Planning is the foundation of any project, program, function or any activity. A poor planning can turn out to be catastrophic, specially when it comes to finances. We all take our money seriously. But the question is, do we actually plan what we have to do with it? One thing that is common with all of us is that we want to invest our money judiciously and, only in those products, where there are low risk and high return. The question still remains the same, do we actually do that? Are we able to select such products?
Financial planning has taken a major role in our lives. Gone are those days where the approach of a common man was to spend first and then save, if something is left. But these days there has been a shift in the approach. Now, our priority is saving and then spending what is left. But why has this shift taken place? What is the role of financial planning in our lives? Let’s have an in-depth analysis of the same.
It is a systematic approach, in which, goals are set for any specific event or purpose or contingencies and funds are apportioned from the inflows towards the same. We identify various financial goals and consider the amount of inflow of funds which we can apportion in instruments which will help us in achieving the desired goals. It is not a science but an art. It is a never-ending process as new financial goals keep on arising or existing goals keep on shifting or changing.
Financial goals are the final result or the target which we want to achieve. A proper planning will lead to smooth course of action, which in turn will result in achieving our goals at the desired time. Both financial planning and setting financial goals should go hand in hand. While carrying out the process of financial planning we should take into account various factors like, time, income, expenses, return etc.
1.) Managing Income: with proper financial planning we can effectively manage our income. First of all, we need to identify all the sources of income. On the basis of that we can estimate the total amount that can be disposed towards monthly expenditure, taxes, investments. Managing fund inflow is very important so that at the end of the month or in case of emergency we do not face cash crunch.
2.) Building capital: be it a business or an individual, everyone needs capital. If there is any huge expense, then capital will help us in discharging it. With proper financial planning we can increase our capital over the period of time. For an individual, capital increases when his inflows are more than his outflows, which include monthly expenditure, investments, taxes etc.
3.) Security: with proper financial planning, we can provide financial security to our family. Having sufficient insurance coverage and sufficient investments can provide a reasonable level of peace of mind to us. But at the same time if we invest our funds in those instruments which gives return lower than the inflation, then that investment will be of no you in the long run as inflation will eat up all the return.
4.) Standard of living: we all want to keep a pace with time and improve or maintain our standard of living. Buying a car, living in our own home, better education of children, all these are possible by proper financial planning. An effective financial plan helps us in achieving our goals and also helps us in improving the standard of living. Financial planning is not only required for improving our standard of living but it is also required for maintaining our standard of living.
5.) Balance of assets and liabilities: a house is not the only asset we can possess. Investing in a plot of land which we can sell after few years when its price appreciates, investing in gold etc. In simple words, we want to own assets so that we can sell them after a period of time, when the price increases. But one thing that goes unnoticed is that we also increase our liabilities with that. Like when we buy a plot of land, most of the time it happens that we take a loan for buying it. Loan is a liability and buying any asset from a loan is not a good idea as interest cost will eat up most of the capital appreciation. Same way most of the people buy a house on loan so that they can let out the house property and get monthly rent as income. But as we all know that a housing loan is a long-term loan and can extend from 15 years to 30 years. The rental income generated will be disposed off for payment of the EMI of the house.
6.) Saving: it is often seen that there are some expenses which occur unexpectedly. We are not ready for them, or even if we are ready for them, we cannot cover them fully. We always focus on the expenses which are certain to be incurred, like child education, marriage, buying a house. But what we fail to take into account is there are some expenses which are to be incurred and we cannot predict them. With proper financial planning we can also make a provision to meet those expenses so that during tough times we are well prepared for them.
1.) Poor planning: many people either have no set of financial goals or have unachievable financial goals. While planning they do not consider their income and expenses. It is also seen that people invest in financial products without any plan. They do not know what they will do with the money which they will receive after the investment matures.
2.) Difference in opinions: financial planning is done not just for an individual but it is done for the entire family or the dependents. But while planning there are differences in the opinions of the partners. It is after all they, who decide what is best for the family. There are times when they differ in the opinions and such differences are never solved by talking and the financial decisions are taken without informing the partner. Leaving your partner outside the financial decisions can turnout to be disaster in case of any casualty and the partner does not know about the investment.
3.) No expert consultancy/advice: financial planners are professionals. They are qualified to give you consultancy on financial matters and plan your finances. For that they charge you a fee. Just like a doctor, lawyer, chartered accountant, who charge you fees for their services, a professionally qualified financial planner charges you a fee for their services. But it is often seen that just to save that amount of fee, people try to plan their finances themselves. People surf the internet and ask their friends and family members about investing in different products, and even they have no clue what is financial planning. This vicious circle of advice continues without anyone knowing the process in and out. Due to this mistake people end up taking a poor financial decision.
4.) Not taking negative events into consideration: life coaches, motivational speakers pitch the idea of positive thinking and this is good. Positive thoughts attract good things happening to us. But life does not go that way. There are chances of unfortunate events or casualties. Most people do not plan for such events or if they plan, they underestimate the financial requirements. This thing makes a huge impact on the person and his dependents.
5.) Procrastination: financial planning is not a one-time thing. It is a continuous process. And the benefits of the same can be reaped if we start early. But it is a common habit of people to delay their financial plans. Instead of starting it as soon as possible, they find out excuses to delay the same. The earlier you start, the better chances of success.
Steps in Financial Planning
These days we hear a lot about planning our finances and setting financial goals. But when it comes to start the same, we get confused as to from where should we start or how to start. There are ‘n’ number of goals which we want to achieve, and there are a vast number of instruments to select. Even if we are successful to identify the goals, we will still face difficulty in selecting the instruments to achieve such goals. Moreover, the funds are limited, so it becomes important for us to prioritize our goals.
Financial planning is a continuous process. We can follow a series of steps to accomplish the same. With every new goal that we set; we can go through these steps. These steps involve:
1.) Understanding our financial position: We should be well aware of our financial position. This includes having an estimated idea about our monthly free cash flows, estimated monthly expenditure i.e. expenses towards necessities, outings, recurring expenses. Based on these factors we can estimate our savings. For example, suppose Mr. A is 30 years old, has a monthly salary of Rs. 50,000 per month. His monthly expenses are Rs. 30,000. His net savings are Rs. 20,000. If he wants to buy a car whose EMI is Rs. 15,000, then he can buy the car as he has disposable income which he can allocate for the car. But on the other hand, if he wants to buy a house whose EMI is Rs. 25,000 then he cannot think of buying a house as he will fall short of funds for the EMI.
2.) Setting a financial goal: financial goals should be realistic and achievable. We should not set such goals which are doomed to fail since its commencement. We can divide financial goals into three categories:
a) Short term goals: This includes expenditure which we will be incurring in the near future, say within 1 year. This can be buying a two-wheeler vehicle, furniture, gadgets, trips etc.
b) Medium term goals: This includes expenditure which we will be incurring from a span of 1 to 3 years. This can be buying a four-wheeler vehicle, shifting to a better house, admission of child etc.
c) Long term goal: This includes expenditure which we will be incurring in a far future but which are certain to be incurred. This includes buying a house, higher education of child, marriage of child.
3.) Finding best options/instruments: Now that we have a proper understanding of our financial position and have set our financial goals, we begin with exploring various options/instruments which will help us in achieving the set goals. These instruments can be investing in mutual funds, recurring deposits, fixed deposits, investing in equities. Different instruments work in different ways. Some will give good returns in long run and thus are fit for long term goals while some will give good return in short and medium term.
4.) Analyzing the options/instruments: After we have selected the best option/instrument, we should analyze them. We shall consider factors such as, time period to attain our financial goal, our risk appetite, returns given by shortlisted option/instrument. Investing in mutual funds and stocks in long run can give us good return, so if there are any long-term goals we can plan to invest in mutual funds or stocks. But in short run, like up to 1 year or 3 years, there can be chances when the stock or mutual funds may not give you high returns or may give you negative returns. But instruments like fixed deposit or recurring deposit will give you guaranteed return in short run.
5.) Investing in the selected option/instrument: After we have decided the option/instrument we should start investing in the said option/instrument. We should also track the instruments on regular intervals and their performances. If we are unsatisfied with the desired performance of the instrument and we find any other instrument which can give us the desired result, then we can shift it to that instrument.
6.) Repeating the process: As mentioned earlier, financial planning is a never-ending process. Ones we have decided our goals and achieved them, we should look for other goal(s) or if any other goal is to be achieved along with the ongoing goal(s).