The financial goal of most people is to become wealthy. This is the reason why a lot of people are seen chasing their dreams of higher income. This is because, in their mind, a higher income correlates with being wealthy. A lot of the time, it negatively affects their health and happiness also. The normal assumption is that if a person has a higher income, then they will also have a higher net worth in the future. However, this is not the case.

The stories of many high-income earners going bankrupt later on in life are not uncommon. These stories can be found in the high earning professional class as well as amongst celebrities. The reality is that long term wealth has been associated with a long term tendency to consistently engage in financial planning. People who pay attention to their finances and take regular action on a month on month basis to end up being wealthier as compared to their peers.

In this article, we will have a closer look at the process of financial planning and how it helps maximize wealth over the long run.

What Does Financial Planning Include?

The goal of financial planning is to ensure that the financial resources of a person are channeled in an optimum way. The objective is to ensure that a person has whatever amount of money they need at a certain point in time.

It is important to note that financial planning is related to life goals. It is not related to maximizing the net worth of a person at the end of their lives. Instead, if they want a certain sum of money ten years from now, the goal of the financial plan would be to ensure that they have the money at the required time.

Human beings tend to have different types of financial goals. Hence, it is no surprise that financial planning is itself internally composed of many different disciplines. Some of them have been listed below:

• Planning to acquire assets

• Investment planning

• Insurance and medical planning

• Tax planning

• Planning for retirement

Steps Followed in Financial Planning?

There are certain predefined steps that need to be followed in order for effective financial planning. The steps have to be carried out in the sequence mentioned below:

1. Step #1 - Decide on Your Life Goals: A typical financial planning session starts with goal alignment. When people are asked about what they would want from their lives, they often tend to start narrating their financial fantasies of several cars, big mansions, etc. It is important to be realistic at this step. The idea is to segregate the needs from the wants.

   The first goal of financial planning should be to make sure that all the needs are met. If excess money is leftover, it can be used to fulfill wants. The typical needs expressed by people are a house, a car, provision of education, and marriage for kids.

   The ability to be financially independent during retirement is also one of the biggest life goals expressed by people. It is important that each goal has a specific time frame attached to it.

2. Step #2 - Know Your Current Situation: The goals should be created, keeping in mind the current financial situation. For instance, if a person is already deeply in debt, then they should try to first get out of debt before they can plan their finances effectively. The current incomes and the possibility of change in these incomes should be looked at conservatively before coming to the goals.

   At this step, the investor has to find out how much money they have leftover for investment. It is also important to keep in mind that as the income will rise, so will the income taxes. This is the reason that tax planning often becomes a part of this step.

3. Step #3 - Evaluate Investment Alternatives: The next step is to allocate the disposable income to life goals. The idea is to use the best investment vehicle which will provide maximum returns. For instance, if life goals are retirement, using individual retirement accounts is one of the best ways to save money.

   This step involves evaluating different debt, equity, and real estate options in order to finally select the investment vehicle. It is advisable to run projections at this stage and see how the desired net worth changes if the market performance changes. The transaction charges and the managing fees should also be taken into account at this point.

4. Step #4 - Set Up The Investment Plan: Finally, after all the alternatives have been considered, the investor reviews the final portfolio, which has been decided. This money is then allocated and paid on a month on month basis.

   It is common practice for investors to set up an annual meeting with their investment advisors in order to review the performance of their portfolio. Based on the performance in the past periods as well as expected performance in the future, portfolio allocations may be changed.

The bottom line is that financial planning is a complex discipline that includes several other disciplines like retirement planning, tax planning, asset acquisitions, etc.

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