Why Financial Planning Matters

by Rande Spiegelman, CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research
Updated November 10, 2008

Why is financial planning so important?

Here’s an analogy: Say you have your perfect dream home in mind, the sort of house you could live in for the rest of your life. It doesn’t exist yet, so you decide you're going to have to build it from scratch.

What do you do first? Shop for drapes and furniture? Better to get an idea of how much you’ll need in the way of lumber, nails, pipes, wiring and plaster first. Don’t forget, you’ll need some land to build on, too. And a set of blueprints wouldn’t hurt, either.

Planning for financial independence is no different. If you hope to achieve your life goals, you have to put a sound plan in place and follow it. In fact, establishing and following a sound financial plan is one of the best and most important decisions you’ll ever make.

The financial planning process

Graphic: Financial Planning Process

Here are the six basic steps.

Step 1: Establish your goals. Financial planning is about achieving your hopes and dreams: a comfortable retirement, paying for your children's education, buying a home, providing for loved ones, charitable pursuits, and so on. Think long and hard about what you want to accomplish in life and how your finances might play a role.

This part of the process also involves a rigorous self-assessment of your personality and tolerance for putting your finances at risk. And, because specific goals are usually tied to a certain point in the future, this step will also help establish your time horizons.
Step 2: Gather your data. Your present circumstances will have a huge impact on the plan that’s best for you. Start by collecting all your bank and brokerage statements, insurance policies, estate documents, and maybe even your most recent tax returns. List your assets (what you own) as well as your liabilities (what you owe). You’ll also need to gather up a record of all your sources of income and expenses, and anything else you can think of that’s related to your finances.
Step 3: Analyze the data. Here's where you start to form a coherent picture of where you are financially. For example, your portfolio's current asset allocation will emerge from your brokerage and retirement account statements. At this stage, you'll create a personal net worth statement and a statement of annual cash flows. You'll also analyze the adequacy of your estate plan, account titling, beneficiary designations and insurance coverage. As the picture develops, specific shortfalls or excesses will come into focus, along with areas you need to change.
Step 4: Create a plan. Now you're ready to lay out the roadmap that will help you accomplish your goals, given your risk tolerance and time frames. Your plan may call for immediate changes, such as diversifying your investments, shifting your asset allocation, consolidating accounts, optimizing your insurance coverage, or drafting wills and other estate planning documents. Your plan may also call for longer-term actions such as altering your spending and saving habits over time.
Step 5: Implement your plan. Here's where the rubber meets the road; financial planning isn’t meant to be an academic exercise, after all. The plan you created in Step 4 is meaningless if you don't act on it. You might be surprised, for example, at how many people pay to have trusts created and never get around to actually funding them.

Implementing your plan may involve opening certain types of accounts or purchasing certain types of securities, policies, funds or other financial and investment-related products. Suitability and performance are key here, of course. But remember, you can potentially boost the overall, long-term performance of your investments by keeping costs and expenses as low as possible.

Also, take advantage of available tax-free and/or tax-deferred accounts, in addition to your regular taxable brokerage account.
Step 6: Monitor your plan. This involves keeping an eye on the performance of your investments, periodically rebalancing your portfolio to keep your asset allocation on target, updating your insurance and your estate plan, and so on. In the absence of a major event in your life, once or twice a year should do it.

Changing your plan
If the future always went according to plan, financial planning would be a one-time exercise. But life throws a few curves now and then. So, when you monitor your plan, revisit the goals you set in Step 1 as well, for two reasons:

You want to measure your progress toward your goals and objectives to make sure you’re on track.
Once in a great while, you may find that your goals need to be modified.

Of course, this means gathering your most recent data, analyzing it, deciding if you need to alter your existing plan or create a new one, and … well, you get the picture. For the most part, the financial planning process is circular.

Get help if you need it
Going back to the "dream home" analogy, it may be you’re a master builder with plumbing, electrical and carpentry skills in abundance. On the other hand, you might be someone who’s better off hiring a realtor to find the land, an architect to draw up the blueprints and a contractor to do the construction.

The financial planning process isn’t exactly rocket science. However, given the specialty areas of income tax, estate tax, retirement planning, insurance, compensation and benefits, and saving for college—not to mention how each of these areas can impact the others—it might pay to enlist some professional assistance, at least to get started. Either way, the road to financial independence begins with taking the first step.

As always, if you have questions or need help, please contact your Schwab consultant. If you're not yet a Schwab client but would like to learn more, a Schwab consultant can help. Call 800-435-4000 to get started.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of strategies mentioned may not be suitable for everyone. Each investor needs to review their investment portfolio strategy for his or her own particular situation. All expressions of opinion are subject to change without notice in reaction to shifting market conditions.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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