Financial planning is a comprehensive process. It involves many areas of finance, such as setting clear goals, budgeting, investing, taxes, debt management, and risk protection. Essentially, the purpose of a financial plan is to help you achieve your financial goals and secure your future, all while making sure that you can manage your resources effectively and make decisions that are aligned with your situation and preferences. Making a financial plan offers many advantages, so let’s understand why financial planning is important, and take a look at the top ten benefits of financial planning. Let’s go!
Why is Financial Planning Important
Financial planning is important because it allows you to handle various financial challenges effectively. Through investment planning, it helps protect against the eroding effects of inflation. Lifestyle inflation is also on the rise, so our generation often spends more than needed. Budgeting is a part of financial planning which helps you be smart with your expenses. Financial risks are all around us. Financial planning can also prepare you for these risks and unexpected circumstances, such as medical emergencies or job loss, through risk protection strategies and emergency planning.
Financial planning helps you fulfil your dreams, whether it’s buying a home, starting a business, or funding your children’s education. Taxes can make a huge dent in your savings, that’s why tax planning minimises the impact taxes have and helps you to retain more of your hard-earned money. Essentially, financial planning ensures that you are well-prepared for any financial challenges.
10 Key Benefits of Financial Planning
Let’s take a closer look at the top ten benefits of financial planning in business and personal finance:
1. Goal Clarity
Whether it’s saving for a peaceful retirement, buying a home, starting a new business, or funding a child’s higher education, our financial goals drive our decisions. Financial planning, especially goal-based financial planning helps us turn these dreams into reality.
Setting these goals is the first step in creating an effective financial plan. One way to start this process is by setting SMART goals. SMART stands for Specific, Measurable, Attainable, Relevant, and Time-bound. SMART goal setting ensures that every financial goal has these five attributes, which makes it easier for us to track progress, stay motivated, and ultimately achieve our financial goals.
2. Budgeting and Savings
Your financial goals give your financial journey direction and purpose, but budgeting is what helps you reach your destination. A budget outlines your income and expenses and helps you keep track of them. This does two things – First, budgeting makes sure you don’t spend more than you earn, and live within your means. Second, it helps you allocate money towards savings, which is what helps you achieve both short-term needs and long-term goals. An effective way to create a budget is by using the 50/30/20 rule. According to this rule, your income should be divided into three parts –
- 50% of your income should be allocated to essential expenses. These are also called ‘needs’, as they include necessities such as rent or mortgage, electricity and water bills, groceries, transportation, insurance premiums, and healthcare. Basically, if you can’t do without something or its absence seriously hurts your lifestyle, it can be considered an essential expense.
- 30% of your income can be used towards non-essential expenses such as dining out, steaming services, hobbies, and travel. These expenses are called ‘wants’, and they allow you to enjoy your life.
- 20% of your income should be dedicated to building your savings and paying off debts. Traditionally, savings were thought of as whatever income that’s left after all expenses are paid, but financial planning encourages prioritising savings just like any other essential expense. By simply setting aside this portion of your income first, you can make sure that you’re consistently working towards building a more financially secure future.
The non-essential category of your budget helps you identify areas where you can make cuts if you are unable to save as much as you need. Savings are important, however, it is equally important to be realistic when creating a budget. If you cut out too many expenses that make your life fun, you can lose the motivation to stick to your budget.
3. Debt Management
From education and home loans to credit card bills, debt is something many Indians struggle with. Financial planning allows you to effectively manage debt through various strategies such as debt consolidation, refinancing high-interest loans, and creating a structured plan for regular debt payments. One can also employ repayment strategies such as:
Debt snowball method
With this method, you start off by focusing on your smallest debts first. In the meantime, you can make minimum payments on your larger debts. Once a small debt is paid off, you can move on to the next smallest amount, then the smallest after, and so on. This is how this method gets its name. As you gain momentum and motivation with each paid-off debt, your ability to take on the larger debts increases, and a snowball effect is created.
Debt avalanche method
This method takes a different approach by focusing on paying off debts with the highest interest rates first while making minimum payments on debts with lower interests. When you concentrate on high-interest debts first, over time it helps you save more money, as the interest paid during the period is lower.
Paying off debt efficiently should be of utmost importance. Once you’ve eliminated all existing debt, financial planning can help you stay out of debt, or at least make sure that any loans that you may take in the future can be easily managed.
4. Risk Management
We are surrounded by financial risks. Be it health emergencies, accidents, job loss, or natural disasters, unexpected events and expenses can wreak havoc on our financial well-being. A major part of financial planning is risk protection, which involves identifying these risks and taking steps to mitigate them. This includes:
Buying health insurance policies
Comprehensive health insurance coverage for you and your loved ones is more than just a luxury. Given the current pace at which the costs of healthcare are increasing, having a financial safety net in the form of health insurance is essential. A serious hospitalisation can deplete your savings, force you to liquidate your investments prematurely, or even push you under the heavy burden of debt. That’s why managing health risks would not only give you peace of mind but would also ensure financial stability in case any unexpected health issues come up.
Having a life insurance policy
In case the breadwinning member of the family passes away prematurely, a life insurance policy can give much needed financial support to their family members. A life insurance policy makes sure that your family is not left financially vulnerable in your absence and can cover daily expenses, pay off any debts, and fund your children’s education. With a life insurance policy, you can enjoy peace of mind knowing that your family will be able to maintain their standard of living and achieve their long-term goals.
Building an emergency fund
An emergency fund is a reserve of cash that is used solely for meeting unforeseen expenses, such as a medical bill, car repair, or a loss of a job. Building this fund is a part of emergency planning, and it can help you stay on track with your financial goals even if you face any unexpected expenses.
5. Investment Planning
To realise your financial dreams, simply saving money isn’t enough. The money you save must be put to work, and you can do that by investing in different financial instruments as per your financial situation, investment horizon, and risk tolerance. This part of financial planning that deals with the growth of your savings through investments is known as investment planning. There are various aspects of investment planning, such as:
Assessing your risk profile
This involves taking a detailed look into your financial life, and assessing how much risk you can afford to take. Generally, investors are divided into conservative, moderate, and aggressive categories.
Identifying suitable financial vehicles
There’s an abundance of investment options available to investors, such as mutual funds, stocks, bonds, ETFs, fixed deposits, gold, real estate, and REITs. One must choose the options that align with their overall financial goals and risk tolerance.
Risk mitigation
Every financial instrument has its own risks. Investors must analyse these risks and use strategies to minimise them. One such strategy is diversification, and it involves investing in a wide variety of financial instruments across different asset classes and industries. This reduces the chance of losses because if one investment underperforms, others would still perform well, thus balancing out the overall risk.
Portfolio review and rebalancing
One should always make a habit of reviewing their portfolio regularly. These reviews allow you to assess the performance of your investments, identify any underperforming assets, and make necessary adjustments so that your investments stay aligned with your financial goals, risk tolerance, situation, and market conditions.
6. Tax Efficiency
The part of financial planning that deals with managing and reducing your tax liabilities legally is known as tax planning. Taxes have the potential to make a significant impact on your overall financial health and wealth. With tax planning, you can take advantage of the various deductions and exemptions offered under the Income Tax Act, and keep more of your hard-earned money. Some common ways financial planning helps save taxes include:
Investing in tax-saving instruments
Investment options such as Equity Linked Savings Schemes (ELSS), the Public Provident Fund (PPF), and the National Pension System (NPS) offer deductions of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. These help reduce taxable income and thus allow you to save more taxes.
Claiming deductions on loans
The Income Tax Act also offers deductions on various types of loans. For example, if you have an ongoing education loan, Section 80E allows you to claim a deduction on the amount paid as interest over the financial year, without any upper limit. Similarly, for home loans, Section 24 (B) offers a deduction on the interest paid on the home loan up to Rs. 2 lakh per year. On top of that Section 80C allows you to claim a deduction on the principal repayment of your home loan.
Claiming deductions on insurance
Section 80D of the IT Act allows you to claim deductions on the premium paid for health insurance policies. You can get a deduction up to Rs. 25,000 per year for premiums paid for yourself, your spouse, and your children. For insurers who are senior citizens, this limit increases to Rs. 50,000. You can also claim an extra deduction of up to Rs. 25,000 for premiums paid for insuring your parents. This benefit rises to Rs. 50,000 if your parents are senior citizens. Deductions are also available for premiums paid on life insurance policies under Section 80C, up to a maximum deduction of Rs. 1.5 lakh.
Making donations
If you make donations to eligible NGOs and charitable organisations, you can claim a deduction of 50% or 100% of the amount donated under Section 80G.
Restructuring salary to maximise exemptions
Some components of salary, such as House Rent Allowance (HRA) and Leave Travel Allowance (LTA) are either fully or partly exempt from tax. Including such components in your salary, or increasing their allocation can lower your tax liability significantly.
7. Retirement Planning
After a life of hard work, every individual looks forward to a comfortable and peaceful retirement. Unfortunately, for many this dream remains just that – a dream. This is generally due to a lack of proper planning and disciplined saving during their working years. However, this dream can be turned into reality through retirement planning. Not only can retirement planning make sure you achieve your desired retirement lifestyle, but it can also help you achieve an early retirement.
This process starts by assessing how much you need to save and invest to achieve the retirement life you want. It should also take into account inflation and life expectancy for a more accurate estimate. Since it is generally a long-term financial goal, savings should be invested in equity instruments and other growth-oriented assets, as these investments have the potential to provide higher returns over the long term.
This journey should start as early as possible. Even if you are in your early 20s and just starting your career, the smallest contribution towards your retirement savings can make a massive difference over time. The power of compounding means that early investments have more time to grow, which means you’ll amass a much larger retirement corpus than those who start late.
8. Education Funding
Every parent wants the best things in life for their children, and education is no different. However, the cost of higher education in recent years has experienced a surge, which can cause a lot of financial strain. To make sure that you can support your child’s educational dreams without facing financial difficulties, it is important to plan for it. As with retirement, planning for your children’s higher education is an endeavour best started as early as possible.
9. Estate Planning
Estate planning is the process of organising and managing your assets to make sure that they are distributed according to your wishes after you pass away. It is an important part of financial planning and is also often called succession planning or legacy planning.
In our country, many people die without having a will or any formal estate plan, which often leads to complications. Our courts are filled with legal disputes among potential heirs, and often the assets of the intestate are misused. With a proper succession plan, you can make sure that your estate is handled efficiently and that your assets are managed and allocated according to your intentions. This would prevent disputes among your loved ones, and ensure that the transfer happens smoothly while saving as much tax as possible.
10. Financial Security
One of the biggest advantages of financial planning is the peace of mind that comes with it. When you actively take steps to manage your finances, you gain confidence in your decisions. With a budget, you can make sure that you don’t spend more than you earn and prioritise savings. By investing your savings, you work towards goals like retirement or funding your children’s education.
Risk protection helps make sure your family is financially safe in case of unexpected events. Tax planning ensures you stay compliant with authorities while minimising your tax burden year after year. Basically, a well-crafted financial plan prepares you for uncertainties and helps you handle any financial challenge with ease. It gives you a sense of security, as you know that you have a strategy in place to protect your future and achieve your financial goals.
Conclusion
Financial planning covers a vast range of strategies that help you achieve your financial goals and secure your future. It has many, many benefits, such as giving your financial goals clarity, helping you track expenses through a budget, and keeping debt under control. It also helps with managing financial risks, investing wisely, and saving on taxes. Overall, financial planning helps you manage your hard-earned money better, prepare for the uncertain future, and achieve financial goals and stability.
