What is Financial Planning?
Financial planning centers on analyzing your financial situation in order to determine the most productive approach to managing your finances. The practice encompasses much more than simply setting up a budget and tracking your expenses and income. It includes planning for both long-term and short-term financial objectives so that you can structure your finances in a way that improves your ability to achieve your goals.
Reaching your financial goals requires taking into account a variety of factors that can influence your financial success, including budgeting for your desired lifestyle, establishing and prioritizing goals, and finding the right mix between earning money and spending it given your short and long-term financial objectives.
The following areas are typically covered in the financial planning process:
Investment planning is about creating an efficient portfolio that is within your risk tolerance and can help you reach your financial objectives. Careful planning is necessary when building a portfolio designed to optimize your returns. Whatever the amount of your investments, portfolio management helps you select investments by taking into account your risk tolerance, investment objectives, and time horizon in conjunction with market conditions and historical performance numbers.
Given the volatile economic conditions we have seen in recent years and decades, planning for retirement can be a challenging task. As a result, it is no surprise that many Americans feel they have not done enough to prepare for it, with one study finding that 64 percent did not feel they were prepared for retirement. While retirement planning is important at any age, the earlier you get the process started the better, due to the powerful effect of compounding returns.
The use of financial planning software can be helpful in modeling the different retirement planning scenarios available to you. It can enable you to make the adjustments needed now to improve your chances of being able to live the retirement lifestyle of your choice in your golden years.
In addition to selecting investments for your retirement savings, retirement planning includes strategic planning regarding the types of investment accounts you plan to use. This includes IRAs, 401(k) accounts, annuities, and more.
Structuring your income and investments to minimize the taxes you pay is an important component of financial planning. If you optimize your tax profile, the savings can be substantial over the long run.
When balancing your income and expenditures or a financial portfolio with a variety of contributions, deductions, and expenses, budgeting is a necessity. Whether you work with a financial advisor or do the planning yourself, finding a way to balance your budgeting for current and future priorities is essential to achieving financial success.
Dealing with debt can be one of the most challenging parts of financial planning. While debt can be helpful if used prudently, if your debt load gets out of control it can seriously impede your ability to achieve your financial goals. Proactively addressing any debt-related issues is an important part of the financial planning process.
For those who want to specify how their assets will be distributed when they are gone, estate planning is crucial. In addition to directing where any assets you leave behind will go, estate planning is also necessary to help minimize or avoid tax consequences and structure your estate to avoid public exposure.
Creating a financial plan doesn’t necessarily mean drawing up a lengthy document detailing every financial move you plan to make for the next thirty years. Your financial plan doesn’t even have to be written down – although putting at least a framework in writing is helpful as a way to focus your planning efforts.
The primary reason for engaging in financial planning is that achieving complex financial objectives generally requires some amount of preparation and forethought. Taking the time necessary to do so helps ensure that you understand the financial steps you need to take to reach your financial goals.
If you hope to replicate your current standard of living in retirement, for example, in most cases simply relying on Social Security to pay your bills will not be enough. Determining how much you will need to amass in retirement savings and how much to set aside from your current income to fund those savings requires planning.
The same dynamic applies to budgeting, which quickly becomes complicated as the number of expenses you have to keep track of rises. To avoid spending more than you can reasonably afford, keeping a close eye on your income and expenses, both current and projected, is vital. This aspect of financial planning helps bolster your overall financial position, as knowing how much you can afford to spend on long-term goals such as retirement is crucial to making realistic plans to reach them.
Some of the most important benefits of financial planning can be summarized as follows:
- Solidify control over your financial life, so you feel organized and prepared.
- Grow your wealth in a predictable, consistent manner.
- Assure your lifestyle.
- Eliminate or substantially reduce capital gain, income, estate, generation-skipping, and other taxes.
- Protect your wealth, income, and assets from legal judgments.
- Manage the value of your business interests.
- Provide custodial and administrative services for trusts and accounts to save you time and worry.
- Keep your affairs free from publicity, and the costs and delay of probate.
While there are individuals who have the knowledge, time, and desire to perform their own financial planning, many people lack the expertise, experience, and training to feel comfortable doing so. Even those who feel comfortable analyzing financial scenarios and assumptions may find that they lack the time or desire to do it themselves.
Working with a financial planner offers you access to a person with the expertise and experience to thoroughly evaluate your finances and provide suggestions for optimizing your financial situation. In addition to their financial knowledge, planners also typically have access to software tools that can thoroughly analyze your circumstances and model potential outcomes.
Experienced financial planners look to gain a thorough understanding of their clients’ social, financial, and personal wealth and to stress the importance of a holistic approach. This type of approach is designed to bring balance and perspective. They also focus on helping clients with their investment, tax, and estate planning strategies.
Many planners will use sophisticated financial planning software that can model your current financial approach in comparison with others to help you determine whether you are taking the right approach to achieve your financial goals. These solutions can perform stress tests on your plans for achieving goals such as saving enough for retirement.
Another reason to work with a financial planner is their experience in dealing with the ups and downs of investing. While the stock market has offered superior long-term performance, in the short run it can be highly volatile. Many investors have panicked and sold during market downturns, only to miss out on the rebound that followed. A financial planner can offer perspective in such times to help you stay focused on your long-term goals during periods of market turbulence.
There are a variety of types of financial planners. Some specialize in certain areas of planning, while others offer holistic advice focused on your whole financial situation. Planners can provide valuable assistance when it comes to strategizing for the future, whether analyzing your plans for retirement or funding a child’s education, or your budgeting efforts.
When looking for a financial advisor, working with a CERTIFIED FINANCIAL PLANNER™ Professional offers you the assurance that you are working with a qualified, ethical financial professional. To gain the CFP® designation a planner must pass a rigorous series of tests covering the full gamut of financial planning knowledge including insurance planning, investment planning, tax planning, retirement planning, and estate planning.
Additionally, all CERTIFIED FINANCIAL PLANNER™ Professionals are held to the strict ethical standards promulgated by the CFP® board, which stipulate that the client’s best interest must take precedence at all times. CERTIFIED FINANCIAL PLANNER™ Professionals are also subject to continuing education requirements which ensure that they are up to date with all the latest developments in the industry.
CERTIFIED FINANCIAL PLANNER™ Professionals generally work on a fee-only or fee-based basis, either as an hourly rate, a flat fee, or as a percentage of assets under management. This frees them from the conflicts of interest associated with charging commissions on trades, which can result in pressure to “churn” a client’s account solely to generate more compensation for an advisor. This type of behavior is prohibited by the CFP® code of conduct, as it goes against the mandate that a CFP® Professional must always put the client’s best interests first.
Those who take the time and effort to engage in financial planning can reap significant benefits from the process. These previously identified benefits are covered in greater detail below:
Take Control Over Your Financial Life
People who try to manage their financial lives without a plan are prone to find themselves having difficulty meeting their financial goals. This might involve coming up short when it is time to make payments at the end of the month due to failing to properly budget for your expenses. More seriously, it could result in a retirement savings shortfall, leaving you facing unpalatable choices like delaying your retirement or having to reduce your retirement lifestyle expectations.
While engaging in financial planning doesn’t mean that goals that were previously out of reach suddenly become feasible, it does provide the opportunity to improve your chances of reaching goals that are practical given your financial situation. A primary reason for this is that it enables you to consider all of your financial goals together, to make sure that they aren’t in conflict with each other and that you have the financial means to reach them.
Taking this type of control allows you to see where you need to make hard choices about your spending patterns and savings habits to put yourself into a position to reach long-term goals such as retirement. Giving you the confidence that you are on track to reach your goals helps you feel better about both your current spending and future savings efforts.
Grow Your Wealth
For most people, reaching their financial goals requires the growth of capital. This is true for two main reasons:
- Income drops in retirement: Generally, your income declines as a result of leaving your job or reducing the time you spend working upon retirement. As a result, to maintain your lifestyle it is typically necessary to rely to at least some extent on income from your retirement savings. If these savings don’t grow while you are working, they may not provide enough income to enable you to live the retirement lifestyle of your choice.
- Inflation: Even if the amount you set aside in retirement savings is enough to support your desired lifestyle in today’s dollars, the erosion of purchasing power caused by inflation means that such an amount is unlikely to be sufficient many years into the future. If you are 10, 20, 30, or more years from retirement, it is crucial to take into account the impact of inflation in your retirement planning calculations.
Financial planning also typically involves an analysis of your investment portfolio to determine if it appears likely to help you realize your financial objectives. This aspect of planning is known as investment planning and involves selecting both an investment strategy and the investments which are most favored in that strategy.
Assure Your Lifestyle
Whether you are planning for retirement or budgeting for current expenses, it is important to consider all steps possible to assure your lifestyle. When it comes to protecting your current income, disability insurance can be a crucial source of funds if you should suffer an accident that incapacitates you or keeps you from working for a significant amount of time. Health insurance is also vital to assuring your finances aren’t devastated should a significant health issue arise.
Eliminate or Substantially Reduce Your Taxes
Financial planning can help you minimize the impact of taxes of all types. To accomplish this, there are a variety of steps you can take.
These may include:
- Emphasize long-term equity holdings to reduce capital gains.
- Use retirement accounts to gain tax deductions and tax-deferred or tax-free growth.
- Structure your income to reduce taxes.
- Invest in securities such as municipal bonds that generate tax-free income.
- Use trusts to reduce estate taxes and generation-skipping taxes.
- If self-employed or in charge of a small business, take advantage of the ability to write off business-related expenses.
Protect Your Wealth, Income, and Assets from Legal Judgments.
We live in a very litigious society. As a result, in addition to considering how to grow your wealth, it is important to consider how safe your assets and income are from legal judgments. In this regard, retirement accounts can be an important way to set aside funds for future use and gain peace of mind, given that they are generally immune from attachment.
Trusts and legal business entities such as corporations, limited partnerships, and LLCs are helpful in this regard as well by offering various degrees of protection from lawsuits and asset seizure.
Manage the Value of Your Business Interests.
If you own a portion or all of a business, it is important to take all possible steps to preserve and increase the value of that business. In some cases, this can involve bringing in professional management to help maximize the value of the company. In other cases, it may be worthwhile to look at potential acquisition targets or to consider testing the waters to see if it makes sense to sell all or a portion of the business.
Establish Custodial and Administrative Services for Trusts and Accounts
Managing your investment assets can involve a significant amount of paperwork, or the online equivalent. Whether you set this up yourself or work with a financial planner, setting up and maintaining these accounts is crucial to taking advantage of the tax, privacy, and administrative benefits offered by such accounts.
Keep Your Affairs Free from Publicity, and the Costs and Delay of Probate
Establishing a revocable trust allows you to shield your assets from scrutiny by the public. These trusts also enable your assets to pass to your heirs without going through probate. In addition to the costs and lengthy period of time probate can consume, the process is accessible by the public. Placing your assets in such a trust enables you to avoid exposing your beneficiaries’ inheritance to public view.
Once you’ve decided to get serious about financial planning or to step up your existing efforts, the key is to stay focused on the process over the long run. Achieving ambitious financial objectives is unlikely to be a short-term effort – it generally requires significant planning along with ongoing monitoring and adjustments from time to time as needed.
If you would like assistance with your financial planning, we at The Normandy Group are happy to offer our expertise to make the process run as smoothly as possible. We’ll help you develop your personal, social, and financial wealth, bring order to your financial life and make recommendations to generate substantial tax savings while meeting your unique objectives.