Financial Planning – Definition, Meaning, Importance and Steps

Table of Contents

What is Financial Planning?

Financial Planning, an integral part of financial management, is a process that determines how a person or a business organization is financially placed at that particular moment. It is a comprehensive overview of current finances and strategies to achieve financial goals and includes all the important details of financial life related to assets, investments, insurance, debt, loans, savings and cash flow.

Creating a financial plan has become a necessity as this roadmap will provide a view of the financial future. This will help to save money every year and accomplish long-term goals. Financial independence is the ultimate dream of every person and an organization and this is what a financial plan will help to achieve.  Create a financial plan by yourself or take help of a financial planning professional if you are unable to do it yourself.

Importance of Financial Planning

Financial planning is considered very important because of the following reasons-

1. Gives direction to your goals

While creating a financial plan it becomes easy to understand what your goals are and why you want to achieve them. A clear perspective gives direction to your goals and helps to take the necessary steps and put your best foot forward in fulfilling all your dreams

2. Manage your savings

A financial plan has proved one of the best tools to manage and boost your savings effectively. As it can track and cut down unnecessary expenses the chance of saving money increases. A person can invest the money and increase his savings further for the future.

3. Manage inflation

A financial plan creates awareness about the prices of all the things. This helps to manage inflation effectively

4. Keep a check on spending

A proper financial plan in place will make you more disciplined towards money and keep a check on spending

5. Plan your future

Planning your finances will ensure a balance between inflow and outflow of cash. It will help to build a proper plan for the future.

6. Tackle uncertainties

A financial plan encourages people to have an emergency fund in place. This will prove a blessing during uncertain times and help to manage sudden surprises easily

Steps to create a financial Plan

Take the following financial planning steps to create an effective financial plan

1. Create Your Personal Financial Inventory

Personal Financial Inventory is very important as it provides the true status of the bottom line. This self-check includes

• Financial planning must take into account all the assets for instance how much salary a person is earning, what is in his bank accounts like a savings account and checking account, how much has he saved as retirement savings in his retirement accounts fund, real estate equity, valuable jewellery, education savings and the emergency fund
• Liabilities like personal debts, credit cards, car loans, other loans, student loans, mortgage/rent, monthly expenses and utility bills.
• The financial situation should also factor investment strategies, tax planning and retirement planning to make sure of correct financial future.
• Credit score and credit report
• Calculation of credit utilization ratio. It is the debt amount versus the total credit limit
• Review of the fees that are being paid to the financial advisor

2. Set up financial goals

After completing the personal financial inventory it becomes easier for a financial planner in setting up long-term, mid-term and short term goals.

The short-term goals of the financial plan include

• Creating a budget to manage personal finances
• Paying off the credit cards
• Creating an emergency fund account

The midterm goals of the financial plan will include

• Getting life insurance
• Estate planning by thinking of owning assets like a home
• Getting disability income insurance

The long term goals of the financial plan will include

• How much money you need to save in retirement accounts
• How to boost your retirement saving
• Purchasing life insurance for risk tolerance

These goals lay the groundwork for financial success and this is why it becomes doubly important for the financial planner to create well-defined and prioritized goals. Break the financial goal so that it will become easier to track, measure and accomplish goals of personal finances. Think in terms of

• What the money can do for you
• What do you want your life to look like in 5, 10 and 15 years?
• What are the assets that you want to own?
• How do you imagine your retired life to be in the long term?

Starting your financial planning process with the goals will prove helpful in making saving more intentional and achieving the set financial goals

3. Track your money and redirect it towards your goals

Keep a track of your cash flow to know the amount which is coming in and going out. Make sure that you have an accurate picture of the cash flow to get started on tracking the money. The investments advisor will know about the ways to direct the cash flow more towards debt payments and savings.

The financial advisors generally follow the 50/30/20 budget principles where

• 50% is dedicated to home pay and recurring payments like transportation, utilities, housing etc.
• 30% is directed towards wants like entertainment, clothing, dining out etc.
• 20% towards debt repayment and savings.

Minimizing debt amounts is a mid-term plan whereas retirement fund planning is considered a long-term plan.

4. Focus on family

Married people should make sure that their personal finance plan includes the following

• Life insurance for yourself and your spouse
• The best step for a couple is to ask for the help of a financial advisor and start investing money in education expenses. Decide on the amount upfront and make sure to make investments accordingly
• Some people have elderly parents make sure that you have insurance for life or care-insurance in place
• Plan your and your spouse’s retirement from the onset

5. Review your retirement savings plans

Review your retirement savings plans like (IRA) or a 401(k) as it has several tax advantages. Look at the following points before creating an effective financial plan.

• Decide which retirement plan is best for you. Should you opt for IRA or Roth
• You can change the IRA to a different brokerage firm
• You can convert an IRA to Roth IRA
• You can change 401(k) into regular or Roth
• Rollover old 401(k) account from a previous employer

The financial advisor is sure to look at the employer-sponsored retirement plan and want to know whether the employer in the company is matching any part of the contribution. Get the full employer match because it is free.

6. Review Your Investment portfolio

Take stock of your investment portfolio and look at financial health.

• Keep a track of asset allocation. Instead of investing in stocks, you can start investing some of the money in real estate to offset volatility in the market
• Understand and identify the investments that will meet your asset allocation goals.

7. Take care of the emergency fund

Create an emergency fund to tackle unwanted expenses during the year.  Start small and put away some cash at regular intervals so that it can at least cover small situations. Increase it gradually step by step to build a good amount.

8. Review your insurance policies

Make sure you have the right type of insurance policies related to life, business, personal property, home, disability, auto and health. Sit at least twice a year and evaluate the cost of the policies. You can purchase or make adjustments accordingly.

9. Take care of high-interest debts

Title loans, payday loans and credit cards balance have some of the highest interest rates. In some cases, people end up paying two to three times the amount of the actual loan. High-interest rates will prove toxic and it is important to pay them as soon as possible. Ask for help from a financial advisor and understand how a debt management plan or a debt consolidation loan can help in combining several expenses into one bill paid monthly at a lower interest rate

10. Make Investments and increase future savings

Put your money to work for you by making investments to increase savings. Start by thinking about the objective of the investment, when you might need the money and about your risk tolerance. The investment amount should be included as an integral part of the monthly budget where a specific amount of the income is allocated towards investment goals. Consider the following options

• Is there a need to finance your mortgage again
• Think about car insurance once again
• Try to lower your food bill by eating at home
• Minimize energy bills
• Utilize health savings account

Work to build alternative income streams by

• Investing in rental property
• Investing in real estate crowdfunding
• Opting for a part-time job
• Making investments in peer-to-peer lending

11. Review, protect and grow your financial well-being

A financial plan is a tool to track your financial health and maintain the financial well-being of personal finance. Review, protect and grow your financial well-being as this step will defend you and your family against financial setbacks. It is important to stay committed so that you are on the right track to creating and managing a solid financial plan.

Conclusion

Times are turbulent and you do not know what is going to happen next. Every person needs to have a financial plan in place. Financial planning is an important tool that will provide peace of mind by securing your future. It will act as a roadmap by improving your savings, decreasing your debts and giving you a sense of direction so that it becomes easy to move forward.