Creating a financial plan could be daunting. It involves several moving parts like income & expense details, future goals, current cash flows etc. However, it is very important to have a financial plan in place to ensure you achieve your goals in a smooth manner.
A financial plan is a comprehensive strategy that helps individuals or families achieve their financial goals. It typically includes an assessment of the current financial situation, identification of financial objectives, and development of a roadmap to achieve those objectives.
Financial plan covers several areas, including cash flow planning, retirement planning, tax planning, risk management, and estate planning. It considers an individual's current financial situation and provides recommendations on how to allocate resources to achieve long-term financial success. Since it involves a lot of factors, financial planning is a recurring exercise & one needs to keep the plan updated per the situation or life stage.
In this article, we are going to discuss important factors to be considered while creating a financial plan for yourself and your family.
- Identification of goals: It is important to make a list of goals that you are planning to achieve along with the time horizon to achieve them. Goals could be child education, retirement funds, buying a house etc. Having the goals in mind keeps you on track to achieve them without worrying about markets.
- Current financial situation: An assessment of current income, expenses, assets, and liabilities must be done to understand the inflows and outflows of an individual. Inflows can be in the form of salary, business income or income from investments. Expenses could be rent, household necessities, EMIs, school fees etc. All this information must be noted down in a single place & savings should be assessed to invest in for future goals.
- Assessment of risk appetite: It is very important to know the risk appetite of the investor before deciding the investment products. Equity oriented investment products are highly volatile but have the ability to deliver inflation beating returns. Fixed income products are less volatile, but it is difficult to generate higher returns in this category. It depends on the investor’s individual capability as to whether he/she can withstand the volatility in the short term.
- Investment horizon: Each and every goal must have a time horizon attached to it. This helps in the selection of the products in which one must invest to achieve the goals. Eg: If an investor wants to plan for buying a car in the next 3 years, then he/she must predominantly invest in debt mutual funds or other fixed income avenues where there is no risk of principal drawdown. However, if one is planning for a retirement goal which is 20 years away, higher allocation should be made towards equity-oriented instruments in order to generate higher returns over the long term.
- Tax impact: Returns generated on investments are taxable at different rates in different slabs. Further, gains on equities and debt are taxed differently and not at the same rate of tax. A financial plan must involve details regarding planning of taxes on the gains that will be generated from the investments. This could lead to significantly higher returns on investment in the form of paying lower taxes.
- Inflation: One must account for the impact of inflation while making a financial plan. Let us understand how inflation can impact a particular financial goal. Suppose you plan for your child’s education and the current education cost is Rs. 25,00,000. Your child is going to need this amount after 12 years. What would be the inflation adjusted amount required if inflation is assumed to be 6%? The future cost would be Rs. 50,30,491. Hence the investment must be planned keeping the future cost in mind and not the current cost due to inflation.
- Emergency funds: It is important to have a definite amount of money specifically kept aside to meet unforeseen events. This money should be sufficient to keep you afloat in case there is a job loss or other such event where the income suddenly stops. Emergency funds should be invested in highly secured and liquid instruments like fixed deposits or liquid mutual funds. One should keep in mind that these funds are to be used when there arises a situation of extreme emergency.
- Insurance: Adequate health & life insurance must be taken to protect yourself and family from unforeseen events like hospitalisation or medical emergency.
It is important to note that the job is not done after creating a financial plan. One must regularly monitor the progress & review the goals. Appropriate changes must be made to the plan to ensure it is in-line with the current scenario. Keep in mind that there is nothing like a perfect financial plan. One has to be conservative with the return expectations and aggressive with savings to ensure the goals are achieved in a smooth manner.
Rohit Gyanchandani is Managing Director at Nandi Nivesh Private Limited
