What is financial planning – Meaning, Steps, types in 2023

What is financial planning? Types of financial planning, steps, and tools to achieve financial freedom | 50-30-20 rule of budgeting.

This post was most recently updated on January 3rd, 2023

What is financial planning? Gone are the days when you can just earn a good salary and live happily forever. In current times it is equally important to do proper financial planning and 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 salaries have excellent financial conditions.

In this article let’s explore all the aspects of personal finance, and what you must do in order to have an excellent financial backbone created for you and your loved ones.

Financial planning
Financial planning

What is personal financial planning?

Personal financial planning can be summed up as an approach to how you can plan your expenses(both fixed and variable), investments, and goals while keeping in mind your personal situation. Financial Planning is the systematic approach through which individuals develop a comprehensive plan to manage their expenditures and fulfill financial goals.

The main objective of financial planning is to help people organize 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.

Why Financial planning is important?

Financial planning is important because it helps you manage your money and reach your financial goals. It involves creating a budget, setting financial objectives, and developing a plan to achieve those goals. By taking the time to create a financial plan, you can make better financial decisions and be more prepared for the future.

Here are a few specific reasons why financial planning is important:

  1. It helps you manage your money: A financial plan can help you track your spending, identify areas where you can save money, and make a budget to ensure that you are using your money in a way that aligns with your values and goals.
  2. It helps you reach your financial goals: Financial planning allows you to set specific financial goals and develop a plan to achieve them. For example, you might want to save for a down payment on a house, pay off credit card debt, or save for retirement. By setting these goals and creating a plan to reach them, you are more likely to be successful.
  3. It helps you prepare for the future: Financial planning can help you prepare for unexpected expenses or changes in your financial situation, such as the loss of a job or a medical emergency. By having a financial plan in place, you can be better prepared to handle these types of situations.
  4. It helps you make better financial decisions: Financial planning can help you make informed decisions about how to use your money. For example, you might be considering whether to invest in a particular stock or whether to buy a more expensive car. By creating a financial plan, you can weigh the pros and cons of different options and make a decision that aligns with your goals and values.

How to do financial planning?

The basic principle of personal finance 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 are commonly referred to as the 50–30–20 rule on budgeting.

What is the 50–30–20 rule on budgeting?

50–30–20 rule on budgeting has become a recently popular method for personal financial planning as more and more people are getting aware of how to effectively use their 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, and your family’s fixed expenses.
  • 30% of your income should be for wants like going out for lunch/dinner or movies. This amount should be optional and always should be in favor of saving 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 categorized into broadly 3 types according to your goals:

  1. Short-term financial planning
  2. Medium-term financial planning
  3. Long-term financial planning

These goal-based financial planning are for different purposes. The biggest problem that we see in individuals is they mix their goals most of the time and do not realize the importance of each goal eventually ending up losing the opportunity to create wealth for themselves.

Let’s evaluate each of the options in detail:

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 of losing money.

For short-term needs, you should keep your money in places where the risk is absolutely minimum. You shouldn’t worry 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 assessing the difference between short-term financial planning and short-term investments. They end up investing in high-beta investment options to get quick returns but more often than not they end up losing a considerable amount of capital.

Best options for short-term investment

Here are some investment options for short-term investments that can take care of your short-term financial planning:

  1. Banked Fixed deposits
  2. Liquid mutual funds
  3. Ultra short-term debt funds

Medium-term financial planning

Medium-term financial planning should be done for things that 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 that 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 planning 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 investing in good quality stocks which can give you 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 that can take care of your short-term financial planning:

  1. Stocks
  2. Equity mutual funds
  3. Gold

Long-term financial planning

Long-term financial planning is probably the most difficult part of financial planning as people most of the time are not able to differentiate between Long term and short-term financial planning.

Most people miss to appreciate the power of Long term financial planning, with this you can create a huge amount of wealth if done right. Sadly, Most people realize this very late in their life and miss the most precious thing in investment which is the ‘Power of compounding.

You need to keep one thing in mind money brings more money. The earlier 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 the 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 a burden for you when it eventually arrives.

Best options for long-term investment

Here are some investment options for long-term investments that can take care of your short-term financial planning:

  1. Stocks
  2. Equity mutual funds
  3. Gold
  4. Real estate
  5. NPS
  6. PPF

Consider reading: Top 10 Best Investment Options in India.

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 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 the below steps to take care of your finances!

1. Income- Expense management

You should be able to track your income and expenses. Many people do a mistake nowadays in that they spend almost everything that they earn without having a strict income-to-expense ratio. The biggest evil for this in the modern era is credit cards. People buy things even if they can’t afford them on a 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 loan 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:

  • Walnut
  • Monefy – Money Manager
  • Andromoney
  • Fudget
  • YNAB

2. Investment Planning

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 the same in their life. You should do investment planning based on the phase of your life and what suits you the most!

3. Insurance planning

This is the most important topic which we talk about in 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 the 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 the difference between life insurance and health insurance. You should have yourself and your family members covered under good health insurance at any point in time.

4. Tax planning

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 that you can use to cut down your tax.

We find people are ignorant when it comes to taxes. 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.

5. Retirement planning

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 earlier you start investing in compounding instruments 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.

How to do financial planning for salaried employees?

Salaried employees can do financial planning easily by following the below steps:

  1. Make a mental resolution to assume you have 20% less salary. Invest that 20% amount in an instrument where your money grows consistently.
  2. Never take too much debt – avoid the debt cycle.
  3. Never buy anything because you can afford it via your credit card.
  4. Get your family members covered via good health and life insurance.
  5. Don’t consider insurance as an investment option.
  6. Plan your tax outgo in advance to avoid last minute rush.
  7. Be aware of long-term investment options like stocks and mutual funds.

Financial planning – Closing thoughts

We hope this article gave you some perspective on 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 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?

Like the article? – please share with your friends and family. Have a question – drop a note in the comment section!

FAQs on Financial planning

  1. What are the types of personal financial planning?

    There are mainly 3 types of personal financial planning and they are:-

    1.Short term planning
    2.Medium term planning
    3.Long term planning

  2. What is the importance of personal financial planning?

    Irrespective of how much or how little you earn; if you have the right approach then you will save yourself from getting into trouble when you are nearing your retirement age.

    Financial planning will help you retire early and give you peace of mind.

  3. How can beginners do financial planning?

    It's very simple. You to create self-discipline and manage your earnings and expenses correctly. You need to plan ahead of time and understand the key principles of how saving early helps create a huge wealth in long term.

  4. When to start financial planning?

    You should start planning for your personal finance as soon as possible. The earlier you start the more benefits you will get. If you start managing your finances early in your life then you will get the benefits of the power of compounding and eventually create huge wealth for yourself.

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