Saturday, September 10, 2011

Need for Financial Planning

Over the last few years, the term “financial planning” has been very often used and heard by many of us. In this article we explore as to what this term really means and why it is important for us all.

Simply put, financial planning is the process of meeting your life goals through proper management of your finances. The life (read financial) goals can include buying a home, saving for your child's education & marriage or planning for your retirement or protecting your family. It is a process whereby a qualified financial advisor will consider your entire financial situation and goals and provide you with appropriate action steps to fulfill your goals and better manage your finances. It is not a one-time process but is continuous in nature as your life situations and finances change over time. You also need to regularly review your financial plans & your investments to ensure that you are well on track to meeting your financial goals / objectives.

Given the nature of today's life, with growing uncertainty, rising aspirations and increasing costs of living, doing a thorough financial planning has become a must for each of us. It is also better to plan and be ready for any situation rather than be passive and wait for things to happen before doing anything about it. A special case to mention is of Retirement planning, which has become very critical since the average life expectancy has increased and appropriate planning is needed to ensure that your 20-30 years of your life after retirement is dignified, peaceful and self reliant.

An important point to understand is that financial planning should be done through a qualified financial planner, preferably a CFP (Certified Financial Planner), or an expert who can advise you holistically on your entire financial situation. Typically financial advisors give advice on areas of insurance or Risk Planning, portfolio or Investment Planning and pension or Retirement Planning. There are also other important areas like Tax Planning, Estate Planning (wills & related aspects), Cash Flow planning, etc. which can be covered in your comprehensive financial plans. Remember that the advice you receive from an insurance broker or a mutual fund distributor or your Accountant will typically be limited to their own area of expertise with chances that they will recommend their own products, independent of your actual financial need.

A financial planner is like your Financial Doctor of your personal finance, who will closely study each aspect of your financial life and accordingly give recommendations. Nothing is free and a financial planner would typically charge you 'fees' for the advice since this is his/her profession. This is something that we should learn and value just like we do it for almost every other service that we enjoy. If we are hesitant in paying fees, we risk getting free but biased advice from people who would seek income from other source, namely – product commission. A good, unbiased advice can help us save a lot of money and give peace of mind in long run.

We should understand that making our financial and investment decisions without a proper financial plan is like buying and eating medicine without any doctor's prescription and medical test. Typically after you receive recommendations for asset classes or actual products from your financial planner, you are free to purchase such products from any source or distributor.

To summarise, the following are the key reasons or benefits that you would get upon undergoing proper financial planning
  • To look at your complete financial situation, including your assets, liabilities, cash flows, financial goals, risk appetite, life situation, family background, etc.
  • To plan systematically for your financial goals and objectives, including life insurance, health insurance, retirement, child planning – education & marriage, house purchase, estate planning, investment planning, etc.
  • To make your financial life better and secured for yourself and your family and ensuring that all financial goals are achieved.
  • To better understand and learn about your financial situation and understand the reasoning and logic behind all recommendations made. Also to better understand the different asset classes and financial products and their suitability to you.
  • To regularly review the progress of financial plans and/or to revise the financial plans to accommodate any major change in personal life or financial situation.
Most of us do not have adequate information about financial planning and only in recent years has there been some growing awareness about it. Most of us though still believe that they are knowledgeable and smart enough to decide upon their finances on their own ignoring the fact that this is a very broad subject that requires professional expertise. We are ready to visit and pay an accountant, doctor, lawyer or any other professional but are shy when it comes to financial planners. A better, secured financial life is a dream for all of us which, with proper financial planning, can become a reality. The need is to be understand this crucial part of our life and give it the importance and priority it deserves.

Setting Smart Financial Goals

As kids we would have read the famous story of Alice in wonderland. In the story, she once reaches a crossroads and was not sure which road to take. A passing cat asked her where she wanted to go to which Alice replied “ I don't know!”. The cat then smilingly replied “Then it doesn't matter which road you take”.

The classic moment in the story is true to each of us in our daily lives. In our lives too we are often at crossroads like Alice and unknowingly we choose our roads without knowing where we want to reach in our life. When it comes to investments, this is in fact the reality for most of us. Since we don't know what we want to achieve from our investments, any investment decision helps us achieve it.

The need for setting goals can never be undermined, be it business, personal life or your personal finance. Every wise investor would know the purpose or objective behind his/her investments and more often than not, the same would be geared towards achievement of some goal in life. The goal can be any personal or financial goal like retirement or a fixed amount at any time in future, with the condition that it can be monetised or spoken in terms of money.

Advantage of setting goals:

The following are some of the benefits of setting financial goals in your life...
  • Goals make you think & prioritise: When you actually start planning for your goals, you are forced to evaluate the need, intensity and priority for each of your goal in life. This gives you a lot of clarity on which goals to pursue and in what priority. Often important goals which are not on the top of your mind, crop up and make you think. 
  • Goals make you take action: After identifying goals, one becomes more inclined to take actions for achieving the goals. We often neglect or delay the action because the goals are not very clear in our minds. Defining goals would help you realise the urgency for taking appropriate actions
  • Goals tells you where you: Unless the goals are defined, we would not be able to comprehend our current situation with regards to the future. Defining goals also clarify their feasibility and practicality for achievement and accordingly, depending of our current situation, we may either change the maturity period or the returns expectations or the targets of the goals. 
  • Goals helps you to keep focus: Understanding your goals would help us keep focus on achieving them. This helps us on a daily basis and you may start making a choice between making small expenditures or saving for the goals. Also, we would be more discipled and regular in making our investments and at the same time, not withdrawing from the kitty saved towards the goal. 
  • Goals lead to success: With goals in mind, you will make optimum use of your financial resources when while planning for them. You would eliminate wastefull expenditure, invest in productive asset classes and tend to maintain discipline in your investments. All these factors ensure that you are much closer to your goals then they mature.
Risks of not setting goals: 

Just like we discussed the benefits of goal-setting, there are similarly down-side risks to not setting and planning for goals. 
  • Compromise on goals: Not identifying or delaying planning for your goals for too long would ultimately lead to situations wherein you would need to either compromise on your goals, in terms of value or by pushing our goals into future. However, more often than not, goals like child marriage, education, retirement, cannot be postponed and it is best left unsaid as to how you would plan when they actually arise. You may even loose out on smaller goals & moments of happiness like say vacations, which would be very much possible if you are planning in advance for them. 
  • Failure to make optimum use of finances: Not setting goals and planning for same will lead to misdirected investments and spendings. Chances are that there would be unwarranted spending which would had been invested had planning been done. There is also high chances that you would save in asset classes or product which are not in line with your goals. For e.g., While planning for retirement after say 15-20 years, you will probably identify equity as ideal asset class for you to invest. However, in absence of same, you may avoid equity investing as a risky asset since your goal & time horizon is not clear. 
  •  Compromising on Long-term financial well-being: In long term, better management of your resources would enable you to achieve same while also creating and protecting your wealth at the same time. Needless to say, you are more likely to be credit-free, while having appropriate wealth at disposal for a better life, especially post retirement. By avoiding goal setting & planning, you may well be inviting financial in-stability or insecurity in long-run since you may be forced to take credit or dilute your un-planned investments when your goals mature.
Setting financial goals is something that we are not completely unaware of. It is like basic common-sense. We all know its importance but rarely do we plan and act accordingly. We have discussed in detail the benefits and risks of not setting your goals and planning for them. Very clearly, they have potentially very far-reaching & defining consequences to your financial well-being in future. Those who are wise would understand its criticality and start taking appropriate actions towards it in immediate future. And for those who fail to do would leave matters increasingly to luck and chance for as long as they continue delaying same.