Financial planning is the art of planning your financial affairs.

Planning for the future always entails uncertainties and a financial plan must take these into consideration. A financial plan based on a crystal ball is likely to prove to be too big-headed. A proper plan must aim for growth but must also be hedged so that it does not fall victim to the unexpected.

Financial planning can be envisaged as a triangle:

¤ Savings and investments

¤ Tax planning

¤ Insurance

Through work and other means a family earns income. In a large number of cases, most of this income goes on consumption which may be:

¤ immediate - food, clothing, medicine;

¤ intermediate - a car, furniture, education;

¤ long-term - a house.

Although it sounds contradictory, many forms of consumption are themselves investments because one is spending today in order to derive a benefit in the future. The most obvious is education and buying a house. Less obvious but more immediate is food, since we eat now for the strength to carry on later and, in children, to build a healthy body. So, like ying and yang, consumption is often investment.

Savings and investments

One usually saves the money needed to meet immediate and intermediate consumption requirements and invests to meet future consumption. What wealth remains on death passes on to the heirs.

As far as possible, savings must be in instruments which have low risk. The importance of bank accounts in this regard is obvious but even bank accounts are not risk free.

Bank accounts are one of the greatest inventions in finance. If you ignore inflation, and currency movements, and other opportunities you may be losing (or dangers you are avoiding!), then what you see in the account remains there, the nominal value of your capital does not fluctuate, you do not "lose your capital". Added to this, you get interest. The further you are from the money (and the more use of it the bank has), the more you get.

Bank accounts, therefore, generally provide a low risk way to save money for a short period of time at a modest rate of interest.

One does not want to take risk with this money and then find oneself unable to make a deposit on a much-needed car or pay for a surgical operation.

The problem with low-risk saving is that the interest received is low, sometimes not even keeping up with inflation. Therefore one often has to leave the "security" of the bank account and invest in other instruments, such as bonds and shares.

When you invest, you have to take certain precautions. But keep in mind from the very start that, however much you try to hedge and limit risk, you cannot eliminate it. If you do manage to push risk down to zero, you can expect to get a rate of return close to zero as well!

Risk can be reduced by seeking to buy at a good price, investing in good-qualinvesting for the long-term so that time works in your favour and to allow market cycles to push prices up, and to diversify by putting money in more than one investment. Get the advice you need by finding a good adviser and by reading and interesting yourself in money matters.

Do not get emotionally involved with your investments - if you made a mistake, cut your losses and get out.

Pay the bearer of bad news as much as you pay the one with good news, they both help you get ahead tomorrow.

Tax planning

The main principle of tax planning is simple: we must pay all taxes if they are due but we are under no obligation to be masochistic and arrange our affairs so as to pay the greatest amount of tax.

The corollary of this is: all tax practitioners, whether advisers or collectors, agree that if you do not fall within the tax ambit (what they ominously call the "taxing net") you should not be made to pay tax.

While the principle is simple, the practicalities are often very complex and there are a lot of grey areas. Albert Einstein once said that "The hardest thing in the world to understand is income tax."

It is very difficult, if not impossible, to arrange matters so as to be able to legally live tax-free. So tax planners often aim at reducing, rather than eliminating, tax incidence.

Knowing the tax laws helps. One of the measures most widely made use of is, of course, the 15 per cent final withholding tax on investment income. Often people are not aware of other less popular measures which exist in the tax laws and which are there to mitigate tax. So, here again, one must often seek advice.

Insurance

You can insure your life, your health, your home and nearly everything else.

Insurance is the protection of the assets which you have accumulated over the years. Life insurance, usually called assurance, protects not so much the life assured as the dependents on that life - the family of the breadwinner rather than the breadwinner himself or herself.

Some forms of life insurance are tied to investments and one has to check carefully how much is going to pure assurance, how much to investment, and how much to charges.

It does not always make sense to pay others to take a risk off your back - sometimes it is cheaper to carry the risk yourself. This is called self-insurance.

Before insuring a risk you must study the policy document carefully to see what exactly you are insuring and against which events. Compare the premiums you have to pay with the probability that disaster strikes and what will be the financial loss if it does.

The art of the plan

Financial planning is an art - the art of maximising the use of your financial resources. One man's plan is another man's poison. Each financial plan, like a suit, should be made to fit a particular individual or family.

A good financial plan represents the balance reached between the three points of the money triangle.

Paul V. Azzopardi is managing director of Azzopardi Investment Management Limited (www.azzopardi.com) which is licensed by the MFSA to provide investment services, including stockbroking. This article is only meant to provide information, which the writer believes to be accurate at the time of writing, and is not intended to give investment advice and its contents should not be construed as such. The value of securities, and the currencies in which they are denominated, may go down as well as up. Readers are requested to seek professional financial advice tailored to their own personal circumstances.