Financial Planning: Definition, Importance & Types

As per a survey, over 50% of Indians between age 35 and 54 feel unprepared for the future even though they have done some financial planning. 60% think they have not saved enough money. Many rely heavily on credit and use up their savings.

These numbers show that while there is some financial awareness, there is a big gap when it comes to putting that knowledge into practice. This points to the critical need for more complete financial planning education and for people to start using better money management strategies.

What is Financial Planning?

Let’s start with the financial planning definition. Financial planning is a step-by-step approach in determining how you would meet your life goals with your money. A good financial plan will help you to remain in control of your expenses and investments at all times. It examines your goals, helps you prioritise, save and invest money in order to achieve targets in the defined time.

For instance, you may need Rs. 25 Lakh for your daughter’s college education by the time she turns 18. For that, you need to have proper financial planning and investments to achieve the goal.

The specific advantages of financial planning include greater effectiveness in obtaining, using, and protecting your financial resources throughout your life.

It is also important to know the difference between financial planning vs wealth management before opting for one.

Recommended Read: Difference Between Financial Planning & Wealth Management

Importance of Financial Planning

Let’s now explore the importance of financial planning in everyday life. Financial planning plays an important role in giving direction to your goals. It helps you set short-term and long-term goals in life and helps you make financial decisions more easily.

To further explain the importance of financial planning, consider how it instills discipline, keeps unnecessary spending in check, and enables consistent savings.

The following points will help you understand the financial planning importance in detail:

1. Helps Manage Income

A good financial plan helps you manage your income better. We need money for our basic needs but occasionally tend to splurge on unnecessary luxuries. Planning your finances will keep a check on your expenses and help you make savings.

As you will have a budget ready, you can easily assess whether you are overspending or are within budget. This will help you understand how much you need to save to reach your goals. Also, financial planning helps you manage inflation by planning your budget in a better way.

2. Help Choose Investments

It is essential to have a financial plan for choosing investments in line with your income, risk capacity, and goals. This will help you maintain a balanced investment portfolio at all times.

A sound financial plan will also help you assess your tax obligations at the beginning of a financial year. So you can plan your finances accordingly in such a manner that you pay the least amount as tax legally.

3. Retirement Lifestyle

Relaxed retirement life is possible only if your finances are in a healthy state and are in order. This means having enough cash reserves for medical expenses and other emergencies.

A proper financial plan will have your retirement goals listed, including your income and expenses as detailed as possible.

4. Takes Care of the Estate

A financial plan will guide those taking care of your finances to manage your estate efficiently. Financial planning includes estate planning, which means the smooth distribution of your wealth after your death.

In essence, a proper financial plan makes things smoother. Life is unpredictable, any untoward incident can happen at any moment and you may need money urgently.

Objectives of Financial Planning

Financial planning anticipates future cash requirements and ensures smooth cash flow at all times. It also highlights the functions of financial planning, including budgeting, investing, risk assessment, and asset protection.

The objectives of financial plan are to make you cash ready by creating reserves to meet the following needs;

1. Medical Emergencies

Medical expenses are an area where cash flows out unexpectedly. Therefore, the first part of your financial plan should be focused on protecting yourself and your family through a good medical claim policy.

2. Insurance

The term insurance component of financial planning offers you the much-needed protection for uncertainties. Term policies require low premiums and provide maximum protection, making them cost-efficient.

Term policies also provide you tax exemptions under India’s Income Tax Act. Further, you can apply for policies to protect major assets such as your home and vehicle from theft, fire or other unforeseen incidents.

3. Children’s Future

One of the prime financial planning objectives is to keep us prepared for our children’s expenses, like their education and wedding.

Mutual fund investments can help secure our children’s future. Investment in equity mutual funds or children’s funds can help build a corpus of wealth until they turn into young adults.

4. Retirement

Proper financial planning will help you plan better for your retirement period right from the beginning of your career.

You can choose investment instruments such as mutual funds, bank fixed deposits or invest in the stock market through expert advice. This will help in timely creating a retirement fund so that you lead a happy and relaxed retired life.

Types of Financial Plans

Financial plans consider future fund requirements in three stages. These stages form the basis of the types of financial planning:

Let us have a look at the types of financial plans.

1. Short-Term Financial Plan

The short-term financial plan outlines financial goals and the investment needs for a one-year period. Such a plan is less uncertain than a long-term plan and can be easily corrected if required. The short-term financial plans include creating an emergency fund.

The corpus requires you to at least have funded four times your monthly salary. The emergency funds are helpful in meeting medical emergencies and temporary income loss.

The emergency funds can be created by investing in liquid mutual funds.

2. Medium-Term Financial Plan

A financial plan for a period of five to seven-year comes under medium-term plans. This is the period wherein you have goals to buy your dream vehicle, go on a foreign vacation or purchase a house by cashing in on your investments.

You can also look for creating a safe multipurpose corpus of the fund to retire a loan or for your wedding expenses.

The medium-term financial plans identify above life goals that need an assured amount of money. It will also suggest you make investments in debt mutual funds, bonds or fixed deposits in order to help you achieve your goals.

3. Long-Term Financial Plan

The long-term financial plan is for periods over seven years and beyond. Planning for the long-term is essential to enjoy financial security in your retirement years.

Preparing for children’s higher education and weddings also come under long-term financial planning.

The long-term plans can be best met through investments into equity mutual funds and shares. This is because over a longer horizon the market volatility levels out and you have better chances of earning higher returns.

How to do Financial Planning?

The financial planning steps are a systematic approach that helps you reach your money goals. Here’s the six-step process:

1. Determining Your Present Financial Status

The first step of a financial planning process is to determine your current financial status in terms of income, savings, living expenses, and debts. This is your present net-worth.

You can prepare a list of existing assets and debt balances and the money spent on various items. Doing so will create a foundation for financial planning activities.

2. Developing Financial Goals

Specific financial goals are very important for creating a proper financial plan. You must decide which financial goals to pursue. Your financial goals can vary from spending all your current income to developing extensive savings & investment plans for financial security and freedom in the future.

It is also important to set up SMART financial goals. Your goals need to be S (specific), M (measurable), A (attainable), R (relevant), and T (time-bound). For example, just saying that I will save money for my vehicle is not a SMART goal. But I want ₹10 lakhs to buy a car after 5 years is a SMART goal.

4. Evaluating Risks

In many financial decision-making situations, identifying and evaluating risk is a difficult task. Hence, you must keep on obtaining relevant information related to your financial plans. You must continually build up and update your knowledge as personal, social and economic conditions do not remain static.

You also have the option to take the help of financial planning experts.

5. Creating and Implementing a Financial Action Plan

The next step of the financial planning process is developing an action plan. This refers to choosing ways to achieve your goals in a systematic manner.

Once you achieve your short-term goals, the goals next in importance will come into the limelight, until you have all the short, medium and long term financial plans covered.

You can take the assistance of an expert while implementing your financial action plan. This will involve making investments into financial assets like mutual funds, liquid funds PPF, ELSS, and bank deposits.

6. Re-evaluate and Revise Your Financial Plan

Financial planning is a constantly changing process and does not come to a halt when you take a certain action. This means assessing your financial decisions on a regular basis. Frequent assessments become necessary given the changes in personal, social and economic factors.

In situations of medical emergencies or accidents, the existing financial planning process will become an instrument for adapting and adjusting to such an unto event. Post the event you once again need to revisit your plans.

Conclusion

You may think that time is with you, but you may not continue to work throughout your life. This means your income and other financial sources will not remain the same forever.

It requires real work for anyone to live on their own terms even after retirement. This goes to show the significance of financial planning and should nudge you to seek financial planning advice to secure your future.

Whether it’s cash flow planning, insurance, or retirement—comprehensive financial services planning makes the journey smoother.

Frequently Asked Questions