What Is Financial Planning?

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What Is Financial Planning?

Financial planning is the method of managing one’s finances in order to achieve one’s goals and dreams. While everyone already does it to some extent, the term in its professional use involves a set of procedures that individuals can use methodically. (In its simpler use, a financial plan can be as short as a single page with a small set of goals and actions—such as paying off debt, starting a retirement account, and opening an emergency fund—and a way to monitor them.) The goals and associated action steps in a professional plan are defined, measurable, documentable, flexible, and reviewable. They serve as a guiding light that you can use to achieve financial success in your life. A financial plan subjects your income, spending and goals to a process that can provide insight and discipline to your financial life. In modern times, most of it is done with the aid of special software.

Why it is important

Financial planning is therefore important because it is a rigorous discipline that directs the way you use money and helps achieve efficiency with it. Like any plan, financial planning requires that you set goals. By seeing the end goal you want to achieve, you can see how you need to allocate the money you earn. By reviewing your plan periodically, you can see where you have gotten off track and where you need to make changes.

What it covers, and the tools it uses

Financial planning covers a number of life areas such as your assets and your income, taxes, and retirement planning, among many others. It addresses a number of specific goals, from removing debt, to funding a retirement plan, to allocating income to major purchases. It even helps you plan for where your money will go after you die.

Financial planning has a lot of tools that individuals (and their financial planners, if they choose to work with them) can use to set goals and gauge progress. For example, a budget is a simple tool that you can use to plan your spending. Budgets are among the most important tools you can use in your financial plan. You also have personal balance sheets, statements of cash flow, and income statements that can be constructed to give you a sense of how your money is doing. You may have financial forecasts, what-if scenarios, and several portfolio scenarios graphed out for easy viewing. These statements are usually offered by professional financial planners as part of their services. They involve various financial calculations that are typically made with financial software.

Although financial planning can be done on your own to some extent, there are professionals who specialize in it. Many of these professionals have undergone extensive education and experiential training to hone their skills. They know how to gather information and present it mathematically in order to give you an accurate roadmap to your finances. Many have designations such as CFP® (Certified Financial Planner™) behind their names that attest to their knowledge and experience.

Write it down

A financial plan is especially effective if it is written down. The act of writing makes you think through your goals and resources and plan their use methodically. Here are some typical sections in a professionally written plan:

• Disclosure information. Assumptions, explanations, methodology, engagement agreement
• Summary of goals and resources. Personal information, net worth summary, investments and other assets, liabilities, current portfolio, etc.
• Risk and portfolio information. Current vs. target portfolio, risk assumptions, investment scenarios, retirement distribution chart
• Risk management. What-if scenarios, disability needs, insurance needs, etc.
• Estate plan. What do you wish to happen when you die? Analysis, calculations, and what-if scenarios.
• Appendix and notes. Risk assessment questionnaire, assumptions, indexes used.

Professionally written financial plans may be quite long—upwards of 100 pages or more. But no two plans are the same—they differ according to who is writing them and what is being covered.