Some months ago, I blogged about the difference between Financial Planners and Financial Advisors. I also blog often about the value of Financial Planning and about Financial Planning topics.
But I’ve never written about exactly what Financial Planning is. How can you know you need a thing if you don’t know what that thing is?
Try an experiment with me.
If I asked you to define the term Financial Planning, how would you define it?
If you are struggling a little, you aren’t alone.
Like many topics in personal finance, the definition of Financial Planning can be hard to articulate. If you search “what is financial planning” you’ll get a variety of answers from a variety of sources.
The definition I found that fits best with my understanding of Financial Planning was from NerdWallet.com. Their website reads “Financial planning means looking at your current financial situation, and finding strategies for how to reach long- and short-term goals.”[1]
But this definition hardly captures the many topics a thorough plan can touch.
In this month’s Wealth Management 101, I’m diving into what Financial Planning really is and how it can help you live a more secure and joyful life.
What is Financial Planning?
Financial Planning is first, and foremost, a process. Processes can be broken down into steps. Let’s address each step in turn.
1: Goals
You cannot plan without a goal. The very first step in the Financial Planning process is to set goals. Those goals should be well-define with respect to dollar amount and timing.
For example, you can’t plan effectively for the goal: “I want to retire someday”.
You can plan effectively for the goal: “I want to stop working at my age 65 and have $100,000 in purchasing power each year until I reach age 95.”
2: Resources
Every plan needs resources, and the part of the Financial Planning process is to inventory and assess those resources.
These typically include:
- money you’ve already saved
- money you will earn and save in the future
- money from employer paid benefits like 401(k) matching or pension plans
- money you may earn from investing activities
- benefits you earn through work like Social Security
Other resources may include:
- your home or other real estate
- insurance products
- non-cash compensation like Restricted Stock Units or Stock Options
- employer benefits like Group Term Life Insurance or Group Disability Insurance
- an expected inheritance
When building a Financial Plan, it is important to account for every resource used to fund the goals you set for yourself.
3: Risk & Investments
The next part of the Financial Planning process is to determine your Risk Tolerance and how your investments should be divided between stocks, bonds, and cash.[2]
Read: Risk Tolerance: What is it? Why does it matter?
Every investor has a Risk Tolerance. Risk Tolerance is the degree of fluctuation in investment results (return) that you can withstand before you consider selling your investments.
Read: What is Asset Allocation & Why Does It Matter?
Your Risk Tolerance dictates how you invest. How you invest dictates the return you can expect capture over time.
When you take more risk, you will likely enjoy more return. You will also need to withstand a higher level of fluctuation in your month to month or year to year returns. The opposite is also true.
When making a plan that will unfold over decades, Risk Tolerance and Investments are key inputs that will drive whether the resources you have can support the goals you are working towards.
Once these inputs are defined, the Financial Planner will know if there is a mismatch between goals and resources and can formulate recommendations to fix any mismatch.
4: Implementation
The next step in the Financial Planning process is Implementation – taking action to make your plan a reality. Some of that work may be done by your Financial Planner, especially if you are receiving Financial Planning as part of a larger Wealth Management relationship.
But if you’re Financial Planner is offering you only Planning, much of the implementation will be up to you.
Let’s pause here. Many Financial Plans are considered complete at this point. Once you have set goals, inventoried resources, assessed plan feasibility, developed recommendations to make the plan stable, and taken action; you could call it a day.
But there is much more that a Financial Plan can, and should, address.
5: Protection
Building resources to make a Financial Plan come to life usually involves a lot of hard work. That hard work can be undone by an unexpected event like disability, death, the need for end-of-life care, catastrophic damage from weather events, or a mistake that could leave you liable for damages to a party you’ve injured.
A robust Financial Planning process will include an assessment of the insurance you have in place to protect your resources from outside threats.
Your Financial Plan may address Life Insurance, Disability Insurance, and / or Long-Term Care Insurance.
A truly diligent planner will also encourage you to seek out experts on Property & Casualty Insurance, Personal Liability Insurance, Health Insurance and (where appropriate) Professional Liability Insurance.
6: Preservation (Tax & Estate Planning)
Once you’ve put your plan into action, built wealth and taken measures to protect yourself, the next step in the Financial Planning process is to consider preservation.
Preservation means holding on to as much of your resources as you can within the bounds of the law. It also means passing along the resources you’ve built up to the next generation in a low-cost and efficient manner.
Doing those two things means engaging in Tax Planning and Estate Planning.
Tax Planning may include:
- maintaining a balanced mix of retirement and non-retirement investing accounts
- building tax efficiency into your investments
- optimizing the value of your charitable giving activities
- planning for the tax impacts of Required Minimum Distributions in retirement
Read: Tax Loss Harvest Time: Making the Most of Your Losses
Estate Planning may include:
- formulating well-thought-out beneficiary designations for retirement accounts
- formulating well-thought-out transfer on death designations for investing accounts
- planning for tax efficient wealth transfer
- reviewing your estate planning documents to make certain those documents set you up for a smooth transfer of asset to your heirs
The Protection phase of the Financial Planning process usually involves collaboration between your Financial Planner, your tax advisor, and your estate planning attorney.
7: Course Correction
The only constant is change and that means your plan must be a living document. The final step in the Financial Planning process is Course Correction.
As your life changes, as your goals develop, as the world changes around you, you’ll find that you need to alter your course from time to time.
A regular review of your Financial Plan is vital to keeping you on track for your goals.
Some families review this plans every 12 months. Others every 18. I recommend not waiting more than 24 months between reviews – life comes at you fast sometimes!
So, what is Financial Planning? Financial Planning is an ongoing process designed to provide a roadmap to reach both long- and short-term goals while keeping your resources protected and preserved.
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Past performance is not indicative of future results and asset allocation/diversification does not ensure a profit or protect against loss. All investments carry some level of risk, including loss of principal.
While Baird does not offer tax or legal advice, our Financial Advisors regularly work with clients’ attorneys and tax professionals to help ensure that all phases of wealth management are addressed. Please consult your legal or tax professional for specific information.
[1]https://www.nerdwallet.com/article/investing/what-is-a-financial-plan
[2] The technical term for this is Asset Allocation.
JH2024-1022