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Financial Planning- A Key to Financial Health

Financial Planning- A Key to Financial Health
Daniel Cohen
UpdatedFeb 28, 2019
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    5 min read
Key Takeaways:
  • Financial planning is something everyone should do
  • The act of making a financial plan forces you to think about your long-term financial goals
  • People who make a financial plan are more likely to have good financial health.

Financial Planning: Securing Your Future

If you want to improve your financial health, financial planning is a crucial ingredient. When you hear the term “financial planning,” it may bring to mind a financial advisor that a rich person hires to help with investment choices and long-term financial goals like financial security in retirement. However, financial planning has a much broader meaning. It is not only the rich who benefit from financial planning. Everyone should engage in financial planning.

In its simplest form, financial planning is a process where you think about the life goals you want to achieve, prioritize them, and set out a realistic route to reach them. Financial Goals don’t remain the same throughout life. There are common, broad goals like financial security but many financial goals change, your goals at 25 are not the same goals you have at 45 or 70.

Basic Financial Building Blocks

The process of making a successful financial plan doesn’t change, however. There are certain building blocks that you need to arrange, regardless of your stage in life. You need to understand your current finances. That means knowing:

  • How your spending compares to your income
  • If you are building savings wisely
  • The amount of debt you carry and what you paid for with the debt
  • Whether you are paying your debts responsibly
  • Your credit score
  • The assets you own and their value

If you can know all the answers, that's great, but it's not a problem if you don’t. With the right tools, you can figure out each of those data points. Knowing all the numbers is an excellent first step, but it's not enough to make a smart financial plan. You also need to think about the way you go about doing things.

The Center for Financial Services Innovation (CFSI)  is a national authority on consumer financial health. In an extensive study, they noted that consumers who planned increased their chances for good financial health.

They focused on two areas to make this determination:

  1. The insurance coverage a person has in place
  2. Whether a person makes financial plans

Whether or not you have medical, auto, life or homeowner’s insurance has practical and psychological implications. Practically, insurance is an investment you make to protect yourself from potential harm. People don’t buy life insurance because they expect to die or want to. They buy it so that loved ones who depend on them financially are protected in the event of a tragedy. Purchasing insurance demonstrates a mindset that weighs the future financial implications of today’s choices.

Why Insurance is Important to Financial Planning

Some parts of a financial plan involve building income, assets, and savings. Another essential part of financial planning is protecting yourself and your family from the unexpected. If there is an interruption of income, due to illness or job loss, you don’t want your financial house to crumble. Building an emergency fund that covers six months of living expenses is one, essential protective step.

Insurance serves a similar purpose. Instead of building savings in an account under your control, you purchase insurance to cover particular events and pay a monthly premium. Without proper insurance, you and anyone financially dependent on is exposed to great harm. Evidence shows that without adequate insurance, you won’t bounce back quickly from a financial shock. Without life insurance, the death of a breadwinner could result in the inability to pay for basic needs, adding financial distress to the stress of the loss of a loved one. Without proper medical insurance coverage, an unexpected medical need could throw a household into a financial crisis (as demonstrated by medical costs being the #1 cause of bankruptcy).

Think about the insurance needs you have now and how they have changed during your life, or are likely to change in the future. Whether you are married or not, have dependent children, and your age all play a part in your insurance needs. Weigh which kinds of insurance could benefit you and prioritize them, so when you have the means, you can put the right coverage in place systematically and thoughtfully. You will find out that thinking about your needs and how to address them is an exercise forces you put your finances in a different light and focus on long-term goals.

 Financial Planning

Combined with evaluating your insurance needs, how you answer the simple, direct question, “Does your household plan ahead financially?” gives a strong indication of the way you are oriented towards your financial future. The CFSI in-depth study showed a very strong link between people who plan their financial future and good health.

People who say that they plan financially take practical steps. They also demonstrate an outlook that gives them a better chance of good financial health. Practically, they are likelier to make a budget, track their expenses, and use different financial tools that exist (and are often free). Psychologically, they create a self-fulfilling cycle. They commit to planning, benefit from it, and continue to plan.

If you are just getting by, living from paycheck to paycheck, it is difficult to plan. If you are struggling, even if you know all the parts of a successful plan, they may be out of reach to implement. Still, knowing what the path is and starting down it, even if progress is slow, is a better way to go than avoiding reality.

When you answer eight questions devised by the CFSI and a few we added in, you will receive a snapshot of your financial health. You get an overall financial health score as well as four separate scores that measure specific areas. This is a fantastic starting point to see what parts of your financial life need the most attention and where you are already on track for a good, long-term result.