I’m sure you must have heard the term ‘financial planning’. It is one of the most used words. Even if you open Instagram, there are 100s of financial influencers who are talking about financial planning. So, what is financial planning? It is nothing but a plan on how to manage your future expenses. It is easy to lose time in life while you are earning and spending as per your own whims. Therefore, I would like to bring this up for people who have decided to initiate their financial wellness journey as many of us are employed folks, for which, this holds more significance.
“Financial retirement planning is more necessary for people with lower salaries than for those with higher incomes”
Source – Journal of Pension Economics & Finance, ‘Financial literacy and retirement planning in Canada*’ by DAVID BOISCLAIR, ANNAMARIA LUSARDI, and PIERRE-CARL MICHAUD
You might have better salaries than your peers/ friends, but you will never be able to forecast the sudden high cost expenses in life which will throw you off of your easy-going account balance. You may need the correct guidance to save and invest money. Let’s delve into what exactly financial planning is and what are the factors affecting financial planning in detail.
Financial planning is a process of planning on how to achieve your future goals. In this process, you will evaluate your current financials, identify your goals, and work towards achieving them. Financial planning deals with multiple areas of finance, starting with budgeting and expenses to savings, insurance, investment, retirement, and finally, estate planning. You can do your own financial planning, or you can go to a certified financial planner who can help you handle your finances.
Financial planning helps improve financial stability and security. It also helps you achieve your financial goals by helping you make informed decisions. Moreover, it inculcates financial discipline and helps you prioritise the right expenses. Most importantly, it gives you a sense of peace as you’ve planned your finances to achieve your goals.
Financial planning is an exercise unique to each individual. Hence, you cannot copy another person’s financial plan and make it your own. Before starting financial planning, it is important to understand the factors that affect it. Below is a list of 16 factors that affect financial planning.
Income is a major factor that affects your financial planning. How much you spend, save or invest will depend on your income. It is always better to have multiple sources of income. You cannot just rely on your salary or business income to run your household. Create multiple sources of income by taking up freelancing opportunities or investing in income-generating assets.
One of the biggest problems people currently face is overspending. There are many who spend beyond their means, leaving them with no savings and a pile of debt. It is important to keep track of your expenses as it is the next important factor that plays a significant role in financial planning. You must know where you are spending your money, as this will help you trim down unnecessary expenses and break your cycle of living paycheck to paycheck. However, it is important to keep in mind that you will have monthly expenses such as rent, transportation, and food that you cannot avoid. You must ensure you budget these expenses into your financial plan so you are not compromising in the present to save for the future.
In the current scenario, taking debt isn’t wrong. In fact, you must know how to use debt strategically to spread out your expenses. There are many credit cards that offer rewards. You can use these rewards to reduce your expenses. However, you should know how to use debt responsibly. This is because debt can be a major hurdle in financial planning. Taking too much debt can harm your finances, affecting your present and the future.
Savings are an essential part of financial planning. Without savings, you will not be able to fund any unexpected expenses or emergencies. It is always wise to have a separate savings account where you can transfer a certain amount every month. You must ensure you don’t use this account for your regular expenses.
Savings are important to fund your unexpected expenses, but it is not enough for all your future financial goals. To ensure you have enough money for all your future financial needs, you must invest. The market has a host of investment options for you to invest in. Investing will make your money work for you and help in accumulating wealth for the long term. All you have to do is select the most appropriate ones for you and invest in them. If you can’t decide where to invest, you can always approach a financial advisor who will help you out with your investments.
You never know when an emergency can knock on your door. Be it losing your job, meeting with an accident, or a natural disaster. All of these can create a dent in your finances if you are not prepared for it. Hence, it is important to take life insurance health insurance, and have an emergency fund. Life and health insurance will take care of your family’s financial security and your hospital bills, whereas your emergency fund will help in paying your unexpected bills. It is recommended that you must take a life cover of a minimum of ten times your income, health insurance of a minimum of Rs. 15 lakhs, and have an emergency fund that can cover at least 6 months of your expenses.
Your age is an important determinant of financial planning. This is because your age will decide what kind of investments will suit you and what is your risk tolerance level. If you are someone in your 20s, you can pick riskier investments as you will have a long tenure for your investments. Even if something goes wrong, you will have time to rebuild your capital. However, if you are in your late 40s or 50s, then you will have fewer years until retirement, and you cannot invest in risky investments.
The number of people who depend on your income increases as you grow in age. You will have to support your ageing parents and your children. Spending money for their medical care and education will be a top priority for you. Hence, the number of dependents you have will affect your financial planning. It is best to prioritise savings when you are young and have fewer dependents, so you need not worry about retirement when you are old.
You want to travel or buy expensive clothes or accessories for yourself. All these are your goals, which can affect financial planning. It is not right to ignore these goals just because you can save for your retirement. Instead, you must inculcate these goals into your financial planning so you can achieve them and also accumulate wealth for your future. When you set a goal, make sure it is realistic and achievable. Moreover, define the goal properly to know when and how much you would need to achieve this goal. For example, going on a vacation to Europe is a very vague goal. A more precise goal would be going on a one-month vacation to Europe in 3 years. This will help you decide how much it will cost and how much you need to set aside every month to achieve this goal.
Your risk tolerance is another important factor in financial planning. Risk tolerance or risk appetite is how much risk you can take when investing. It is determined by your age, number of dependents, and your view on the stock market. Your risk tolerance level determines which investments suit you the best. You can know your risk tolerance level by taking a risk profiling questionnaire. There are many websites that offer free risk profiling.
All the factors up until now are more or less personal factors that affect financial planning. It is important to understand that there are several external factors that can affect your financial planning, the first one being cultural trends. Cultural trends can influence your financial decisions, such as spending and saving habits. If you live in a society that prioritises saving and investing, you will be inclined towards saving. You will prefer saving over spending. However, if you are influenced by societal trends of buying material possessions that create a dent in your pocket, then you might spend more on luxuries. Being aware of how the society around you influences your financial behaviour will help you make more informed decisions.
Inflation is the rise in prices of essential commodities, which can erode your purchasing power. If inflation rates in a country are high, then they will reduce your real return on your investments. In such cases, you must pick investments that have a higher return than the inflation rate, which will help mitigate the effect of inflation on your money.
Interest rates are another important factor that can affect your financial planning. If an economy has high interest rates, the cost of borrowing money will be high if you are planning to buy a home and have saved up for a down payment. In case the interest rates are high, then you will be paying a higher EMI (equated Monthly Instalment) than when the interest rates were low. This increases your expenses, and your savings will be reduced.
A country’s economic growth also affects your financial planning. If a country is in its growth phase, the businesses will do well, and the stock prices will go up. Hence, investments will reap good returns, and the interest rates and inflation will be moderate. This encourages investors to invest in high-return investments as they feel confident in the markets.
A country with a stable political environment has a more prosperous economy. This is because political parties in power give more importance to economic and societal growth. Economic growth implies higher returns from investment.
The economy of a country is affected by global issues. For example, if the oil prices rise globally, then it forces a rise in prices in an oil-importing country, which also affects the prices of other commodities in the country, leading to inflation. In such a case, your investment decision also changes. Hence, global issues can also affect your financial planning.
Now that you know the factors affecting financial planning, you must keep the following things in mind when you are creating a financial plan.
Before you start planning your finances, make a budget. A budget will help reduce your expenses and manage your finances efficiently. You can start off with the 50-30-20 rule, where 50% is for living expenses such as rent, food, transportation and EMIs, and 30% for lifestyle expenses such as entertainment, clothes, and eating outside. The rest 20% can be for savings and investments.
One form of debt we tend to overuse is credit cards. Although credit cards are a convenient financial tool, utilising more than 30% of your credit limit every month can land you in a pile of debt. Moreover, if you default on a credit card bill, the banks charge a penalty in the form of high interest. Hence it is always best to use credit cards responsibly and pay off the bills before the due date.
When you invest your money in the market, it is always better to stay invested for the long term to ensure your wealth multiplies through the power of compounding. You can only stay invested for a longer duration if you start early. Ideally, you must start investing right from the time you earn your first paycheck. This will give you a huge head start and allow you to reach your goals much faster than you expected.
Not everyone has the time and knowledge to figure out their finances and invest money in the market. It’s not wrong to take the help of experts who can help you figure out your finances and suggest suitable investments for you.
Investing is not a one-time activity. Once you invest your money in the market, you must review it regularly (at least once a year) and see if the investments are helping you progress towards your goal. If they are underperforming, you can always rebalance your portfolio and replace the underperforming investments with better ones.
Taxes take up a huge chunk of your income. Hence, it is important to plan for your taxes as well. The government has given multiple options to reduce your taxable income. You can invest in any of the tax-saving investments to reduce your current taxable income. Moreover, when you plan to withdraw your investment, don’t forget to account for taxes.
I would like to float this statement/ fact in front of you –
” People who practice good money management will have better financial circumstances, including higher savings and increased financial security for themselves and their families.”
Source: https://www.cfinancialfreedom.com/9-tips-creating-discipline-with-money/ – Last accessed 2nd November, 2023
Financial planning is a continuous process which needs to adapt to your changing needs and economic conditions. Hence, it is important to carefully analyse your resources and create a sound plan that can meet your current and future financial needs.