What are the basics of financial planning?
Financial planning is a systematic approach to your long term goals. You typically
begin your working life with a dream. You dream of buying a house, you dream of
taking your spouse on an exotic holiday, you dream of sending your children to the
best B-schools and you also dream of a quiet and calm retired life. But, dreams
will remain just dreams if they are not planned for and the monetary resources are
not provided for it. That is what financial planning is all about! Essentially,
financial planning entails 4 very important steps…
1. Lay out your long term and medium term goals:
This is the first step where you actually write down your long term goals and medium
term goals. The most important thing here is that you have to be specific. You cannot
have a generic goal to be happy or a goal to be contended. All goals must be reduced
to financial terms. You must lay out how much money you will require to live peacefully
post retirement, how much money will be required to send your children to B-schools
and how much money will be required to pay the margin money for your home loan.
When you are projecting deep into the future, you need to factor in inflation and
the increase in the cost of these services over a period of time.
2. Creating a mix of equity and debt in your financial plan:
Once you are clear on how much money is required at what point of time, the next
step is to work backwards and start investing. You will need to combine equity and
debt. Equity can create more wealth over a period of time, while debt gives you
stability and regular returns. Your long term goals must have a larger equity component
while your medium term goals must have a larger debt component. SIPs work the best
as they put power of compounding in your favour! This investment mix must be structured
considering four factors viz. your return requirements, your risk appetite, your
liquidity needs and your tax status. Remember, that all these keep changing over
3. Don’t forget to impute insurance into your financial plan:
A financial plan will be incomplete (at times it can become meaningless) without
a proper insurance plan. If you are the principal earning member, then your life
should be adequately insured. Prefer term plans as they can offer higher cover at
lower premiums. Ensure that you and your family members have proper and adequate
health cover. You do not want medical emergencies to disrupt your financial plan.
Lastly, ensure that your liabilities like home loan and even personal loans and
car loans are covered by proportionate term covers. This will give added security
to your family!
4. Critically and periodically review your financial plan:
Your task does not end with just creating a financial plan. The bigger challenge
is to periodically review and monitor your plan. There are a lot of questions here.
Are you adequately insured with your changing risk profile? Are you over-invested
in equities at a time when market valuations are quite steep? Are you under-invested
in debt at a time when the RBI looks poised to cut rates aggressively? Are the funds
I am invested in, outperforming or underperforming the peers? Financial planning
begins with outlining your goals and ends with periodic review. The underlying theme
of financial planning is the monetary implication of all your actions.