7 Important Factors of Financial Planning

article image

The main goal of personal financial planning is to offer you a financially secure life. However, there are several ways to get there. Financial planning is complicated and requires years of experience and financial expertise to reach your goals. It is also highly dynamic, and the ever-changing stock market requires you to make alterations to your plan from time to time. While there is no fixed approach to devising a successful financial plan, certain financial elements are critical components of a plan and can need your attention and focus. 

When you create a financial plan, you do so on the basis of several factors. These can include your income, risk appetite, investment budget, lifestyle, future goals, number of people financially dependent on you and their financial needs, your age and the chosen investment term, and many others.

These components of financial planning are the foundation of your plan. Now evaluating each of these and many others can require time and effort. They can also be confusing and misleading as they tend to change with age and your personal and professional growth. This is why it helps to create a list of financial elements that are likely to affect your plan. This way, you can go back and forth quickly and compare your progress to what’s on paper and make the necessary modifications. Making a list of key components of financial planning also helps you establish the proper roadmap for your future and eliminate any deviations along the way. If you need help with creating a financial plan that suits your financial needs and would enable you to achieve your financial goals, you can reach out to a professional financial advisor who can advise you on the same.

Read on to know more about these critical financial elements

What are the components of a financial plan?

Here are the main components of financial planning that you must know:

1. The objective of financial planning:

Every person has a distinct objective for financial planning. It could be to save for retirement or put a child through college. It could also be to travel the world or buy a house. The first step in financial planning is to know the intent behind the plan. Once you see the purpose, you can pick out the right investments and savings instruments and prepare for the said objective accordingly. Try to be as precise when you set the intent for financial planning. For instance, if your financial goal is to retire securely, it is essential to understand the minute details of your retirement. For example, when do you plan to retire and where do you intend to live post-retirement? If you plan to retire in your 60s like most people, you may have a considerable amount of time ahead of you. This way, you can take a relatively relaxed approach to retirement planning. However, if the main goal of personal financial planning is early retirement for you, then you would need an aggressive investment strategy that focuses on capital appreciation in the short term. This would further dictate your risk appetite and the kind of investments you choose. In addition to this, it would also determine your budget and how frugally you must live in order to reach your goal in the shortest possible time. 

2. The appropriate level of risk:

Each investor has a risk appetite, which refers to the amount of uncertainty and market volatility they can afford to take. For instance, a young investor who falls in the high-net-worth category would likely have a high-risk appetite. Such a person has a long investment term before retirement to make up for any losses. Besides, the high net worth lends the investor the ability to make bigger bets. However, someone who is approaching retirement in the next five years or is already retired would have a low-risk appetite because of the absence of enough time and an active income to overcome any unprecedented loss along the way. Risk is one of the key components of financial planning, and the sooner you understand where you stand, the better it can be. You can look at factors such as your age, income, expected or preferred retirement age, family situation, health situation, and other similar factors when assessing your risk tolerance. Typically, risk reduces as you age. For instance, you have the highest risk appetite in your 20s and 30s. However, your 50s and 60s may be a time to shift to more stable investments that can promise capital preservation over appreciation and growth. You can analyze and reanalyze your risk appetite every decade based on these factors and modify your financial plan.

3. Liquidity needs and planning:

Financial liquidity is the availability of cash in your hour of need. If you were to lose your job today, your financial liquidity and planning would likely determine your financial security at such a time. Liquidity is vital as it can help you tackle immediate financial needs. You may have thousands of dollars stacked away in a 401(k) or an Individual Retirement Account (IRA), but you cannot use it before the age of 59.5 years without incurring a 10% penalty. This is why it is crucial to have enough liquid savings that can help in case of an emergency, such as a health expense, home repair, creditor situation, etc. Typically, a financial advisor recommends having at least twelve to sixteen months of your annual income in a highly liquid emergency fund. This can be a fund that can be easily accessed but also one that offers growth on your money, so it does not sit idle in the face of inflation. Liquidity is one of the noteworthy financial elements that require your focus from day one. 

4. Portfolio asset allocation:

Thee are different asset classes that you can invest your money in. One of the key components of financial planning is to have the right blend of all asset classes on your portfolio. Your asset allocation can primarily depend on your age and risk appetite. A common rule to find this out is by subtracting your age from 100. If you are 40 years old, your asset allocation in stocks can be 100 – 40 = 60%. The remaining 40% can be in bonds, cash, and other asset classes. If you are 45 years old, your asset allocation in stocks can reduce to 55%, and your other asset classes can increase by 5% up to a total of 45%. Asset allocation can also be determined based on the type of portfolio you want. Typically, there are three types of portfolios:

  1. Aggressive portfolio: Such a portfolio is heavily concentrated on stocks with up to 65% asset allocation. The remaining assets can be bonds, cash, and others.
  2. Conservative portfolio: These portfolios focus more on bonds and fixed-income securities with up to 50% allocation in debt, 25% in equity, and the rest in cash and others.
  3. Moderate portfolio: Such a portfolio offers a balanced approach to investing with up to 50% in stocks, 30% in bonds, and 20% in cash and others.  

When you list the key components of financial planning, you can choose the appropriate asset allocation for your goals, age, and financial needs. Moreover, when you set an asset allocation percentage, it is also essential to revisit it from time to time. For instance, if your stock investments do well, your asset allocation of 60% in stocks may increase to 65%. This could add an unwanted risk that you may or may not be ready for. In such a case, it is essential to rebalance your portfolio and accordingly make changes to your asset allocation to match your current risk appetite. 

5. The proper investment management style:

There are different management styles in investing. You are at liberty to choose what you like and go with what works for you. However, it is essential to understand the pros and cons of each. Active investing involves a greater level of experience and knowledge of investing. If you pick active investing, you would have to search for suitable investment options, time the market yourself, diversify your investments, rebalance your portfolio and do a lot more on your own. This can be time-consuming and hassling. However, you can rely on your judgment and make decisions that you feel are right. There is no external prejudice, and you do not have to depend on anyone else but yourself. 

Passive investment styles are more suitable for beginners or those who do not have the right knowledge to time the market or make decisions on their own. If you are a new investor or have a hectic schedule where keeping in tune with the fluctuations of the economy and the stock market can be challenging for you, you can adopt this style. Passive investment options include mutual funds. Mutual funds are managed by the fund manager, who makes all buying and selling decisions. In return, the mutual fund house charges you an expense ratio for management fees, administration expenses, and other similar costs. The professional manages your money, invests in different stocks, and ensures portfolio diversification. All you do is decide how much you wish to invest and when you want to redeem your money. Index funds are another passive investing option. An index fund tracks a benchmark index, such as the S&P 500. The only objective of the index fund is to follow the underlying index. It does not outperform the index but merely mimics its performance. Index funds, too, can offer an excellent level of diversification. Moreover, since the fund does not exceed the index, you can sit back and relax. 

6. Costs involved in investing:

Investing comes with many hidden and unhidden costs. These can include expense ratios, management fees, advisor fees, administration and marketing fees, taxes, and more. These components of financial planning cannot be avoided, but you can adopt strategies that help you lower their impact. As far as investment costs are concerned, you can look for options that cost less. For instance, check broker fees when investing in stocks. Go for a broker that charges the lowest commission, so you are able to maximize your profits. Likewise, you can opt for a financial advisor that uses a payment model that fits your budget. Financial advisors charge by the hour, by the service, or according to the investments they help you with. They could either charge you a commission for each of your investments or a percentage of your assets under management (AUM). You can select a payment model that suits you the best. 

Lastly, tax planning is essential in financial planning, too. You can use tax-advantaged accounts like the IRA or the company-sponsored 401(k). These can help you save on tax. You can select a traditional or Roth option as per your present and expected future tax situation. If your tax liabilities are high, you can use strategies like tax-loss harvesting. Additionally, you can use estate planning to lower taxes. For instance, gifting or donating to charity. There are several ways to reduce tax, as long as you make this financial element an integral part of your financial plan.

7. The decision to take professional assistance: 

Hiring a financial advisor can offer a lot of benefits. However, it is not mandatory to get professional assistance. The ultimate choice depends on you and how much help you need with your money and investments. If you have no understanding of the stock market and the economy, you can consult a financial advisor to get a basic idea of how to start financial planning. In this case, getting a professional on board can help you streamline your investments and focus on other key components of financial planning, such as debt management, budgeting, estate planning, tax planning, retirement planning, and more. A financial advisor may be able to provide you with comprehensive knowledge and understanding under these circumstances. However, if you are an experienced investor or are reluctant to get a professional on board, you can consider hiring an advisor on an hourly basis. You could also only consult on matters of concern at the moment. Not only will this lower your expenses, but it will also help you prioritize the important things. 

Before you get in touch with a financial advisor, make sure you understand the relationship between an investor and advisor. Communication plays a critical role in the success of such an association. So, be prepared for open and honest communications, complete transparency, and candidness in order to benefit from your relationship. 

To summarize

These financial elements can help you list the key components of financial planning and use them to create a fool-proof plan. So, try to keep an eye on them and understand their relevance in personal finance. Financial planning is an integral part of any individual’s life, irrespective of your age, gender, financial status, or profession. The wealthy, the poor, the successful, and the freshers all need a robust financial plan that can take them to their goals with minimal digression. As long as you pay attention to these elements and accommodate them in your financial plan, you can expect to reach your goal in time and lower the unwanted stress along the way.

Further, if you find any roadblocks and need professional assistance, you can always entertain the idea of hiring a financial advisor. Use the free advisor match service to  engage with a professional financial advisor, who can help you create a financial plan that would allow you to attain your unique financial needs and goals. Based on your requirements, the service matches you with 1-3 advisors suited to meet your financial needs and goals.

You may also be interested in

Popular Articles

Get matched with the best financial advisors near you to guide you towards your financial goals

The blog articles on this website are provided for general educational and informational purposes only, and no content included is intended to be used as financial or legal advice.
A professional financial advisor should be consulted prior to making any investment decisions. Each person's financial situation is unique, and your advisor would be able to provide you with the financial information and advice related to your financial situation.