Last Updated on 2 weeks ago by Raj Kumar
What is financial planning – Meaning, Steps, types
What is financial planning? Gone are the days when you can just earn a good salary and live happily for ever. In current times it is equally important to do proper financial planning as earning a good salary. We have seen people struggle to manage finances earning a great salary but at the same time we have seen people earning decent salary have excellent financial conditions.
In this article let’s explore all the aspects of financial planning, what you must do
What is financial planning?
Financial planning can be summed up as an approach as how you can plan your expenses(both fixed and variable), investments , goals while keeping in mind of your personal situation. Financial Planning is the systematic approach through which individuals develop a comprehensive plan to manage their expenditures and fulfil financial goals.
The main objective of financial planning is to help people organise their expenses and savings, and plan for a better future.
Before you do any planning you should always make sure that you have emergency fund in place to take care of your needs in case of emergency.
How to do financial planning?
The basic principles of financial planning is to control your expenses. You should be cautious about how you spend your money irrespective of what stage of life you are in.
A popular method is to do budgeting your earnings into 3 categories which is commonly referred as 50–30–20 rule on budgeting.
What is 50–30–20 rule on budgeting?
50–30–20 rule on budgeting has become recently popular as more and more people are getting awareness of how to effectively use your money. He is what 50–30–20 rule on budgeting:-
50% of your income should be spent on your needs like paying for your house (Rent/EMI), paying bills, your families fix expense.
30% of your income should be for wants like — going out for lunch/dinner, movies. This amount should be optional and always should be in favour of save money rather than spending it.
You should at least save 20% of your income. This amount should be the minimum amount you should save. You should always target to increase this amount when your salary increases rather than increasing the spending amount.
Types of financial planning
Financial planning can be categorised into broadly 3 types according to your goals
- Short term financial planning
- Medium term financial planning
- Long term financial planning
These goal based financial planning are for different purposes. The biggest problem that we see in individuals is they mix the goals most of the time and do not realise the importance of each goals eventually ending losing opportunity to create wealth for them selves.
Let’s evaluate each of the options in details –
Short term financial planning
Short term financial planning is done to plan your immediate needs. For example, If you are not married and you will be soon married in 1-2 years, to manage the expense of marriage you will need money to take care of your marriage arrangements. This money should be kept in a way that it shouldn’t have the risk loosing money.
For short term needs you should keep your money in places where the risk is absolutely minimum. You shouldn’t worried about returns on your investments rather you should worry about capital preservation. If you can beat the inflation rate with your short term Investment then that should be enough for your goals.
People often get the wrong end of the stick when it comes to assess the difference between short term financial planning and short term investments. They end up investing in high beta investment option to get quick returns but more often than not they end up losing considerable amount of capital.
Best options for short term investment
Here are some investment options for short term investments which can take care of your short term financial planning:-
- Banked Fixed deposits
- Liquid mutual funds
- Ultra short term debt funds
Medium term financial planning
Medium term financial planning should be done for things which are not immediate in nature but are required in 5-7 years. For example, you want to purchase a car in 5 years or you want to purchase a house in 5-7 years.
In this circumstance , you can think of investing your money in instruments which can give higher returns than defensive investment instruments like fixed deposits or liquid funds. You can take a bit of risk while planning for your medium term financial panning but you should be cautious and aware of the investments you are making.
If you are a person who is aware of stocks then you should consider in investing into good quality stocks which can give you a decent returns in 5-7 years. If you are a person who is not very close to tracking stocks on a frequent basis then investing in mutual funds will be a great option for you.
You should also consider investing into Gold to diversify your portfolio.
Best options for medium term investment
Here are some investment options for medium term investments which can take care of your short term financial planning:-
- Equity mutual funds
Long term financial planning
Long term financial planning is probably the most difficult part of financial planning as people most of the times are not able to differentiate between Long term and short term financial planning.
Most of the people miss to appreciate the power of Long term financial planning, with this you can create huge amount of wealth if done right. Sadly, Most of the people realise this very late in their life and miss the most precious thing investment which is ‘Power of compounding’.
You need to keep one thing mind that money brings more money. The early you start investing for Long term financial planning , you will have to invest less to get more returns as the money you invested will bring more money for you!
Be smart, Invest in right instruments like good quality stocks and equity mutual funds early in your life to enjoy the power of compounding. Plan for your retirement early by investing in instruments like NPS and PPF in your career so that it doesn’t become burden for you when it eventually arrives.
Best options for long term investment
Here are some investment options for long term investments which can take care of your short term financial planning:-
Steps for financial planning
We talked about types of financial planning earlier now we will look at what steps you should take to achieve financial freedom and set a realistic goal for yourself.
The very first thing you need to understand when you start to set any financial goal is about Inflation. Inflation may be the biggest enemy in your financial freedom path. You must understand that the value of your money constantly depreciates over time. Mere keeping the money will not do any good for your financial planning.
After you have dealt with inflation then you should look at below steps to take care of your finances!
Income- Expense management
You should be able to track your income and expenses. Many people do a mistake now a days that they spend almost everything that they earn with out having a strict income to expense ratio. The biggest evil for this in the modern era are credit cards. People buy things even if they can’t afford on credit card eventually leading into the credit card trap.
You need to estimate your present and future expenditure, accordingly, you need to create a roadmap to keep your expenditures under control and achieve your financial goals faster. In all circumstances you should avoid going into the credit card debt trap!
Remember – credit card debts have the highest interest in any form of loans you can avail!
There are a number of money management apps that are available to use ; These apps should let you manage your finances really well.
Some of the money management apps that we like :-
- Monefy – Money Manager
We talked extensively about the various types of goal based investment planning earlier. It’s paramount that you understand the difference between each goal and you should take the step in the right direction.
Note- Not everyone is same in their life. You should do the investment planning based on the phase of your life and what suits you the most!
This is the most important topic which we talk about financial planning. we have seen often people mix insurance with investment and they end up buying Insurance products thinking those insurance products will give them excellent returns over long term.
You should do insurance to protect yourself and nothing else apart from that. You shouldn’t be expecting any returns from your Insurance.
You should have adequate Insurance for yourself and your family members. You must understand difference between life insurance and health insurance. You should have yourself and your family members covered under a good health insurance at any point in time.
You should be aware of the tax element for your salary and always should look to save as much tax as possible. There are various tax savings options available which you can use to cut down your tax.
We find people are ignorant when it comes to tax. You should absolutely make sure that you understand the various tax options available for you to choose from.
We encourage you to use the income tax calculator which can help you assess how much tax you have to pay.
when you are young , it’s a natural phenomenon that retirement will look very far for you but it will come faster than you expected and when it comes you better be prepared with a solid plan.
As we talked about it earlier – Money brings more money and the early you start investing in compounding instruments then you will have to shell out less money to make money. If you start retirement planning early then you will have an easy time managing your retirement.
Financial planning – Closing thoughts
We hope this article gave you some perspective of financial planning and what are the dos and don’ts around it. Remember that at the end of the day the money that you earn is your money and the ultimate responsibility of managing the money effectively lies with you and only you.
You should make every attempt to let your money work for you rather than you work hard to make money.
Financial planning is easy if you are willing to take the first step. So are you willing to take the first step?
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FAQ on Financial planning
What are the types of financial planning?
There are mainly 3 types of financial planning and they are :-
1.Short term financial planning
2.Medium term financial planning
3.Long term financial planning
What is the importance of financial planning?
Irrespective of how much or how little you earn; if you have the right approach then you will save yourself getting into trouble when you are nearing your retirement age.
Financial planning will help you retire early and give you peace of mind.
How can beginners do financial planning?
It’s very simple. You to create self discipline and manage your earning and expenses correctly. You need to plan ahead of time and understand the key principles of how saving early helps creating huge wealth in long term.