Building a house….Funding children’s education…..Preparing for retirement…. Going on world tour…
These are a few statement that define a person’s life goals. To achieve these goals one needs to manage their finances, this is where financial planning steps in.
Financial planning is the process of estimating the capital requirement for these goals and developing investment strategies to raise the capital.
With proper Financial planning you can arrange to spend, save and invest money to live a comfortable life, with financial security, and achieve goals. Uncertain economic times intensify the importance of wise personal financial decisions.
Wise money decisions form a basis for good present as well as future financial health.
6 Steps in financial planning
This planning process is a method of maintaining control over your financial situation. Each person or household’s financial position is unique, and any financial activity must be carefully planned to meet specific needs and goals. Financial planning is a six step process-
Step 1: Determining the current financial situation
This step involves calculating individuals net worth and analysing his cash flow situation, Net worth of an individual is amount of his assets exceeding his liabilities. Whereas assessing cash flows would indicate their saving capacity, standard of living, and highlight the problem areas.
Step 2: Developing financial goals
Goals can be classified into three categories:
- Short-term Goal- These goals are within one year and may include objectives like paying credit card bills, contingency fund for next three months, acquiring insurance and so on.
- Mid-term goals- Goals to be accomplished between two to five years are mid-term goals. For instance, buying a new car within the next three years is a mid-term goal.
- Long-term goals- They are greater than five years from today. Owning a retirement property, building a house with in next 10 years are examples of long-term goals.
Specific financial goals are vital to financial planning and can range from spending all of your current income on short term goals to developing an extensive savings and investment program for your future financial security.
Step 3: Identifying alternative course of actions
It is impossible to make a good decision unless you are aware of all the options. Suppose your saving is Rs. 5000 per month. You have following course of actions as options to take:
- Expand the current situation- You may decide to increase your saving to Rs. 6000.
- Change the current situation- You could invest in stock instead of putting the money in saving accounts.
- Take a new course of action- You could use your savings to pay off your debt.
- Continue the same course of action- You may choose to do nothing at all.
Considering all of the possible alternatives helps in making more effective and satisfying decisions.
Step 4: Evaluating your alternatives
In this step, one needs to evaluate all possible courses of action, taking into consideration life situations, values, and present economic conditions
- Consequences of choices- Each decision made, closes off alternatives. For instance, a decision to invest in stock may mean you cannot take a vacation. A decision to go to school full time may means you cannot work full time. Thus, one needs to consider the lost opportunities that will result from the decisions.
- Evaluating risk- Uncertainty is a part of every decision. Selecting a college major and choosing a career involves risk. What if you later realize that you don’t like working in this field or there are not many employment opportunities in it? Other decisions involve a very low degree of risk, such as putting money in a savings account or purchasing items that costs very less. In these situations, chances of losing something of great value are low. In many financial decisions, identifying and evaluating risk is difficult and the best method is to gather information based on one’s experience and the experiences of others.
Step 5: Creating and Implementing a Financial Action Plan
This step of the financial planning process requires choosing ways to achieve predetermined goals. Once short-term goals are fulfilled, the goals next in priority will come into focus.
Step 6: Re-evaluating and Revising the Plan
Financial planning is a dynamic process that does not end when you take a particular action. One needs to regularly assess his financial decisions. Changing personal, social, and economic factors may require more frequent assessments.
It is important for individuals to set up a personal financial plan in order to avoid hardships and financial difficulties in the future. Financial planning assure financial stability and financial freedom that one wants to possess till the end of his/her life.
Developing strategies to improve a person’s standard of living has become increasingly difficult with rising complexities around us.
Being able to anticipate our financial need provides an edge and high probability of success in comparison to just reacting to financial happenings as they unfold.
