What is Financial Planning?
Managing money can be tricky. There are many things to take care of – household expenses, loans, investments, retirement, emergency fund, and insurance! That is where financial planning steps in to ease the process of handling money.
So, a financial plan refers to a comprehensive overview of available funds and their allocation. It involves reflecting on your financial goals and the strategies you have adopted for fulfilling those to gain the most out of your assets.
What is the Importance of Financial Planning?
In the past few years, the world has undergone significant events like COVID-19 and the Ukraine War that have deeply impacted the global economy. Today, we are in a weak growth phase, and all these periods of volatility have reiterated the importance of financial planning. Below are some points which describe how good financial planning can be beneficial:
- Better Savings – Creating a financial plan gives us a deeper insight into our income and expenses, which might otherwise be overlooked. Thus, being more conscious of where you are spending your money makes it easier to cut down superfluous expenses and, ultimately, increase your savings in the long run.
- Manage Debt and Increase Your Standard of Living – Piling debt can greatly burden your savings and may even lead to a debt trap. Hence, disciplined investing according to your financial plan can help you manage your loans and credit card bills. It is common for parents to spend the majority of their savings on children’s higher education and often compromise on their comfort. Through goal-based investing, individuals can establish a more sustainable lifestyle where they would not have to rely on debt.
- Risk Mitigation – Two critical components of a financial plan include asset allocation and risk diversification. Without a proper financial plan, you may invest in high-risk assets threatening your long-term well-being. Having a balanced investment portfolio protects from market vulnerabilities.
- Increased Tax Savings – Being aware of government taxation policies can help make the most tax-efficient investment decisions. For example, an investment plan enables you to save taxes via deductions under Section 80C.
What is the Importance of Financial Planning for Attaining Life Goals?
- Wealth Creation: Our grandparents all say, “During our times, things were much cheaper.” The phenomenon of prices rising over time, also called inflation, is something we must account for in our financial plans to create long-term wealth. If you want to buy a house or a car some years later, you must start building a corpus of wealth from today. Knowing which assets will not be heavily impacted by inflation is necessary to secure your funds. For example, one of the suitable options for long-term goals could be equity mutual funds.
- Education of Children: Every parent wants to send their children to the best universities. Unfortunately, the cost of education has been rising considerably, not only in India but around the globe. Hence, starting planning for your child’s education from the moment they are born is necessary.
- Retirement Planning: You may think retirement is far away, so why save for it now? But to lead a happy and comfortable retired life, you must start building your funds early in life. If you start investing at a young age, then you can invest smaller amounts, and with the power of compounding, you will have a sufficient retirement fund ready when it is time to utilize it.
- Emergency Fund: Life is uncertain. You never know when a medical emergency or a huge repair can disturb your finances heavily. This necessitates setting up a separate fund for contingencies so you have a safety net during such times. Experts suggest that this corpus should be at least six months of your monthly expenses and be invested in a liquid fund to withdraw quickly whenever the need arises.
What are the Steps Involved in Building a Financial Plan?
Here are some general steps that you can follow during your financial planning journey:
- Lay down your financial goals: Before anything else, you must know what you want to achieve in the short and long term. For example, you might want to buy a phone in the next six months, while you may want to start saving for your newborn’s college education in the long run.
- Evaluate your current financial position: Having clarity about your income sources, expenses, assets, and liabilities is essential to understanding where you stand financially.
- Create a budget: Once you know your income and expenses, setting a budget becomes easy to manage your cash flow and regulate your spending.
- Develop a savings and investment plan: It is time to set up appropriate savings and investment planning based on your financial goals and evaluated financial position, considering your return expectations and risk tolerance.
- Evaluate your insurance needs: If you do not have life and health insurance, then get proper coverage for you and your family. Also, consider other insurance that you may require, including disability insurance, automobile insurance, mobile/laptop insurance, etc.
- Plan for taxes: Understand how taxes will impact your financial plan and ensure that you take advantage of any tax benefits available.
- Periodically monitor your progress: Review your financial plan periodically to see if it aligns with your goals. Check progress and make necessary changes as per life circumstances.
Overall, building a financial plan may seem like a daunting process, but the financial security and peace of mind associated with it make the efforts all worth the time and attention.
Q1. Who can formulate a financial plan?
A1. You can build a financial plan yourself or take help from a professional. Today, there are robo-advisors that make financial planning even more easily accessible.
Q2. What is the most important step in financial planning?
A2. While it is difficult to point out one step because each is essential, implementing your plan may be the most important to reach your financial goals.
Q3. Give three reasons highlighting the importance of financial planning.
A3. Three reasons why financial planning is important are:
- Better savings and debt management
- Risk mitigation through diversification
- Increased tax savings