Financial planning is a strategy that helps you meet your financial goals. You gain control of your expenses, income, and investments, so you can handle your finances. Financial planning acts as a guide in helping you make the best choices about spending and saving, so you can achieve stability and accomplish your goals.
Money is a huge part of people’s livelihood, and it guarantees everyone has a place to stay and food on the table. That is why it is wise to manage money wisely. Financial planning can help you reach goals such as getting a bigger home, a new car, improved career training, a vacation abroad, and much more. Successful financial planning involves identifying and mapping out priorities (money management).
What is Financial Planning?
Financial planning involves creating a plan for your future. It centers around how you will manage your finances and prepare for any costs and issues that may occur. You will also examine your current financial situation, identify your goals, and develop and implement applicable recommendations. Financial planning is prevalent across various services and does not solely focus on one aspect of your finances. It considers clients real people with a wide range of goals and responsibilities. However, it is not the same as asset management, which refers to managing investments for a client.
What are the Goals of Financial Planning?
The goals of financial planning involve working toward achieving something with your money. Thinking about things you want to accomplish within the next year is easy, but setting specific goals and developing a plan can be challenging.
The following are the main sections to divide your financial goals into for effective plans:
- Short-Term Financial Goals: Short-term goals require immediate attention. One example is credit card debt, which should be at the top of your list. You can tackle it by paying it off to avoid additional charges. While you work towards getting your monthly balance to zero, setting up a budget to track your spending will help you avoid the same pitfall in the future. However, there are fun short-term goals. You can take a spring break vacation next year or plan a big graduation party for your niece by creating a plan to save for those expenses. Having monthly deposits set aside allows you to enjoy various things without worrying about debt.
- Medium-Term Financial Goals: For medium-term financial goals, you have more time on your side. Maybe you have your sights set on a new house, and you want to save a down payment of 20 percent to avoid paying mortgage insurance. Or perhaps you wish to purchase your next car in cash. These goals are not approaching quickly, but a proper savings strategy can bring them closer.
- Long-Term Financial Goals: A popular long-term financial goal is retirement. When you are in your twenties, leaving the workforce seems years away. But, this is the best time to set a goal. You have a longer period and can maximize an employer-sponsored retirement plan and an IRA. It may be a massive struggle if you wait to set retirement goals until you are 45. You will feel overwhelmed about where to begin and how to proceed with a plan.
1. Calculating Capital Requirements
Capital requirements are the sum of funds a company or individual will need to achieve goals. How much money will you need to get something up and running? Or take that trip you have desired for several months? You can determine the capital requirement by adding founding expenses, investments, and start-up costs. When you subtract your equity capital from the capital requirements, you will find how much external capital you need.
Ensure you calculate capital requirements as accurately as possible. Do not have a strict budget where you cannot compensate for unexpected financial problems. However, do not calculate too generously since it can be more expensive (even though you have more flexibility). This especially applies if you fund capital requirements with loans. Capital requirements are closely linked to various parts of your financial plan since they consider follow-up costs and other money needed for funding.
2. Choosing a Capital Structure
Capital structure is the amount of debt or equity a firm incurs to fund its operations and finance assets. Capital structure is usually stated as debt-to-equity or debt-to-capital ratio: debt and equity capital fund a business’s operations, capital expenditures, acquisitions, and other investments. Eventually, tradeoff firms decide whether to use debt or equity to finance operations, meaning managers will balance the two to find the optimal capital structure.
Optimal capital structure is the proportion of debt and equity that provides a firm’s lowest weighted average cost of capital (WACC). To optimize the structure, firms either issue more debt or equity. Any new capital acquired can be used to invest in new assets or repurchase debt/equity that is currently outstanding (recapitalization).
3. Developing Financial Policies
Financial policies focus on creating guidelines or principles about how an individual or company should operate to achieve tasks. Good financial policies offer reasonable ways to address specific issues. Though they can be adjusted, do not alter financial policies too often. Financial policies should be obeyed for a while to become routine practice. Before developing them, gather enough information and set reasonable time frames for various scenarios. By exploring different situations and clarifying why the policy is needed, you make it easier to follow and change the policies less frequently. This will help you accomplish future tasks.
4. Guarantees that Scarce Financial Resources be used as Efficiently as Possible
By creating a financial plan, you are setting yourself up for a better current financial state and a bright future. When you examine your plan, you should be able to identify areas you need to improve. Also, you should see the things you can accomplish over the next few months and several years. By working on financial plans alone or with a financial planner, you can ensure that all of your resources are accounted for so nothing is left to waste. Consider developing a financial plan or working with a financial planner to handle your finances more efficiently.
What is the Importance of Financial Planning?
Financial planning involves framing objectives, policies, procedures, and budgets for certain financial activities. It leads to effective and adequate financial and investment policies. Other things financial planning does is ensure that sufficient funds are available and produce a reasonable balance between outflow and inflow of funds. Additionally, it creates growth and expansion programs that help a company’s survival and reduces uncertainties related to changing market trends. Financial planning is vital since it ensures you have all the financial information and resources you need to achieve your goals and plan your future.
Where should I Start with Financial Planning?
To begin your financial planning journey, consider these things:
- Evaluate Your Current Situation: A thorough understanding of your finances is crucial before creating a plan. This is important, especially concerning your expenses, income, debt, investments, and savings. By doing this first, you have a good handle on the current state of your finances and can find ways to improve.
- Write Down Your Financial Objectives: Logging the different financial goals you want to accomplish (short-term and long-term) helps you visualize your goals and follow through with them. It is even better when you make your goals clear and specific. But, also make sure they are attainable. Aiming to purchase a new car over the next three years or set aside 10% of your income for a down payment are reasonable things to accomplish. Setting specific goals will guide you in laying out your plan and allocating your money.
- Carry Out the Right Plan: When you are making a financial plan, consider multiple factors:
- Your age
- Risk tolerance
- Current investments
- Retirement plans
Financial plans are tailored to your situation, so do not follow a one-size fits all approach. Instead, accept recommendations and tailor them to meet your circumstances. It might take some time and effort to get all the elements of your financial planning straightened out, but putting in the work will benefit you in the long run.
Which is the Most Important Step in Financial Planning?
The most important step in financial planning is monitoring your financial progress. Regular communication and follow-up are crucial parts of financial planning. Creating a plan is the first step, but you will have ongoing contact with your financial planner to determine whether you are on track to meet financial goals. Benchmarking is a part of the process, which requires matching your progress with your initial goals. Once you meet with your advisor, you will use the results of the follow-up meeting to adjust your goals, plan, and expectations. This is an ongoing process in financial planning. If you want to save for your kid’s college education or a trip to Brazil, you may need to earn more money or cut back on spending. An alternative is to adjust your goals.
What are the Good Components of Financial Planning?
The good components of financial planning are:
- Financial Goals: Start making a list of your goals, big and small. The list will help you organize them based on how soon you need the money. You cannot establish a plan until you know what you want to do with your money. Organize your goals into short-term, medium-term, and long-term goals. Then, specify a dollar figure and target date. This will help further your progress towards them.
- Net Worth Statement: Make a list of all your assets (bank and investment accounts, real estate, valuable personal property) and another for your debts (credit cards, mortgages, student loans). You can find your net worth by subtracting your assets from your liabilities. Determining your net worth provides a baseline for your financial plan.
- Budget and Cash Flow Planning: Budgets are beneficial in helping you notice where your money is going and where you can cut back to meet goals. Budget calculators ensure you do not overlook irregular but important expenses (car repairs, out-of-pocket health care costs, and real estate taxes). As you make your list, compile it into two sections: must-haves like groceries and rent, and nice-to-haves like eating out and gym memberships. Furthermore, an excellent way to test out your goals for your budget is by inventing “what if” scenarios. What if you downsized your mortgage? Or if you suddenly lose your job? What if your car broke down? You can determine how certain things may affect your savings and where you need to make adjustments.
- Debt Management Plan: Not all debt is bad. For example, mortgages can help build equity and boost your credit scores. High-interest consumer debt like credit cards dramatically affects your credit score. And every dollar you pay in finance charges and interest is one you cannot put toward other goals. If you have high-interest debt, create a plan to help you pay it off quickly. If you are unsure of how to proceed, financial planners can help you. They will show you how to prioritize and determine how much of your budget should go towards monthly debt.
- Retirement Plan: An old saying is that you will need about 80% of your current income in retirement. But remember that applies if retiring frees you from any work-related expenses and taxes. Or you have paid off your mortgage, and your children will be financially independent. Also, Medicare does not cover everything, and the things it does not cover (ex., Long-term care) can add up quickly. You may spend more on other things in retirement, such as travel, dining out, gifts, or financial support for a relative or friend.
- Emergency Plan: When unexpected things happen (losing a job, receiving an unexpected medical bill), emergency funds can help you cover these periods. You will not have to worry about disturbing your long-term savings to support yourself. Having enough savings to cover at least three to six months of essentials (groceries, housing, transportation, and utilities) is ideal. Store the money in a liquid checking or savings account so you can access it quickly.
- Insurance Coverage: Insurance is a significant part of protecting your financial struggles. However, you should not overpay for coverage you do not need. Generally, it would help if you had health insurance, disability insurance, auto and homeowners’/renters’ insurance, and life insurance. It is essential to have coverage in case an injury or illness occurs, you or a loved one cannot work, and other types of instances. Make sure you are adequately covered in each of your plans.
- Estate Plan: At the very least, you should have a will stating your final wishes regarding your assets, dependents, and who you want to administer your estate. Also, keep the beneficiaries of all your insurance policies and retirement accounts current. And consider cementing powers of attorney for financial and health care decisions (in case you become incapacitated). Knowing and following the good components of financial planning can create a better future for yourself and keep track of your financial goals.
What is the Example of a Financial Plan?
Various situations apply to financial planning. Suppose you want to take a trip abroad with three friends. You must be realistic about your current financial situation and what you envision in the future. You will likely have to cut back or adjust certain things to accomplish something. If you desire to travel abroad with friends, you may have to delay the trip you wanted to take with family five months later. Or, you may have to postpone your trip to focus more on retirement savings and education funding. Having a financial plan helps you navigate through these decisions.
Who Helps in Financial Planning?
Financial planners typically help people with financial planning. They help clients manage their money and reach their long-term goals. Financial planners have a vast and thorough knowledge of personal finance, taxes, budgeting, and investing. They can also specialize in tax planning, asset collection, risk management, or retirement planning. If you need more financial planning assistance or want someone to confide in about certain matters, consider hiring an advisor. They can help you with various situations to help you obtain what is best for you.
How can Financial Planning Benefit Individuals?
Financial planning can benefit individuals in numerous ways. Creating a strategy for your savings is part of any concrete financial plan. You should have a good understanding and insight into your earnings and expenditures. You will then discover how much income you have to save or how much you can alter your current budget. Also, you do not have to lower your living standards to make better financial decisions. Your goals can still be accomplished while living in moderate comfort. However, it would help if you prepared yourself for crises. Having an emergency fund is a vital component of financial planning. Aim to have at least six months of your monthly earnings stored for emergencies. This way, you will not have to worry about producing funds and can handle things as they arise. Moreover, you can cover monthly costs, invest in future dreams and goals, and spend somewhat lavishly on yourself and your loved ones without worrying, with sufficient funds. Financial planning enables you to organize your money and enjoy peace of mind that your bases are covered.
How Much Money Do You Need for Financial Planning?
The amount of money you need for financial planning will vary based on your goals. Every situation is different and requires a specific timeline for planning and investment. For instance, you may plan to save for a weekend trip a few states away, an opportunity to go to trade school, and a family trip abroad in the same year. But, the trip abroad may cost more and need more planning than the weekend trip and savings for trade school.
If you are considering hiring a financial planner, each professional receives payment differently. Some take money upfront and help you through your financial situation hourly. While it costs more initially, you can possibly save more. This mainly applies if your financial advisor offers a percentage-based fee, and you bring in a substantial amount to their firm. Ensure you know your needs and consult with various financial planners before making a final decision.
Is Financial Planning Beneficial?
Financial planning is beneficial. It does not have to follow a specific structure or format. Still, the purpose is to be able to examine your financial situation and manage your money efficiently. You should be able to live without worrying about your finances and how your future will pan out. Also, once you set up a plan, it is okay if things do not always go accordingly. Financial plans are a guide to help you accomplish various things. You may discover that you have to save more for something than you believed. Or, you may find that you can afford to go back to school without sacrificing anything else you want to achieve in a year.