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Financial Planning

Many times, you wonder if it is necessary to have an investment strategy. Is it not adequate to manage expenses and set aside a certain amount from your income towards savings? An introduction to financial planning is necessary to allocate your savings to the right assets with a specified timeline to align with your risk appetite and financial goals for wealth creation over time. ...Read More

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Financial Planning

Financial Planning: Definition, Importance & Benefits

Financial Planning
December 03, 2024

Table of Content

 

What is Financial Planning?

Financial planning is the pathway to planning for your future. It gives you an idea of how to manage your expenses and savings within the available resources to be equipped for emergencies and other financial objectives.

Financial planning entails setting up financial goals, assessing your current financial standing, creating an emergency fund, investing for the future, and reviewing and readjusting your investments. In simple words, financial planning definition is — having control over your finances with respect to income and expenditure and investing meaningfully to grow your money and create wealth for a secure financial future.

What is the Purpose of a Financial Plan?

Financial literacy is important for prudent financial management. Financial planning comprises setting goals, budgeting, investing, tax planning and much more. The primary purposes of a financial plan are:

  • Fulfilling Short and Long-term Goals

Setting milestones for different life stages is one of the primary financial planning objectives. It could be owning a car or a dream house, planning a family trip, building an emergency fund, children’s education, retirement planning, etc. Financial planning navigates you through the journey with a financial strategy to create wealth and fulfil your financial goals.

  • Safeguards Against Inflation

Inflation has a great impact on the value of your savings and investments. The importance of financial planning lies in defining investment strategies that fetch returns to beat inflation. It helps you wade through the rising cost and preserve the goals set for different life stages.

  • Keeps You Equipped For Emergencies

Unforeseen expenses that crop up at various times in life drain your finances. The financial planning process enables you to manage your finances and set aside certain amount for contingencies and ensures that you are prepared for such emergencies.  

What are the Different Types of Financial Planning?

The extension to understanding what is financial planning is awareness of different types of financial planning. The following are the different types of financial planning:

  • Tax Planning

Tax planning involves finding ways to minimise tax liability and increase tax refunds. It involves analysing income, expenses, investments, etc., and finding tax-saving opportunities. Financial advisors will help you to strategically arrange your finances and develop tax strategies while adhering to tax laws.

  • Estate Planning

Estate planning simplifies the process of identifying legal heirs and passing on the assets when you leave the world. The life stage you are in matters while planning the inheritance. Whether you are single, married and having children, or have any other legal objectives. Estate planning also prepares you for any estate tax you are liable to.

  • Retirement Planning

Retirement Planning enables you to create a regular income stream as well as build a corpus for a future date when you stop working. A retirement plan involves allocating funds to a long-term savings plan like NPS, PPF, etc., during the career days. It ensures financial independence during your post-retirement years.

  • Philanthropic Planning

If charitable giving is one of the financial objectives of financial planning, then philanthropic planning helps create a strategy that aligns with your resources, values, and goals. This approach helps in identifying ways to make effective contributions taking into account the tax implications.

  • Education Funding Planning

The constantly changing education costs mandate planning for every stage of your child’s education. Understanding the impact of inflation on the costs, analysing your current financial standing and finding different investment avenues for better returns with tax benefits are components of the planning. Child plans are specifically designed for the purpose of education fund planning.

  • Investment Planning

Investment planning helps you draw a chart of various investment opportunities and defines the extent of allocation to each of them. A diverse investment portfolio balances the risk involved and minimises the losses on the returns. Planning your investments by having robust investment plans in place can really help you achieve your financial goals.

  • Insurance Planning

If you prioritise your family’s financial security, insurance planning should be one of the main goals. Evaluate your insurance needs, compare different life insurance plans, and purchase a plan that offers high coverage for an affordable premium.

  • Budgeting

Budgeting is the foundation of financial planning. You will have a spending plan that rules out unnecessary expenditures. It helps set long-term goals and makes sure that your investments are within your financial resources and that the savings are on track for the future.

What is a Comprehensive Financial Plan?

A comprehensive financial plan comprises a detailed financial analysis to gauge your current financial health. It warrants a discussion about short and long-term goals and planning an investment strategy to take you from the current financial position to where you aim to be in years to come.

Drawing a charter of goals, reviewing financial documents to understand the current financial position, equipping for unforeseen expenses, investing for the future, and reviewing and redefining the asset allocation periodically to match the changing goals and financial scenario are all components of the financial planning process. For example long term financial goals can be achieved by investing in long term investments such as life insurance, NPS etc.

Key Steps to Create a Successful Financial Plan

Now that you have understood the importance of financial planning here are some of the key steps to create a successful financial plan.

  • Setting SMART Objectives

Goal setting is the first move towards financial planning. Your short and long-term planning should be realistic and achievable. The goals include creating an emergency fund, funding children’s education, financial independence post-retirement, owning a home, buying a car, etc.

  • Assess Your Current Financial Situation

Assessment of the current financial situation requires cash flow analysis, i.e., how much comes in and how much goes out. This is the most difficult part, as accounting for every penny spent can be overwhelming. However, it is an integral part of evaluating the resources available for investment to meet the goals set.

  • Develop a Budget

Budgeting involves tracking expenses and eliminating unnecessary ones. Debt management, i.e., paying off expensive debts to reduce the cost of debts, restricting expenses to mandatory requirements like buying groceries, paying utility bills, etc., creating an emergency fund, and allocating funds for investments, are also elements of budgeting.

  • Develop an Investment Plan

Develop an investment plan based on your specific needs, risk tolerance, and time horizon. The plan includes allocating funds to high-yielding savings for emergency funds and creating a diverse portfolio to build a corpus for funding long-term goals.

  • Review and Adjust Regularly

The goals change with changing life stages and so does the financial position. Review the financial plan periodically, at least once a year, and adjust it if necessary. It enables tracking the progress towards financial fulfilment. In the meantime, if your goals and financial situation change, you can make changes accordingly.

  • Invest for Future

Investing for the future provides financial security and prevents you from falling into a debt trap. You will be prepared for the financial goals emerging at every life stage. For instance, you can make systematic investments in child insurance plans to fund your children’s education, pension plans for retirement planning, high-yielding savings accounts for emergencies, etc.

When to Create a Financial Plan?

Having understood the financial planning definition and the importance of financial planning, you should also know when to create a financial plan. There is no defined time to create a financial plan. However, different life stages can be a motivation to create a financial plan.

  • Parenthood

Figuring out ways to fund children’s school, college, and higher education motivates the parents to create a financial plan which serves as a game plan to achieve the goal.

  • A Sudden Income Hike

Lifestyle changes with sudden income hikes and a need to create a financial plan arise to preserve finances to maintain the lifestyle even in changing situations.

  • Health Issues

Serious health issues can emerge at any age. Sudden medical expenses can cripple your finances and persuade you to dig into the savings preserved for other financial goals.

What is the Financial Planning Process?

The financial planning process is a roadmap for the financial future. It involves assessing your current financial situation, identifying your future goals, and working towards achieving them.

The process involves various steps like setting financial goals, reviewing documents relating to your finances and sequentially arranging them to understand your current monetary situation, drawing a comprehensive financial plan, creating a budget, building emergency funds, investing for the future, and reviewing and readjusting your plan.

The process helps in heading towards a robust financial future by readjusting investment strategies to match the changing income scenario and goals.

Benefits of Financial Planning

Knowing the importance of financial planning and the benefits attached are equally pivotal to being motivated to create a plan. Some of the key benefits are:

  • Clarity and Focus

With a financial plan, you will have clarity about your financial status, investments, and the resources available. You will be prepared to grab opportunities or to face any emergencies. You will have a better understanding and will be capable of smart investment choices whenever there is additional income.

  • Goal Achievement

Accuracy in saving is essential to achieve your goals. Income planning is a part of financial planning that gives insight into the resources available and how it has to be allotted to achieve the various goals on your bucket list.

  • Improved Financial Management

For improved financial management, a financial plan is an absolute necessity. It sets a road map to achieve your future financial goals considering your current income and expenditure. You will have control over your finances with your expenses, and taxes well managed.

  • Risk Management

Risk management is an important element of a financial plan. It manages market volatility, protects your assets and prevents capital erosion. It helps you seize opportunities and make informed decisions.

  • Maximised Returns

With an investment plan aligning your goals and risk appetite, a financial plan maximises returns. Through risk assessment, a financial plan enables appropriate investments to balance potential risks and minimise losses.

  • Financial Security

A financial plan sets goals, creates a budget, builds an emergency fund, and draws well-structured investment plans to meet the goals. It provides financial security and prepares you for any unforeseen events.

  • Peace of Mind

One of the major benefits of financial planning is a secure future. You can be stress-free when you have sufficient funds to meet your goals. You will not have to worry about uncertainties that might emerge in the future, with wise investments yielding good returns.

  • Adaptability and Flexibility

A financial plan facilitates changing the investment strategies according to the changing circumstances. It could be a changing market scenario, a rise or windfall in income, a change in goals, etc. With a well-structured plan, you can adapt to the changes, tweak the investment strategy, and progress towards your goals.

Objectives of Financial Planning

Financial planning helps you achieve your financial goals with a strategy that navigates your finances in the right direction. The basic purposes of having a financial plan are:

  • Wealth Creation

It helps create wealth to achieve your long-term as well as short-term goals.

  • Risk Management

Identifies potential risks and helps adjust the investments accordingly to balance the risk and minimise losses.

  • Retirement Planning

It helps invest in long-term plans to build a corpus and create a regular income stream to meet post-retirement needs. Retirement planning can be really enhanced with proper financial planning.

  • Tax Planning

It helps understand tax laws and make tax-efficient investments to derive the benefits under various sections of the Income Tax Act 1961 and reduce overall tax liability.

How Much Money Do You Need for Financial Planning?

An introduction to financial planning is not complete without understanding how much money is required for financial planning. It should be commendsurate with your resources goals. However, following the general rule i.e., the 50/30/20 rule gives a fair idea. As per the rule, 50% of your income should be allocated for living expenses, 30% to spend as per your choice, and 20% towards savings for long and short-term goals.

What are the Five Main Parts of Financial Planning?

Financial planning involves various steps, but the main parts are:

  • Perusing your finances from a tax efficiency perspective is smart tax planning. To reduce tax liability, you can claim various tax benefits under Sections 80C to 80D of the Income Tax Act 1961.
  • Insurance planning encompasses term insurance to secure your family’s financial security and health insurance for medical treatments.
  • Investment planning is crucial to achieve your financial goals. It helps to invest savings generated over a period to reap returns. Asset allocation to align with individual risk appetite and goals is the core purpose of investment planning.
  • Retirement planning helps evaluate your specific needs post-retirement and invest accordingly. The purpose of the planning is to ensure financial freedom after retirement, even in the absence of regular income.
  • Estate planning is about ensuring that personal assets are effectively distributed among the right persons.

Understanding the Difference Between Financial Planning and Wealth Management

You should not misunderstand financial planning with wealth management, as there is a vast difference between the two. Below are some of the differences:

Basics

Financial Planning

Wealth Management

Purpose 

To manage the income and expenses and invest wisely to attain financial security

To maximise returns from the existing investments

Scope

This involves understanding different financial instruments and mapping financial goals to respective financial instrument.

Allocating assets to match the goals and risk tolerance, portfolio adjusting, and new investments.

Management Type

Passive management. Financial plans are for the future. Does not need regular monitoring.

Active management. Have to monitor the performance of existing investments and balance them according to market trends.

Financial decisions 

Current financial status, goals, and risk tolerance govern the decision.

Based on the existing investment portfolio.

Conclusion

Financial planning is a tool for your existing and future financial health. It entails assessing your current financial standing, setting goals, and creating an investment portfolio to create wealth for accomplishing the goals. There is no specific time to create a financial plan but the earlier the better. It offers you the flexibility to change the plan according to your changing life stage and income so that you are prepared to meet any monetary situation irrespective of your income levels.

FAQs on Financial Planning

Q. What is the meaning of financial planning?

Financial planning is controlling your finances by creating a comprehensive plan to build a corpus for financial stability. In the process, we examine various areas including income, expenses, investments, tax, estate, retirement planning, etc. to keep the finances on track.

Q. What is the objective of a financial plan?

The objectives of financial planning are goal setting, understanding the current financial position, creating a budget, building an emergency fund, investing for the future, and reviewing and adjusting the plan.

Q. What are the four basics of financial planning?

The four basics of financial planning are setting financial goals, gauging the current financial situation, creating a budget, and investing for short and long-term needs.

Q. Why is it necessary to create a financial Plan?

A financial plan helps you to set goals according to life stages, have a spending plan, and make wise investments to earn ample returns to fulfil your goals. It is a proven method to stay at the best of financial health at all times.

Q. What is personal financial planning?

Personal financial planning is a systematic approach to controlling finances. It involves understanding your finances, setting goals, creating a budget, building an emergency fund, making wise investment decisions, and monitoring and tweaking the plan periodically.

Q. What are the five steps of financial planning?

The five steps of financial planning are goal setting, evaluating your finances, creating a budget, building an emergency fund, and investing for the future

Q. What is long-term financial planning?

Long-term financial planning is having an investment strategy for needs that arise over several years or decades. These plans need regular reviewing and adjustment to align with the changing market scenario and life goals.

Q. What is short-term financial planning?

Short-term financial planning involves a structure that derives results within a year or much earlier. These plans prepare to meet any unexpected expenses that arise at any point, like medical emergencies. 

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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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Vishal Subharwal Vishal Subharwal

Vishal Subharwal heads the Strategy, Marketing, E-Commerce, Digital Business & Sustainability initiatives at HDFC Life. He is responsible for crafting and ensuring successful implementation of the overall organisation strategy.

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