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Understanding the Importance of Financial Planning

written by: AlexisW•edited by: Laurie Patsalides•updated: 2/17/2010

The importance of understanding financial planning cannot be understated. Financial planning is required for all aspects of a successful financial life, from budgeting to retiring.

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    What is Financial Planning?

    Financial planning, in a broad sense, simply refers to managing finances wisely. It essentially means that instead of spending money and resources without thinking or on impulse, that you sit down and make a concrete plan to determine about how to spend money wisely and make money work for you. There are several forms of financial planning, some of which are more sophisticated than others. Essentially, financial planning is like goal-setting; it is setting up a plan to reach a desired outcome or goal. For example, financial planning may include:

    • Setting up a budget
    • Saving for retirement
    • Saving for a home purchase or for any large expense
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    The Importance of Financial Planning

    Without a financial plan, it becomes difficult to allocate money appropriately. If a monthly paycheck is not budgeted correctly, you may find yourself living paycheck to paycheck. Worse, you may find yourself unable to afford basic living expenses, or relying on credit cards to pay for bills and groceries. Financial planning will allow you to determine how much you can afford to spend on rent, food and entertainment. Planning how to best spend and allocate your money will help you meet long term financial goals.

    Without long term financial planning goals, one may never be able to build wealth or become financially secure. Eventually, every individual becomes old or incapacitated and unable to depend on a paycheck for his or her monthly expenses. Financial planning is vital to prepare for that eventuality. Social security and government programs can provide some income in old age, but in order to be able to retire with dignity, most people need to engage in financial planning.

    Even meeting goals along the way to retirement can involve financial planning. For example, if you want to buy a house, you will need to plan to save money for a down payment, and plan to achieve good enough credit to be able to qualify for a loan. Each of these activities- saving money, paying on a mortgage and protecting future credit- is a form of financial planning.

    Financial planning thus must exist on both a macro and micro level. The importance of financial planning extends to the daily decisions you make, and to creating a larger vision for what you want to do with your money.

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    How to Do Financial Planning

    The first step toward financial planning is to set goals. Most people create narrow and broad goals. For example, your goal may be to stop living paycheck to paycheck. This may be a narrow goal, and part of your broader desire to save money to own a house. Your desire to own a house may also be part of an even broader goal: to achieve financial security in retirement, in part, by having a paid off house.

    Once narrow and broad goals have been identified, then it is time to create a concrete plan to achieve them. Start by looking at your current income to determine how much money you have to spend. Make a list of set expenses and allocate your money toward those. See if you have any money left over after your monthly fixed expenses are taken are of. If you do, set up a budget for how to allocate that money. Include saving for short term and long term goals in a budget. If all of your money is going toward fixed expenses and you have nothing left to save for goals, then the first step to your financial planning picture is to figure out how to reduce your fixed expenses or increase your income so you have money left over to achieve your dreams and build wealth after your day-to-day living expenses are taken care of.

    Once you have a budget in place that determines where your money is going to go, take specific steps to accomplish your goals. Begin by setting a date that you want to accomplish each of your goals. For example, you may decide you want to save $20,000 for a home down payment. Set a date to accomplish it in one year, or two years, depending on how much of your money you can set aside each month toward buying the home.

    When it comes to saving for your future and financial security, you will also need to identify the ways you will save- stocks, mutual funds, savings accounts or other investment mechanisms. Determine how much to save for retirement, or for your other goals, and figure out a plan to do so.

    If you have a problem coming up with your own plan, certified financial planners can help. However, financial planning should be doable for everyone if you simply break down your goals to get a handle on your finances.

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