What is Financial Planning?

It's been awhile since I had the chance to write for students and incoming financial planners. This is the first part of a series of content about Financial Planning. It's not professionally edited quite yet, but I'd love any constructive feedback.

Financial Planning is the process of identifying financial goals and helping meet those goals. This process can be broken into more distinct steps and finessed across types of clients, but at its core has two sequential steps. Helping clients identify their financial goals and once identified, optimize resources and decision making to help meet those goals.

           When the financial planning process is deployed to individuals and households the process can be identified as “personal financial planning” or “family financial planning”. Deploying the process to small businesses, working with non-person entities such as trusts and estates, or higher net worth families can be referred to as “wealth management”. Professional business lines may also utilize different naming conventions for the process of identifying and solving financial goals. Banking tends to prefer the phrase “wealth management” where insurance and brokerage agents will often use “financial services” to describe the planning process.

           The core financial planning process, regardless of its name, remains the same. Identify financial goals and marshal resources to help meet them. These two steps may appear somewhat simplistic at their face value. But wrap them around economic scarcity, financial trade-offs, a fluid regulatory environment and overlay them on human behavior and the steps quickly become departure points into more complicated solutions. Lets meet a typical college graduate to understand how this process can evolve.

           Jade (22) recently graduated with a bachelor’s degree from a four-year university. She studied engineering and accepted a job with an aerospace firm earning $60,000 annually. Jade graduated with $24,000 of federal student loan debt and $6,000 owed on her credit cards. Her employer offers a retirement plan, but will require Jade to contribute some of her own salary into the plan to receive any matching employer contributions. Jade would love to live close to her new job and walk to work. Jade’s mind is focused on paying off her debt.

           But Jade faces scarcity. She will earn $5,000 a month, before taxes. After income (about $650 a month), payroll taxes (about $350 a month) and health care benefits ($500 a month) this amount will likely shrink to $3,500. And $3,500 has to be spread across her physiological needs such as safe housing, utilities, food and reliable transportation. This $3,500 is also going to be called on to maintain and build relationships and friendships. After meeting her actual needs what remains can be used towards financial goals. Economic scarcity is prevalent across age, income and wealth.

           Jade also faces goal oriented trade-offs. Assuming Jade sets a reasonable budget. She determines she has $1,000 a month remaining after taxes, benefits and core living expenses. Her trade-offs are vast. Should she consume her resources or save? Have one extra meal out a week with friends or put an extra $100 a month towards her loans? If she floats on the side of savings should she pay down debt, save for her future retirement or build an emergency savings fund? How much risk should she allocate to each asset? Is she willing to sacrifice return for liquidity? As Jade builds assets should she allocate some of these resources towards insurance, mitigating her risk of loss? How much time will be allocated to work, household tasks and leisure? These trade-offs are personal, important, dynamic and cyclical. They set the stage for Jade’s future and rely quite a bit on understanding how her stated goal (paying off loans) intersect with scarcity, Jade’s understanding of financial risk, how Jade wants to live today and how Jade views the future.

           Jade’s decisions require both technical and regulatory understanding. Jade’s federal student loans qualify for a number of repayment plans. Some repayment plans, such as REPAYE, provide her with income-based payments and guaranteed forgiveness. Others, such as Standard Repayment, will require her to make ten years of higher, equal payments. Jade would also benefit from an understanding of contributing part of her salary to her employer retirement plan. Those contributions are most likely tax-deferred, allowing her to lower her tax bill today while building wealth for her future. Retirement and student loan repayment are only two technical areas of many Jade will face, but understanding options and tax-repercussions is critical in weaving her course of action.

           Jade’s actions will be influenced by her personality, fears, family of origin, biases and dreams. Jade’s ability to defer gratification will influence her savings rate. Her biases surrounding risk and loss will help shape her investment preferences. Jade’s personal financial literacy will drive her credit card repayment and continued usage. Her ability to implement a financial plan may hinge on how it is framed around her biases and personality.

           Financial planning for Jade or any client remains a two-step process. Identifying goals and optimizing resources may appear straightforward. However identifying goals requires understanding true needs, scarcity and trade-offs; optimizing resources can only be achieved through understanding technical elements and regulatory strategies. Even the best of financial plans will only succeed with an understanding of how people behave.