Financial Planning will Make Your Money Work Harder

by Miriam Lopez and Agnes Lizaso

Where do you want to be 10 or 20 years from now? Will you still be working or happily retired? Will you have your own house or still be renting an apartment? Will you be free from debts or still struggling paying your loans? Will your children be in college? Will you have a better car? A new boat? What kind of lifestyle will you be living? Thinking about the future is stimulating and it certainly helps you visualize your goals.

Each individual aspires to live a better life in the future. To have such a life though, one must recognize the requisites, the needed actions to reach those goals. Money is definitely part of the equation; a primary requisite to fulfill those goals.

Other requisites that must be taken into consideration would be:

1. Creating sufficient financial resources to live a comfortable retirement,

2. Providing for one’s children’s education and marriage,

3. Buying one’s dream house, and

4. Providing for medical emergencies.

Financial planning is important because it ensures that an individual has a plan for the future. The irony, however, is that some people hate planning. But the fact remains that it is always good, if not imperative, to prepare oneself financially.

As we age, expenses tend to increase: from children who want toys, to teens who want to support a party lifestyle, to adults who want a home, a car, a good marriage, and finally to elders of old age who want a good funeral when we die.

Unexpected things happen all the time, so being financially ready for these makes life much easier. People who don't plan often find themselves living from paycheck to paycheck and struggling to come up with money when something unexpected does occur.

The good news though is that those who don't have financial plans can easily create one, and can even get themselves out of debt. These plans should include all their projected expenses, from those that are fixed to those that are variable and incidental. One should also allocate the amount of savings to be used for vacations and recreation.

The first step in making a financial plan is to identify goals. These goals are the needs, aspirations and objectives of an individual. Typical goals most people have are paying off their credit cards and student loans, saving for retirement, sending their children to college, setting aside money for medical expenses, and planning for their estates for their successors.

The six key areas of personal financial planning are:

1. Financial Position. This area is concerned with understanding the personal resources available by examining net worth and household cash flow. Net worth is a person's balance sheet, calculated by adding up all assets under that person's control, minus all liabilities of the household, at one point in time. Household cash flow totals up all the expected sources of income within a year, minus all expected expenses within the same year.

From this analysis, the individual can determine to what degree and in what time the personal goals can be accomplished.

2. Adequate Protection. This is the analysis on how to protect a household from unforeseen risks. These risks can be divided into liability, property, death, disability, health and long-term care.

Some of these risks can be insured by the individual himself, but most will require the purchase of an insurance contract. Determining how much insurance to get, at the most cost-effective terms requires knowledge of the market for personal insurance. Business owners, professionals, athletes and entertainers require specialized insurance professionals to adequately protect themselves. Since insurance also enjoys some tax benefits, utilizing insurance investment products may be a critical piece of the overall investment planning.

3. Tax Planning. Typically the income tax is the single largest expense in a household. Managing taxes is not a question of whether you will pay taxes or not, but when and how much. Government gives many incentives in the form of tax deductions and credits, which can be used to reduce the lifetime tax burden.

Most modern governments use a progressive tax. Typically, as your income grows, you pay a higher marginal rate of tax. Understanding how to take advantage of the several tax breaks when planning your personal finances can make a significant impact on your success.

4. Investment and Accumulation Goals. Planning how to accumulate enough money to spend on luxury and expensive items should also be considered when doing financial planning.

The major reasons to accumulate assets are: (1) purchasing a house, (2) purchasing a car, (3) starting a business, (4) paying for education expenses, (5) accumulating money for retirement, and (6) generating a stream of income to cover lifestyle expenses. Achieving these goals requires projecting how much each costs, and the timing of when to withdraw funds. A major risk to the household in achieving their accumulation goal is the rate of price increases over time, or inflation. In order to overcome the rate of inflation, the investment portfolio has to get a higher rate of return, which typically will subject the portfolio to a number of risks. Managing these portfolio risks is most often accomplished using asset allocation, which seeks to diversify investment risk and opportunity. This asset allocation will prescribe a percentage allocation to be invested in stocks, bonds, cash and alternative investments. The allocation should also take into consideration the personal risk profile of every investor, since risk attitudes vary from person to person.

5. Retirement Planning. This is the process of understanding the costs related to living at retirement and having a plan to distribute assets to meet any income shortfall.

6. Estate Planning. This involves planning for the disposition of your assets when you die. You can leave your assets to family, friends or charitable groups. Typically, there is a tax due to the state or federal government at your death. Avoiding these taxes can be done if most of your assets are distributed to your heirs.

Adjustments to the financial plan maybe needed in certain scenarios. Any significant change in lifestyle which is not covered in the estimates would impact one’s long-term financial situation. Similarly, any major change in one’s situation would require a reworking of the financial plan, like having a baby in the family or reduction of household income due to one member of the family taking time off from work to raise children. Our priorities in our own lives change constantly. Our plans should be reviewed whenever major events happen such as a marriage, birth, death or career change.