress on your employer to pay matching amount because that essentially is free money they will be contributing to your retirement planning.
4. Plan for the rainy day
A key foundation layer of any financial plan is having a provision for unforeseen and emergency expenses.
You can adopt a gradual approach. Starting with $300 saved away for any personal emergencies or unexpected repair expenses, increase the provision to $1000 gradually. And eventually the target should be to have at least an emergency fund for one month of living expenses. This will guard you against building up high interest credit card debt.
Another way to plan for emergencies is building a good credit worthiness. Having a good credit profile gives you options to get a low interest loan when you need it. This will not only empower you to get cheaper insurance rates but you may also be not required to submit deposits for utilities as security.
5. Reducing high cost debt
Any financial plan would definitely be incomplete without a plan for reducing high interest debt such has payday loans, credit card loans, rent-to-own payments and title loans. Some of these loans are so pricey that you end up paying twice or even thrice the amount you took as loan.
If revolving debt is something you have not been able to control, try to get advice about debt consolidation. Having a good debt management plan will club all your loans into a single loan with one monthly payment and most likely at a significantly lower interest rate.
6. Have an investment plan
Investment is not only for those rich people, or people who have already established careers and have access to abundance of money.
Investing can be quite simple as well. For example, money you will contribute to your 401(k) is investing for your future. Similarly, you can easily open a brokerage account and start investing for your retirement savings, owning a house or paying for college fees.
You can annually contribute up to $20,500 to your 401(k) or similar plan. The limit goes up to $27,000 per anum for those who are 50 year or older.
Another option is traditional or Roth IRA accounts which are tax-advantaged and you can build your savings for when you retire by up to $7,000 a year.
You may also explore 529 college savings plans which are sponsored by state and provide tax free investment options for qualified educational expenses.
7. Opt for insurance
All the above options provide you buffers to protect yourself and your loved ones when life throws curveballs at you. As you grow professionally, keep making conscious effort to increase your financial moat by even more contributions to your retirement accounts, enhancing emergency funds even up to a buffer for 6 months of living expenses.
Insurance is also another tool for financial stability which should factor in a good financial plan. Having an insurance means you are protected against a major illness or a car crash so that these major setbacks leave little impact on your financial wellbeing. Consider life insurance of 10 year or more.
Importance of financial planning
Financial planning is a good tool to give you confidence while you traverse through bumpy roads of life. For example, the current inflationary trends or a future recession will impact you less when you would be having a sound financial plan.
Those people who have a written financial plan are more likely to be financially sound with better savings and investing habits. Modern wealth survey from Charles Schwab has shown that these people are also more likely to have an emergency fund for three months than those who do not have a plan.
A financial plan not only helps you take care of your day to day needs and short term financial goals, but you are well placed to address big-picture goals too. If you invest with prudence, you can build generational wealth. That coupled with thoughtful estate planning would ensure that you pass down fruits of your labor to your next generation.
Different Types of Financial Planning
There are many different services that a financial planners offer. Many a time, these services are interconnected and have linkages with each other. Because of this, a good overall financial plan considers all dimensions of your present situation and future goals and ambitions.
Here are eight different types of services which are part of financial planning.
Tax planning: The key services include advice on how to reduce your tax liability and maximize your tax refunds. Many advisors also work with you to prepare your tax returns and help in filing your annual tax statements.
Estate planning: By careful estate planning, you ensure that your loved ones have easier access to your funds and estate after you pass away. Having a will is part of a financial planning. A financial planner may also help you prepare and file any estate tax that your may be subject to.
Retirement planning: All of us stop working at some point in our life. Retirement planning helps us prepare for that retirement day and post retirement life. Having a good retirement plan will ensure that you have enough money saved to live a retired life with the lifestyle you imagined for yourself.
Philanthropic planning: Doing charity is always a nice feeling and you may like to fund a cause that you are emotionally or ideologically connected to. Financial planning would help you in doing that with more efficiency and also ensuring that you get tax credits for your philanthropy.
Education funding planning: Financial planning also considers that you might want to fund education of your children or other dependents. By making provisions for education fund planning, you are able to do that in a systemic way.
Investment planning: The day to day management of assets is not part of financial planning. But it can still help you in coming up with an idea about your investment portfolio by going over your investing options and how to fund those investments.
Insurance planning: As part of financial planning process, a financial planner would sit with you and evaluate your needs for insurance. In fact, some financial planners are certified insurance agents and you could buy insurance from them. But you have to be careful and take a second advice too because financial planners earn commission on selling you insurance, which may be a conflict of interest.
Budgeting: The real cornerstone of any financial plan is budgeting. A sound financial plan and budgeting ensures that your spending is within your means and that you are not falling into unnecessary debt.