The phrase “Financial Planning” seems somewhat of a ubiquitous term. An idiom used by many in the financial services industry. This then poses the question: “Just what is Financial Planning?” A good question and I hope to make sense of it over the next few paragraphs.
To explain what Financial Planning is, it might be best to explain what it is not. Financial Planning is not the process of selling financial products such as mutual funds, insurance policies, individual stocks and bonds, or the like. A pure product approach knows less about the total financial needs of a person and more of only what the products are designed to accomplish. This approach makes any advice given incidental to the sale of the product. Simply meaning, the financial advice is a direct result of the product sold. This method is lacking and leaves many areas exposed to possible deficiencies.
Financial Planning however is the amalgamation of several disciplines with the purpose of administering methods and behaviors in line with specific goals and dreams of the individual – quite the mouthful. But let’s break it down.
Six core components make up a comprehensive financial plan. These are (1) Money Management, (2) Risk Management, (3) Investment Management, (4) Tax Planning, (5) Retirement Planning, and (6) Estate Planning. The following is a summary of each component coupled with a professional observation.
Money Management is a fundamental foundation to Financial Planning; a necessary and often overlooked component. Money Management is not just about budgeting. It is the building and analyzing of Statements of Net Worth and Statements of Cash Flows. These tools direct resources for current lifestyle needs; in addition, they assist in determining required capital for wealth accumulation. Disregarding these tools is parallel to driving on an unfamiliar road with no map and no directions. You will end up somewhere, but likely not where you want to be.
Risk Management is the concept of identifying and evaluating loss exposures and is normally associated with the term “Insurance.” However, Risk Management is more than just buying insurance.
Risk permeates every aspect of life, from catastrophic events to simple aggravations. The costs of poorly managed risk can impact multiple generations. Moreover, inefficiencies in managing risk can deprive one of future wealth. Taking the time to analyze current risk positions and exposures; in addition to exploring alternatives, helps to alleviate the severity and frequency of losses associated with life’s risks.
Investment Management is more about building a portfolio of securities designed to meet your personal needs, objectives, risk tolerances, and investment time horizons, and less about chasing returns or betting on the next hot stock tip.
Relying on the latest market trends, fund rating services, or even the financial industry pundit’s guessing games makes for inefficient portfolio construction and often leaves investors unaware of the risks owned in their portfolios.
Because of this, investors get blindsided by market movements. This leads to other inefficiencies destructive to wealth accumulation – using emotion as an investment tool. A prudent method is managing risk exposure in the portfolio, not chasing returns.
Tax Planning is a category that permeates almost every aspect of personal and business life. An oversight of tax liability in one area becomes a costly reality in another area. Before setting a course to fulfill a financial goal it is wise to recognize the tax consequences of your decisions. A miscalculation here can impact you and your subsequent generation.
In today’s economic environment Retirement Planning is a necessity. The use of pensions, the holdings within an investment portfolio, Social Security benefits, and/or other elements of retirement require diligence and caution. Not only must you discover your proper investment risks, you must also determine sustainable income distributions from retirement accounts. Mismanagement in this area can amplify the dilemma of outliving ones resources.
Estate Planning is a vital component to financial planning. It makes no difference whether you have an estate tax problem or not, estate planning is necessary. Prudent strategies for protecting family interests must be determined and recorded prior to the event. Lacking a simple Will or Living Will can add to the grief of a family who has lost a loved one. Moreover, failed planning in this area can derail your desires for surviving family members.
As you have read “Financial Planning” is more than a product, it is a process. Each area of planning can, and does, affect the other areas. So next time you hear the term “Financial Planning” you are now equipped to discern if what is said truly is in the realm of “Financial Planning.”