What is financial planning and why is it important?

What is financial planning?

Financial planning refers to acquiring information about your financial needs and then making a comprehensive plan to reach your financial goals with as much certainty as possible.  

Financial planning considers the following factors: your current financial situation, what you wish to do with the money you will acquire, and how you are willing to invest your money to achieve your goal.  

Thus, to define it in a sentence, we can say that financial planning is a means to achieve your future goals through proper development and implementation in accordance with some general guidelines. 

Financial planning includes applying globally accepted management principles like planning, directing, organizing, and procurement of funds to invest and generate the maximum possible returns.  

It helps you prioritize your investment decisions based on the urgency of your goals. People have both short-term and long-term goals.  

For example, a short-term goal like buying a car in two years requires a much different planning approach than a long-term goal like buying a house in 10 years.  

Both these aims have entirely different capital, returns, and financing requirements. 

We can say that financial planning will lead to asset management and not the other way around. Once a plan is laid out, the implementation requires proper management of the available assets to generate maximum returns to fulfill your goals.

Importance of financial planning 

A significant advantage of a financial plan is that it helps you build financial security for yourself and your family as well can grow your assets and prepare for financial emergencies.  

It helps you fulfill your dreams. Some reasons why you should consider building a financial plan: 

1. Give a perspective on your financial goals

Once you have a clear goal in mind, you will be able to employ financial literacy in a well-defined direction to achieve your goals.  

With a plan, you also employ popular money-management techniques like the 50/30/20 rule (See here: Tips to follow for 50/30/20 Money Management Rule) and the (15-15-15 rule of investing), according to your needs. 

2. Income management

Through financial planning, you can prioritize monitoring a fixed budget for your expenses and moving towards investing a chunk of your income. 

3. Growth of assets

The ultimate purpose of a financial plan is to increase your asset base. By investing intelligently (with proper diversification and allocation), you will earn high returns and preserve your wealth, thus extending your investments and increasing your net worth. 

Start your financial planning journey now so that you don’t miss your goals by the margin. 

Steps to follow when creating a financial plan

1. Create an emergency fund

The first and foremost step towards saving is to create an emergency fund so that you do not want to disturb your financial routine if any emergency arises.

There are many formulas to create an emergency fund. One way is to create an emergency fund for six months of your expenses.

So, in situations like job loss, your emergency fund can take care of your expenses until you find another job. You can park your emergency fund in liquid funds to maintain liquidity. 

2. Make a monthly budget

Making a monthly budget will help you save money better, as you will be able to identify and analyze your income and expenses better.

In this step, identify all your income first and then expenses, where you spend most of your money. Making a monthly budget will assist you in segregating income and expenses into different categories.

To create a proper budget, you can follow the 50-30-20 rule. It says that 50% of your income should go towards your needs, 30% toward wants, and 20% for saving and investing. By following this rule, you can manage your monthly budget. 

3. Spend wisely

Spending wisely is as critical as making a budget. After making a budget, you can evaluate where to cut down your unnecessary expenses. And where you do not need to spend your hard-earned money.

For example, you may have bought a monthly subscription to some adventure park, but you may not be utilizing it. So, you can cancel your subscription and save a lot of bucks.

Also, don’t make quick decisions in buying things. Evaluate its cost and usage, then make a thoughtful decision. If you spend wisely, you can make a huge difference in future savings. 

4. Set goals

The next step is to set your short-term and long-term goals. Categorize your short-term and long-term goals based on their priority. And start saving for them.

For example, sending your child for higher education after ten years is an example of a long-term goal, but paying for the school fees in the next 11 months is an example of a short-term goal.

Identifying and prioritizing your goals is very crucial. Some parents could have a short-term goal to pay for a child’s higher education. So, it is essential to prioritize your goals based on time availability to achieve them.  

5. Create a savings plan

After deciding on your goals, create a savings plan for each goal. Try to save a fixed amount for each specific goal. Evaluate the cost of your goals; save and invest some money to quickly achieve your target.

For example, if you want to send your child for higher education in the future, and the cost of IIM Ahmedabad in 2030 may cost Rs 60 lakhs, to save Rs 60 lakhs in the next eight years, you need to save and invest Rs 34000 every month in such asset class which can generate 14% annualized returns over the period.

So, creating a savings plan for each of your targets is vital, such that you know how much you need to save and for how long. Before investing your money in any of the asset classes, please do thorough research on it. 

6. Review the plan

After creating the savings plan, try to review the same yearly and see whether the savings and investment are on track. If they are not aligned with your goals, review your savings plan and make the changes accordingly.