What It Means
Financial planning involves the setting of long-term goals for spending, saving, and investing. Expenses include money spent on groceries, clothing, child care, and other necessities, as well as monthly bills such as mortgage payments (the monthly fee paid by those who have purchased homes with money borrowed from a financial institution) or rent (the monthly fee paid by people who lease space in an apartment or house); utilities (gas, electric, water, sewage, and garbage disposal bills); telephone expenses (cell phone and landline); credit card payments; cable television and Internet bills; and payments on other outstanding loans (car payments and student loans, for example). Expenses also include dollars spent on pleasure, which can include an evening out at a restaurant or the movies or, possibly, a family vacation.
Savings usually refers to the amount of money one keeps in a savings account at a bank. Such accounts typically pay low interest (which means a savings account is, technically speaking, an investment), but people who maintain savings accounts are usually permitted to withdraw their money at any time without having to pay a penalty. When assembling a financial plan, it is a good idea to keep some money in a savings account in case an emergency expense (such as a costly repair to an automobile or the unexpected loss of employment) arises. Many professional financial planners suggest that, if possible, one should maintain a sum that equals four months worth of expenses in a savings account.
Investments refers to assets such as stocks, bonds, mutual funds, and life insurance policies that one purchases with the hope that the asset will appreciate in value or generate more income in the future. A good financial plan will include investments that will one day provide for the funding of one’s children’s college educations and for an individual’s postretirement needs. Most safe long-term investments (those that are likely to pay moderate returns) require an individual to keep the invested money in an account for a predetermined amount of time. Funds in many retirement plans, for example, cannot be accessed without penalty until the investor is 59½ years old.
When Did It Begin
In one sense financial planning could be said to have begun as far back as 9500 bc with the start of agriculture in the Fertile Crescent of Southwest Asia (what is today Iraq and Syria). Since people were subsisting on what they could harvest, any planning associated with rationing crops and storing them for later use or trading them with others could be considered financial planning. With regard to savings, it is believed that people began storing grains and precious metals in banks in 3000 bc . At the time, banks were housed in temples because these structures were well built and frequently occupied by priests and other worshipers. With regard to investing, people could purchase stock as far back as the Roman Empire. The first stock brokers (people who facilitate the trading of stocks among buyers and sellers) are believed to have appeared in twelfth-century France.
Through the centuries stock brokers have served as financial advisers, attempting to help clients conduct sensible and profitable transactions by discussing trends in the stock market and the direction of the economy. However, stock brokers do not necessarily discuss the individual client’s specific financial situation and the person’s long-range goals and needs. Personal financial planning of this sort began much more recently. In 1969 a group of financial service consultants (professionals who gave clients advice on how to invest their money) met in Chicago to discuss their dissatisfaction with the state of the financial services industry. This initial meeting led to the formation in 1970 of a trade union called the International Association of Financial Planners. In 1971 the group created the College of Financial Planning, which in turn introduced the Certified Financial Planner (CFP) designation for those who successfully completed study there. The institution graduated its first class in 1973. Members of the profession vow to give more comprehensive individual service to their clients.
More Detailed Information
Given the complexities of modern life, many people hire personal financial planners to help them devise and execute a financial plan that fits their lifestyle and earning patterns. Whether hiring a financial planner or developing his or her own strategy, a person should follow a series of steps to ensure long-term financial security. First it is necessary to set goals. It is never too early for a person to begin considering the type of house and the type of neighborhood he or she would like to live in. It is also necessary for a person to consider the job he or she would like to hold. If the salaries available along a certain career path are not likely to enable a person to live in the house and neighborhood of his or her choice, it then becomes necessary to modify long-term goals. One either has to consider other lines of work or be satisfied in a more economical home. From the beginning it is crucial to understand that lifestyle choices must be consistent with earnings; otherwise a person risks going into unmanageable debt.
After stating his or her goals a person must gather relevant information and then carefully analyze that information to begin charting a course that will help him or her realize the established goals. For example, if two 30-year-old working parents with two kids hope to pay for their children’s college tuition and to retire comfortably by age 62, they need to gather a substantial amount of information about college tuition and retirement funds. If their children are five and three, the couple has about 13 years to establish a college fund. To figure out how much money they should deposit in the fund, they must review tuition costs at the schools their children might one day attend and check the average annual rate of tuition increases at those schools. In this way the couple can decide how much to put into the account every year. Likewise, with their retirement fund, the couple needs to do research on the funds available, the tax laws associated with those funds, and the average returns on those funds.
After the information has been gathered and analyzed, it is time to build a plan. Most financial planners suggest that an individual reserve 20 percent of his or her pretax income for long-range investments. Second most financial planners suggest that people invest their money aggressively in the early stages of the investment process and conservatively in the later stages of the process. For example, the couple saving for their young children’s college tuition might invest in some riskier mutual funds in the early going because these investments might yield high returns, and if they do not, there is still time to recoup losses. However, as their children enter high school and move closer to graduation, a financial planner will suggest that the couple invest in more conservative mutual funds. These funds may not yield high returns, but they are unlikely to lose money. Whatever long-range plan a person devises, it is important to make sure that this plan is consistent with the person’s present lifestyle. Parents are not advised to budget for colleges that force them to compromise their present happiness because it is possible that their children will not share the parents’ ambitions for college. Likewise, with retirement plans, investors are not advised to construct a plan that forces them to forgo too much of what they enjoy doing in the present.
Perhaps the hardest step in the process is abiding by the plan. For example, if a plan requires an investor to deposit $400 each month into a fund, the investor must be disciplined enough to stick with the plan. This often means that one cannot have the very latest technology, the most stylish clothes, or the most elegant car. Keeping with a plan requires discipline and sound decision-making. Most financial planners suggest that a person arrange with his or her bank to have investment funds automatically drawn from his or her checking account each month. Left to themselves, most investors stray from their plans and neglect to make their monthly or quarterly investments. Often when they have strayed too far, they give up on their plans. The last step is to review the plan at scheduled intervals. This allows a person to make deliberate and prudent modifications to the plan rather than hasty changes.
In the early years of the twenty-first century, it appeared that some Americans had not planned their finances well. For example, in 2006 banks filed 1.2 million foreclosure proceedings (processes by which a financial institution holding a mortgage repossesses a home) against homeowners. This represented a 42 percent increase from 2005. About this same time it was estimated that one in 73 households filed for bankruptcy and that the average American owed $8,000 in credit card debt. Statistics from 2006 indicated that credit card spending was at an all-time high, with data indicating that Americans put as much as 25 percent of their purchases on credit cards.
While the preceding statistics may paint a dire picture, other statistics suggested that Americans were seeing the wisdom in sound financial planning. For example, more American families were enlisting the services of personal financial planners each year, and as of 2003 personal financial planning was one of the fastest-growing career fields in the country. In 1993 only 40 percent of the Certified Public Accounting firms in the United States offered personal financial planning services. By 2003 more than 60 percent of the firms in the country offered those services. According to the Bureau of Labor Statistics (BLS), in 2004 there were over 158,000 personal financial advisers working in the United States, 40 percent of whom were self-employed. The BLS predicted that the field would grow at a rate of 18 to 26 percent each year until 2014. In 2004 the median salary for personal financial planers was $61,000. More important than the salary, surveys conducted among workers in the field indicated that personal financial planners found considerable satisfaction in their work, with the majority of respondents saying that they found their work exciting and worthwhile.