What is Financial Planning?
Financial Planning is a process of clearly understanding your future financial requirements and making provisions for it accordingly. It doesn’t start and end in a specified time frame, hence it won’t be wrong to say that it is an ongoing process.
It is the process of knowing your current financial standing, understanding where you want to reach by charting out away, and taking appropriate steps to attain your goal.
But like any other plan, a financial plan also needs to be reviewed from time to time to understand whether you are off track and taking corrective measures for the same.
You work hard to earn money so that you can save for your and your family’s forthcoming requirements, but only saving isn’t enough. Investing the saved money into appropriate and suitable investment options is the key to securing your financial future. Different individuals have different requirements depending upon their income, expenses, and risk appetite.
A person at the onset of his career can take more risk than the one who has more responsibilities. Different investment options catering to the varied needs of people are readily available in the market.
Investment options, including stocks, equity, debt, serve diverse requirements such as accessible liquidity, regular income, cash flow, as well as an increase in capital.
A holistic financial plan takes care of your short term as well as long term financial requirements. It also helps in inculcating the golden habit of saving along with determining whether you need a particular asset or not.
As Warren Buffet rightly said about Spending and Savings,” If you buy things you do not need, soon you will have to sell things you need,” and,” Do not save what is left after spending, but spend what is left after saving.”
Let’s understand in detail what is Financial Planning all about, and how can it benefit us?
In layman’s language, Financial planning is an ongoing process of continuously evaluating your financial position and keep investing accordingly, keeping your goals or objectives in mind.
Sounds easy, isn’t it? Each one has different life goals to be achieved at different stages of life. Let’s understand how to formulate goals and the steps in attaining them.
Financial Planning Process
It starts with establishing your goals, be it short term, medium, or long term.
- Do you want to be a millionaire before you turn 40?
- Do you want to keep a buffer for harder times in life?
- Do you want to pre-plan for all your future expenses like marriage, child’s education, retirement, et al.?
The answer lies in getting an objective and sound Financial Plan in place for yourself.
Where do you stand?
The next step involves correctly evaluating your assets and liabilities, what you own right now? and what you plan to own in the future?
This gives a clear picture of your net worth, and your current financial position vis-à-vis your objectives. It provides you with an idea of how far you are from your goal and what should be your run rate to achieve the desired objective.
In other words, it helps in determining the expected rate of return in the required number of years needed for attaining the financial goal set by you is.
How to Create a Sound Financial Plan
The third step in creating a sound financial plan is to develop a road map for your objectives.
The essence of creating a financial plan is to take into consideration the short, medium, and long term objectives. Investment is made accordingly, in options that do not hamper liquidity for the short and medium-term whereas, for long term investment, options are chosen to keep the long term perspective in mind, which usher an increase in your invested capital.
Financial Plan – How far have you reached?
It makes for a good financial plan if reviewed from time to time after implementation. Implementation is the key to achieving goals but along with it, what holds more importance is to keep reviewing the plan from time to time. Financial planning is not static; it is an ongoing process that requires monitoring and reviewing financial decisions at the very least, yearly. As they say, if you don’t control your finances, they will control you.
Financial planning is all about being clutter-free and organized. It involves segregating your goals into short, medium, and long term and making provisions for them, keeping the cost of inflation in mind along with provision for any untoward incident that might occur in the future. It provides you with a sense of security and confidence in dealing with whatever the future has in store for you with more ease and lessen anxiety.
Benefits of Financial Planning
Financial Planning is a very beneficial practice. Without sound financial planning, you can miss out on important life goals. It provides you with a roadmap to achieve your financial goals and reduces uncertainty about the future by managing your money to achieve personal monetary satisfaction. A holistic financial plan can increase your quality of life, along with providing you with the following benefits.
- It provides you with a sense of freedom as far as financial anxiety is concerned about investing systematically so that you can attain your life goals with ease through early anticipation of expenses and investment thereof. It is an attempt to be future-ready and attain your personal financial goals at the same time.
- It provides you with an increased sense of awareness and control of your financial goals. Since you are completely in control of your expenses, it saves you from facing unwarranted debt or reliance on others for your financial stability or even bankruptcy in certain cases.
- The most important function of financial planning is to safeguard your financial future, thereby protecting your personal relationships. A sense of security for the family members leads to enhanced personal connections and less trouble for you in the future.
- It also provides you with a comprehensive roadmap for your future obligations, thereby giving you an opportunity to obtain and protect your financial resources.
- It helps in monitoring your spending and expenses along with maintaining budgets and planning your tax expenses beforehand, thereby somewhat increasing your cash flow.
- It provides a better financial understanding of your current financial condition and what it would take to maintain the same standard of living in the future. By properly investing money in the existing financial options, you can save for the future depending upon your objectives and risk appetiteRisk AppetiteRisk appetite refers to the amount, rate, or percentage of risk that an individual or organization (as determined by the Board of Directors or management) is willing to accept in exchange for its plan, objectives, and innovation..
- It helps you understand whether you need a particular asset at a given point in time or not. Many a time, we accumulate unnecessary assets just to cushion our current standard of living, thereby putting more pressure on our expenses. A good and sound financial plan helps us avoid making such mistakes.
Importance of Financial Planning
There is a myth that financial planning is for people who have surplus money. A well-planned and holistic financial planning process can benefit one and all. It provides provision for savings, investments, planning for education, major purchases, retirement, insurance, and other financial needs.
According to forbes.com, Only 31% of financial decision-makers in families say they have created a comprehensive financial plan either on their own or with professional help. It also states that 35% of people have a plan to save for emergencies, and only two-thirds have a plan to meet any of the six savings goals, such as emergencies, retirement, a child’s education, or a down payment on a house.
Financial plans are meant for people from all walks of life, irrespective of their earning level. Most people opine that financial plans are for the older ones. This is a complete myth. If you keep investing at an early age, you will be better off in achieving your life goals than many of your peers. In fact, most millionaires and billionaires are the ones who got hooked to financial planning at an early age and kept track of their financial decisions.
One of the biggest mistakes made is not to invest early. Investing at the onset of your career provides large scopes for any gaps that might occur in the future. It also helps in determining your spending habits. By making simple changes in your lifestyle and keeping away from high-rate loan debt, for example, credit cards, you can increase your saving rate manifold.
The easiest mantra to conjure up your savings is to save first and spend later.
Financial planning and Analysis
A healthy financial plan is one that suits the requirements of a particular individual considering his/her monetary standing at that particular time. For example, a financial plan for a person in his 20s would be completely different from the one in his 40s.
Early 20s Financial Planning
Just at the onset of your career, your financial plan would incorporate long term savings primarily into retirement funds or increasing your contribution to the 401(k) plans. It’s more important for you to comprehend the importance of saving and spending wisely. It is also essential to have ample liquidity by maintaining at least 6 month’s salary in a fund for any unwarranted situation.
Mid 30s Financial Planning
If you are in your 30s, it is essential that you buy life insurance to safeguard the future cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. of your family. Investment options that provide liquidity in times of a crisis along with financing of future needs are the need of the hour. Spending habits need to be revisited with ample attention to be paid on buying assets that drain you of your future savings. An expensive car or house to impress the neighbors is a better idea only when it doesn’t burn a hole in your pocket.
Late 40s Financial Planning
In the late 40s, your kids must be ready for a college education. This is the right time to start thinking about your retirement and post-retirement care plans as well, along with your kids’ education funding. A medical condition might further put pressure on your savings. Hence having a contingency fund is a good idea.
Early 50s Financial Planning
This is the time to lap up and bask in the glory of all the hard work you put in all those years. If you haven’t saved anything for retirement until now, this is the time to gear up and mobilize all your savings towards your retirement planning.
Experts claim that the amount of equity exposure you can have in your early 20s or even mid-30s is much higher than what you can have in your 50s. Hence, it is time to play safe now and orient your savings towards debt instrumentsDebt InstrumentsDebt instruments provide finance for the company's growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans. rather than equity.
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As Antoine de Saint-Exupery has said, “A goal without a plan is just a wish.” A detailed financial plan helps in establishing your priorities right, saving with an objective, and investing with a future road-map in mind leading to success; like everything else in life, planning beforehand and regular monitoring and reviewing leads to greater financial freedom.
“People often confuse financial planning with investing, but financial planning is much broader than that,” said Noel Maye. Financial planning is a holistic and all-encompassing approach towards the financial organization, which involves keeping track of spending, expenses, budgeting, risk toleranceRisk ToleranceRisk tolerance is the investors' potential and willingness to bear the uncertainties associated with their investment portfolios. It is influenced by multiple individual constraints like the investor's age, income, investment objective, responsibilities and financial condition., as well as retirement planning.
As has been rightly saying, “Life is inherently risky. There is only one big risk you should avoid at all costs, and that is the risk of doing nothing”, so don’t sit still by doing nothing. Secure your financial future by making a financial plan if you haven’t already done so.