If you’re like me, getting from point A to point B requires a plan or a roadmap. I was taught a long time ago that if a plan isn’t written, it probably doesn’t exist. Shooting from the hip may work in some instances, but in critical areas such as one’s personal finances, I’d rather have a well thought out and written plan or roadmap that I can follow. When a life event occurs such as marriage, the birth of a child or medical situation, it’s a simple matter of adjusting the financial plan just as you would alter your roadmap to take a more scenic route.
So what is financial planning? The best definition I could create is this:
Financial planning is the on-going process to help you make prudent decisions about spending, investing, and transferring your income and assets to help you achieve your goals.
It is an on-going process because your goals change, life events occur, income changes due to illness or unexpected layoff, and of course, the unpredictable nature of our global economy. Because of so many constantly changing variables, it can be a daunting task to understand and manage all the dynamics, perform the analyses, and make non-emotional financial decisions.
To help sort through the myriad of what needs to be done, here is a short description of the 7 key financial planning components. All components are inter-related, the sum of the parts being your comprehensive financial plan:
7 Financial Planning Components
Cash Flow Planning
Probably the least favorite but one of the most important aspects of your overall financial plan is understanding the income/spending cash flow and relationship between your debts and assets. If you are living beyond your means bleeding money every month, it will be impossible to reach your goals. I include goal planning as part of this step because setting realistic goals and achieving them is highly dependent on your ability to save for those goals.
Risk Management
How you manage risk should you become disabled or medically unable to perform your current work obligations or pass away early in life are also part of financial planning. Young families need to understand the risks and various options to prevent financial disaster for the remaining spouse and children.
Retirement planning
Understanding your pension, 401(k), and IRAs and how long they will last throughout your retirement years is very important. Social Security claiming strategies and Medicare applications are also very important and can add or detract significantly from your retirement income if not optimized. One of the most important items overlooked is your lifestyle expectations and required retirement budget plan. All of this needs to be taken into consideration for determination of your withdrawal strategy to best provide you the income you need throughout your retirement years.
College planning
Determining your college savings strategy isn’t as easy as it sounds. 529’s, filling out the FASFA, understanding your Expected Family Contributions (EFC), the CSS profile, educational tax credits, student loans, and a host of other terms and issues facing college students and parents today. College planning consists of understanding the options that are out there and providing you with sound advice to help your son or daughter achieve their aspirations.
Investing
When most people think of financial planning, they may think of investing. Many people ask, “What is the latest hot stock?” or “What is the best mutual fund?” Studies have shown that those are bad questions because investing is not about the latest stock or timing the market. What investing really is, however, is a strategy that takes your goals, your risk tolerance, and your timeline into consideration. Then, developing the best investing strategy to meet those goals.
Your investing strategy should be the foundation for meeting your retirement goals, college goals, and other long-term goals. If done properly, your portfolio strategy should include an asset allocation mix that minimizes risk through a global and well-diversified (properly correlated) set of assets such as stocks, bonds and other alternatives. The asset mix and correlation factors of the portfolio are personalized to your specific needs and are key to the long-term success of the portfolio.
Investing is highly individual, based on a lot of factors. The best way to get started is to write out your Investment Policy Statement (IPS) which outlines your goals, risk levels that you’re willing to take, and general strategy (active vs passive investor). The IPS can then be your guide for all the investments that you make or that you have your financial advisor make on your behalf.
Estate Planning
Some of the most important goals in life may be in how you transfer money at the time of death. Estate planning including wills, trusts, durable power of attorney, and medical directives are also a part of financial planning to help you meet your goals at end of life. Blended families have the unique end of life asset transfer challenges. Protecting the children of the spouse that is first to pass in the current marriage needs to be planned for well in advance.
Tax Planning
Although financial planners are typically not CPA’s, there is a base level of tax knowledge that a financial planner may provide in terms of the tax consequences of a given financial strategy. A CPA is always recommended for professional consultation in a complex tax situation.
What Financial Planning is Not
Financial planning is not about picking the stock of the week, or the best performing mutual fund of last year. It is not about taking unnecessary risks or any financial strategy that you are not educated on or comfortable with. If your financial professional has you in investments that you don’t understand or can’t explain to someone else, it’s probably time to get educated or to make some changes.
Actions You Can Take
Start by writing down your overall purpose in life, the specific goals you would like to achieve (short, medium and long-term), your income, assets, and debts. Make an attempt to create a personalized Investment Policy Statement for yourself. Then seek out a qualified professional to help you come up with your personalized financial plan.
About Kastler Financial Planning
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