What is Financial Planning? Definition, Importance, Role

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What is Financial Planning?

Financial planning refers to a process of planning finances by an individual to identify his/her financial needs and objectives and invest according to the requirements. It can also be defined as a process of meeting financial goals through the proper management of finances. An individual may have various financial goals, such as buying a house, saving for a child’s higher education, or planning for retirement.

As a process, financial planning helps an individual to identify his/her current situation by following a few steps that consist of:

  • Gathering relevant financial information
  • Setting life goals
  • Examining current financial status
  • Coming up with a strategy or plan to meet life goals

In this way, financial planning enables an individual to assess his/her current situation, recognize future needs, and identify the measures that may help the person to reach the goals.

According to the FPSB, “Personal financial planning” or “financial planning” denotes the process of determining whether and how an individual can meet life goals through the proper management of financial resources. Financial planning integrates the financial planning process with the financial planning subject areas.

In determining whether the certificate (planner) is providing financial planning or material elements of financial planning, factors that may be considered include, but are not limited to the:

  • Client’s understanding and intent in engaging with the certificate.
  • The degree to which multiple financial planning subject areas are involved.
  • The comprehensiveness of data gathering.
  • Breadth and depth of the recommendations.

Financial planning gives more clarity to the goals of life. It creates a kind of road map in terms of what has to be done to achieve those goals. The main objective of financial planning is to meet the financial goals of the investor through the right combination of savings and investment. Many factors are to be taken into consideration for financial planning, e.g. economy, government, consumer, education, geographic factors, career, age, etc.

Importance of Financial Planning

Every aspect of an individual’s life requires planning. Of these, planning personal finances is the most important as it secures the individual’s and his/her loved ones’ futures. Financial planning is important as it offers the following advantages:

Helps in taking the right investment decisions

Financial planning provides a direction to individuals about their financial decisions. It helps them in making the right investment decisions and ensures that funds are available at the time when individuals need them the most.

Helps in understanding an individual’s risk appetite

A financial plan helps individuals in assessing their risk appetites and taking calculative steps while investing. The risk profiles are based on various factors including family conditions, commitments, age, and available liquidity.

Helps in accumulating wealth as per individual goals

Financial planning limits random investing and helps individuals to systematically accumulate wealth for fulfilling short and long-term goals.

Role of Financial Planner

A financial planner is a qualified investment professional who guides individuals to meet their long-term financial goals and develop strategies to achieve these goals. Individuals are generally not able to take complex financial decisions and take the aid of the financial planners for the same. The main objective of financial planning is to meet financial goals through proper planning and management of finances.

A financial planner suggests to individuals how to meet their financial goals through proper planning. Financial planners have a good understanding of investment options available and their suitability to the overall financial situation of an individual before making recommendations.

He helps individuals in the following:

  • Identifying investment needs.

  • Translating the needs into measurable financial goals.

  • Planning investments to achieve those goals.

  • Providing financial security and thus ensuring that all financial goals are met.

  • Giving direction and meaning to one’s financial decisions.

A financial planner suggests to individuals regarding their lifetime financial decisions, which include the following:

  • Risk Management and Insurance Planning: Controlling money flow threats through better risk management and insurance functions.

  • Investment and Planning Issues: Plotting, innovating, and controlling capital consumption to create better capital and money flows for reinvestment and spending.

  • Retirement Planning: Ensuring financial independence after retirement. This has been discussed in detail later in the chapter.

  • Tax Planning: Aligning financial goals with tax efficiency planning.

  • Estate Planning: Arranging the transfer of an individual’s assets in anticipation of death.

  • Cash Flow and Liability Management: Controlling and expandinging individual’s money flows through debt and lifestyle management.

A good financial planner assists individuals to develop investment plans that suit their financial circumstances. The characteristics of a good financial planner are as follows:

  • Considers all aspects of the present financial condition of an individual and plans accordingly.

  • Provides an unbiased assessment of what needs to be done.

  • Helps in the appropriate allocation of resources.

  • Helps to plan investments in a manner that keeps taxes to a minimum.

  • Uses ethical means to attain financial objectives.

Factors Affecting Asset Allocation

How an individual’s portfolio is invested across different investment avenues is one of the most important decisions in financial planning. This is because markets are cyclical, what offers higher returns today may become a risky choice to opt for later. By spreading the investments across different asset classes and markets, an individual can take advantage of the opportunities in the market.

Let us discuss the relevance of these factors to asset allocation in detail.

Time horizon

This factor provides an idea about how long an individual expects his/her assets to last. Time horizon decides whether an individual is interested in investing in the short-term or long-term asset class.

Risk tolerance

This factor gives an idea of how willing an individual is to endure market changes in exchange for more growth potential over the long term.

Financial situation

This factor gives an idea about an individual’s lifestyle and asset details. This helps in deciding investment options that could help in maintaining a particular living standard in the future without compromising on the present.

There are three basic types of investment that an individual could opt for after the above factors have been taken into consideration. There are as follows:

Short-term investments

These investments are the most con- servative in nature and are also referred to as cash investments. Short-term investments generally involve the least amount of risk and tend to provide least potential returns. Individuals with lower risk profiles tend to invest in short-term investment avenues.


These investments are moderately risky, which means that bonds are less risky than stocks but riskier than cash investments. Bonds offer moderate returns and risk to individuals with a moderate risk profile.


These refer to securities that signify ownership in an organization and represent a claim on part of the organization’s assets and earnings. Stocks are the riskiest of the three investment options as they fluctuate with market changes. Individuals with an aggressive risk profile prefer to invest in stocks. Although stocks are riskier, they tend to offer maximum returns to the investor.

Aligning Investments to Goals

Traditionally, investing processes involved the identification of a few investor goals, often with the help of a financial planner, and investing all assets into a single portfolio. The investors were advised to expect a given return based on the past and expected performance and market volatility. In reality, the investors’ financial objectives differ in terms of their financial status, time horizon, and risk appetites.

For example, an individual could take more risks with long-term goals and less risk with short-term goals. Likewise, an individual would take less risk with funds assigned for covering day-to-day expenses, while taking more risk for discretionary goals such as luxury vacations. By tracking each goal separately and monitoring them accurately, investors could get a clear picture of how well they are invested to cover their short and long-term financial goals.

The existing investment approach supports goals-based investing oriented around the individual investor. The effectiveness of an investment strategy cannot be evaluated using traditional yardsticks such as market indices, benchmarks, etc. Individual goals distinguish the investment approach of different investors.

Investment strategies should be aligned with each client’s personal goals. Goals-based investing recognizes that investors have conflicting goals. Whether a client intends to accumulate assets for retirement, save for a luxury vacation, donate to trusts, or achieve any other goal, the investment strategy should be aligned with each goal.

Therefore, instead of pooling all client assets into a single portfolio, a separate portfolio for achieving each goal is preferred. The portfolio performance is measured in terms of the client’s progress toward achieving each stated goal. Provides an example of how aligning investments to goals helps individuals to prioritize their financial needs against their wants with details of the time horizon for each goal.

What is Retirement Planning?

Retirement planning is the process of setting and achieving financial goals to ensure a secure and comfortable retirement. It involves making financial decisions and creating strategies to accumulate sufficient funds to support one’s lifestyle and expenses after they stop working. Retirement planning is essential because it allows individuals to maintain their desired standard of living during their retirement years when they no longer have regular employment income.

While deciding to earmark an amount for savings and investment, a percentage amount of an individual’s must be kept aside. For example, if an individual assesses that his/her annual salary would grow from the existing 3, 00,000 to 4, 00,000 in the next two years, he/she could plan an instalment percentage of 30,000 in the first year and gradually in- crease it to 40,000.

Another point to keep in mind is to avoid withdrawing any income gained from investments. Individuals should re-invest this income to generate a sizeable return after retirement. This helps in avoiding additional pressures on an individual and enhances his/her comfort to arrange for cash to meet his planned investments.

Early retirement planning is critical as it takes several years to accumulate the estimated funds for a comfortable living even when an individual no longer enjoys the benefits of a regular salary. With growing years, there is generally an increase in medical needs and social security of an individual. The retirement plans should thus include medical insurance and social security benefit plans. Even without regular salaries, early retirement planning could help in maintaining the lifestyle that individuals have become accustomed to.

Retirement planning through investing in securities and retirement-focused tools such as employer-based pensions, Individual Retirement Arrangement accounts (IRAs), and 401(k) plans could provide individuals with enough resources to enhance their post-retirement monthly incomes. IRAs are investment instruments used by individuals to earn and earmark funds for retirement savings. 401(k) plans are established by employers for which employees could contribute by way of salary reductions on a post-tax or pre-tax basis.

However, the most important point to be noted for retirement planning is that once an individual establishes an investment strategy to reach his/ her retirement savings goal, he/she should follow it religiously. Individuals could also consider establishing a special savings account to cover emergency or unexpected expenses for their post-retirement years.

Guidelines for Retirement Planning

Let us discuss each of these guidelines in detail.

Time Horizon

The present age and expected retirement age are the basis of the initial groundwork for retirement planning. The longer the time horizon between the present day and retirement, the higher would be the level of risk that an individual’s portfolio could withstand. In addition, the risks of return volatility are mitigated with a longer time horizon.

Spending Requirements

Precise assessment of retirement spending goals would help an individual to plan retirement accurately as higher spending needs in the future require additional savings today.

After-Tax Rate of Return

The after-tax rate of return must be calculated to assess the feasibility of the portfolio producing the needed income. The retirement income should be estimated by keeping in view the tax deductions applicable.

Portfolio Allocation

The most important step in retirement planning is to arrive at a proper portfolio allocation that balances risks and returns and still meets post-retirement income expectations.

Estate Planning

Proper estate planning and life insurance coverage ensure that an individual’s assets are distributed in a way that his/her family members do not experience financial hardship following the individual’s death.

Risk Management Strategies

Individuals are exposed to a variety of financial risks such as financial loss from investing in the stock market, potential damage to assets, etc. Such incidents can drain the financial resources of individuals and undermine their financial plans. Risk management helps in mitigating the potential financial risks to minimize the effect they could have on an individual’s finances.

Risk management provides financial security through the use of financial strategies, tools, and services. It mitigates the risk of potential financial losses if and when they occur. A comprehensive risk management strategy is based on minimizing personal, property, and liability risks.

  • Personal risks: These are risks associated with the potential loss of income due to injury, poor health, and unemployment.

  • Property risks: These risks are associated with the potential loss of value of assets due to fire, hurricanes, negligence, and other uncontrollable events.

  • Liability risks: These include risks associated with circumstances such as lawsuits and damage to other’s property or persons due to negligence.

Let us discuss these risk management strategies in detail.

Risk Transfer

One of the most common ways to mitigate and manage financial risks is through the purchase of insurance instruments. Insurance refers to the equitable transfer of financial risks from one entity to another in exchange for payment. Insurance is a risk management strategy used for hedging against contingent risk and uncertain losses.

Insurance offers protection to policyholders against large and unexpected financial losses, by way of compensation as per their contractual obligations. This form of risk management is often referred to as risk transfer.

Risk Avoidance

The other common way to mitigate financial risks is through the avoidance of risk. Individual’s assets are exposed to various potential hazards and exposures.

For example, not buying a house at a place prone to earthquakes is risk avoidance. Individuals can choose to avoid certain risks by making different choices in life. Individuals avoid investing in equities and stocks and prefer fixed income securities to avoid financial risks.

Risk Reduction

Another risk management strategy used by individuals is through the reduction of risks. This involves reducing the severity of the loss or the likelihood of the occurrence of loss.

For example, fire extinguishers are used to reduce the risk of loss by fire. Individuals diversify their investment portfolio to minimize the potential loss that could occur if one of the investments fails to provide the expected return.

Article Reference
  • Charupat, N., Huang, H., & Milevsky, M. (2012). Strategic financial planning over the lifecycle. New York: Cambridge University Press.

  • Greenwood, R. (2002). Handbook of financial planning and control. Aldershot, Hants, England: Gower.

  • Stovall, J., & Maurer, T. (2011). The ultimate financial plan. Hoboken, N.J.: John Wiley.

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