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Personal Finance

Personal finance and the steps involved

Financial planning is a key component of personal finance which is a dynamic process and requires regular monitoring, reviewing and reevaluation. It normally has five steps:

1. Assessment: A person's financial situation can be assessed through the financial balance sheets and income statements. A personal balance sheet lists down the values of all the personal assets such as stocks, car, house, clothes, or bank account along with the personal liabilities like mortgage, credit card debt, and bank loan. The personal income statement lists personal income as well as expenses.

2. Setting goals: One can have several financial goals. These can be short term e.g. – buying a house in a few months and some long term goals like planning for children's education and marriage or even planning for one's retirement. Setting financial goals helps a great deal in direct financial planning process.

3. Formulating a plan: Once the goals have been listed, the next step is to create a financial plan which details how to accomplish these goals. It may include, for example, increasing one's income, curtailing unnecessary expenses, or may be investing in the stock market.

4. Execution: The next step is execution of one's personal financial plan that needs discipline and perseverance. For this purpose, lots of people rely on the assistance from professionals like financial planners, investment advisers, accountants, and lawyers.

5. Monitoring & reassessment: Over a period of time, it is necessary to monitor one's personal financial plan for possible adjustments and/or reassessments.

Key areas of Personal Finance Planning

The 6 key areas of personal financial planning, as recommended by the Financial Planning Standards Board, are as follows:

1. Financial Position: It is concerned with understanding the available personal resources by investigating net worth and the household cash flow. Net worth is nothing but a person's balance sheet that is calculated by adding together all assets of a person, and subtracting all liabilities of the household, at one point in time. The household cash flow adds up all the expected income sources within a year, minus all the expected expenses within the same year. Through this analysis, a financial planner can determine the degree and time required to accomplish the personal goals.

2. Adequate Protection: This analysis is done in order to understand how to protect a household from all unforeseen risks. These risks include liability, death, property, disability, health as well as long term care. Some risks may be self-insurable, while others may require the acquisition of an insurance contract. As insurance enjoys some tax benefits, investing in insurance may be an important area of the overall investment planning.

3. Tax Planning: Income tax is generally the single largest expense of a household. Managing taxes when and how much tax should an individual pay. Government provides many incentives in the form of tax deductions & credits that can be used to reduce the lifetime tax burden. Most of the modern governments use a progressive tax; meaning that as income grows, you need to pay a greater marginal rate of tax. Tax planning if understood and planned properly can make a significant impact upon your success in the financial planning process.

4. Investment and Accumulation Goals: Some of the main reasons to accumulate assets is for purchasing a house, buying a car, starting a business, paying for education expenses, accumulating money for retirement, to create a stream of income in order to cover ones lifestyle expenses. A major risk to the household in achieving these accumulation goals is the rate of price increase over time, or inflation. In order to deal with the inflation, one needs to have a financial planner who can mange the portfolio taking into consideration the net present value and proper asset allocation, so as to diversify the investment risk and generate maximum returns over a period of time.

5. Retirement Planning: Retirement planning is the process of allocation of finances for retirement while understanding how much it will cost to live at retirement. This generally means setting aside of money and/or other assets in order to obtain a steady income at retirement. The objective of retirement planning is to achieve financial independence and arriving at a plan to distribute assets so as to meet any shortfall in income.

6. Estate Planning: Estate planning is a process by which an individual makes arrangement for the transfer of assets to legal heirs incase of death or disability of the individual. This includes the distribution of real as well as personal property of an individual to the legal heirs. Protecting the needs of loved ones during lifetime and even after death can be achieved through estate planning by distribution of assets among the beneficiaries.