Financial Planning for Beginners
1.1 What is financial planning?
Financial Planning is the process of meeting your life dreams/goals through the proper management of your finance. It includes estimation of financial needs of an individual and designing a comprehensive plan to meet those financial needs through proper investments. The financial goals can range from buying a new car, a dream house, education of children, getting your children married in style, meeting emergency situations like illness, accidents or natural calamities to simply retiring early to Live Life King Size.
1.2 Why financial planning?
Everyone aspires to have a sound financial life. The real life goals are inseperable from financial goals. Planning finances thus becomes mandatory.
1.3 Step-by-Step guide to effective financial planning.
1. Identify Current Financial Position:
Before planning for future we should understand our present properly. We must determine our current financial status. We should honestly determine our incomes, expenses, assets and liabilities/debts. Preparing a list of current asset and debt balances and amounts spent for various items gives us clarity in regard to state of our finances. This will give us our Net Worth.
Assets – Liabilities = Net Worth
The Net Worth tells us our ability to meet financial goals.
2. Set Financial Goals
The financial goals can be varied based on factors like age, income, preferences etc. of the investor. Their can be many financial goals to be achieved simultaneously like buying a car, making provision for emergencies or building a retirement corpus. They can also be short term, medium term or long term.
Specific financial goals are very important to financial planning. A good financial goal needs to be SMART i.e. Specific- Measurable- Achievable- Realistic – Time-Bound.
3. Explore various investment avenues
Once the goals are clear, we need to identify the alternatives, for investing money, available in the market. The investment avenues available for an investor are fixed income securities, equity investments, mutual funds, pension plans, insurance plans etc. Each of these investment options has it’s own risk-return ratio. These investment options can be highly secured (Bank deposits, Fixed Deposits, Postal savings schemes etc.), moderately secured (Debentures, bonds etc.) or unsecured (Shares, Mutual funds etc.). Further they will achieve investment goals, insurance goals or retirement goals (Pension funds, NPS, real estate etc.). The tax provisions regarding returns gained from investments in different financial instruments should not be ignored; instead the returns should be adjusted accordingly.
4. Evaluate alternatives
This is the most crucial step in financial planning. Here we need to balance between our financial goals, risk appetite, the time line to be achieved and what is offered by the investment avenue. The evaluation of alternatives should be based on three important pillars viz; Safety, Liquidity and Return.
For instance when planning for daughters marriage right at the time of birth there is ample of time and scope for investing in long term investment options. Risk prone instruments like equities which will fetch extravagant returns over a longer period of time can also be opted to achieve this goal.
5. Design Financial Plan
It’s time now to define a concrete financial plan that will help achieve the set financial goals. For every financial goal we will need suitable investment option. Here decision pertaining to the mix of financial avenues or financial instruments will be made. Uncertainty, risk and return will be the deciding factors of the soundness of financial plan. Diversification can help us reduce risk by allocating our money within different financial instruments across varied risk-return proportions.
6. Review and Revise
Though the financial plan is made with utmost care, market situations can have a deep impact on it’s performance. Hence it is necessary to review the finances periodically. One must monitor the investments made and keep oneself updated about various market happenings. This will help in taking corrective action by revising the financial plan.