GET THAT FINANCIAL PLAN, NOW
Doing so helps you clearly identify goals and work to a plan of getting there in your earning years
Most people tend to have a random approach toward personal finance. They either invest whatever is left after spending rather than the other way round. Or they invest in multiple instruments rather than in a product suited to their needs. As a result, they are unable to meet their life goals. Financial planning gives you a bird’s eye view of your future goals, helps you pace your financial journey and enables you to achieve your goals optimally and efficiently. However, while investing is an important aspect of financial planning, a financial plan is much more than just investing. To embark on this journey, you need to do the following:
KNOW YOUR FINANCIAL POSITION
Drawing up a budget is the first step toward financial planning as it gives you a clear idea of your financial position. To make a budget, list your income from all sources, be it salary, rent or interest. Then list all your expenses, including payments of insurance premiums and school fees, which may differ in periodicity, but have to be divided monthly to be added to the expenses for a month. At the end of the exercise, you will find yourself with an investible surplus. You’ll also be able to identify the months you may face a cash flow problem in for which you can prepare in advance. Your expenses also need to be listed under different heads, so that you can delineate discretionary expenses and cut down on them if you need more money to meet your life goals. “If this exercise is not done, then the plan might trigger budget gaps. Pre-planning a budget can help you avoid the need to re-plan,” says Jeevan Kumar, head of investment advisory at Geojit Financial Services.
COVER YOUR RISKS
Providing for exigencies, such as a job loss or medical emergencies, is an important part of financial planning. It saves you from digging into your savings or borrowing unnecessarily.
To prepare for unforeseen events, the first thing you should do is set up a contingency fund, a corpus that can take care of 3-6 months of expenses. You can put this money in a liquid fund as it gives better returns than money in a savings bank account. Alternatively, you can go for a short-term
fixed deposit with instant redemption facility (of Rs 50,000 or 90 per cent of investment value, whichever is lower). Over the medium term (more than three years), they also have a tax advantage over bank FDs as long-term gains are eligible for indexation and hence reduces tax outgo; interest on bank FDs, conversely, is taxed according to your tax slab.
Next, you need to have a medical cover for yourself and your family. The amount of cover can vary with factors such as the health condition of family members, city of residence, life status, nature of job, affordability etc. As a
rule of thumb, you should have a health cover 10 times your monthly income, going up to 20 times. Family floaters are better, cheaper options than individual health policies for family members. You can also go for top-up plans.
Then, you need to have adequate life cover. Buying just any life insurance is not enough. The ideal insurance cover should be at least 10 times your gross annual income. Or you can have an income plus expense approach. “The life cover should be sufficient to cover current household and lifestyle expenses, EMIs, SIPs, premiums, present value of future goals so that all those can continue in case of an unfortunate event,” says Tarun Birani, founder & CEO of the SEBI-registered TBNG Capital Advisors. Pure term plans are the best and cheapest as they give high life cover at less cost.
ASSIGN A MONETARY VALUE TO YOUR GOALS
It is very important that you assign monetary values to your goals to ascertain how much you need to save. Also factor in inflation—you need to calculate the compounded value of the goal at the rate of inflation on the required date. “One needs to be cautious while using inf lation numbers, since over longer periods, even a small gap can result in wide corpus spreads,” says Kumar. One can also have different portfolios for different goals. “If different goals fall at different points of time and if this interval is too wide, separate investments should be made.” A Rule of 72 can help you decide the goal amount. Divide 72 by the expected rate of inflation (say, 6 per cent), and you get the years (in this case, 12) it will take for prices to double.
DETERMINE YOUR RISK APPETITE
Risk appetite helps you decide the debt-equity ratio. To calculate your risk appetite for equity, the thumb rule to follow is: 100 minus your age. So if you are 30 years old, 70 per cent of your portfolio should be in equity. Debt includes options such as bank FDs, small saving schemes and debt mutual funds. Exposure to equity can be achieved either through direct investments in stocks or equity mutual funds depending on one’s risk appetite and knowledge of markets. For short-term goals, it is not advisable to invest in relatively volatile assets such as equities. However, for long-term goals such as retirement, one can have higher exposure to equities, as they fetch higher returns in the long run.
“For short-term goals, due in 2-3 years’ time, you cannot take much risk by investing in equities, since equity markets are very volatile for short duration investments, and must stick to debt or fixed deposit-like safer instruments, which are less volatile and protect your capital as well,” says Birani. Even for long-term goals such as retirement, one can’t rule out debt entirely. More equity can make a portfolio too risky while a debt-heavy one gives lower returns. You need a right mix of the two.
ASKING RATE ON INVESTMENTS
Depending on your debt-equity ratio, you can work out an expected rate of return on investments. The more your exposure to equity, the higher your likely rate of return. With the value of goals, the tenure and the expected rate of return on investments, you can calculate how much you need to invest monthly, an amount that should be revised with rise in income. If you can’t invest the required amount, revisit your budget and pare down discretionary expenses. Else, you need to make your goals more realistic.
TAX SAVINGS
Tax saving is not a standalone activity and should be aligned with one’s overall goals. Most people invest in tax-saving mutual funds or endowment plans and think they’re done with tax saving. “If you plan your investments in a structured way, your investments can help you avail deductions in your taxable income,” says Birani. Choosing the right instrument is crucial. One should consider factors such as lockin period, tax on maturity, etc., apart from returns. Term and health insurance premiums help save tax, as do ELSS and ULIPs, while allowing you to invest in equity. Investments in fiveyear FDs and PPF do the same for the medium and long term, respectively.