What is Financial Planning? Financial planning is the roadmap to realise and achieve financial goals in life. Everyone has financial goals in life. These goals may include: • Planning for children’s education • Planning for children’s marriage • Buying a house or buying a second larger house • Buying a car • Enjoying a vacation with family every year • Living a comfortable retirement life without any compromises • Leaving behind an estate for children Through proper financial planning a person can accomplish all the above goals. Given this it is so scary to know how less people know about money. As they say “Being wealthy is not about how much you earn or what you do. It is just a matter of proper Financial Planning”. Financial planning can help a person identify his / her goals, invest towards achieving those goals and regularly review the investments every year to make sure they are on track to meet the desired goals. In short financial planning is a journey and not a destination. Financial Planning Stepping Stones The process of financial planning is divided into seven steps. Let us try to understand the process of financial planning with the help of an example. Amit is an MBA working for a MNC and is reasonably well placed. Amit is married, has a 7 year old son Karan. Amit stays with his parents. Amit’s parents are retired and are dependent on Amit. Amit now wants to buy a new home and start saving money for his child’s education and marriage and his own retirement. He would also like to go on a short vacation once every year. Let us see how financial planning can help Amit realize his goals with a high degree of certainty. The first step to financial planning is to assess the strengths and the risks involved. Strengths: Amit is (30 years of age). That means a 30 year investment horizon till retirement. Amit has regular income @ 8 Lakhs per annum Amit is debt free and has no financial liabilities. Risks Involved: Amit is sole bread earner of the family. Amit’s parents are old and hence more susceptible to health issues. Now keeping Amit’s example in mind let us see how the process of financial planning works.
1. Emergency / Reserve Fund This is the first step of financial planning. Amit should have a reserve fund equivalent to meet his 3 to 6 months expenses. A reverse fund is needed for the purpose of covering unforeseeable expenses like medical emergencies or temporary job loss etc. With an adequate reserve fund Amit will not be required to dip into his investments in times of crisis. 2. Insurance Life is full of uncertainties and so it is imperative that one has adequate insurance cover to help mitigate the risks that might arise due these uncertainties. A term insurance plan for Amit would ensure that the family’s survival is not at stake in Amit’s absence. Amit’s insurance cover should be equivalent to the present value of his future earnings till his retirement. Also Amit should buy a good health insurance policy for the entire family to take care of any expenses that might arise due to medical emergencies. Amit’s parents are dependent on Amit. If his parents get hospitalised due to some critical illness the huge hospital bill can burn a big hole in Amit’s pocket. 3. Child Education Fund Amit wants his son Karan to become a doctor. Amit wants to start saving for his son’s education from now onwards. If the cost of the course as on today is Rs. 10 lakhs then the same course will cost Rs. 41,77,248 (Rs. 42 lakhs approximately) 15 years down the line if the cost of education increases by 10% (inflation) every year. If Amit wants to reach this target of Rs. 42 lakhs 15 years down the line then he will have to start investing Rs. 9300 per month (Rs. 1,12,000 per annum) if his investments earn him a return of 12% per annum. 4. Child Marriage Fund Amit wants to start saving for his son’s marriage from now onwards. The marriage is planned 18 years from now. If the cost of an normal wedding as on today is Rs. 6,00,000 then the same marriage will cost Rs. 33,36,000 (33.36 lakhs) 18 years down the line if marriage expenses increase by 10% (inflation) every year. If Amit wants to reach this target of Rs. 33.36 lakhs 18 years from now then he will have to start investing Rs. 5000 per month (Rs. 60,000 per annum) if his investments earn him a return of 12% per annum. 5. Buying a House Amit wants to buy a house worth 25 lakhs 3 years from now. For this he will have to make a down payment of Rs. 5 lakhs (20% margin money). He will have to start setting aside Rs. 13,000 every month in a recurring deposit account. 6. Annual Vacation Amit wants to go for an annual vacation every year. This will cost him anywhere in the range of Rs. 25,000 to Rs. 40,000. Amit can make provision for this from his monthly cash flows. He can
set aside Rs. 3,500 from his monthly salary in a recurring deposit account and withdraw the money at the end of the year and go for a vacation at the end of the year. 7. Retirement Planning With advancement in medicine and technology the life expectancy of individuals is on the rise, this means more number of years of retirement. Therefore in order to reduce dependency on others; individuals must start working early on building their retirement corpus. Amit wants to live a comfortable retirement life. So he wants to start investing for it from today itself. Based on his current monthly expenses Amit can calculate his retirement expenses assuming an average inflation rate of 5%. And accordingly Amit can start investing from today onwards to build his retirement nest. 8. Asset Allocation Amit needs to invest for various goals like Karan’s education and marriage, his own retirement. Amit can invest in a mix of asset classes like equity mutual funds, fixed income securities, commodities etc. to meet these goals. Initially Amit can have a higher exposure to equity mutual funds. As his age goes on increasing he can change his asset allocation and go on gradually reducing the equity exposure and go on gradually increasing the fixed income securities exposure. 9. Tax Planning Amit should make sure that while choosing his investment instruments he gets maximum income tax benefits. Under various Sections of the Income Tax Act (like Section 80C, 80D, 80E, Section 24) an individual can avail deduction from taxable income. Conclusion In this way with Amit’s example we have seen how proper financial planning can help a person plan for all his financial goals and start investing towards achieving these goals. Also financial planning is not a one time process. It is an ongoing activity wherein the investments need to be reviewed year after year till the targets are not achieved. Also above we have mentioned the Financial Planning is a journey and not a destination.
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Thanks and Regards, Kirang Gandhi Corporate Financial Planner www.kgandhi.anindia.com M-9271267305,9028142155