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Financial planning: What it is and how to do it right

Financial planning is the first step in the process of achieving your financial goals. For many, our financial goals will be intimately tied to our wider life ambitions, meaning you’ll need a certain degree of financial stability to achieve the life you want. Financial planning is a key support in this financial journey, helping you to stay on track during periods of upheaval and financial downturn.

A financial plan, like any plan, keeps you focused. A good one will aim to improve returns, reduce losses, and help to absorb the shock of a financial crisis. Effective financial planning is, in many ways, critical to leading a stable, secure and comfortable lifestyle. 

It is, therefore, important to get financial planning right. It should cover all possible goals, contingencies, debts, investments, insurance, savings, retirement plans and taxes, all broken down into small and achievable objectives. A financial plan is never finished, either. Once created it needs to be reviewed on a regular basis to ensure it’s fit for purpose.

How is financial planning different from financial advice?

Although financial planning and financial advice are two sides of the same coin, they are not interchangeable. Both are an important part of wealth management, but financial advice focuses more on your current investments, while financial planning puts specific emphasis on meeting long-term financial goals.

Broadly, financial advice is more related to markets, securities, and investments. In contrast, financial planning is the wider process of managing overall finances, including your investments, by putting a broader structure in place. Additionally, financial planners need to hold the Certified Financial Planner (CFP) designation and are bound by regulations to act in the best interests of their clients.


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Steps of financial planning

Financial planning is a streamlined and progressive process. It has to have sequential components for the plan to work. The step-by-step nature of financial planning is integral and should be part of writing any personal financial plan.

  • Know your cash flows, and expenses: The first step to financial planning is to analyse your current financial situation. You should properly assess your finances, including all sources of income, cash inflows, and your outflows. This will help you create a budget and a financial plan that has a better chance of working in the long run. You get a sense of where you stand financially and how the situation can be worked on and improved.
  • Define your financial goals: Once you’ve assessed your financial status, it becomes easier to define the financial goals. You need to ask yourself what you want to achieve, but within specific periods of time. Financial goals may include buying a home or a car, or saving for a wedding, your children’s education, and retirement. These financial goals can be split into short term, medium term, and long term, and planned accordingly.
  • Research the options and allocate assets appropriately: Now that you’ve identified what you need the money for, the next step is to explore your investment options. Asset allocation is the most critical step in financial planning. A wide variety of financial products and assets are available, including mutual funds, stocks, bonds, commodities, and foreign exchange. Investment portfolios should be diversified to hedge risk and get the right returns.
  • Keep funds for contingencies: Financial planning doesn’t just mean putting away money for the future. It also caters for your current financial needs. A well-rounded financial plan includes a contingency fund for when you need cash most. You should cover yourself for loss of employment, medical emergencies, unexpected losses, etc., and you should hold at least six months’ worth of living expenses.
  • Monitor and review the financial plan regularly: The process of financial planning doesn’t end with the allocation of funds. The investment portfolio and the overall health of the financial plan should be reviewed at regular intervals to incorporate any changes in personal plans or in the economic situation. Periodic reviews of financial plans ensure all the investments are working as expected. Investments that no longer add value to the portfolio can be weeded out as a part of the review process.

Golden rules of financial planning

Financial planning is the basis of a financially secure future. The right allocation of funds to different investment avenues should generate a steady cash flow in the future. However, financial planning is an intricate and complex process – here are a few key things to bear in mind during financial planning.

  • Start planning as early as possible: Effective financial planning should utilise the power of compounding. The simple idea that getting started early leads to compounded returns in the future is powerful. So, start investing as early as possible. It’s also highly recommended to put around 10% of your monthly income into a pot for the future. This percentage can vary slightly depending on the retirement you want, as well as your financial needs in the medium term.
  • Manage debts: It is, obviously, ideal to have no debt at all. However, this isn’t realistic. Most of us have student loans, credit cards, home loans, and other obligations to pay from our monthly income. Keeping debts under control, then, is vital to any financial plan. Monthly payments towards debts should not exceed 36% of your income to maintain a healthy balance sheet. Efforts should be made over time to reduce the debts to a minimum, consolidate them, and bring down the interest rate to as low as possible. There is nothing that disrupts financial planning more than a debt trap.
  • Keep a good balance of risk, security, and liquidity: Also important is finding the right balance between risks, liquidity, returns, and security. Just as equity investments tend to make the portfolio more risky, more emphasis on debt instruments may end up making the portfolio less profitable. Any portfolio should have a good mix of asset classes, including stocks, bonds, and cash. The addition of cash gives added liquidity for emergencies.
  • Don’t ignore taxes: Taxes are, naturally, a big part of financial planning. They need to be considered and incorporated into financial planning throughout the entire process. Consider tax-efficient investment options to make financial planning as smooth as possible. Be sure to look at allocating adequate funds to tax-saving investment vehicles like a SIPP or an ISA. Additional factors like withdrawal taxes and annual allowances should also be considered during financial planning.
  • Be realistic: Financial goals should be specific, realistic, quantifiable, and adjustable. Financial planning should always be done within the context of your current financial situation, including expenses, income, savings, debts, and investments. A financial plan should be as achievable in reality as it is on paper. This includes factoring in potential extraneous shocks along the way.
  • Stay aware and alert: This is a critical rule in financial planning. Any good financial planner knows that, for it to be successful, regular and consistent reviews are necessary. This means that when large events occur – coronavirus, for example – or personal financial setbacks make a dent – a new boiler or a car repair – you can react accordingly.

Why do we need a personal financial plan?

Financial planning is about helping people keep on track to achieve their financial goals. It helps them establish their objectives, create a plan to meet them, and follow the step-by-step approach to fulfilling their financial goals.

  • Gain financial security: The core benefit of financial planning is that it can lead to financial security. Once a financial plan is in place and steps are taken to achieve the goals, you should feel financially secure. The future becomes less daunting as you position yourself to absorb economic ups and downs and have an idea of where you’ll be and when.
  • Achieve peace of mind: Knowing that you have the funds at hand to meet your long term goals can give you immense peace of mind. Financial planning helps people to make the best of whatever amount of money they have and use it to the best of their abilities to generate good returns. Also, they can worry less about retirement, family, health expenses and other contingencies with a well-thought-out plan.
  • Stay prepared for emergencies: One of the most important steps of financial planning is setting aside funds for emergencies. Thus, financial planning gets you read for unforeseen events as and when they arise, like loss of employment or health emergencies, for example.
  • Maintain a good standard of living: Your standard of living is usually directly proportional to your income. Therefore, if monthly expenses rise ahead of your income, your standard of living is impacted. Financial planning ensures that a good standard of living can be maintained even when expenses are high. If you start financial planning at a young age, you can worry less about your lifestyle even during difficult times.
  • Prepare for retirement and other long-term goals: Financial planning is key to achieving long-term objectives. Systematic and efficient financial planning ensures that people can meet their life goals and live a comfortable life, even in retirement.

Ultimately, financial planning forms the foundation of a financially secure and comfortable future. It plays a key role in providing security, the fulfilment of long-term goals and dreams, maintaining a decent standard of living, and preparing for contingencies and retirement. It is recommended to connect with a certified financial planner to understand the intricacies of financial planning and get the most out of your finances, for now and for future.

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