Financial Planning 101 - 6 simple steps

"Would you tell me which way I ought to go from here?" asked Alice.

"That depends a good deal on where you want to get," said the Cat.

"I really don't care where I get" replied Alice.

"Then it doesn't much matter which way you go," said the Cat.

-Lewis Carroll, Alice's Adventures in Wonderland

Financial Planning doesn't require a jargon spewing financial adviser but is essentially a simple 6 step process.

1. Identify and list down your future needs/ objectives

The very first step as you begin to plan on how to save/invest your surplus money is to - take a sheet of paper and write down your future and immediate plans/goals. Different people have different goals in life, some may want to buy a house, a car, save for children’s education and marriage, retire early to pursue a hobby or to do social service and many other long term and short term goals. Once you have listed your goals you should assign them a certain priority depending on how fast you want to achieve these goals and how crucial these goals are for you. Clarity in this respect would be the starting point to help an individual work out the journey on the financial road which needs to be followed.

You have to physically list down your goals and not just run them through your head. Seeing it in physical form on paper or on your computer screen actually helps you think clearer about your goals.

2. Convert your personal goals into financial goals

It is very important to convert each of your personal goals to financial goals. Two components go into converting the needs into financial goals. First is to evaluate and find out when you need to make withdrawals from your investments for each of your objectives. Then you should estimate the amount of money (how much) needed in current value to meet the objective today. Once you have estimated the amount needed today, then you should apply an inflation factor to project how much would you need in the future.

For eg. If you want to purchase a house 5-6 years from now and if an apartment costs Rs. 30 lakhs in the locality you are looking at and if the cost of housing is rising at about 10% annually, the total amount required at the end of 6 years would be Rs 48.32 lakhs.

3. Get clarity on your current financial stage

The next step to financial planning is to list down your income and monthly expenditures. This enables you to get an idea of the pattern of cash outflows (expenses) during the year. Accordingly you can plan to keep adequate money liquid for the necessary expenses during the course of the year. All Loan EMIs (equated monthly installments) paid should be kept separate under the monthly expenses head, as after a finite number of years they will no longer be part of your regular living expenses.

The most important information that you get from the above study is your current annual cost of living (that part of expenses which supports your current lifestyle). An analysis of the above figures would enable you to understand the amount of savings (income less expenses) that you are left with on an average. This in turn will give you an idea of surplus regular money available for investment. This is the savings that will take care of you and your family when income from your work stops.

4. Risk Planning:

Before you start thinking of various instruments where you could invest your money to achieve your financial goals, you need to focus on the oft neglected area of risk planning. India is a severely under-insured country. Most people have not fully grasped the full impact of improper risk planning and the most people consider insurance as a ‘waste of money’. An insurance product aims at financial protection from risk of death or illness (the two major risks). A suitable health insurance cover is worked out after taking into account the situation of the family and information about the availability of any cover from the employer. The next step is to estimate the amount of life insurance cover required. Loss of income in case of death of an earning member may put the rest of the family into financial discomfort (especially where he/ she may be the primary bread winner). The role of insurance is to take care of this financial discomfort. The most suitable life Insurance cover for this is a term cover. To read more about insurance, please visit the Insurance section on this blog.

5. Determining allocation of your surplus among different assets for investment

Different assets classes like debt, equity, real estate, etc. grow at certain natural growth rates over the long term. You have to work out an investment strategy to invest the saving across various asset classes in a suitable ratio so that you meet the targeted return as per the financial plan. If a higher return is needed then accordingly a higher exposure to higher growth assets like equities is needed. Discipline in maintaining the asset allocation is the key to achieving success in the long term.

A lot of individuals invest into an investment option without understanding its overall long term impact on their lives. Due to this reason they may find out that they are left with inadequate financial resources during their later years.

To read about the popular common investment options, please visit the different sections in this blog.

6. Monitoring and evaluating your investments and your financial plan

Financial planning does not end as soon as investments are made. It is a continuous process where regular monitoring and periodic evaluation is necessary to ensure that things are happening as per the plan. It is essential to ensure that planned contributions from your savings are happening towards your investments. In addition to this the returns being generated, the investments should be monitored and rebalancing of investments should be made as per the asset allocation strategy. Based on the above evaluation the financial plan should be fine tuned if necessary.