In the most basic terms, financial planning is the management of one’s financial resources for consumption, investment, retirement and insurances. In simple terms, it is the forecasting or prediction of future financial conditions on a long term basis. The process helps an individual understand what his/her financial position is and how it will evolve in the future. A sound financial planning helps people avoid unfortunate situations like inflation, unemployment, deflation, credit crunch, financial crisis, price rise etc. Financial planning is indeed very important.
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In reality, financial planning is a systematic way of setting goals, identifying possible obstacles and calculating the required financial resources to achieve those goals. In layman’s terms, it is the art of being able to foresee the goals with the appropriate amount of resources. In simpler terms, it is about setting up a savings plan so that you can reach your retirement or purchase a luxury so that you can enjoy life to the fullest. In layman’s terms, it is about investing in education, health, children and future for better future.
Financial planning helps you to chart out a strategy to reach specific financial objectives with realistic estimates of investment returns, time period and cost involved. The objective should be a long term objective such as purchase of a car or house or saving for retirement so that you reach that age without any difficulties. For investment purposes, financial planning helps you make the right investment decisions on the basis of present day conditions as well as projections of future market conditions. If your objective is to purchase a car now, your investment planning decision should take into account future fuel costs, insurance premium, maintenance cost, etc. This is very crucial because the wrong investment decisions can lead to future complications.
The major components of any financial planning roadmap are finance, goal setting, investment objectives, control, identification and measurement of key drivers, risk management and benchmarking. The process of formulating a financial plan includes setting a budget, creating a financial plan, determining the maximum amount of money you can borrow or invest, determining the purpose of your financial plan, implementing the plan, monitoring the effectiveness of the plan, and testing the results of your plan. The major components include finance which includes allocation of the total cost of capital to the various investment projects; goal setting which includes the determination of what the overall objectives are; investment objectives which are based on current and future conditions; control which involves identification of key drivers and risk management which includes measures to protect the interests of your creditors. The measurement of key drivers is important because it will determine whether the plan is working effectively and the benchmarking is used to evaluate the performance of your plan and your individual investments.
Your financial planning map should include all the major financial objectives that you wish to achieve in the long term. If one objective is not achieve, you can easily move it to the next objective. The objective and savings rate of each area of your financial planning map should be equal to the benchmark rate. Another important aspect of your overall plan is savings rates. The rate of growth of your savings should be based on your current and projected earnings. This ensures that your long-term financial objectives are reached.
Proper financial planning helps you achieve the future goals and prevent emergencies. Emergency funds are usually short term saving tools whereas long-term saving is usually achieved with prudent investing strategies. The two types of strategies are usually used interchangeably.