Importance of financial planning

Earning is only one-half of making a living. The other half involves planning how, when and why to spend. It is necessary to take steps at every income and age level to make efficient use of assets and ensure asecure and fulfilling financial future. Individuals typically have various investment goals, such as allocating emergency cash, children’s education, maintaining family’s lifestyle, retirement planning, and financial independence, among others. Financial planning involves developing strategies for using financial resources to achieve short, intermediate and long-term goals with the objective of ensuring financial growth and security in the future.

Often enough, people think that only one part of their overall finances needs expert attention—be it investment, insurance, retirement or portfolio clean-up. There is a tendency to assume that everything else is fine. However, in the dynamic world that we live in, unless updated, plans become obsolete quite soon. For instance, as your income grows, so does your lifestyle, and, therefore, the life insurance cover you had taken at the age of 30 is no longer sufficient at 35. As fixed deposit (FD) rates crash, you may be better off raising your contribution to EPF instead of locking money in a five-year FD. Secondly, various aspects of your financial life are interlinked. Your retirement corpus requirement may mean that you can choose a longer-tenure product for your monthly savings, which otherwise you would have avoided from a liquidity (shorter-term) standpoint. Planning for the whole ensures that you are not dealing with your finances piecemeal. Most importantly, it is not the Plan by itself that we value. It is the Process of planning that extricates the neglected aspects of your financial life. That may help you to get a grip on your sustainable savings rate or assist you to clearly understand the trade-offs that confront you. It may even tell you that things are much better than you had always believed. Whatever the outcome, the process of financial planning is a very important mirror that you must hold to yourself regularly.


Hierarchy of financial freedom

The ignorant: Not in charge of his finances and not aware of the difference it makes. Ignorance is bliss for him, but quite costly too!

The seeker: Aware that he does not know enough owing to lack of time and/or expertise. Has a lot of questions, with only a few aspects of his finances managed comfortably.

The diffused: Manages things well, but does not have an overall plan. That leaves him short of an ideal state, which he very much deserves.

The optimum: Has a fully-developed Financial Plan. Various aspects of his financial life are dealt with in the context of the overall plan, and, therefore, his decisions are always optimum.

Goal of financial planning: Moving up the financial freedom hierarchy

The process of financial planning is eventually intended to help a family get to the optimal stage in the above-mentioned hierarchy. Typically, the ignorant families are the most difficult to pursue
in regard to the need for financial planning as they do not quite appreciate the benefits of planning and the costs of not doing it. On the other hand, the seeker families are easier to convince as
they already have a lot of questions formed in their minds. The diffused families react in one of two ways. There are some who believe that they know ‘enough’ and do not need to formally
plan. The “diffused” are clearly far better-placed than the “ignorant”, but still miss out on the benefits of a formal financial planning. That said, there are several “diffused” families who know they are not fully optimized in terms of their financial lives. These families are much more open to the process of financial planning. Interestingly, several optimized families continue to rely on formal financial planning on an ongoing basis to maintain their exalted status.

Where do you belong in the hierarchy?

Every individual needs to introspect and figure out his/her classifi cation in the above hierarchy. While it is difficult to do that in a quick-fix manner, the following are some guidelines:
If your investible funds are largely lying in fixed deposits and your insurance cover is way below your annual income, then you probably belong to the ignorant level. You belong to the seeker level if your investments and insurance decisions are driven by distributors “selling” the products to you, although you manage to invest most of your money one way or the other. If your investment decisions follow one plan, your insurance decisions follow another— albeit different—plan, and your loans and future goals are dealt through still another plan, then your family is at the diffused level. If all your sub-plans are well-coordinated among themselves and you feel fully in charge of your financial future, then your family is at the optimized level. :-)