Why Is Financial Planning Important?

Recently I was asked this question, Why is financial planning important?. I am of the opinion that financial planning is critical to achieve your financial success. However, with the increase of distress of many families in the United States many are going by without a financial plan and many even question the importance of having one.

It is understandable that if you are currently in financial distress you may not see the point of financial planning. You may be living paycheck-to-paycheck, thus why bother with financial planning. It is understandable and if you are doing so, you are making a huge mistake. Let me tell you why; It doesn’t matter if you’re well off or work for every cent; knowing the importance of financial planning is critical for your future. In fact, it’s never too early or too late to prepare for it.

The problem I see today with the attitudes of the families that have been affected by the recent recession is that by not developing a plan of action, how will you get out of the current situation? In essence, they have accepted the current situation (living paycheck-to-paycheck) as the "new normal". The "new normal" becomes their current reality and accepted as the truth. These families become comfortable with this "new normal" to the point that it is the only way to live. They do not see any other way, therefore when other people like myself approach them with the idea of financial planning they look at me like I am from another planet. "What do you mean "financial planning"? I can hardly pay for my rent".

Financial planning is not for the rich. Great wealth has been built one dollar at a time. All it takes is financial planning; a financial road-map to get you out of the current storm. The fact that you may currently be in a financial distress situation does not mean that you belong there. Furthermore, the fact that you may be in a financial distress situation today does not define you. Accept responsibility for your past actions that lead you to the current situation and develop a financial road-map towards financial success and freedom.

If you are currently in financial distress, let me offer you some tips that may help you:

1. Put together a budget, the method does not matter (use a pencil and paper, excel worksheet, Quicken, etc.)

2. Do not overlook your insurance coverage in these difficult moments. This is not the time to be driving without car insurance. However, do not fall prey to predators insurance coverage. Assess the risks that are truly needed to be covered to protect the financial future of your family.

3. Develop a plan to reduce/eliminate your debt. With a national average of 14.6% effective annual interest rate of this debt is too expensive to bring to our families.

4. Track your monthly expenses. This is where many families fail. Most of the times families develop budgets but they do not track the actual expenses. A budget without a monitoring system is not adequate. Compare your actual expenses to your budget to be able to make the necessary corrections.

5. Watch for the small expenses. This is where a lot of the damage happens. We notice the big ticket items. Big corporations have been bankrupted $5 at a time. It does not take long until those trips to your Java Shop for the super-duper high calorie with whip cream on top coffee for $5 will become a hole in your finances. You do not notice it on a daily basis. However, when you track it and realize that you spent $1,250 a year in those daily trips to your Java shop, you may get an upset stomach.

* Tip: Use the $100 monthly and apply towards a high interest debt. For example, if Mary is spending $100 per month in her daily Java trips and she has a credit card debt of $10,000 with interest rate of 12% and she is currently making monthly payments of $300, it will take her 14 years to payoff that balance and she will pay approximately $4,000 in interest. If she applies the $100 per month extra towards her credit card debt, she will payoff her credit card in 30 months and her interest payment will be decreased to approximately $1,400.

* Opportunity: Did you know that if were to invest the $100 per month in a mutual fund that gives a 8% annual return for 10 years you would accumulate approximately $19,400?

“Money makes money. And the money that money makes makes more money.”
- Benjamin Franklin

6. Create an emergency fund. The amount depends on each family situation. In todays environment you should strive to have 9 months of living expenses in reserve. These funds should not be in high risk/volatile investments, consider placing this funds in a money market account/savings where you have access to them. Remember the idea is to have liquidity in the event of an emergency.