What is Financial Planning?
Financial planning is not valued or considered important in itself unless used in achieving the ultimate planned objective. Being human, it is natural for everyone to have some kind of objective, which may be rational or material. However, to achieve any such objectives, we need to organize our efforts financially and act on the same. Just like when we think of a vacation, we need to pre-plan the route, things to carry, money required etc.
Financial planning is not an item or product instead, it is a process to achieve any desired results. Financial planning is a tool, which is essential to achieve your financial objectives without being disrupted by the uncertainties of life. It is simply a step by step process, which lay the ground rules in order to reach the ultimate objective. Objectives or goals can be anything from, marriage to vacation or buying a house to a retirement fund. These objectives require a huge sum of money, which cannot be generated in a day. Thus, to avail of such a large sum, one needs to set and implement a financial plan and at a later stage, continuous monitoring to reach the desired results. Goals or objective are the first pre-requisite for any financial planning, without which it becomes a mere process without definitive term.
Setting clear goals is the first thing you need to do while developing a financial plan. These financial goals vary from person to person and situation to situation. However, you need to be rational with your objectives and time frame. For example, there is no point in buying a sports car after your fifties. Therefore, financial goals, if not met within time, can turn the whole planning futile.
Another objective of financial planning is to ensure the availability of emergency funds. One cannot put their entire earnings into savings even if they try. Therefore, financial planning ensures you have an adequate amount of money in your hand for medical or other emergencies and at the same time do not disturb the flow to savings.
Debt management also forms an important objective of financial planning. Bifurcation of savings and expenses determines the amount of debt one can serve. Financial planning helps in bifurcating these expenses and manage the debts accordingly since everything cannot be dependent upon savings.
Investment is another goal-oriented term. As discussed above, to collect a certain amount of money, one cannot keep funds idle in the savings account. Thus, financial planning helps in ascertaining these investment avenues to arrive at a predetermined profitable junction.
Importance of Financial Objectives
You cannot fly without knowing where to land. Financial planning is important to understand how high you can fly and when is it necessary to land. It allows you to understand how much savings are necessary to achieve your financial goals and how much expenses you can afford. Enough has been said about how important financial planning is when it comes to targeting the financial goals, however, it is not just the goals which are taken care of, there are numerous other factors as well. Financial planning is necessary for tax planning, where judging on the income factors, need of liquidity and amount of taxable income, the investment targets are narrowed down.
Financial planning brings those necessary brakes on your spending and educates you in prioritizing things. It is an important factor in inculcating the habit of saving in your daily routine and bringing a general sense of achievement. On the other side, it is also important in creating a sense of security for the dependents. Often we see a situation where the child is burdened with educational loan and ends their prime age in repaying it. Financial planning plays an important role in giving that additional monetary cover for dependents when the only earning member in the family passes away.
Therefore, financial planning is important in every aspect, of savings, expenditure, investment, financial goal, retirement savings, and estate planning. Each of them requires a detailed study and strict implementation in order to achieve the desired results.
6 Steps of Financial Planning
To create a strong and effective financial plan, there are certain standard steps you need to follow. The magnitude of the steps may differ from person to person but the overall crux remains the same. Here we give you the 6 steps to create an effective financial plan.
Step 1: Determine your current financial situation
Before creating a financial plan, you must be fully aware of your finances. You must have an acute knowledge about your assets and liabilities. Determining your current financial situation also gives you ample insight into what you need to achieve in the coming future and what are your immediate financial priorities. Thus, this step will lead indirectly lead you to the next one i.e. setting up clear objectives.
Step 2: Developing Financial Goals
Once you are aware of your assets and liabilities, you are in a better position to set up clear and rational financial goals. You need to be reasonable while setting up goals. Having unrealistic objectives can hamper your financial stability. You may end up concentrating on an objective which you may not be able to achieve. This, in turn, will hamper your overall plan. Thus, keep clear and reasonable financial goals is imperative.
Step 3: Identifying an alternative course of action
At times, life may throw some challenges at you, which may force you to alter your course. Planning for such alternative courses forms the third step in our process to make an effective financial plan. This includes creating an emergency fund, saving money for some medical expenses, and similar situations. You may or may not need to use this course of action. But having a clear plan will keep you moving in the right direction and will not completely derail your financial situation in case of an emergency.
Step 4: Evaluating alternatives
You need to measure and evaluate all the alternatives in front of you. You must factor in your age, personal ethics, and financial situation at the time. If you decide to side-step from your original plan, you must consider how it will affect you in the long run and will it be helpful for your overall planning.
Step 5: Creating and Implementing the Financial Plan
You now have a clear understanding of your assets and liabilities and have the perfect knowledge of your objectives. You also have a considered an alternative course of action keeping in mind their consequences and impacts in the future. With all this information, you are now ready to create a suitable plan of action and implement it.
Step 6: Re-evaluation and Revision of the plan
No plan is perfect. Situations change, priorities change and thus comes the need to make the necessary adjustments in the original plan. You must be agile enough to make these minor (or major) adjustments in your plan so that you are in control of your finances during these changing times.