What are the essential components of financial planning?

Financial planning has five essential components. Planning for all five components is called a comprehensive plan which will help an individual to achieve his/her life goals.

Financial planning has become an essential aspect of an individual’s life. If an individual does not possess an adequate financial plan, then he/she might end in a financial crisis in the event of a mishap and cannot fulfil his/her life goals.

Unless and until an individual is already a millionaire and have bequeathed wealth everyone needs to plan their finances. Financial planning helps you give direction and meaning to your financial decisions. It is the process of meeting your life goals through proper management of your finances. It allows an individual to understand where he currently stands and what he desires to achieve and allocate adequate finances towards the same. Life goals can include buying a home, savings for your child education or marriage, planning for your retirement or estate planning, etc.

There are five essential components of a financial plan such as Insurance planning, Retirement Planning, Investment Planning, Tax Planning and Estate Planning.

Let’s look at these components further in this article:

I. Insurance Planning: Insurance planning is critical so that your major risks are covered. Insurance covers only financial loss which is caused by various risks. Essential insurance one should possess to financially cover any unfortunate mishap are as follows:  

• Life Insurance Cover: This is the most important insurance and one must possess if one has dependents. In case of the untimely demise of the breadwinner, it will help his dependents to maintain their existing lifestyle.  

• Medical Insurance Cover: One should buy this insurance in case of any medical emergency to avoid any financial stress and will help you pay your medical bills.  

• Disability Insurance Cover: One should buy this to ensure continuity of income in case of any permanent or temporary disability.  

• General Insurance Cover: One should buy this type of insurance to replace or repair tangible assets held. 

It’s very important to purchase adequate insurance because underinsurance can be highly damaging as it won’t cover all your losses and over insurance can also adversely affect the current cash flow as you will have to pay higher premiums. 

II.Investment Planning: Investment Planning is critical for helping you reach your financial goals. These financial goals are met through creating financial resources by investing savings generated over time. Every individual has different levels of risk appetite and thus the investment needs of every individual are different. The core part of investment planning consists of deciding on an asset allocation strategy that is in line with meeting the overall objectives of an individual. Asset allocation means diversifying money among different types of investment categories such as stocks, bonds, cash, etc. 

III.Retirement Planning: It is extremely critical to carefully evaluate the lifestyle you will require at the time of retirement. The purpose of retirement planning is to ensure that an individual will be able to maintain his/her current standard of living after retirement, even in absence of regular cash inflows by way of any income such as salary income. Generally, many individuals ignore and underestimate the amount of financial capital required for comfortable retired life. One should plan their retirement right from the age they start earning.  

IV.Tax Planning: A lot of individuals invest only to save tax. No considerations are given to where the money is invested and how does it fit into the overall strategy of meeting life goals. Tax planning is all about using allowable strategies to reduce tax liabilities. Tax planning is supposed to be used as part of the overall strategy and not independently. Tax planning helps an individual minimize taxes, not evade taxes. 

V.Estate Planning: This is a very important component of a financial plan as a majority of people neglect and ignore estate planning as they don’t want to think about their death. Estate planning is crucial as a means of providing for one’s family over the long term. Failing to plan for the legal and financial aftermath of death usually results in much heartache and pain for survivors. So, to peacefully bequeath the wealth to their legal heirs it's important to do estate planning.