What Is Personal Financial Planning And Why Is It Important?

Personal Financial Planning refers to a systematic approach to managing one’s finances by allocating resources optimally in an effort to maximize the use of these resources in order to achieve one’s financial goals and objectives.

Having a sound personal financial plan is important because it helps reduce and possibly eliminate financial distress arising from various responsibilities and unexpected situations.

It is key to note that financial planning largely depends on one’s age, income level, risk tolerance, the responsibilities at hand, and future objectives.

These factors have led to the broad classification of investors into three phases:

Accumulation Phase: It constitutes the young population of ages 18- 30. Their net worth is low and restricts them to low-priced investments. Nevertheless, they have a high-risk tolerance because of their long-term investment lifespan since a loss incurred during this phase can be recovered in the next investment cycle,

Consolidation Phase: It encompasses the middle age income earners of ages 30-55. At this stage, the net worth of individuals is relatively high since payment of school loans does not burden them like those in the previous stage. They can afford a range of investment commodities. However, their risk tolerance is lower than that of individuals in the accumulation phase. They seek out ventures that would not imbalance their accumulated capital while still investing to offset inflationary rates, and,

Spending/ Gifting Phase: Most people at this stage are retired and are of age 55 and beyond. Their source of income is majorly from the investments held. They have a low-risk tolerance and prefer little to no-risk investments.

It is critical to evaluate these three phases before launching a financial map. Once an individual identifies the appropriate classification, one should be able to determine the personal optimal plan. After this evaluation, we describe the process of creating a financial plan.

Section 2: The Financial Planning Process

Personal financial planning is a continuous process founded on four pillars namely; budgeting, saving, investing, and debt management.

The planning process takes into account every aspect of your financial situation and how they affect your ability to achieve your goals and objectives.

Achieving financial freedom can be through the following steps:

Assessment: This step involves identifying factors that are likely to affect one’s financial plan by evaluating his/her income, spending habits, lifestyle and seeing how each of them will affect their financial plan,

Goal Setting: In this step, one should outline their financial end goal before developing financial action plans. An individual could have multiple goals, some long-term and others are short-term. Usually, financial goals and priorities attached to them differ by person and change over time and therefore it influences the path one takes towards the achievement of their financial objective.

Your financial planning goals should be measurable and achievable by one or a combination of the following four practices:

Saving – Saving basically means deferred consumption and entails consuming less out of a given amount of resources in the present in order to consume more in the future by setting aside part of your income in some form of asset. Efficient saving requires discipline. While saving, it is important to treat savings as a necessary expense and have a plan. Here are a few tips to guide you. Firstly, save with a goal. Secondly, save first, and then spend what you have left. Thirdly, don’t just save, invest,

Investing – Saving is often confused with investing, but they are not the same. Saving allows you to earn a lower return but with no risk involved, while investing gives a higher return but at the risk of loss. Investing involves the purchase of an asset with the hope of generating some income in the future or the asset appreciating hence being able to sell it at a profit. There are different asset classes that one can consider and an investor will choose the different vehicles based on their risk appetite, the returns expected, and the liquidity requirement. As you invest, it is important to diversify one’s portfolio through investing in different instruments in a bid to mitigate risk,

Debt and Debt Management – Is debt good or not? Debt is only good if used towards an investment or for future financial gains such as business, education, or property. However, it is advisable to take up debt for investment only if the economic rate of return, which is simply how an investment’s economic benefits compare to its costs, is able to finance the debt repayment.

Here are a few do’s and don’ts for debt management;

Plan before you borrow,

You should never use more than 1/3 of your net income in loan repayment,

Never borrow for things you desire but don’t need,

Avoid borrowing on consumption items, and,

Live within your means.

Budgeting – Budgeting is simply creating a plan on how to spend your money. It is important that you have the discipline to create a budget around the resources you have and stick to it. When budgeting, prioritize your needs and necessary expenses and try as much as possible to cut down on unnecessary expenses to save money, 

Plan Creation and Execution: The financial plan is a well-detailed process of how one intends to accomplish the goals in the step above, how long it would take to achieve said goals, and the best strategy for achieving those goals. Execution refers to how best to put the created plan to action.

A well laid out plan should highlight the following items:

Suitable channels and investment instruments to achieve your goals- This involves selecting the best strategies to achieve your financial targets. This may be through saving, proper budgeting, cutting expenses, and investing.

Timelines- Depending on whether your goals are long-term or short-term, your plan should indicate how long you are willing to invest in a given investment instrument. Long-term investments, such as bonds and real estate, may be most suitable for long-term goals, and short-term investments, such as money markets, are suitable for short term investments, and,

Monitoring and Reassessment: Financial planning is a continuous process because goals and priorities change over time and therefore monitoring a financial plan for possible adjustments or reassessments are necessary. A review allows you to analyze individual investments and determine if they are helping in the achievement of your goals.

The following factors should prompt one to make changes to their financial plan during a review:

Status of Set Goals- Achievement of pre-determined goals should prompt you to change your financial plan. If the goals are yet to be achieved it is necessary to determine if they can still be achieved, given the present circumstances,

Change in Income- A change in income levels directly impacts your financial plan because it may require a change in priorities and may also lead to early maturity or a delay of set goals and therefore affect the set timelines.

Number of Dependents- An increase/ decrease in the number of dependents may mean that one has less or more disposable income to put into investments.

Change in Risk Appetite and Risk Tolerance- Factors such as age, number of dependents, and income levels of an individual affect the risk appetite and tolerance of individuals, therefore their financial plan should adjust to suit their new risk appetite and tolerance.

Section 3: The Key Considerations to Make When Coming Up With a Financial Planning Strategy

The investment considerations made will largely depend on one’s individual risk tolerance and appetite, which largely depends on age and the level of income. Some of the factors likely to inform one’s financial plan include:

Age– Younger people have a longer time horizon and can, therefore, make riskier investment decisions as they have time to recover if they end up making losses. Their investments are mostly in real estate and equities, which allow the investor time to grow value in their investment. For older people, the time horizon is shorter and therefore they are averse to high-risk investments. Safer investment options are preferred because they offer steady and predictable income, with their investments skewed towards government-backed assets such as bills and bonds, which offer an almost guaranteed return after a given period. They may also invest in various collective investment schemes such as fixed income or money market funds, which are professionally managed, and offer liquidity, periodic income, and principal protection.

Risk Profile– Risk is the potential threat that may affect the outcome of your investments and individuals either tolerate or avoid risk. Risk-averse individuals generally avoid riskier investment decisions. Their financial planning decisions are geared towards safer investment plans and their portfolio will most likely include investment instruments such as treasury bonds, bills, and bank deposits. They can also invest in these securities through money market funds or fixed income funds. Risk-takers, on the other hand, will channel their planning towards high-risk investments such as real estate and equities, with the aim of generating higher returns,

Income– A change in an individual’s income affects their disposable income and the amount of money they have left to invest. The investment vehicles one uses in achieving their financial goal are dependent on their level of income. Low-income earners can gain access to various securities such as bank deposits, treasury bills, bonds, and equities through the various types of collective investment schemes and structured products given the relatively lower initial investment requirement.

Investment Goals– What individuals hope to achieve will determine the type of investment they venture into long-term or short-term investments. Investment goals address two major themes regarding money and money management. First, they generate accountability, forcing individuals to review progress from time to time, and second, they help in generating motivation, and,

Marital Status and Number of Dependents– People with few dependents have the freedom to make riskier investment decisions as compared to those with many people depending on their income. Married individuals often prioritize their families and would always look for less risky portfolios due to their responsibilities in the family.

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