Financial planning refers to the process of systematizing finances and putting them in order. It is an important tool that can be put to use by anybody, from the largest organizations to the smallest, and down to the level of the family and individual. Systematizing one’s finances with an orientation toward the future will help you to use your money efficiently, meet your responsibilities, and save money. A good financial plan has, at minimum, several components. In the following, we’ll consider eight of the most important of these components.
1. Financial Goals
A “financial goal” can refer to anything that you want to spend your money on. It’s a good idea to start off by defining your financial goals. Doing this helps to organize your thinking and can help to motivate you to do what’s necessary to achieve them. These goals can and should be made with reference to various time frames. Short-term goals might include paying off your credit cards or buying a new appliance. Looking a bit further out, an example of a medium-term goal could be starting the process of buying a house by making a down payment. It’s also important to make long-term goals, with retirement being the most important example of this. These goals should be as specific as possible, which can be done by associating a certain amount of money with a certain date in time.
2. Retirement Plan
“Retirement planning” refers to saving up the money you’ll need after you’ve grown too old to work. While planning can help with a lot of different financial needs, retirement is probably the most significant and the one that requires the most foresight. Once you have no regular income coming in, you’ll need to have a pretty large amount of money in order to live up to the standard to which you’re accustomed. This is not to mention things like healthcare expenses. Assuming you’ve paid off your major debts and have no other obligations, you’ll still need to have a very large proportion of your annual salary on hand, if not the entirety of it.
3. Emergency Funds
Another important consideration to include in your financial plan is the possibility that some emergency will arise that will require a significant amount of money. Everything from car accidents to medical emergencies to unexpected unemployment can put a dent in your financial situation. For this reason, it’s essential to have some money set aside that you can use to meet unforeseen problems without upsetting the rest of your financial plan. A good rule of thumb is to have enough money in your emergency fund to meet your needs over a period of three months and preferably up to six months.
4. Debt Management Plan
A debt management plan is a systematic allotment of funds for paying off what you owe. Not all debt is created equal. Some kinds of debt can help your financial situation over the long term, but other kinds need to be dealt with as quickly as possible. One element of financial planning is being sure to pay off high-interest debt. If you have any high-interest debt, determine how to meet your obligations by setting out the amount of money you need to resolve it. In this way you can avoid having your debt spread like cancer over the rest of your financial portfolio, choking out all life and hope for the future.
5. Estate Plan
Planning for how your wealth will be distributed among your beneficiaries after your death can be complex. It’s important to understand the tax laws imposed in your jurisdiction, for example. A financial professional can help you to draw up a will with these considerations in mind. Another good idea is to determine who will be authorized to exert power of attorney on your behalf should you be unable to make significant decisions.
6. Insurance Coverage
Insurance helps you to offset large potential expenses by paying a monthly premium to an insurance company. This component of financial planning also relates to emergency considerations. Establishing a balance between the premiums you pay and the coverage you need will help to put you in the optimal position. Health insurance helps you to meet medical emergencies. Disability insurance ensures that money will be available in the event that you become incapacitated and unable to work. Vehicle and homeowner’s insurance protect against outlays that become necessary in the event that your property is damaged. Life insurance is another common form of insurance that will provide money to your beneficiaries in the event of your death.
7. Net Worth Statement
All of these considerations need to be weighed against the amount of money and assets that you have in your possession. For this reason, you should determine your net worth, which you can do by subtracting the liabilities that you owe from the assets that you own. This number should serve as a reference when determining your approach to the other components of financial planning.
8. Budget and Cash Flow Planning
“Budgeting” refers to planning out your expenditures over a period of time, while “cash flow planning” refers to the laying out of anticipated revenue streams. Net worth captures a moment in time, but budgeting takes a diachronic perspective that presents in a more comprehensive way the amount of money that you can expect to receive and expend over a longer time frame. This is the most significant component of financial planning. By making modifications and adjustments to your budget, you can organize the way you use your money in order to direct funds away from irrelevant or wasteful uses and toward more essential, crucial, or desirable ends.
What is Financial Planning?
Financial planning is any future-oriented approach that seeks to organize the way that money is used. The various components of financial planning work together to arrange the use of money in an optimal way. These components take into consideration the most important needs for which you’ll need to spend your money. Anybody can benefit from a financial plan, from the short-term to the long-term. Although it’s always a good idea to make your own financial plans, for some purposes you’ll need the help of financial professionals like those here at NumberSquad.
What are the Benefits of Financial Planning
Financial planning has a number of benefits. One of the many benefits of financial planning is that it helps you to organize the way in which you spend your money. This has the additional benefit of making your use of money more efficient. In this way, your money can be directed to the most important and essential purposes. There are psychological benefits, too. Making financial goals can help you to stay focused and to gain monetary discipline. Also, financial planning can give you peace of mind, knowing that you will have what you need and are working for what you want.
What are the Limitations of Financial Planning?
Financial planning has certain limitations, however. “Fate”, “fortune”, “destiny”, and “acts of God” are some ways that people have referred to the fact that the future is unknown to us.
The uncertainty of the future is a good reason to make financial plans, but at the same time, you’ll need to remember that all your plans may go wrong, even to the point that you’re left with nothing. You should cultivate the inner fortitude you’ll need to meet financial disaster in the event that your financial plan goes catastrophically awry.
How to Do Financial Planning
Listed below are the steps of financial planning.
- First, determine your net worth.
- Set out your financial goals over the short-, medium-, and long- terms.
- These goals should include both things that you need (retirement, debt obligations, emergency costs) as well as things that you want.
- With all this in mind, prepare a budget that is calibrated to meet your financial goals.
- Perhaps most importantly, show discipline in adhering to your financial plan.
Is Financial Planning Beneficial?
Yes, financial planning is beneficial in a number of ways. Not only will it help you to occupy the best financial position possible over the course of your life, but it will also instill some of the discipline necessary to meet life’s challenges. Financial planning will help you to use your money wisely, directing it toward the most important and necessary purposes and away from frivolous waste. Using financial planning to make your financial activity more organized and efficient, you will be best placed to take advantage of the opportunities you come across, and to meet the challenges with which you are confronted. Good luck!