Most of us don’t even have a basic financial plan in place. We typically have loose investments with some part of the salary going into recurring deposit while some of it is sitting in our bank and the rest going into the employer’s PPF. We think that this is more than enough for us, but the reality is very different. This random process is nowhere near to a financial plan! I have observed many people underestimating the money that is required in the future. Inflation reduces the value of our money, so we have to make sure that our cash grows 5-6 percent more than the inflation rate. Our returns must be about 12-14% in the long term as the inflation rate in India is around 5%. We are utterly stupid in believing that our jobs are going to be there for the whole life! What happens if we are sacked or due to some health issue we aren’t able to work? There are many possibilities which we don’t take into account. The only solution is to have a sound financial plan in place.
A basic financial plan should take care of three things:
- Provides cushion if we lose our income
- Helps us plan for our long term goals including but not limited to retirement
- Gives a sound sleep at night without any worries of losing money
A basic financial plan is nothing but which takes care of the above goals. Let us first see what are the things that are absolutely essential. The below things are must have in our plan:
Emergency Fund: An amount equal to one year of expenses saved in a very safe place like a liquid fund or an FD. This is not to be touched unless and until it is a grave emergency like losing a job, urgent health-related outgo or anything which affects the basic needs of our life. This is not to spend on luxuries but purely for our emergency.
I personally have one year of expenses distributed into cash and liquid funds.
Health Insurance: Have a health cover of a minimum of 15 lakhs for the whole family. A heart attack operation costs about 5-8 lakhs depending on the severity. There is no option to a health insurance cover.
I personally have health insurance coverage of 50 lakhs.
Term Insurance: It’s okay to delay getting term insurance unless we are married and have someone dependent on us. I have seen many people look for returns in term insurance but don’t make that mistake. Term insurance is a protection product where it’s okay not to get returns. If they are promising a payback or return rate, then it means that you are paying a lot of fees to the insurer. Term insurance should be as simple as if I die or become disabled then I should get x amount of money. Aim to have a cover of 45-60 times of your yearly expenses.
I personally don’t have term insurance because I do not have anyone dependent on me as of yet. I plan to get term insurance which covers 60x of my yearly expenses as soon as I get married.
Let me reiterate myself – the above three listed items are the most crucial to our financial plan. They render a cushion in the times of adversity helping us make rational decisions to wait for the right opportunity, provide a cash flow if we have health issues and give money to dependent family members if something life threatening happens to any of us.
The next part of planning is focused mostly on our immediate and long-term future. We all have many goals like buying a house, children’s education, overseas vacation, marriage, and many other personal wishes. They all have different timeframes – some are 20 years away while others are only a couple of years away. Our typical mindset is to not only not planning for goals but also we never take the necessary efforts to identify them. We make investments without any aim and so don’t have any plan in place. Before preparing for any of the financial goals the first step is to identify them, write on paper and the timeframe that we have before they materialize. This gives us an idea of the work that we need to plan ahead for achieving these financial goals on time.
Now there is no one simple financial plan for each one of us. Our needs are different, the goals vary, the income-spending pattern has enormous gaps, and there is a personal touch to everything. Another critical thing to consider is to track our expenses. This gives us an overview of how our costs are growing year on year and a slight glimpse into what we need to plan for our retirement. Reducing expenses is also a very crucial part of a sound financial plan. But I can assure that most of the long term goals would be achieved only through consistent investment in equities. List down your current assets, how much of that is in cash, gold or real estate and ULIPs, etc. Take a note of your liabilities, subtract it from assets and understand your personal net-worth. You need to then plan on how you can grow your networth over the next few years, get out of debt if there is any, etc.
In a basic financial plan if your goal is a minimum of five years away then start investing in an equity mutual fund for the next four years. After the fourth year, begin withdrawing your investment and move it to a liquid or debt fund. Similarly, any goal that is twenty years away invest in good equity mutual funds for seventeen years and then slowly move them into liquid funds or debt funds over the next three years.
Next, for any goal that is less than four years away, please don’t invest everything of the money for that goal in equities as we are never sure of what might happen to our cash in equity investments in the short term. I would suggest allocating 80% of the money in debt funds while the rest 20% can be in equity mutual funds. Keep the majority of the money required for short term goals strictly in fixed income instruments. We have to understand that in the short term the equity returns can be less than fixed instruments while in a long time if a good mutual fund is selected, then our returns are bound to be 5-6% higher than the long term inflation rate.
Whatever you do the most important thing is to identify our goals. If we don’t know what our needs are, then we would never be able to generate enough money for them in the future. Remember the famous quote – Failing to plan is planning to fail.