L2 Financial Planning Process PDF

Lesson 2 PERSONAL FINANCIAL PLANNING INTRODUCTION This section will first explain what is personal financial planning and its advantages. It will then discuss the different steps in the personal financial planning process namely, dete...

Lesson 2 PERSONAL FINANCIAL PLANNING INTRODUCTION This section will first explain what is personal financial planning and its advantages. It will then discuss the different steps in the personal financial planning process namely, determine current financial situation, develop financial goals, identify alternative course of action, evaluate alternatives, create and implement financial action plan, and review and revise the financial plan. It will also tackle steps to overcome financial problems and difficulties. LEARNING OBJECTIVES 1. Explain the financial planning life cycle 2. Identify financial needs in different stages of life cycle 3. Recognize the advantages of personal financial planning 4. Formulate short- and long-term goals related to financial well-being 5. Compute for financial net worth 6. Identify financial problems and propose solutions to these problems LECTURE DISCUSSION PERSONAL FINANCIAL PLANNING is the process of managing money to achieve personal economic satisfaction. It is a process of managing one’s financial resources accompanied by strategies for accumulating, protecting, allocating, and distributing financial resources in accordance with your financial goals. It is also defined as the development and implementation of total coordinated plans for achieving one’s overall financial objectives This planning process allows the control of financial situation. Every person, family, or household has a unique financial position, and any financial activity therefore must also be carefully planned to meet specific needs and goals. A comprehensive financial plan can enhance the quality of life and increase satisfaction by reducing uncertainty about future needs and resources. ADVANTAGES OF PERSONAL FINANCIAL PLANNING  Increased effectiveness in obtaining, using, and protecting financial resources throughout lifetime.  Increased control of financial affairs by avoiding excessive debt, bankruptcy, and dependence on others for economic security.  Improved personal relationships resulting from well-planned and effectively communicated financial decisions.  A sense of freedom from financial worries obtained by looking to the future, anticipating expenses, and achieving your personal economic goals. THE PERSONAL FINANCIAL PLANNING PROCESS The personal financial planning process is a logical, six-step procedure: 1. Determine current financial situation 2. Develop financial goals 3. Identify alternative course of action 4. Evaluate alternatives 5. Create and implement financial action plan 6. Review and revise the financial plan Step 1: Determine Current Financial Situation In this first step of the financial planning process, one needs to know where his is financially. He needs to know and establish his financial reference point by computing his current financial net worth. Financial net worth is another term to describe how much wealth one has. It is the difference between what he owns, and what he owes. Example: WHAT I OWN WHAT I OWE Current Assets Current Liabilities Cash Credit Card Debt Savings Deposit Personal Loans Long Term Assets Advances and Loans from relatives Stocks Advances and Loans from employer Retirement Fund Long Term Liabilities Personal Assets Housing Loans Home Furnishing Insurance Policy Loan Automobiles Auto Loan Jewelry Real Properties TOTAL  Don’t be afraid to have a negative net worth. You are worse off if you have a negative net worth, didn’t know about it, and you are not doing anything about it. Step 2: Develop Financial Goals Financial Goal – Objective or target, usually driven by specific future financial needs. Some common financial goals for an individual are:  saving for a comfortable retirement  saving to send children to college  managing finances to enable a home purchase  start a business Steps in Creating Financial Goals 1. Identify the goal 2. Set a deadline for achieving the goal and be as specific as possible 3. Estimate the cost of the goal, either in terms of time and/or money 4. Break down the total cost into monthly amounts required 5. Identify the specific actions or tasks to take to reach the goal 6. Track progress Goal Worksheet – highlights all of the important information required for each goal and allows one to get a nice visual picture of what he wants to accomplish and how to go about it. Goal Term Total Cost Monthly Ways to Commitment Reach (specific) (timely) (measureable) (realistic) (action) Step 3: Identify Alternative Course of Action Developing alternatives is crucial for making good decisions. Although many factors will influence the available alternatives, possible courses of action usually fall into these categories:  Continue the same course of action.  Expand the current situation.  Change the current situation.  Take a new course of action. Not all of these categories will apply to every decision situation; however, they do represent possible courses of action. Creativity in decision making is vital to effective choices. Considering all of the possible alternatives will help in making more effective and satisfying decisions. Step 4: Evaluate Alternatives Evaluate possible courses of action, taking into consideration life situation, personal values, and current economic conditions. Consequences of Choices Every decision closes off alternatives. For example, a decision to invest in stock may mean not taking a vacation. A decision to go to school full time may mean not working full time. Opportunity cost is what one gives up by making a choice. This cost, commonly referred to as the trade-off of a decision, cannot always be measured in monetary amount. Decision making will be an ongoing part of personal and financial situation. Thus, one needs to consider the lost opportunities that will result from these decisions. Evaluating Risk Uncertainty is a part of every decision. Other decisions involve a very low degree of risk, such as putting money in a savings account or purchasing items that cost only a few pesos. The chances of losing something of great value are low in these situations. In many financial decisions, identifying and evaluating risk is difficult. The best way to consider risk is to gather information based on one’s experience and the experiences of others and to use financial planning information sources. Financial Planning Information Sources Relevant information is required at each stage of the decision-making process. Changing personal, social, and economic conditions will require continually supplementing and updating knowledge. Step 5: Create and Implement Financial Action Plan In this step of the financial planning process, one develops an action plan. This requires choosing ways to achieve goals. As one achieves his immediate or short-term goals, the goals next in priority will come into focus. To implement financial action plan, one needs assistance from others. For example, he may use the services of an insurance agent to purchase property insurance or the services of an investment broker to purchase stocks, bonds, or mutual funds. Step 6: Review and Revise Plan Financial planning is a dynamic process that does not end when one takes a particular action. He needs to regularly assess his financial decisions. Changing personal, social, and economic factors may require more frequent assessments. When life events affect financial needs, this financial planning process will provide a vehicle for adapting to those changes. Regularly reviewing this decision-making process will help in making priority adjustments that will bring financial goals and activities in line with current life situation. STEPS TO OVERCOME FINANCIAL PROBLEMS AND DIFFICULTIES Financial problems and challenges happen to everyone at some point, and the stress and worry can get to him. However, realizing that there is almost always a way out can help one not feel so depressed. He may be able to find the way out himself, or he may need someone else's perspective to help in finding a solution. Below are ways how one can overcome financial problems and difficulties and ease his stress. But, one size does not fit all. 1. Identify the underlying problem that's causing the difficulties The first step to overcoming financial problems is to identify the underlying issue that’s causing the financial difficulties. Financial problems are usually a symptom of a bigger issue. To come up with solutions that work in the long run, take the time to identify the real source of financial troubles. Here are some common things to think about: Reason Why Source of Difficulties Often Solution Financial Problem Occur Unemployment or Using credit for living Re-evaluate lifestyle, create a budget lower than usual expenses on and follow it. If employed, see if you income reduced income can get a 2nd job or more overtime Simplify lifestyle. Get all the help you Unexpected illness can. Make sure you're getting or accident everything you're entitled to  Increased medical expenses and low/ no income Used to a high Adjust expectations and learn to live standard of living Moving out on your on what you earn rather than what that took your own you're used to; use cash, not credit parents decades to achieve Parents didn't budget for the Adjust your budget and your lifestyle increased expenses First baby is born to fit the reduced income and and the drop in increased expenses income during maternity leave Got the house but can't afford the Sell the house and downsize to Separation ongoing expenses something you can afford or generate on only one income; revenue with the house left over bills You are now asset rich and cash poor. You can no longer Sell the house, move into something Retirement afford to live life plus you can afford, invest extra proceeds pay the house from the sale, and enjoy life more upkeep on your reduced income You are not willing to part with something Set emotions aside and look at the Emotional you can no longer situation from a financial perspective; attachment to afford: could be a picture life 5 years from now & what something home, business, bills will be then vehicle or toy  Get professional counseling to deal Spending more than with the addiction. If you don't, you'll An addiction you earn trying to never overcome your financial satisfy the addiction problems The concept of identifying a specific problem is important because it is more likely to result in a lasting solution. Just like with a leaky faucet; placing a bucket below is temporary. Fix the tap and the leak will stop. Focus on solving the problem that’s causing money troubles, rather than dwelling on stress. 2. Create a budget - spend money in a way that helps solve the problem One of the best weapons for combating financial problems is a budget. Creating a budget is like turning the lights on to find way around a dark room. There is no need to wander in the dark; banging shins, tripping over the furniture, and stepping on the dog. Instead, with the lights on, one can see what’s going on and prevent problems before they happen. A budget works much the same way; it guides spending decisions so that one is spending money on what's really important to him. In this case, money is spent in a way that helps solve financial problem. 3. Determine financial priorities to guide spending choices To overcome financial problems and solve difficulties for good, one needs to determine what his priorities are. Some might be clear-cut financial priorities, e.g. to pay off credit cards. Others might be lifestyle-goals, based on values, e.g. save up for house repairs so that the family has a nice place to call home. Setting clear priorities makes it easier to make tough financial decisions. Turning priorities into actionable and achievable goals will help solve money troubles and get back on track. For instance, one of short-term goals may be to reduce expenses and pay off smallest credit card balance. A medium-term goal could be to pay off credit card debt. 4. Identify small steps to take to address the problem & achieve goals The solution to financial problems is often to reduce expenses, increase income, or do some combination of both. This might not be something one wants to do, and he’s not alone. Most people don’t want to make changes to their lifestyle, but faced with the choice of ongoing money troubles, or making several small changes to ease up on the financial stress - most people are game to try. Big changes are always much harder than small changes so to accomplish goals, identify small steps to take to achieve them. For example, if one keeps running into money problems because he’s P3,000 short every month, then maybe one of the first short term goals could be to pay off a small credit card balance that requires a P3,000 minimum payment each month. Get the card paid off, and then permanently have P3,000 extra to use in his budget every month. However, if by the time he reaches this goal, he learned to get by without this P3,000, then he can use it to accelerate the payment of another debt each month, and get all of his debts paid off more quickly. There is actually a name for this, it is called the “snowball effect” - maintaining minimum payments on all debts but putting all extra money towards one debt to get it paid off faster. Once that one debt is paid off, one can put all of the extra funds towards eliminating the next debt. It’s one powerful method of paying debts off faster. Look for things to do, even temporarily, to improve situation. Here are more ideas or steps one can consider taking to improve financial situation and alleviate difficulties: Learn more about separating needs from wants. As you look through your budget, ask yourself:  Do I want this or do I need it?  Will spending this money get me closer to my financial goals or further away?  Can I live without it? Learn how to reduce or change impulsive spending habits. Do you use credit cards for impulse purchases? This can contribute to a cycle of ongoing financial difficulty and add as much as 50% to everything you purchase. Ask yourself if you can downsize anything in your budget or switch to a less expensive option.  If vehicle costs are straining your budget, can you downsize your vehicle, get rid of one vehicle, take transit, or car pool?  If your rent, mortgage, or home upkeep is bleeding you dry, can you downsize to something more affordable, rent out your basement, rent a room in your house, rent out the storage space in your garage, or can you take in a student for some extra income? If debt is causing you financial problems, here are a lot of ways to reduce your debt or here are a dozen of the most effective ways to get out of debt.  Do you have any assets or toys you can sell to pay off debt?  Can you take on a side job or create another source of income with something you know how to do well?  Look outside the box, ask yourself tough questions, invite a trusted friend to have a look at your budget and make suggestions, or sit down with a Credit Counselor and get their suggestions.  Research viable options that will move you towards your goals. A consolidation loan, speaking with a Credit Counselor, a Debt Management Program, or some other option may be a possibility. While doing any of these can be an unappealing thought, don’t just dismiss them because they’ll move you out of your comfort zone. Keep thinking about them and give them some consideration. Come back to these ideas from time to time to see if you can come up with a new angle on decreasing your expenses or increasing your income that might just work for you. Remember, you’re trying to get through a tough a time; you don’t need to do this forever, just to get back on track. If you’re really struggling, an experienced Credit Counselor can be a great, free source of suggestions. 5. Develop plan to overcome financial problems for good Once one comes up with some ideas for how to begin tackling his financial problems and difficulties, he can put together a realistic plan to accomplish his goals. Some goals will have a timeline of a few months; others will need a longer timeline, like 24 - 36 months. Write goals down, but also write down where one is at now in relation to each goal. For example, if one of the goals is to pay off a P10,000 debt, make sure to write down the current debt balance and the future goal of paying this down to P0. Include in the plan the amount of money to pay on this debt every month so that it can be paid off within the desired time frame. 6. Review how things are going Every once-in-a-while, take a few minutes to review how things are going.  Is the plan working towards the goals? If not, take a closer look to figure out why not and adjust the plan. The plan needs to be realistic, or it’s not going to work. It should also contain some things not done before putting the plan in place.  Keep doing what were done before, will get the same result as before – problems. Do something different to get a different outcome. Be open to the possibility of fine-tuning the plan. Improve the plan to accomplish the goals more quickly as long as the budget can afford the changes and everyone who relies on the budget are okay with the more aggressive approach. Unexpected financial challenges are bound to arise in the future - major life events will arise that will challenge prior financial plans. The key to tackling these challenges is to be flexible. Review the budget occasionally and make necessary changes. Build up savings to handle unanticipated expenses without going into debt and be in a difficult situation. Overcoming financial problems and difficulties isn’t easy, but by setting some clear priorities, identifying ways to achieve these goals, and persevering with the plan, one can overcome the challenges and at the same time, put an end to the financial stress.