The concept of financial planning can evoke different meanings. Some think it’s as simple as knowing how much of your money is coming in versus going out. That’s an important element of financial planning — but that’s really just budgeting. So, what is the difference between budgeting and financial planning?
Budgeting looks at what’s happening with your financial picture now and helps you prioritize how you’re spending and saving your money on a regular basis.
Financial planning, on the other hand, is a broader look at your entire financial picture over time. It can show you how and where you’ll save money to reach your goals and typically includes aspects to help you stay on track if something unexpected should happen.
WHAT’S INCLUDED IN A FINANCIAL PLAN?
When you do financial planning you’re figuring out how to go from point A (where you are now with your finances) to point B (where you want to be in the near, medium and long-term). While there are several things a plan will consider, it typically covers a few key areas:
- How you’ll protect your money
- How you’ll grow your money over time to meet big goals
- How you’ll pay down debt
- Whether you’re balancing spending now and saving for the future
- What kind of legacy you want to leave behind with your money
CREATING A SAFETY NET IN A FINANCIAL PLAN
A financial plan (and a budget really) depends on one key component to make it work: income. And there’s a lot that can throw that income out of whack — anything from a large, unexpected expense, to being out of work for an extended period of time. That’s why a plan will typically include things like:
An emergency fund: A roof repair or a surprise medical bill can easily cost more than your monthly income. Having an emergency fund can help make sure you can cover these costs without having to go into debt. You could also rely on the emergency fund to help cover costs if you lose your job. Typically, it’s a good idea to save around six months of expenses in an emergency fund.
Life insurance: If others depend on your income, life insurance protects them if something should happen to you. And permanent life insurance accumulates cash value, which can help protect your family while also allowing you to grow funds that you can use for big goals while you’re alive.
Disability insurance: If an illness or injury prevents you from working for a long period of time, disability insurance can help to replace some of your lost income.
Estate planning: This is often misunderstood as a tool only for the super-rich. In reality, an estate plan is how you specify things like who will take care of your young children should something happen to you, or how assets you leave behind will be distributed.
GOALS WITHIN YOUR FINANCIAL PLAN
There are probably any number of goals you’re trying to accomplish that are related to your money. You might be trying to pay off credit card debt or student loans. You may be trying to grow and invest your money for a specific goal like retirement through a retirement plan. A financial plan can help you work on reaching multiple goals, including:
- Getting married
- Buying a home
- Growing your family
- Paying off debt
- Sending your kids to college
- Starting a business
- Living your dream retirement
A financial advisor can help you balance how much you’re saving for those future goals with how much you need to live today, as well as make recommendations about the best ways to get out of debt so you can free up income that can go toward goals.
Budgeting is a big part of financial planning because it will help you see how you are spending money today and where you can make changes based on your plan. Then, once you’ve built a plan, you can adjust your budget.
When you create a budget, you’re essentially doing the math to figure out how much you bring in each month in take-home pay, and then what you spend on different categories. Although there are many ways to allocate how you spend your money, here’s one general guideline to consider:
60 percent of your budget should go toward fixed expenses. This includes costs like mortgage or rent, car payments, daycare, groceries or utilities — basically expenses that are essential to your daily life.
20 percent should go toward financial goals. This can be anything from saving for the family vacation you want to take next year to college tuition you want to pay for in 10 years to the retirement you want to be ready for in 30 years. It can also include any money you put into an emergency fund or toward life insurance premiums.
20 percent should go toward discretionary spending. This can be the money that you spend on eating out, fun family activities or the latest tech gadget, and is likely the category where you have the most flexibility to spend less if you really needed to in order to meet other goals.
It’s a good idea to do a budget before you build a financial plan. A financial advisor can also help take a look at your budget to see how it fits into you overall plan, and help you tweak it to make sure you’re balancing what you need for today with the future goals you’re trying to achieve.