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6 Reasons Why Financial Planning is Important

Financial planning aims at ensuring that a household has adequate income or resources to meet current and future expenses and needs. The regular income for a household may come from sources such as profession, salary or business. The normal activities of a household and the routine expenses are woven around the regular income. However, there are other charges that may also have to be met out of the available income. The current income of the household must also provide for a time when there will be no or low income being generated, such as in the retirement period. There may be unexpected expenses which are not budgeted, such as a large medical expense, or there may be needs in the future that require a large sum of money, such as education of children or buying a home, all of which require adequate funds to be made available at the right time. A portion of the current income is therefore saved and applied to create assets that will meet these requirements. Financial planning refers to the process of streamlining the income, expenses, assets and liabilities of the household to take care of both current and future need for funds.

Importance of Financial Planning

  • Personal financial analysis: A financial plan assesses the financial position of a household by bringing together its income, expenses, assets and liabilities. The sources of income, its stability and growth determine how a household may be able to finance its current expenses and future goals. For example, a sportsman’s income accrues over a short span of time, depending on his success in his chosen sport. The income has to be allocated to his current goals of excelling in his chosen sport, which may need significant investment and the future goals of securing his living when his income from his sport falls or stops altogether.
  • Debt counselling: Financial planning help households plan their liabilities efficiently. It is common for households to borrow in order to fund their homes, cars and durables. Several households also use credit cards extensively. To borrow is to use tomorrow’s income today. A portion of the future income has to be apportioned to repay the borrowings. This impacts the ability to save in future and in extreme cases can stress the ability to spend on essentials too. The asset being funded by borrowing may be an appreciating asset such as property, which is also capable of generating rental income. Or the loan could be funding a depreciating asset such as a car, which may require additional expenses on fuel and maintenance, but provide a better lifestyle and commuting conveniences.
  • Insurance Planning: Several unexpected expenses that can cause an imbalance in the income and expenses of a household can be managed with insurance. Insurance is a risk transfer mechanism where a small premium payment can result in payments from the insurance company to tide over risks from unexpected events. The temporary loss of income from disabilities and permanent loss of income from death can be covered with life insurance products. Health and accident insurance covers help in dealing with unexpected events that can impair the income of a household while increasing its expenses on health care and recuperation. General insurance can provide covers for loss and damage to property and other valuables from fire, theft and such events. Insurance planning involves estimating the losses to the household from unexpected events and choosing the right products and amounts to cover such losses.
  • Investment Planning and Asset Allocation: A crucial component in financial planning and advisory is the funding of the financial goals of a household. Investment planning involves estimating the ability of the household to save and choosing the right assets in which such saving should be invested. Investment planning considers the purpose or financial goals for which money is being put aside. These goals can be short-term such as buying a car, taking a holiday, buying a gift, or funding a family ceremony or can be longterm such as education for the children, retirement for the income earners, or high expense goals such as the marriage of children. An adviser helps with a plan to save for these goals and suggests an appropriate asset allocation to pursue
  • Tax Planning: Income is subject to tax and the amount a household can save, the return they earn on their investment and therefore the corpus they are able to build for their future goals, are all impacted by the tax regime they fall under. A financial adviser should be able to assess the impact of taxes on the finances of the household and advice appropriate saving and investment options. The post-tax return of financial products will have to be considered while choosing products and estimating holding periods. The taxability of various heads of income such as dividends, rents and interest differ. The treatment of return if accumulated, rather than paid out periodically, varies. The taxability of gains differs based on the holding period. A financial adviser should bring in these aspects while constructing a plan for the household.
  • Estate Planning: Wealth is passed on across generations. This process of intergenerational transfer not only involves legal aspects with respect to entitlements under personal law but also documentation and processes that will enable a smooth transition of wealth in a tax-efficient way. Estate planning refers to all those activities that are focussed on the transfer of wealth to heirs, charity, and other identified beneficiaries. There are several tools and structures to choose from, in estate planning. Some choices such as gifts can be exercised during one’s lifetime, while choices such as will come into play after death. Financial advisors help households make these choices after considering all the implications and help them complete the legal and documentation processes efficiently.

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