Financial planning is the process of meeting your life goals through the proper management of your finances. Life goals can include buying a home, saving for your child’s education or planning for retirement, elimination of debt, etc. This often includes a budget which organizes an individual's finances and sometimes includes a series of steps or specific goals for spending and saving future. This plan allocates future income to various types of expenses, such as rent or utilities, and also reserves some income for short-term and long-term savings.
Step 1 – Starting point - Where are you now?
Get a realistic picture of where you are financially. We spend more than half our lives working and saving, but hardly spend any time planning on how to put that hard-earned money to work more effectively. So, how do you plan your financial life?
List everything you owe (liabilities) and the value of everything you own (assets). Also, track your monthly income and expenses in a notebook or on a budget form. Even if it’s not a pretty picture now, that’s OK. You’ve faced your financial situation, and financial planning will help you improve the picture. Financial planning starts with a review of your overall financial profile, and not at investing. Before rushing to build an investment portfolio, you need to address the following issues: Insure your health; life and assets. Start by protecting your family’s current lifestyle against events/ expenses beyond your control. Buy appropriate insurance policies for your medical expenses, life, car, and other important assets. Repay high-cost loans, paying credit card bills on time can save you more money in interest costs than most of your investments could earn you. Same is for borrowings that cost you more than 15% pa. So, put high-cost loans behind you, and only then start building your investment portfolio. Put money aside for emergencies. Deploy some money in short-term investments that can be encashed on demand to help you tide over unforeseen needs and emergencies. Draw up a savings plan Income - Expenditure = Savings. Do not leave this equation to chance, make a savings plan. Put away as much as you can, as regularly as you can, aim to save at least 15% of your take home annual income. Investment planning is simpler than you think, and more rewarding than you would imagine.
Identify your financial goals. What are your goals? What are you saving for? A house? Child's education/ marriage? New car? World tour? Retirement? Quantify this in terms of amount of money needed, and time horizons. Understand your risk profile Depending on our income and needs, we all have different capacity for risk. We also have a different risk tolerance, based on our individual psychological make-up. Understand your risk profile and plan your portfolio accordingly. Find out: Your risk profile, Plan your asset allocation. Returns should not be your primary objective; you could end up taking more risk than you are financially/ psychologically capable of. It helps seek expert advice and create a portfolio with the right spread across asset classes to minimize risk of incurring a loss.
Step 2- Avoiding Potholes: Insurance, Debt, Job Loss, Taxes and Estate Planning
Financial potholes will inevitably come your way — stock market downturns, recessions, losing a job, wrecking the car, paying for an illness. You may not be able to avoid these potholes, but you can minimize their financial impact. Here are a few suggestions:
• Have adequate insurance- Insurance prevents financial catastrophes. For most people, that means having the following insurance: auto, renters or homeowners, liability, health, disability and life insurance (if someone depends on you financially). Take advantage of insurance offered to you at your job and supplement it with insurance you buy on your own. Shop for the best price, but make sure you buy from a reputable, financially sound insurance company.
• Control debt- Having a lot of debt puts you at financial risk. If you’re spending more than you earn, start using a budget to plug spending leaks, and make paying off your credit cards a top priority.
• Job loss- You can’t control the economy or a company layoff, but you can control how much time you invest in keeping your skills sharp and in meeting people who may help you find a job in the future.
• Taxes- Computer software can help you find deductions on your tax return. However, if your financial situation is complex, you may benefit from working with a tax or financial professional who can suggest tax strategies and make sure you are getting all of the credits and deductions due to you.
• Estate planning- Every adult should have these four basic documents: will, power of attorney, medical power of attorney and a living will (also called a medical directive). A financial planner can guide you and refer you to an estate planning attorney to draft these documents.
Step 3-Saving, Investing, Retirement and Other Goals
Your goals likely will require money. Whenever you can save the money you need instead of borrowing, do it! That’s how you will become financially independent. Here are a few more tips:
• Pay yourself first- To get into the savings habit, automatically transfer a certain amount of money — for example, 15 percent of your paycheck into a savings or money market account. Online banks often offer competitive interest rate.
• Have an emergency fund- Most experts recommend that one of your goals should be a separate savings account to pay for emergencies, such as losing a job or having an unexpected medical bill. Work toward saving three to six months’ salary in an emergency savings account at a bank. If you own a house, consider getting a home equity line of credit for emergency use only.
• Fund your retirement plan- If you have a retirement plan at work, take advantage of it or set up your own Individual Retirement Account (IRA). The earlier you start, the more time you have for your money to compound, or grow. If you can’t put in the maximum amount allowed every year, at least fund your plan up to what your employer will match. If you leave your job, avoid the temptation to cash in your retirement fund.
• Invest the rest- After you take care of the above priorities, implement an investment strategy. First, however, take time to educate yourself about investing, including investment risks, your risk tolerance, expenses and the importance of diversification. Never invest in something you do not understand.
• Buy a house with care- One of your goals may be to buy a house, and that could be the largest financial investment you will ever make. To gauge if you are financially ready to buy a home, ask yourself the following questions: Is my credit in good shape so I will get the best financing terms? Do I have a steady job history so the lender will have confidence that I can repay a home loan? Can I afford to make the monthly mortgage payments along with my other bills? Have I saved for a down payment? If you can’t answer “yes” to each of these four questions, don’t get discouraged. Just give yourself a little more time to get ready.
The only thing worse than investing late is not investing at all. Use the power of compounding Compounding is the best reason for starting early. The sooner you begin investing the better. Every day that you are invested is a day that your money is working for you.
Opt for a shorter term, low capital risk investment (such as liquid/ gilt/ money market funds, bank term deposits or top-rated company deposits/ fixed income investment options). Similarly, invest money that you will not need for 3-5 years in the stock market. Evaluate your investing skills Finding the right money manager for your investments is important. You could manage your money yourself, use professional money managers, or invest through mutual funds. Financial planning is not about financial expertise and hard work. All it needs is the right approach and discipline.
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