What is Financial Planning?

Financial planning can mean many different things to people. For some people, it may be budgeting. For others, reducing debt. Working individuals may think of employer benefits or their 401(k). Retired individuals may think of their social security or pension payments. Others might think it has something to do with taxes. The answer to the question is all the above.

Defining Financial Planning

Investopedia defines financial planning as, “a thorough evaluation of one’s money situation (income, spending, debt, and saving) and expectations for the future.” While this is not a bad definition of financial planning, it nonetheless leaves out a few minor (or major) details. In fact, financial planning should really be called, “Life planning with a dash of finance.” Granted, that name would be difficult to print and cumbersome to say; however, it is a more accurate representation of what financial planning truly entails.

Traditionally, financial planning covers five topics:

Retirement Planning
Investment Planning
Protection Planning
Tax Planning
Estate Planning

The names are relatively self-explanatory. Investment planning deals with things like your Roth IRA, 401(k), 403(b). Tax planning can answer the question of Roth (after-tax) vs. Traditional (pre-tax). Estate planning involves trusts, wills, power of attorneys, etc. Where the traditional definition of financial planning falls short is the human element.

Planning Is Personal

You could go to a financial planner and build a plan that encompasses the five topics mentioned above, and it would certainly be a good plan. However, what truly makes the plan great is its focus on your life, your values, and your dreams. Whenever I meet with clients, I always emphasize that there is both a mathematical answer to questions and a human answer, with some overlap between the two. Therefore, you cannot focus solely on one element while disregarding the other.

For example, many of you reading this article may currently be in the market for a home or may have recently purchased one. To illustrate, let’s say the average mortgage interest rate in the state of Wisconsin, with a 700 credit score, is 7.934% for a 30-year fixed mortgage (though this rate will have likely changed since the date of this article). I get this question all the time: should I buy a house right now?

The Math Answer:

Let’s say you and your spouse currently rent an apartment for $1,500 per month in La Crosse, WI. Now, you are considering purchasing a $300,000 home, and you have $30,000 set aside for a down payment. The interest rate offered by your lender is 7.94% for a 30-year mortgage. If you decide to purchase this home and stop renting, you would need to live in your home for at least 18 years before you break even on the decision, taking into account interest payments, closing costs, and other expenses. So, does it really make sense to purchase a home under these conditions? The answer is: not really.

The Human Answer:

In the same situation as above, there is now more context to consider. Your two-bedroom, 1,100-square-foot apartment is located on the third floor of your building. Currently, you have a two-year-old in the second bedroom, and a newborn is on the way. Meanwhile, the house you are looking at offers a two-car garage, a fenced-in backyard, and four bedrooms. Additionally, it has a finished basement and a newly remodeled kitchen. Given these factors, does it make sense to purchase a home under these conditions? Absolutely!

Which answer is correct? More importantly, which perspective is more important? This is precisely where financial planning truly carries its weight. Essentially, financial planning seeks to merge your personal and financial lives in order to develop a game plan that addresses both sides of the coin and finds ways to resolve conflicting answers, such as in the situation described above. This personal-financial model of planning can be applied to each one of the five topics listed earlier.

An Example

For example, how much life insurance do you need? The math might say $500,000, but your spouse wouldn’t want to re-marry if you pass away, so you may need more. Similarly, when can you retire? The math may indicate age 65, but if you have a family history of Alzheimer’s and want to retire earlier to enjoy more years of good health, your personal circumstances alter the answer.

These questions, among others, are real-life examples of why financial planning matters. As I’ve mentioned before, it’s important to find a planner who will incorporate your life circumstances into your planning and not just focus on the math.

This article is educational only and is not intended to be investment, legal, or tax advice or recommendations, whether direct or incidental. Again, this is not investment advice. Consult your financial, tax, and legal professionals for specific advice related to your specific situation. Never take investment advice from someone who doesn’t know you and your specific situation. All opinions expressed in this article are those of the people expressing them. Any performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be directly invested in.