What is Financial Planning?
Financial planning can mean many different things to people. For some people, it may be budgeting. For others, reducing debt. Working individuals may think of employer benefits or their 401(k). Retired individuals may think of their social security or pension payments. Others might think it has something to do with taxes. The answer to the question is all the above.
Defining Financial Planning
Investopedia defines financial planning as, “a thorough evaluation of one’s money situation (income, spending, debt, and saving) and expectations for the future.” This is not a bad definition of financial planning, but it leaves out a few minor (or major) details. Financial planning should really be called, “Life planning with a dash of finance.” Granted, that name would be difficult to print and cumbersome to say, but it is a more accurate representation of what financial planning entails.
Traditionally, financial planning covers five topics:
- Retirement Planning
- Investment Planning
- Protection Planning
- Tax Planning
- Estate Planning
The names are relatively self-explanatory. Investment planning deals with things like your Roth IRA, 401(k), 403(b). Tax planning can answer the question of Roth (after-tax) vs. Traditional (pre-tax). Estate planning involves trusts, wills, power of attorneys, etc. Where the traditional definition of financial planning falls short is the human element.
Planning Is Personal
You could go to a financial planner and build a plan that encompasses the five topics above, and it would be a good plan. What makes the plan great is the focus on your life, your values, and your dreams. Whenever I meet with clients, I always outline that there is a mathematical answer to questions and a human answer to questions with some overlap between the two. You cannot focus on one element and disregard the other.
For example, many of you reading this article may be in the market for a home or may have recently purchased a home. Let’s say the average mortgage interest rate in the state of Wisconsin with a 700 credit score is 7.934% for a 30-year fixed mortgage (it will have changed from the date of this article). I get the question all the time; should I buy a house right now?
The Math Answer:
Let’s say you and your spouse currently rent an apartment for $1,500/month in La Crosse, WI. You are looking at a $300,000 home and you have $30,000 set aside for a down payment. The interest rate offered by your lender is 7.94% for 30 years. If you decided to purchase this home and stop renting, you would have to live in your home for 18 years before you breakeven on the decision considering interest payments, closing costs, etc. Does it make sense to purchase a home under these conditions? Not really.
The Human Answer:
Same situation as above, but there is more context now. Your two-bedroom, 1,100 square foot apartment is on the third floor of your building. You have a two-year old in the second bedroom and a newborn is on the way. The house you are looking at has a two-car garage, a fenced in backyard, and four bedrooms. It has a finished basement and a newly remodeled kitchen. Does it make sense to purchase a home under these conditions? Absolutely!
Which answer is correct? Which perspective is more important? This is where financial planning really carries its weight. Financial planning seeks to merge your personal and financial lives to develop a gameplan that addresses both sides of the coin and find ways to resolve conflicting answers like the situation above. This personal-financial model of planning can be applied to each one of the five topics listed earlier.
How much life insurance do you need? The math says $500,000 but your spouse wouldn’t want to re-marry if you pass away so you need more.
When can I retire? The math says at age 65 but you have a family history of Alzheimer’s, and you want to retire earlier to have more years of good health.
These questions, among others, are real-life examples of financial planning. As I’ve mentioned in the past, find a planner that will incorporate your life circumstances into your planning and not just focus on the math.
This article is educational only and is not intended to be investment, legal, or tax advice or recommendations, whether direct or incidental. Again, this is not investment advice. Consult your financial, tax, and legal professionals for specific advice related to your specific situation. Never take investment advice from someone who doesn’t know you and your specific situation. All opinions expressed in this article are those of the people expressing them. Any performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be directly invested in.
