Financial Planning Awareness

Financial planning is the process of defining different financial goals, quantifying these goals factoring in inflation and having an investment plan to meet these goals. Financial planning also prepares you for unexpected risks e.g. untimely death, serious illnesses, sudden loss of employment etc.

The importance of financial planning helps investors achieve their financial goals e.g. home purchase, children’s higher education, children’s marriage, retirement planning, estate planning etc. and long term financial security.

Elements of financial plan

To explain the importance of financial planning, we will discuss the seven steps involved in financial planning. We will describe in brief what these steps are: -

• Defining and setting goals: This involves defining your financial goals, timelines by which you want to achieve these goals and quantifying the goals factoring in inflation.
• Expense budgeting: You need to save money to invest for your financial goals. Expense budgeting determines how much you can spend, which expenses you can reduce in order to save more.
• Assessing your risk appetite: In this step, your financial advisor will assess your risk appetite based on your age, income, expenses and financial liabilities (e.g. loans). Your advisor may also assess your risk tolerance, which is personality based and how you react to adverse events.
• Asset allocation: This refers to the mix of different asset classes e.g. equity, fixed income, gold etc. in your investment portfolio. Asset allocation is essential for risk diversification and achieving your financial goals. Your asset allocation will depend on your goals and risk appetite.
• Investment plan: Investment plan is essentially knowing how much to invest and where to invest. Systematic Investment Plans (SIPs) are usually recommended for your long-term financial goals. Your investment plan may have a mix of equity, debt and hybrid funds depending on your asset allocation requirements.
• Risk protection plan: An unfortunate death, critical illness or serious accident can cause financial distress to your family. Risk protection is an important element of your financial plan. You need to have adequate amount of life and health insurance cover.
• Monitoring and tracking: You need to track progress of your financial plan towards different goals and take actions if required. Over a period of time, your goals may also change and you may have to make changes to your financial plan accordingly.

Why financial planning is important

Many investors do not understand the significance of financial planning and think that if they are able to save money, they will have financial security. But saving is not enough. Let us assume average life span of 75 – 80 years.

Your needs for the first 20 – 25 years of your life are taken care of by your parents. Your working life will typically be about 35 years long during which you will have to take care of the needs of your family (e.g. spouse, children, dependent parents etc.) and also save enough, to take care of your needs during the 15 to 20 years of your retired lives.

Inflation reduces the purchasing power of money in the long term and therefore, your money needs to grow at a faster rate than inflation if you want to achieve your financial goals. Certain expenses like education, medical etc. are inflating at a much faster rate than CPI inflation.

You need to plan for it. Also, with rising incomes lifestyle changes, which means more expenses. It is not easy to change your lifestyle once you get habituated to it.

You need that much more savings, if you want to achieve financial independence and also maintain your lifestyle. Given these challenges, you should know the importance of financial planning and know how much to save and invest, know where to invest and most importantly, start saving and investing from an early stage of your working life, in order to meet all your aspirations.