What is Financial Planning and Why Should You Care?

Last updated on July 22nd, 2017

During my PhD, I’ve taught numerous classes related to personal financial planning. In these classes, I’ve noticed that many students don’t understand the financial planning process. If my students don’t understand the process, and they are enrolled in a CFP® Board registered academic program, then what about the general public? I’m guessing few individuals outside of the financial industry have an accurate understanding of financial planning.

This lack of understanding is exacerbated by the hoards of people calling themselves “financial advisors” or “financial planners” or  “financial consultants” or “financial brokers” or “wealth managers.” All of the different titles and job descriptions are confusing, and confusion ultimately reduces consumer demand in a knowledge based profession.

If you’re considering hiring professional help, you need to know what to expect from a good financial planner, and how to tell the difference between a salesperson and someone who offers fiduciary financial planning advice. Hopefully this article will lead you in that direction.what-is-financial-planning

What Financial Planning is NOT

Before I describe the financial planning process, let’s clear up a major misconception surrounding the profession:

Financial planning is not synonymous with asset management, stock picking, or investing.

Investing is an important part of the financial planning process, but it’s only one small part of the overall plan.

Low-cost index funds, robo-advisors, and automated investment platforms have made investing ridiculously easy for everyone. With a few clicks of the mouse, anyone can establish a well-diversified, low-cost portfolio of index funds. I believe this trend will continue to accelerate, making it harder for brokers and salespeople to sell commissioned investment products (most of which should not exist in the year 2016).

What is Financial Planning?

Financial planning is about using your money to achieve your goals. 

A financial plan should begin with a series of questions about you. For example:

  • What do you want to achieve in the next 5, 10, 20 years?
  • What are the most important things in your life?
  • What activities make you happy?
  • What are your core values?

These questions should make you think about your life, goals, and priorities. Without a clear understanding of these things, it’s impossible to create a personal financial plan.

You may be asking, what about the financial aspect? Well, that’s part of the process, but it’s secondary. Your financial assets are the means by which you achieve your goals. You must define your goals before worrying about the dollars and cents.

Financial planning is an ongoing process. 

Your life circumstances, goals, and values will change over time. A good financial plan allows for that change.

Financial planning is multifaceted.

A customized financial plan should consider all of the following (and more):

Cash Flow Management

  • How much money are you making, spending, and saving?
  • What is your savings rate?
  • Do you have an adequate emergency fund?
  • Where should you hold that emergency fund to obtain the highest risk-adjusted return?

Debt Management

  • How much debt? At what interest rate? What are the minimum monthly payments?
  • Do you qualify for any Government loan forgiveness programs?
  • Should you prioritize debt repayment over saving and investing?

Real Estate

  • Do you own a home, rent, or something else?
  • Should you refinance your mortgage?
  • Should you use a HELOC as an emergency fund?
  • Should you consider a reverse mortgage during retirement?

Education Planning

  • Do you want to return to school? Do other members of your family?
  • What funding vehicles are available, and which is most appropriate given your situation?
  • If you can’t do both, should you save for college or fund your retirement?

Career Planning

  • What is your career and income potential?
  • Do you enjoy your work, or are you looking for something different?
  • What benefits are offered at your job? Are you properly utilizing them, or paying for unnecessary benefits?

Investing

  • How much are you paying in fees and what are the available investment options?
  • Are you utilizing available retirement plans?
  • Does Traditional or Roth make more sense for you?
  • How risky are your investments, given your risk tolerance?

Insurance

  • Do you have adequate coverage for your home, cars, etc.?
  • Do you need life insurance, disability insurance, or an umbrella policy?
  • Should you consider switching providers to save money?

Retirement Planning

  • Do you have adequate savings to fund your retirement?
  • Should you consider purchasing an annuity to provide guaranteed income?
  • How can we plan retirement income distributions to minimize the tax burden?

Estate Planning

  • Have you completed the essential estate planning documents (will, power of attorney, etc.)?
  • Will you have a taxable estate? If so, how can we minimize taxation?
  • Should you consider whole life insurance or a trust?

Sound financial planning requires a significant investment in human capital, and a competent financial planner should have a thorough understanding of the content areas described above. Without this knowledge base, how can a planner add value to your life?

There are some great financial planners out there, and some terrible ones. It’s mixed bag, and I’ve seen numerous brokers masquerading as financial planners, despite having zero financial planning education. An individual’s level of education, training and experience will make a big difference in their ability to provide sound financial advice.

Why Does it Matter?

Financial planning can improve many aspects of your life:

Clarity for your financial life – Knowing your cash flows can help you identify problem areas, and can ultimately help you better manage the resources available to you.

A positive mentality – Taking control of your financial situation can improve your outlook on life. Instead of being worried or anxious about money, you can rest assured knowing that your money is being used to fund your goals and dreams.

More confidence – According to a CFP Board survey, 52% of those with a financial plan feel “very confident” about managing their money. Only 30% of those without a plan feel the same way. Having a tailored financial plan helps you feel in control of your finances.

More wealth – That same survey, among other research, shows that financial planning often leads to high levels of wealth for clients. You won’t get rich overnight, but a financial plan can help you be more intentional with your spending, saving, and investing decisions.

What has been your experience with financial planning? Feel free to share with a comment below.

Comments
    • Emily White
    • February 3, 2017
    Reply

    It is good to have someone professional that could help on how to have a good financial status. It’s good that you’ve mentioned on what to expect from a good financial planner. Becuase there are tons of financial planners that has their own way of planning it. Somehow, the most important things must to in-order to have a good financial status is knowing what you need and what you want. Mostly all of the people are being stuck into “wants”, than “need”. They feel that they need it, when the truth is they want it. Don’t go spend some cash on things that you want unless you’re having a lot of money on your pocket. This is such a good article you made. This would help a lot of people who are struggling on their financial status.

  1. Reply

    Thanks Jacob,
    Financial planning always provides security and peace of mind. You don’t even need to predict/estimate your future savings, investments, or retirement accurately. The point is that you’re creating a mentality where you’re thinking about your financial future – an important mindset that should help you to grow wealth naturally!
    Only recently came across your blog. Keep up the good work!

  2. Reply

    Nice article Jacob! I just hope that more people take time to study what financial planning is all about because most of us don’t take it seriously and do not make informed decisions for long term.

    • Julia Scott
    • November 3, 2016
    Reply

    As an accounting professor whose research interests are in financial planning and federal income tax, most people do not understand what financial planning is, and isn’t. There is no reason why a true financial planner should be paid based on a percentage of assets managed. That is an asset manager, or an investment advisor, and for that, you should work with someone who has the backing of a reputable trading company.

    I recommend to my clients, however, that they only work with fee-based financial advisors who are either CFP, CFA, or CPAs, preferably with at least one related masters degree from a nationally ranked, AACSB-accredited business school. When in doubt, find a good estate attorney and ask them who they use as their financial advisor. A good FA is like a good psychologist – it takes a few visits to see if there’s a fit.

  3. Reply

    I think a one time session with a financial planner would be very helpful for people just starting out that don’t have much of a financial background. They can get you set up with a good plan to meet your goals. However, I don’t see the benefit of paying a certain percentage of your assets for a financial adviser year after year. I recently wrote about my experiences talking with a financial adviser that a former colleague had referred me to. After the initial set up, I just don’t see the value in continuing to pay for something that doesn’t need constant updating. Also, there are enough resources on the internet now for someone to obtain a basic financial education on there own. For those less savvy, I agree with a one time session with a financial planner for a one time fee and then follow up sessions when your situation significantly changes.

      • Jacob
      • November 1, 2016
      Reply

      Good points about using a financial advisor, and there is nothing wrong with either approach that you mention.
      However, I disagree with the point about obtaining a financial education. Yes, it’s true, there are a multitude of available resources – both online and offline. But that’s true for almost everything in life. There are free resources that teach you how to change any part of a motorized vehicle, but most people choose to pay top dollar for a mechanic. It’s a perfectly rational decision to outsource any type of skilled labor, if you have the means, and lack the desire to learn.
      Furthermore, a basic financial education won’t touch on many of the content areas I’ve outlined. A knowledgeable financial advisor, much like a knowledgeable attorney or accountant, is worth their weight in gold. That’s half the point of my article – the industry needs to move towards a required minimum investment in human capital before you can call yourself a “financial planner.”

      • Reply

        That’s true not everyone has the inclination to learn. For them, paying someone else with knowledge to handle it for them provides value. My main point is to know what value you are getting for your money. Those fees add up. If you have a complicated financial situation, then maybe it’s worth it. If you hate finance and don’t want to spend the time on it, then it’s worth it. For many people though, I don’t see their situation changing that much year to year to warrant the fee paid on a yearly basis. I see the value in the initial setup, just not the value in the years after until your situation materially changes.

          • Jacob
          • November 2, 2016
          Reply

          I don’t disagree.

  4. Reply

    Financial planning is extremely important and it is scary how little people know about it! All of the questions you listed are important to take into consideration and are great ways to start your financial planning process! This was such a great article, thanks for sharing!

      • Jacob
      • November 1, 2016
      Reply

      Glad you enjoyed it.

 

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