What is Financial Planning?

Importance of Financial Planning

The Importance of Financial Planning: Your Path to Financial Success

Financial planning is extremely important in your personal finance journey. In fact, your financial journey begins with a sound financial plan, it is the first step. Whatever are your financial goals - be it buying your first house, saving for your children’s education, or ensure a comfortable retirement - a well-crafted financial plan is the roadmap to meet these goals.

In this blog, we will look at the essential aspects of an effective financial planning process that will put you on the path to achieving your financial goals.

What is Financial Planning? 

Financial planning is the process of setting your financial goals, evaluating your current financial position - analyzing your income, expenses, savings, and investments, and taking steps toward the financial goals. In short, it’s about preparing a framework for your financial decisions. An effective financial plan acts as a blueprint for managing money and covering for unexpected financial risks.
A common misconception is that the scope of financial planning is limited to tax saving or investment decisions. If you believe that financial planning is not for you because you have either too little money or too much money to handle, think again. Financial planning is essential for everyone—whether you're a gig worker or a CXO in a high-rise office.

A comprehensive guide to Financial Planning

1. Set Financial Goals

The first step in your personal financial planning journey is to define clear and specific financial objectives or goals. Well defined goals provides direction and purpose for your financial planning. Your goals should be realistic, taking into account both your needs and wants.  For instance, while it may be tempting to dream about owning a luxury car or a penthouse, you must keep your financial priorities in mind. If you're planning to expand your family, then child financial planning - focusing on your child's health and education - should take precedence over other extravagant goals.

On the basis of the time horizon of each of these goals, break them down into three buckets of short-term (paying off credit card debts, EMIs), medium-term (buying a car), and long-term goals (buying a house, saving for children's education, or retiring comfortably).  

Next, prioritize each of the short, medium and long term goals based on importance and urgency. Now you can identify the most pressing objectives - short term and unavoidable goals (next months credit card b bill) and the long term goals and important goals (retirement planning) and take necessary saving and investment decisions to meet these goals. 

Remember, goal setting is a dynamic process that should be recalibrated regularly to reflect changing priorities. 

2. Net Worth and Cash Flow Assessment 

Once you have clear goals, it's time to analyse your current financial position. This includes calculating your net worth - the difference between your total assets (savings, investments, property, gold, valuable art, etc) and total liabilities (loans, credit card debt, EMIs). 

You should also conduct a monthly cash flow assessment - evaluating your incomes (salary, rental income, dividend income, etc.) and regular monthly expenses (EMIs, bills, groceries, entertainment and other discretionary spends, etc.). Cash flow assessment can help you identify the amount of money (if any) left after all monthly expense are met, and where you can potentially save money, which expenses can be cut down and so on. 

Such analyses helps you understand where you stand financially and what steps you need to take to improve your financial situation. By regularly tracking your net worth (ideally every year) and cash flow (ideally every 3 or 6 months), you can better understand your spending patterns, saving potentials and the how far off your are from your long term financial targets. 

3. Research and Asset Allocation

With a clear picture of your financial position, you can move on to the next step of educating yourself of different available avenues of investment and deciding how to allocate your savings in fruitful investments. Allocation is the process of diversifying your investments across various asset classes such as equity instruments (stocks, mutual funds, etc.), debt instruments (fixed deposits, bonds, NCDs, etc.), real estate, gold, etc. to grow your wealth and minimizing possible risk. 

The right asset allocation will depend on your financial goals and your risk tolerance so this will be different for every individual. For instance, if you are just starting off with your career, you might choose a more aggressive allocation of risky investments so as to gain maximum returns (like equity). As you approach your retirement, you may add more conservative options in your investment basket like bonds, gold, real estate, etc.   

Finally it is always a good idea to involve an expert to guide you through this process. 

4. Tax Planning

Tax planning is another crucial aspet of financial planning. Understanding how taxes apply can significantly impact your financial decisions. You should familiarize yourself with the tax provisions, the applicable taxes, the relaxations and reliefs on offer. 

Remember that investments should not be done for the purpose of tax saving. The primary goal of investments is growing your wealth. However, you should know what are the taxes applicable in various situations so you can take correct financial decisions. To give a few examples: 

1. You should know that your Provident Fund or PPF or NPS withdrawals do not incur any tax.

2. You should know the taxes applicable on redemption of mutual funds, selling equity shares, selling property, etc. 

3. You should be aware of taxes applicable on various types of incomes - dividends, savings account interests, F&O profits, and so on. 

Consulting a financial expert Chartered Accountant (CA) is highly recommended to understand taxes and take informed financial decisions of investing money, selling investments and property.

5. Build and Emergency Fund

An emergency fund is an essential component of any financial plan. This fund serves as a safety net for unforeseen events like medical emergencies, job loss, or urgent home repairs, etc. Ideally, your emergency fund should cover 3 to 6 months of your living expenses and be in a highly liquid, easily accessible account and less risky investment  - such as a savings account, liquid debt mutual fund, Fixed deposit which can be easily liquidated.

Having an emergency fund helps maintain financial stability and also reduces stress, providing peace of mind with the knowledge that you are prepared for an unexpected event. 

6. Risk Management

Risk management involves identifying potential risks to your financial well-being and taking steps to mitigate them. This includes protecting both physical assets (such as health, home, vehicle, valuables, etc.) and financial assets (investments)

To protect against physical risks, purchasing insurance policies (term insurance, medical insurance, auto insurance, etc.) is a wise thing to do. Always remember that insurance should only be considered as a safety net and not as an investment or tax saving tool (so always go for term insurance and not a life insurance where you get your money back after the policy tenure).

Selecting the right insurance which aligns with your needs is important and this requires detailed study of your needs, risks, number of dependents, number of earning members in the family, and many other parameters. 

To safeguard your financial investments from risks like economic downturns, sectoral and market fluctuations, etc., diversification is an essential factor to consider. It is advisable to have a healthy mix of equity, debt, gold/ silver, property in your investment portfolio. This diversification will depend on your financial goals, age, risk appetite, etc. 

7. Retirement Planning

Retirement planning is one of the most critical components of financial planning. The earlier you start, the better. You will work for 35+ years, but post-retirement, you'll need to sustain yourself without a salary for another 30+ years (depending on how long you live). It's essential to understand inflation, the time value of money, and how much you need to retire comfortably. 

Start building your retirement corpus as soon as you start working. Regularly review your retirement plan and consult with a financial expert to ensure you're on track to meet your long-term financial goals.

The Path to Financial Security

Financial planning is not a one-time task; it's an ongoing process that evolves with your changing needs, incomes and other circumstances. Regular financial planning and analysis should be done to make necessary adjustments and stay on course to reach your goals.

Financial planning should start the very moment you begin earning, helping you build a solid foundation that supports your dreams and ensures a happy future. 

Remember, it's not about how much you earn - it's about how well you manage what you have. the sooner you start financial planning, the sooner you can start investing and unlock the doors to financial freedom. Remember the first rule of investing - Start early, stay invested! 

So have you made your financial plan?