Financial planning doesn’t come easily, but to know the meaning of financial planning and build a financial process for yourself is as essential as getting a job today. I wasn’t born into a wealthy family, so I understood the importance of saving my money for the future from a young age. The truth is, most people aren’t going to win a lottery. If you want to get ahead in life, it will likely take hard work, discipline, and a concrete strategy.
A solid financial plan may be the key to your financial freedom. And here are the steps in financial planning you can refer to and get a head start on your future planning.
A financial plan is a comprehensive guide to managing your finances to achieve your monetary goals. It takes into consideration an individual's current net worth, savings, cash flows, debt, and long-term goals.
It isn’t possible to have a one size fits all approach when it comes to financial planning. Several factors like your current earnings, savings, loans etc. can affect how you should decide what’s best for your financial future. Understanding the components and steps in financial planning should make these decisions easier.
If you’re just starting out in your career and reading this to plan out your future, you’re already ahead of most. Financing planning has a few key components that help create a roadmap for your financial future. While there are several components involved, here are five most prominent components of a financial plan that can help you start out
Anyone who is looking to chalk up a financial plan must clearly understand their goals. These goals can be categorised into -
Every good financial plan must include a risk management strategy. The amount of risk an individual is comfortable handling depends on person to person. Despite the difference in risk profiles, all risk management strategies should include a plan to pay off an individual's debt over time.
It is important to have a retirement plan. People often take their financial situation for granted as they get older. It is crucial to understand how much money you need to save by the time you retire so you can live comfortably. The amount you need to save till you retire will depend on your standard of living, how much you spend, on the things you spend etc. Retirement plans must also include long-term investment strategies.
It is always a good idea to have contingencies in place in case of an emergency. While making a financial plan, it’s recommended that you set aside six months to a year’s worth of expenses. This will give you a buffer period in case of a rainy day. (Like losing your job, for example)
Many good long-term financial plans have fallen prey to a lack of insurance coverage. In the midst of achieving your financial goal, there’s always a risk of an eventuality that can occur, leaving all the burden on your family. Insurance can help avoid having to shell out massive chunks of finances towards a medical condition or fix your car in case of an accident. What insurance coverage you must have depends from person to person. Even so, it’s advisable to have medical and life insurance for most people.
It is important to understand that these components are not individual strategies but rather moving parts of the financial planning machine. Each component works in unison with one another.
If you’re looking to increase your wealth with time, then the importance of having a concrete financial plan cannot be stressed enough.
1. A financial plan can go a long way to reduce your stress and instil peace of mind. Knowing that they are financially secure allows you to pursue your dreams and hobbies with a reduced fear of failure.
2. Having a sound financial plan makes it more likely for you to achieve your financial goals. This is a direct result of the roadmap set by a financial plan for its users. Having a set path with a defined goal instils patience and financial discipline.
3. Having a set spending budget, understanding of cash flows, and investment strategies leads to smarter allocation of finances. Once you know why you are saving money, you are less likely to splurge it on things they do not need.
4. Sticking to a financial plan long-term helps prepare for emergencies. A good financial plan ensures that you have life, health, and property insurance. Following a financial plan will also make sure that your debt is kept under control.
5. A good financial plan accounts for your tax liabilities as well, making them easier to tackle. Avoiding tax is a crime, but understanding the taxation system helps mitigate your outstanding liabilities.
Examine your current financial situation by calculating your net worth. You can do this by subtracting your total net liabilities from your total net assets. A measure of your net worth will make it easier to start planning your financial future.
Assets - Liabilities = Net worth
Determine whether you wish to take on low, moderate, or high risks. Based on your choice, you will need to adjust how you save and invest your money as well as how much money you are willing to borrow in the form of loans.
The third step in the financial planning process is determining your goals. Ideally, you should break these goals up into short-term, medium-term, and long-term goals.
In case your plan goes south, which it may, you should always have a contingency fund with 6 - 12 months of expenses. If you wish, you can also increase the size of this fund for more security.
Once all these factors are considered, it is time to begin implementing your financial plan. Remember, this is a long-term commitment, and it needs patience, discipline, and time to take effect.
You should periodically review your current financial plan and make changes if necessary. These changes could include saving a higher percentage of your income over time or trying to reduce expenses if you’re undergoing a money crunch. A financial plan must be dynamic in nature, changing as the individual's goals or circumstances change.
Note: While it is okay to edit your financial plan, you should remember it is also a long-term commitment at the same time. You shouldn’t change such a plan on a whim- only when it’s well thought through or necessary.
Reaching financial freedom isn’t an easy process. Being financially free means having the ability to live your life without worrying about the next paycheck. Like any challenge, you give yourself the best possible chance at success through meticulous planning and execution.
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The three most important benefits of financial planning are
1. Improved standard of living: Following a financial plan generally leads to growing wealth in the medium to long term. This entails being able to gradually increase your standard of living and lead a comfortable life.
2. Financial security and freedom: Financial security and eventually financial freedom allow people to pursue their passions worry-free. They also reduce the stress of your family’s future.
3. Early Retirement: Most people tend to work for much longer than they wish to as they have to pay the bills. Adhering to a financial plan may allow you to retire early.
To create a successful financial plan, you should follow the steps in financial planning. Make sure you go through these steps thoroughly and take them one step at a time. Alternatively, you could consult a financial adviser to help you make your financial plan.
The five steps in financial planning are -
Financial planning has several types. These may be classified based on two parameters.
Time-based financial planning can be broken into short-term, medium-term, and long-term plans.
a) Short-term plan-
Short-term financial planning includes all the necessary steps to follow during the first 1 - 3 years of your plan.
b) Medium-term plan-
Medium-term financial planning involves the schemes to follow from years 3 - 10 into account. This includes things like
c) Long-term plan -
Long-term financial planning generally involves strategies for over 10 years.
Component-based financial planning is composed of all the types of “mini-plans” that come together to form a long-term financial plan.
a) Cash flow plan -
A cash flow plan includes understanding your current income and expenses to chalk up a budget to track the inflow and expenditure of your money.
b) Investment plan -
Investment planning is extremely important. This component ensures you allocate your resources in a timely fashion towards investments. Strategic investments can help grow your wealth over time, especially in the long term.
c) Retirement plan -
Having a retirement plan can be highly beneficial to stay secure in old age. Calculating the amount of money you need to save to maintain your standard of living post-retirement is crucial. Retirement planning may also include things like pension disbursements.
d) Risk management plan -
People often overlook managing risk when managing finances. This can be a costly mistake. An unforeseen medical emergency can run a lot of deep pockets dry. Managing risk involves strategies to ensure your health and safety, your property, and your finances. Having medical and life insurance as well as a rainy day contingency fund are two great steps you can take to begin your risk management journey.
e) Estate plan -
When it’s all said and done, you will likely leave most of your assets and finances to your family. It is important to ensure in the case of your demise that these assets and investments are readily available to your family to secure their future. An estate plan includes writing your will and nominating people as your successors for your bank accounts, portfolio, and property.
To keep it simple, a financial plan is a a document with all your current financial details and your financial aspirations. The plan looks into the details of how you can achieve your goals and the strategies you need to apply on a short and long term for the same. It's important to build on a financial plan to streamline everything from your budgeting to investments to ensure that you stay on track.
Still curious? Here are the top books to consider for financial planning: https://www.youtube.com/shorts/SE_gr9vAgHk
