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What is financial planning and why should you use it?

“If you don’t know where you’re going, any road will get you there.” This quote is attributed to Lewis Carroll, an author well known for Alice’s Adventures in Wonderland. Without a plan, any action will bring you closer to that non-goal. 

However, if you’re here, then you most likely have a specific goal in mind that you want to achieve. Whether that’s saving for when you’re older, for when times are worse, or perhaps a happy moment in your future. By utilizing the methods of financial planning, you can get to that goal.

What is financial planning?

Financial planning is a process, often used in the corporate world, to determine how much capital is required to achieve a certain goal. This entails determining capital requirements, the structure (e.g. debt, long term, short-term investment) and also having a finance manager who makes sure that the financial resources are used to their fullest potential.

Why is it used? Because it provides a visible way forward for growth. When doing the analysis, the company can see how much money is needed and how to acquire these funds. It also creates a sense of security and reduces uncertainty because the company knows that with sufficient capital it can pursue other avenues, should market trends change.

Financial plan for your personal budget

Now, you may not need to look for investors for your personal budget, however creating a financial plan still has its uses. There are certain similarities if we were to compare your financials to that of a business:

  • Negative cash flow isn’t good for prolonged periods of time
  • You should maximize your gains made with your capital
  • Bite sized goals beat huge seemingly unattainable goals
  • Income and expenses need to be known to operate sustainably

Do you know how much money comes in and goes out every month, and what’s your net worth? If you do, then you are ahead of the majority of people.

Furthermore, did you account for all the unexpected expenses that could suddenly drain your bank account? Things like a broken washing machine, your car, which you need to drive to work every day, not working. Surveys show that, if people save, the biggest part of them saves for unexpected expenses.

The bottom line is, when you know how much you make, spend and how high your net worth is, it’s much easier to attain your goals than if you’re free flowing.

Professional financial planning vs DIY planning

If you want to create a financial plan, you have basically two options, you could do it all on your own, or you could enlist a professional financial planner. Both ways have their pros and cons, and it ultimately comes down to what you’re looking for and how much budget you have.

Professional financial planners

When working with a professional on your financial plan, then you can be sure that they have a template to follow, which streamlines the whole process. They know what data to collect in the first place, how to analyze your income and expenses, and what often-overlooked areas to keep in mind.

Often they also have a certain area of expertise, which could be taxes, investments, retirement, insurance etc. Through this, they have much more knowledge about these fields and could help you optimize your taxes, maximize capital gains or pick the right insurance plans, which can all have a big impact on your net worth.

The downside to all that is, that they can be expensive. Financial planners come in all shapes and forms and could be independent financial advisors, work for banks or even a non-profit organization. In the majority of cases you would have to pay for it yourself, though, which can cost hundreds of dollars.

Do-it-yourself financial planning

The biggest advantages to creating the financial plan yourself is of course the money saved, but also the profound insight gained into your own finances. If you’re not already in the minority that has an overview over their finances, then this step can be eye-opening. 

It could be embarrassing to see where all your money goes, or it could be empowering because you realize that you’re a big saver and investor. Either way, it helps you understand your spending habits. There are many tutorials online on how to create a financial plan, both in text and video, and you will also find a step-by-step tutorial in the next section.

The drawback of doing it yourself is that you potentially forget about certain things like insurances or retirement plans, or are not that well versed in the tax laws of your country. But don’t fret, you can always consult a professional if you feel your own power plus the help of a search engine is not enough.

Step-by-step tutorial to create a financial plan

Below is a simple step-by-step guide you can follow to create your own financial plan. Keep in mind that you should have goals in mind already for this exercise, i.e. what you want to save for, and also know how much money you need for that goal.

Get an overview of your cash flow
For this you should collect all the documents that you have on your income (salary, investments, payments from the government etc.) and everything on your expenses (food, rent, insurances, transportation you name it). Try to make it as comprehensive as possible by analyzing the whole year, then dividing both numbers by 12 to know your monthly cash flow.

Prioritize your goals
It’s important for your plan to set priorities on which goals to tackle first. Some will require more capital, while others less. Yet, it’s unlikely that this will be the determining factor on which goals have the highest priority. So make a list, which of your goals are an absolute must and which are nice to have.

Work out the strategy to attain the goals
This is the most important and difficult part. With the cash flow in mind and priorities set straight, it’s time to plan how to achieve each goal. This means playing around with different savings rates (maybe you can save more?) and interest rates for different investments (how much risk do you want to take?).

This is also where future retirement payments from your pension plan, insurances and tax optimization comes into play. If you’re not a numbers’ person, then a professional financial planner could be the key in this stage.

Once the framework is done, and you have a plan, the only part left is acting upon that plan. This is easier said than done. It’s one thing to make a plan, but another to get up every day and follow through with it. If you always visualize your goals though and know why you do it, it allows you to keep working on your goal. And slowly but surely, you will reach it and maybe even surpass it!

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