What is Financial Planning?
Financial planning is the process of evaluating someone’s financial situation and creating a plan to help them achieve their financial goals in the short and long term. Financial planning advisors work with clients to help them create a financial plan, but you can also do it yourself. Financial planning encompasses comprehensive aspects and covers every aspect of a person’s financial life. A comprehensive financial plan typically includes strategies for saving and investing money, budgeting, debt repayment, retirement planning, taxes, and insurance. Family financial planning may also include matters such as buying a home and saving for college.
Why is Financial Planning Important?
Financial planning is important for improving and maintaining long-term financial health. Financial planning can help you:
- Feel in control of your money and confident in the decisions you make
- Set financial goals and create a roadmap to achieve them
- Develop good financial habits such as saving consistently and keeping debt to a minimum
- Understand the importance of investing and its role in building wealth
When you neglect financial planning, you expose yourself to risks. For instance, if you are not saving or investing regularly, you miss out on the power of compound interest. Compound interest is the interest you earn on your principal plus the accumulated interest. For example, let’s say you invest $500 monthly in an Individual Retirement Account (IRA). You do this every year for 30 years, earning an annual return of 7%. At the end of those 30 years, your investment of $180,000 will grow to $566,764 thanks to compound interest.
Your Financial Planning Roadmap
Budgeting
A budget is simply a plan for how to spend your money each month. There are various methods of budgeting you can use, but the mechanics are the same:
- Gather all your income for the month
- Gather all your expenses for the month
- Subtract expenses from income
Ideally, you should live within your means and have some money left at the end of each month. If you calculate the numbers and find there are more expenses than income, you will need to get this sorted out before addressing the other aspects of your financial plan. You may benefit from meeting with a nonprofit credit counselor if you have difficulty organizing your budget.
Building an Emergency Fund
An emergency fund is money you set aside to cover unexpected expenses or unplanned life events. For example, if you lose your job or your car breaks down, you can rely on your emergency fund to cover your expenses.
According to statistics, 36% of Americans would be unable to cover a financial emergency of $400 or more in cash. If your emergency fund is weak or non-existent, you may want to consider how to build up this savings.
In terms of the amount of savings required for emergencies, the value can depend on your situation and needs. While a common guideline is three to six months’ worth of monthly expenses, you might save more or less depending on your monthly expenses and the ease of replacing lost income.
Getting out of Debt
Debt can be an obstacle to achieving your other financial goals when all excess money goes to outstanding balances instead of saving and investing. When it comes to prioritizing debts, it usually makes sense to target those with the highest interest rates, as those are the ones that cost you the most money. For many people, credit card debt is that.
If you have credit card debt, you can follow two approaches to pay it off: by highest interest or the debt snowball method. The highest interest method prioritizes paying off debts from highest interest rate to lowest. The debt snowball method pays off debts from lowest balance to highest.
Once you deal with high-interest debt, you can focus on paying off lower interest debts such as student loans, car loans, or personal loans. You might consider refinancing your private student loans if it allows you to lower your interest rate.
Retirement Savings
Retirement planning is an important part of financial planning because there is no guaranteed safety net waiting for most people. Social Security benefits may provide one source of retirement income, but it may not be enough on its own to meet all your expenses.
The first step in creating a retirement plan is to determine how much you need to save. Then
Source: https://www.thebalancemoney.com/financial-planning-basics-personal-finance-101-1289798
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