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Submitted by: Michael Plude
What is financial planning?
Financial planning is the process and various steps that lead to the proper management of available income and better management of expenditure.
Financial planning requires a meticulous and disciplined approach. It is important that you know from where your money will be coming and what you intend to do with it, whether it is for saving or for investment. You should be clear in your mind about how you propose to attain your objectives.
Steps in financial planning:
There are mainly four steps involved in financial planning. These are:
Analyze and identify your objectives and document them, for example, childrens education, buying a new car, constructing a house, going on vacation, clearing your credit card debts, planning your retirement and so on.
Break down each objective into smaller slots such as short term (less than 1 year), medium term (1to3 years) and long term (5 years and more).
Educate yourself about how to improve your net worth by reading books and journals, browsing the Internet, attending seminars and discussing with knowledgeable people.
Using this information, formulate an action plan for you.
Evaluate your progress at convenient intervals; say every 3 or 6 months. Wherever necessary, review the process and take corrective action.
Remember that there are no fixed rules for implementing the action plan. The most important thing is to start it immediately and avoid any postponement.
Implement the financial planning schedule:
1. Make sure that all of the objectives in the financial plan are realistic and feasible.
2. Prepare a list of priorities according to the amount of money involved and the time horizon for each of the goals.
3. Choose investment instruments appropriate for each objective short, medium or long term.
The power of compounding in financial planning:
The first and most vital action you should take is to start your savings plan as early as possible to obtain the full advantage of compounding. This is not difficult in the early years of your life when you are single and free of family problems. The determining factor in the growth of your savings is the length of time available. As a matter of fact, the time value of an investment is more crucial than your age or the size of your contribution to the savings account. A hypothetical example is given below:
Tom and Dick are two young men, 25 years old and unmarried. They hold good jobs and enjoy a reasonably good standard of living. Tom contributes $1000 every year to his savings account for 10 years and then stops without making any further contribution thereafter. Dick does not make any contribution during these 10 years and then starts contributing $3000 every year for the next 20 years. We can assume a constant rate of growth of 15% in both cases. When the respective total savings of both are compared at the end of the 30 year period, it will be found that Toms amount is substantially higher that that of Dicks, even though he had been paying in $3000 every year for 20 years. It can be proved by calculation that even if Dick continues his $3000 contributions till the end of time; he will never be able to catch up with Toms total savings. Such is the power of compounding, which Einstein once described as the eighth wonder of the world.
Note that the bottom line for financial planning is to start saving and to start it NOW.
About the Author: Michael Plude has more than 20 years of experience in the field of financial planning. He has helped varying clients from small to medium sized companies and has provided audit services to Fortune 500 companies. For more information, visit