Are you tired of living from paycheck to paycheck? Do you shop impulsively? Do you have any control over your expenses? Do you struggle with reaching your financial goals? If it’s you then you need to adopt few habits. Learn the need of personal finance, so you don’t go bankrupt. Before you declare yourself broke and bankrupt, read this blog and make necessary changes in your life.
Important key points:
- Financial planning enables better management of the personal financial situation of a household or individual
- Understand what incomes, expenses, assets & liabilities are.
- How much income you need in future to sustain the life
- Know What investment products are good for you according to your risk appetite
- Save & invest.
- Be consistent
Financial planning refers to the process of streamlining the income, expenses, assets and liabilities of the household or individual to take care of both current and future needs for funds. Financial planning aims at ensuring that a household or individual has adequate income or resources to meet current and future expenses and needs. The regular income for a household or individual may come from sources such as profession, salary, business or even investments. The regular income provides for normal activities and regular expenses of the household.
Analyzing current situation
However, what are the expenses you can pay rom available income?. The current income must also provide for a time when there will be no or low income, such as in the retirement period. You can’t possibly think of expected expenses, such as a large medical expense, or there may be needs in the future that require a largesum of money, such as education of children or buying a home, all of which require adequate funds available at the right time.
We need to save a portion of the current income and create assets that will meet these funds. Rajesh is 35 years old and earns Rs.1 lakhs a month. He is able to save about Rs 30,000 a month after meeting all the routine expenses of his family, paying the loans for his house, car and other needs. His investments include those for tax savings, bank deposits, bonds and some mutual funds. He pays premiums on life insurance for himself and his wife.
How would financial planning help him?
Rajesh is 35 years old and earns Rs.1 lakhs a month. He is able to save about Rs 30,000 a month after meeting all the routine expenses of his family, paying the loans for his house, car and other needs. His investments include those for tax savings, bank deposits, bonds and some mutual funds. He pays premiums on life insurance for himself and his wife.
Rajesh is the sole earning member of his family. He believes he takes care of his finances adequately to take care of his current and future needs. How would financial planning help him?
The following are a set of indicative issues that financial planning will help Rajesh resolve:
a)As the sole earning member is he making plan for expenses by creating an emergency fund if his current income might be off for any reason?
b) Does he have adequate insurance cover which will take care of his family’s requirements in the event of his untimely demise?
c) Does the family have adequate health insurance cover so that any medical emergency does not use up all the accumulated savings?
d) What are his specific future expenses and how will he fund them?
e) If Rajesh has to create a corpus to fund large expenses in the future, what is the size of the investment corpus he should build?
f) Given his current income and expenses is he saving enough to create the corpus required?
g) Will he have to cut back on his current expense or can he increase his current income so that his expenses in the present and the savings for the future are met?
h) What is the wealth Rajesh has so far built from his savings and how can he best use it to meet his needs?
i) How should he deploy his savings?
j) How much of risk is Rajesh willing and able to take with his investments? How can he manage those risks?
k) How should Rajesh ensure that his savings and investments are directed o changes in his income, expenses, future needs?
A formal treatment of the issues that Rajesh faces will require a financial planning process to assess the current situation;
Identify the current and future needs
Determine the savings required to meet those needs and put the savings to work so that the required funds are available to meet each need as planned. It works primarily through the identification of key goals and putting in place an action plan to realign the finances to meet those goals. It is a holistic approach that considers the existing financial position, evaluates the future needs, puts a process to fund the needs and reviews the progress.Formal treatment of the issues that Rajesh faces will require a financial planning process to assess the current situation.
Understand the need for financial planning
There is a large range of financial products and services that are available for investors today and the client should understand their needs to match specific investment products. Not every product may be suitable to every client; nor would a client be able to identify how to choose and use products and services from the choices that are available in the market.
Financial planning bridges this gap as the Investment Adviser possesses the expertise to understand the dynamics of the products on the one hand and the needs of the client on the other. This makes them best suited to use such products and services in the interest of the client.The Financial Planner has a significant role to play when it comes to advising clients because the needs of each person is different front that of the other.
a) The financial planner has to recognise the exact needs and goals of an individual and a household or family and then make efforts to ensure that the client achieve the desired goal.
b) Personal financial management requires time and attention to recognize income and expense patterns, estimates of future goals, management of assets and liabilities, and review of the finances.
c) Individuals do not have time to undertake all these detailed financial activities in a busy world and they need someone like a financial planner to focus on this area and help them in their efforts.
d) It is not easy to set financial goals and this requires specific expertise and skill which may not be present with most individuals.
e) Every financial goals requires finding a suitable product and a proper asset allocation to different asset classes,which is where the financial planner steps in.
f) Selecting the right investment products, choosing the right service providers and managers, selecting insurance products, evaluating borrowing options and such other financial decisions may require extensive research. A financial planner has capabilities to compare, evaluate and analyse various products which enables making efficient choices from competing products.
g) Asset allocation is a technical approach to managing money that requires evaluating asset classes and products for their risk and return features, aligning them to the investor’s financial goals, monitoring the current and expected performance of asset classes and modifying the weights to each asset in the investor’s portfolio periodically to reflect this. Financial planners with technical expertise enable professional management of assets.
h) Financial planning is a dynamic process that requires attention to the constantly changing market and product performances and matching these with the dynamic changes in the needs and status of the client. This kind of attention can be provided by a financial planner.
How is financial planning different from a typical financial advisory services? Financial planning requires following of a specific process wherein the client along with their overall needs and goals are at the core of everything. Other financial advisory services would normally look at meeting just a specific need like advising on stocks or debt but the relation with other aspects might be missing.
Financial planning effort is a comprehensive process as it covers all aspects of a client’s personal financial requirements including retirement, insurance, investment, estate and others. A typical financial advisory service is more likely to look at just a small part of the total financial requirements. Goal setting becomes the central part of the financial planning process and all efforts are then directed towards meeting the goals. Overall goals might not be given too much importance in a normal financial advisory activity, where some specific target is sought to be achieved.
Financial planning looks to ensure that all the financial activities are not at cross purposes with each other. As against this, a typical financial advisory service might not even realise that some steps suggested would be working against some other goal or requirement. For example, financial planning would ensure that the asset allocation for an older individual meets their risk taking ability and that their equity exposure across asset classes is kept in check. This might not happen when normal advise is taken just for say equity mutual funds investment without knowing the equity exposure elsewhere.
Monitoring the situation and then taking action to ensure that things remain on track is a key part of the financial planning process. It is inbuilt to the entire effort, so this becomes a natural part of the activity. This might not happen with respect to a normal financial advisory where the individual might have to take the initiative themselves and see that things are going according to plan.
Financial planning looks to select what is right for an individual and this would differ from person to person. This takes into account both the returns as well as the risk which is vital. This might not happen for a normal financial advise, where the goal might be completely different like earning higher return and where risk might be ignored. There has to be continuity in financial planning efforts which sets it apart from other financial advisory wherein this could be a short one time exercise or even piecemeal efforts at different periods of time.
Goal setting with prioritizing of goals
The financial planning process starts with the goal setting process. Goals refer to what has to be achieved. This gives a clear target that has to be reached. There are several features that are important when the goals are set. There should be some specific detail with respect to the goal. For example, saying that I want to be rich is a vague term because it can mean different things to different people. Saying that I want to earn an income of Rs. 50 lakh a year is specific.
The goals have to be measurable, so that a person knows the exact amount that will help them reach the goal. At the same time the goals have to be realistic. If an individual is able to save around Rs 20,000 a month, then a goal which requires an investment of Rs 50,000 a month is not realistic. Finally, goals also have to be time bound so the individual has a clear idea of when they need to be reached. A goal of wanting to retire in 20 years with Rs 5 crore as corpus is clear because there is a time period attached to it which will help in planning to reach the goal.
Right approach
Once all these features are considered in the goal setting process there will be a list of goals that will be available. However, every individual has restrictions in terms of the income earned and amount saved. This will require that the goals be ranked in order of priority. Important goals need to be put first. So, things like children’s education and retirement should come in front of something like spending on a luxury car or other expense that does not create an asset. It is easy to look at short term needs but this can come at the cost of long term disruption of the goals. This is why there has to be priority to goals that improve the financial health of the individual. For example, there might be a large credit card outstanding and some extra income is earned by the individual. In such a situation, instead of spending the amount, it should be used to pay off the credit card debt.
This might not add to an asset but it still improves the financial condition of the individual.
Focus on important goals.
Goals such as retirement and education of children are important.Long-term goals such as retirement often get lower priority for allocation of savings because it has time on its side. The urgent, shorter-term goals often get higher claim on the available savings. While this may be acceptable for shorter-term goals that are also important, such as accumulating funds for down payment on a home, it may not be right to prioritize consumption goals, such as holidays and large purchases, over long-term important goals. The delay in saving for such goals will affect the final corpus, since it loses the longer saving and earning benefits including that of compounding.Clients often believe that the provident fund, superannuation and gratuity corpus they will receive on retirement will be adequate to ensure a comfortable living during the retirement years.
Conclusion
The sooner we take control of our finance the larger our retirement fund will be. You need to be conscious of the choices you make & don’t fall into trap of short term gratification. Always think for long term financial success. Thanks for reading.
Leave a Reply