It is widely known that financial planning involves evaluating all aspects of personal financial needs and providing suitable solutions to achieve one's financial goals.
At first glance, it seems like financial planning is relevant only to people who have enough money to pursue their dreams. Actually, this is not the case. Financial planning also concerns people on low salaries and particularly those carrying a large amount of debt.
Similar to American psychologist Abraham Maslow's Hierarchy of Needs - of which the physiological and psychological needs are ranged and predetermined by the order of importance - financial planning has a hypothesis called the Financial Planning Pyramid.
Based on this hierarchy, the lowest tier signifies the basic needs that should be met before moving up to the next. Cash flow management occupies the most elementary tier, while the upper tiers represent insurance, investment, retirement, and estate planning.
Focusing on the ground level, the planner's financial check-up tool embraces the analysis of cash inflows and outflows, as well as an analysis of debt repayment capability.
It should be noted that having debt does not always mean a threat to personal financial well-being. Depending on the purpose, the use of this money can be beneficial when the advantages can be made today rather than having to postpone to the future.
Purchasing a home or a car are obvious examples since most people are unable to buy these items in one go.
However, things are different if the debt is used for regular household expenditure. Although the proceeds from personal loans or other kinds of short-term debt can be used to satisfy an immediate financial need, it comes at a high cost of borrowing which might not be worthwhile at all, if it is not extremely necessary.
Thus, financial planning plays a crucial role. The planner often employs a method called "Financial Check-up" to assess the state of a someone's personal finances. Collecting data on monthly cash flow, assets and liabilities, the planner can come up with some beneficial results.
By breaking down the expenses into categories, unnecessary expenditure can be detected and the propensity to spend less and save more can be organised. At this point, the planner might be in the right position to help you set a realistic budget to pay off any debt.
This financial information can also indicate the capacity to service debt. Dividing scheduled monthly repayments by monthly income, the debt payment ratio will be presented in percentage terms. The rule of thumb suggests that this ratio should not exceed 35%, or about one-third of monthly income.
Finally, a sound financial planner might also suggest how to mitigate the deficiency should unexpected events occur, namely getting laid off, disability, or even death. These risks should be somehow insured.
Financial planners usually recommend building up cash and liquid assets totalling around three to six times an average monthly payment.
Moreover, applying Credit Life Insurance against an enormous amount of debt such as a mortgage is a good choice. Paying a low premium in exchange for total debt coverage, provides effective protection without leaving a financial burden for your family members.