13 Jan What Is Financial Planning?
Have you ever considered hiring a financial planner? You don’t have to have lots of assets and be wealthy to benefit from financial planning. In fact, some people even do their own financial planning.
Whether you do your own financial planning or you hire a financial advisor to help you, getting it done is the most important part. So let’s take a look at what financial planning involves, why it’s important, and some key elements of it.
Definition
Financial planning involves evaluating your current and future financial status based on what you currently know about your financial situation, including asset values, cash flow, and investments, in order to make adjustments to help you reach your financial goals.
Financial Planning Process
There is definitely a process to financial planning, and there are several steps involved:
#1 Develop your financial goals.
Before you can get to where you want to go, you have to know where it is you want to eventually be. Don’t just breeze past this step. And make sure that your financial goals are both specific and realistic.
Some people find it helpful to create short-term, intermediate, and long-term goals. It breaks things up into more bite-sized chunks and seems more attainable that way. And tying these together in a progression can be especially beneficial. For example, you may decide that you want to improve your credit score. That could be an intermediate goal with your short-term goal being reducing your debt by $100 per month, and your long-term goal being able to buy a home at a better interest rate.
Other examples of financial goals can include retiring by age 50, paying for your daughter’s wedding, being debt free by age 35, buying a vacation home, or fully funding your retirement.
Don’t neglect this part: write down your goals! Research shows that by writing down your goals, you have a much better chance of actually attaining your goals.
#2 Collect your financial data.
This can be a real eye-opener, and you may even feel very defeated or hopeless once you really see where you’re at financially. But remember, if you don’t know where you’re starting from, it’s hard to get to where you want to go. Remember, this is simply a snapshot of where you are right now; it’s not where you’re going to stay.
Here are some questions to ask yourself as you collect your financial data:
What’s your net worth (the value of your cash, investments, and other assets versus your debts)?
How much money do you have coming in and going out?
Where does your money go each month (assess or update your budget)?
What’s your retirement strategy?
What’s your plan for short-term and long-term investments?
How is your risk management regarding your investments?
What is your estate plan?
#3 Develop a short-term, intermediate and long-term plan.
Just like you developed short-term, intermediate, and long-term goals, you want to develop a strategy to support those goals. Where you’re at in life (as a millennial, middle-age, or soon-to-be retiree) will determine which goals you concentrate on first.
For each goal, consider what you need to do to make it happen. Do you need to spend less and save more? Do you need to increase your income by getting a part-time job on the weekends? Do you need consult a financial advisor to help you get a handle on your retirement?
#4 Put your plans into effect.
This is where the rubber hits the road. This is where your self-discipline really needs to kick in. You’ll want to evaluate your progress each month by examining your budget and considering the progress you’re making toward your short-term goals. By taking an honest look at your progress, you can gauge whether you need to make adjustments or stay the course.
#5 Monitor and update your plans.
If after 6-12 months of working your plan you’re not seeing the progress you were hoping for, then it’s time to rework your strategy. Consider this a fluid process that requires ongoing monitoring and updating so that you can get the most benefit from your plan. It’s a good idea to revisit your financial plan each year to make sure you’re on track to meet your goals.
Importance of a Financial Plan
Developing a financial plan is like going on a trip with a map. You would never go into a different country without having a guide or map to help you navigate. Likewise, it’s important to have a financial map to help you navigate your financial journey. It’s discovering where you’re at and making a plan to get to where you want to be.
You’ve heard the saying, “If you fail to plan, you’re planning to fail.” Well, it’s especially true when it comes to your financial life. One thing is for sure: Regret is a terrible feeling. You don’t want to end up at the end of your life and wish that you had planned your finances better. Rarely will you hear someone say that they regret developing a financial plan, but you’ll often hear people saying that they wish they had taken the time and put forth the effort to create one.
Key Areas in Financial Planning
There are four main areas that you want to consider when you’re doing your financial planning: Liquid Cash, Protection, Estate & Taxes, and Asset Management. Imagine that your finances are like a house with four pillars on each corner. Each of these four areas are like four pillars that help to stabilize your “financial house.” Let’s take a closer look at each of these.
#1 Liquid Cash.
Don’t let the title deceive you. Liquid cash includes not only how much cash you have on hand but also your income and expenses (cash flow), debt management, and saving 6-12 months of living expenses (a long-term emergency fund) that you can access in case of job loss, illness, or other emergency.
#2 Protection.
Protection refers to insurance. There are many types of insurance and different companies as well. You want to ensure that you have the right amount of life, disability, health, and long-term care insurance for the best price.
#3 Estate/Taxes.
Everyone needs to have a will, a power of attorney, and maybe a trust. Depending on your assets, you want to ensure that you’re being tax-efficient and able to avoid probate.
#4 Asset Management.
The final area is asset management. This is last because if you don’t have the other three areas sorted out, your financial plan will not be successful. (It’s sort of like getting your cart in front of your horse.) Some assets you’ll want to actively manage include retirement accounts (401(k), IRA, SEP, SIMPLE), non qualified accounts, and Roth IRAs.
People often choose to seek the advice of a financial planner because they have lots of assets, but if they don’t have the other three areas taken care of, managing their assets won’t do them much good.
When in doubt, you may want to hire a financial advisor to at least get you on the right track. After that, you can decide if you can handle your own financial planning or if it would be best to continue to seek advice from a professional.
