We are aware that financial planning enables us to reach our financial goals in a much more organized and scientific manner. But, have you ever wondered about the importance of financial planning in your financial scheme of things. In fact, the importance of financial planning can be gauged from the following 13 unique factors. These are the 13 unique reasons why financial planning is so important. We prefer to call it the “Bakers Dozen” of financial planning.
Why financial planning is important (Baker’s Dozen)…
- Financial planning compels us to crystallize our medium term and long term goals. These include goals like child’s education, retirement, lifestyle planning etc. Crystallizing your goals forms the first step in financial planning and actually helps you translate many of your intangible dreams into tangible goals.
- Financial planning creates measurable milestones for your futures. Dreams do not become goals unless there are milestones that are ambitious, achievable and can be expressed in financial terms. Milestones also help you to periodically measure if you are on track to meet your life goals.
- Financial planning enables you to convert all your goals into financial targets. This is the first stage in planning your goals and making adequate financial provision for them. The basis of financial planning is that all goals should be granularly broken up into milestones and they should be measurable in monetary terms.
- Financial planning enables you to categorize your risk appetite. Are you conservative or aggressive or does your risk appetite lie somewhere in between. Risk appetite is not just about how much risk you can take but also about how much risk you should take. It underscores that every financial decision in your life is a risk-return trade-off.
- It helps you to categorize your goals based on time frame and complexity. For example, some goals like your mortgage planning may have to be achieved in 3 years while retirement plan has to be achieved in 25 years. Some goals are achievable while some may be impossible without inordinate risks. Financial planning underlines all that!
- Financial planning creates a clear picture of your current and future cash flows. It holds a mirror on the limitations of depending on your regular sources of income and therefore underscores the importance of making money work for you. You actually get a perspective view of your cash flow requirements over the next 30-35 years.
- The process of financial planning helps you to impute inflation into your long term goals. The price of a goal today is not the same as the price of the goal tomorrow. There will be inflation and there will be sudden spurt in costs. All these factors are imputed into your calculations right at the very beginning based on solid and back-tested assumptions.
- It throws light on the portfolio mix that you need to adopt to attain your long term goals. It is financial plan that guides into more risky assets in case of long term goals and less risky assets in case of short term goals. This forms the basis of your proposed allocation to equities, debt and other hybrid products.
- Financial planning also places a major focus on liquidity. Financial planning is not just about creating paper wealth but also about ensuring that you have liquidity available at minimal cost at regular intervals. Forcing liquidity can have a prohibitive cost and the planning process makes the entire process more organized.
- Above all, it creates the all important balance sheet as your starting point. You are aware of how much you own and how much you owe. You also get a picture of how much you will own and how much you will owe. This helps decisions pertaining to modifying the asset mix, reducing high cost debt etc.
- An important component of your financial plan is your insurance cover. The plan not only forces you to get adequate life cover at the lowest cover but also dissuades you from getting into long-term endowments and ULIPS. The plan also focuses on the need to get health and asset insurance to hedge the overall risk of your financial future.
- The best way to reach your financial goal is to map your assets against your goals. Once you know the gap, you know which asset to invest in and how much protection to take. This mapping creates a very clear chart of your goals and the journey of your assets towards these goals.
- Last, but not the least, the financial plan is an important tool for monitoring. Remember, a financial plan will not operate on auto-mode. It has to be consistently and granularly monitored on a regular basis. Additionally, the portfolio has to be flexible enough to adapt changing conditions. That can only be achieved through a financial plan.
The Baker’s Dozen is just an indicative list of the importance of financial planning and not necessarily an exhaustive list. Suffice to say that the financial plan will form the lifeblood of your financial future!