Personal Financial Planning

Personal Financial Planning

“We all work for money, but making money work for you is financial planning” – anonymous investor.

If this sentence interests you, go on reading further. I will try to explain about the basics of financial planning.

So, what is financial planning?

According to Nimish Shah, Director and CEO of Parag Parikh Financial Advisory Services - ‘Financial Planning’ is a process that emanates from our concerns for our financial future. We all need to plan a safe and sound financial future so that our family can continue to lead a desired life style. It helps create and preserve wealth for the generation next. Financial planning involves investing in the right mix of wealth enhancing asset classes so as to meet the financial needs of the future.

According to Financial Planning Standards Board, Financial Planning is the process of meeting one’s life goals through the proper management of his finances with the help of a Financial Planner.

Based on these, we can say that financial planning involves sacrificing the present pleasures for the benefit of future rewards.

Why we need financial planning?

A need, as defined by the Oxford dictionary, means “a situation in which something is necessary or must be done”. Need Analysis is the process of identifying and evaluating needs. The well known theory of needs is Hierarchy of Needs Theory by Abraham Maslow. Maslow's theory suggests that the most basic level of needs must be met before the individual will strongly desire (or focus motivation upon) the secondary or higher level needs.

In today’s scenario, all these needs can be satisfied if a person has a very essential resource – “Money”. Money has become the most important thing to satisfy ones needs and to achieve ones goals in life.

So, financial planning involves careful need analysis followed by taking investment decisions. Investing is an act of putting ones savings to work with a view to earn further wealth. It’s about taking reasonable risks to reap steady rewards. Here, finance enters the area of Psychology creating a new entity called Behavioral Finance. Traditional theory of finance – Efficient Market Hypothesis considers that markets are always efficient and that investors make rational decisions. According to Behavioral Finance, the markers are inefficient and investors frequently make irrational decisions. Most investment decisions are taken on the basis of Fear or Greed. The options for investing are continually increasing and individual agents/advisors are at best product sellers and are able to provide only limited advice.

This calls for a systematic professional approach for Personal Financial Planning.

What is Personal Financial Planning?

Personal Financial Planning is planning for your financial needs, present as well as future, while keeping in mind your income. Planning and Decision making are the most basic activities of management. The monthly cash inflows have to be adequately distributed between spending and accumulating wealth. It is a step-by-step process, and involves six main steps as shown in the diagram.

1.       Determine current financial situation:

Before planning for the future, you should assess the financial position you are currently in. What are the assets you own as of now? What are the liabilities or loans including credit cards? What is your net worth? The answers to these questions will make you aware of the present situation and on this basis planning for the future can be done.

2.       Develop your financial goals:

Financial goals are the road-map of a strategy for you to implement. Financial goals are based on the term and priority. By the duration of attainment of the goal, financial goals are classified into short-term, medium-term and long-term goals. If the horizon of investment is one year or less, it is classified under short-term, if the goal is set for the next two to five years, it comes under medium-term goals and goals having horizon of more than five years come under long-term goals. You can also prioritize these goals into three levels – low, medium and high.

3.       Identify alternate courses of action:

This is the core part of personal financial planning. Depending on your goals terms and priority, have a separate plan for asset acquisition, liability reduction, risk management through insurance, tax, retirement and estate planning.

 4.       Evaluate alternatives:

Once you decide on various plans for action, choose from a gamut of various investment alternatives considering life situation, personal values, economic factors, risk and time value of money.

5.       Create and implement your financial plans and strategies:

This is the practical part of your financial planning. Based on the chosen alternatives, decide on the financial intermediary to deal with and complete your investments.

6.       Review and revise the financial plan:

As the environment is very dynamic, review your plan once in a year (or once in six months) to keep it on course to meet your financial goals. You may have to balance your portfolio, liquidate some investments or increase investments into some.

Personal Financial Planning and Nation’s Growth

Individual is the basic unit of economy. As financial health of companies is important for the economic growth, individuals’ financial health is also very important. The government runs on taxes that we pay, our savings and investments form the backbone of the equity and debt markets which in turn fund companies for their growth. Therefore, it is of paramount importance that the financial future of individuals is secured. Similarly family is the basic unit of society. Unless, maximum number of families grows financially, the society will not prosper. The importance of personal finance cannot be better underscored and it is important to gauge and monitor the financial health of individuals. So, for the nation to grow, every literate needs to plan their personal finances properly and have a financially secure future.