Why Is Financial Planning Important?

Financial planning can be as simple as setting a budget and as complex as allocating a retirement portfolio with the right balance of stocks and bonds. Regardless of your definition of financial planning, it is extremely important if you want to achieve your goals and build financial security.

According to a study conducted by the Employee Benefit Research Institute (EBRI), 42 percent of workers believe they need at least $500,000 to retire comfortably. However, this same study reports that 49 percent of workers reported less than $25,000 in total savings and investments (excluding their homes). These workers with less than $25,000 are not necessarily years away from retirement either: half of individuals aged 35 to 44 had less than $25,000 saved for retirement; and a third of individuals aged 45 and up less than $25,000.

Obviously, this reflects a serious discrepancy, and a serious problem. While social security benefits do provide some assistance to those who are retiring, social security benefits may not be enough to replace your previous level of income. Employer sponsored pensions are also becoming less and less common, leaving more and more individuals to cope with retirement on their own.

According to the Bureau of Labor Statistics, "retirement savings behavior was shown to be influenced by attitude, subjective norms, perceived control, and past experience."

This answers the question of why is financial planning important - particularly if you want to be able to retire comfortably. In order to be able to save the money you need to retire, ideally you should begin investing early and investing regularly. In order to do so, you need to establish investment goals and create a plan. Most experts suggest investing 10 to 15 percent of your income over the course of your working life for retirement; with these numbers and compound interest, you should be able to easily amass enough to retire comfortably. For most people, if you start young enough and do this, you can be more than comfortable; you can retire a millionaire by the age of 65.

In addition to being able to retire comfortably, financial planning is essential if you want to buy a house or save for a college education. Savings plans, such as 529 plans, allow you to put money away for your kids to go to college, but you have to come up with a plan to do so.

What Is Financial Planning?

The Dictionary defines a financial plan as:

An outline of a person or family’s financial goals and the steps that are necessary to reach them. The goals can include establishing a cash reserve for emergencies, purchasing a home, funding children’s education, or setting up a retirement account.

Financial planning, therefore, involves setting your financial goals and taking concrete action in order to achieve those goals.

Almost everyone, whether single or married, with children or without, has some type of financial goal. Many of these goals involve large sums of money. For example, buying a house, sending a child to college, retiring with savings, or achieving financial freedom all require large amounts of money. In order to ensure that you have the money you need to achieve those goals, you need to determine what those goals are and set up a system in which to work towards achieving them.

Investing

In addition to coming up with a plan to save, financial planning is also important so you can learn how to invest those savings. Amassing enough for retirement would be very difficult if your money earned no interest. In fact, if you save money under your mattress, you can actually lose money as a result of inflation.

Generally, you should aim to earn around 10 percent on your money per year. More conservative portfolios will earn you less but have less risk, while less conservative portfolios can earn you more, but you take on more risk.

Financial planning involves allocating your money and investing it wisely, based on your goals and the stage you are at in your life. A young individual who is in his twenties or thirties should typically have more of his money invested in stocks, since he has more time for the market to recover if the stock prices fall. An older individual should switch more of his assets into safer investments, since he'll need to begin drawing from the income sooner.