What is Financial Planning?
Planning of any type means thinking ahead of time before the actual event takes place. This way we are prepared for the actual event whenever it happens. We plan things daily which helps us achieve our smaller goals. Right from what to eat for breakfast to reaching your school, college, to meeting your client for work everything needs a plan. On the same lines, management is required to achieve your financial goals. In this topic, we shall determine how to manage personal finance.
Financial planning is the process of planning your expenses and investments in accordance with your revenue and future goals.
You need to have an adequate amount of money to fulfill your goals and desires in the long term. More importantly, you need to have money at the right time and place, else it will be of lesser use. For example, if you want to buy a house, you need to have money enough each month to pay for your installments. This is where financial planning becomes essential. Also, financial planning will differ depending upon the needs, e.g., for purchase of an asset such as car or house, marriage, higher education for children, emergencies, and retirement.
Benefits of Making a Financial Plan.
1. To improve saving
Saving money is the first step towards financial planning. When you create a financial plan, you understand your income and expenses. You come to know where you were spending unnecessarily, one needs to look into money spent on multiple credit cards and especially substantial interest and fine paid on the delayed payments.
Again, simply saving and collecting money and keeping it at home would not be the right way of saving money. You need to invest that money saved to earn returns by investing it in different avenues to get a better yield. Financial planning also helps in obtaining certain tax benefits, thereby saving more money.
2. To inculcate the habit of discipline and commitment around money
When you start thinking and managing finances, it brings a sense of responsibility and discipline around money. E.g., when you have a goal to save more for buying your favorite mobile phone you start spending less on frivolous things to have the required amount for the instrument. This way you are in more control of your finances, thereby making an individual financially disciplined and independent
3. To have a better standard of living
To live life comfortably, you need to have a plan in place. People feel that they would have to sacrifice their standard of living if their monthly bills and EMI repayments are to be addressed. When you have a good financial plan handy, you do not have to compromise your lifestyle.
4. To prepare yourself for contingencies
It is generally advised to have a balance of at least the last 6 months' salary in the bank balance sheet of your bank account for any unknown contingencies. For example, if a person loses a job due to a recession, the person has money enough to survive till he finds a new job if he has enough savings. Thus, you don’t have to stress at the last moment to meet your needs and you can directly focus on getting a job. Having an emergency fund especially for current times like Covid-19 helps you survive. Another way of doing that is getting yourself life insurance coverage.
5. To have a peaceful mind
With enough funds in your hand, you can cover your routine monthly expenses, invest for future goals and spend a little for yourself and your family, without worrying. It brings a sense of control and satisfaction when you know you are spending mindfully.
6. To create a retirement plan
Due to better healthcare facilities, the life expectancy of an average person has increased, however, a person would not want to work for his / her entire lifetime, and thus to have a secured financial future it is necessary to have a retirement plan by taking the right financial decisions in his / her youth and for the respective partner also if applicable. Due to the changes in our lifestyle, people are vulnerable to ailments like diabetes, hypertension, and heart attacks. Healthcare costs have increased over the years.
Keeping all this in mind you need to create a retirement account/retirement fund so that you can prepare for your retirement from a very early age. The earlier you start, the richer you retire. It happens due to the “magic of compounding” thus enabling to earn a high interest rate.
While planning for retirement, it is important to decide at what age you want to retire and the post-retirement expenses. In the United States, a 401K account is a retirement account created to cover employees post their retirement.
Creating a Financial Plan
1. Study your current financial status
This will start simply by determining your sources of income, expenses, loans, savings, and investments, long term as well as short term along with your assets. Once you have determined your current situation, you are now in control of your finances and you know better ways of improving them. You can start with writing down daily expenses in a book by referring to your bank’s statement as well. Timely reviewing of one’s balance sheet to check assets & liabilities and cash flow statement is essential to understand one’s financial situation.
2. Determine your financial goals
Write down all your goals on a sheet of paper and keep them on your desk where you can see them daily. Once this is done, add value to the goal by writing the amount of money required for the same and by when you would like to achieve it. For example, if you have a goal of buying a car, your goal could be “I want to purchase a car worth Rs. 10 lakhs by June 2021.” Keeping it on the desk will serve as a reminder and also motivate you to save for the goal.
3. Determine the different investment options and create an investment portfolio
There are a lot of investment strategies in the market that could help you save money depending upon the nature of your goal. Again, the investment strategy and plans will vary basis your age, risk tolerance/appetite, amount of funds available, and your current financial situation. Your financial plan must be such that in the event of unforeseen circumstances, your entire plan must not be rendered useless, and hence your investment portfolio must be well diversified. As a popular saying goes “Do not put all your eggs in one basket”. A diversified portfolio must include investment in shares, mutual funds, bank deposits, real estate, government bonds or securities, and gold.
4. Monitoring your financial plan regularly
Financial planning doesn’t end by determining your goal and investing in options, it’s an ongoing process. You need to monitor how the investments are performing regularly. If they don’t perform, you may have to replace them with better-performing investments. Again, as you grow old, your priorities change, your dreams evolve and so do your goals. Keeping this in mind you may have to keep the plan flexible for such cases. For example, if there is some emergency at home that needs to be paid attention to more than your goal, then you will have to align your funds accordingly.
For all of the above, you can also seek financial advice by hiring a financial planner or a financial advisor who can help you achieve your financial goals easily. These professionals are also known as CFPs or Certified Financial Planners. Most financial advisors work on a fee-only basis, but rarely some also take a small percentage/brokerage of the profits earned.
Financial planning is not rocket science, it just needs a little commitment and patience to achieve all your financial goals in life.
Failure to communicate the right plan to stakeholders: Once the planning exercise is over, communicating the final plan to all those involved is very important. Else there could be differences at the later stages when variances can’t be explained
Not considering the regulatory or economic changes: While planning it is important to consider the regulatory changes else the entire plan can go for a toss.
Not considering unforeseen circumstances: Life is very uncertain and unpredictable and thus there certainly is a need to provide for any unseen situations/contingencies that may arise in the future. The covid-19 situation is one such unprecedented situation the world is currently facing.
Not updating the Management and its Board about exigencies: Not informing the higher management about huge variances would backfire upon the teams. Timely informing helps to prevent the problems in advance.
Inexperienced people are involved in the process resulting in a lack of understanding and miscommunication.
Context and Application
This topic is applied in professional exams courses like B.Com, BAFF, Chartered Accountancy, CIMA, CFP, and other finance courses.
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