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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 time.

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.