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The Need To Be Your Own Financial Planner Today   Feb 07, 2017


For a layman, the subject of finance is complicated and boring. To master it seems an uphill task! Although there is plenty of information freely available on the internet, it can be confusing. To make matters worse, there are views, articles, and strategies that stand contrary to each other. If you follow the advice blindly, then your financial wellbeing may deteriorate. At the end, it is your hard earned money and no one, other than you, is obligated to protect and manage it.

Here are simple every day strategies you can immediately implement to keep your personal finances on track:

 
  • Start with a budget: Budgeting is the process of creating a balanced formula on how to optimally utilize your hard earned income. Simply put, a budget is an itemized summary of the anticipated income and expenses for a given period, say a month.  It will keep your expenses in check and keep you out of debt. It will also help you work your way out of debt, if you are in one. Although there are plenty of free budgeting software and apps available online, you could just start with a pen and paper or an MS-Excel sheet to get a hang of the exercise. Keep a contingency reserve: An essential component of a solid financial plan is its emergency fund (also called a contingency fund). Emergencies (such as loss of income, medical emergency, loss of assets, etc.) are contingent in nature and therefore, an intelligent approach would be to put away a portion of one's savings to counter these emergencies if/when they arise.

    Ideally, review your budget and save a minimum of 6 months of monthly living expenses in a contingency fund – that includes everything from household expenses, to EMI payments, or any other expenses you may incur during a regular month. On the higher side, 24 months of monthly expenses can be maintained by those with financial responsibilities and averse to risk, as well as those who require high amounts of liquidity. But on an average, 12 months of living expenses can be held as a contingency fund.
     
  • Purchase an adequate life and health insurance plan: This is the most neglected area of personal finance. People seem to understand its importance only when an untoward event happens. If you are the sole bread earner of your family or there are liabilities to be repaid, make sure you purchase an optimum life and health insurance plan.

    According to the 'Income Rule' used by insurance advisors, one should have a sum assured of 8 to 10 times of one's annual income. This thumb rule gives a good starting point for a bread-winner to know the amount one should be insured for in case of any unfortunate event.

    However, it is a prudent practice to consult a financial planner to calculate the amount of insurance required based on the "Human Life Value" principle, which takes into account the financial goals and the outstanding liabilities while calculating the amount of insurance required.

    From a health insurance perspective, purchase a policy with a minimum cover of Rs 5 lakh and covering all your family members.
     
  • Pay-off your credit card debt: It's a no brainer, retiring the highest-interest credit card debt first, regardless of size, helps consumers minimize the amount of interest they pay over time. Don't just honour the minimum payment highlighted in your credit card statement, it is advisable to repay the outstanding dues in full every time your credit card bill arrives and always spend within your means.

    Paying the minimum amount would only ensure that a penalty isn't levied, but this won't save you from the burgeoning interest cost. The moment you carry your dues forward to the next monthly cycle, you will be liable to pay interest on the unpaid amount along with taxes, which turns out to be quite expensive.
     
  • List down your financial goals: The objective of financial planning is to help you achieve your financial goals. Start by listing them down into short term (up to 2 years), medium term (from 2 to 5 years), and long term (above 5 years). We recommend using the S.M.A.R.T. technique to gain a clear and solid approach on achieving your financial goals.

    Once you do so, you should calculate the future value of these goals using an inflation rate. Ideally, a 7% inflation rate would be sufficient to derive the tentative figure. For financial goals maturing in 3 years, make sure to allocate the entire corpus to a debt fund. The equity exposure will go on increasing as the maturity period of the goal increases.
8 Tips to Keep Your Personal Finance On Track
 
  • Start planning for your retirement, NOW: By nature, Indians are 'savers'. The number one rule of saving money is 'pay yourself first'. It is a prudent practice to set aside a percentage of one's income towards savings before using the money for other things, including paying bills. The thumb rule is to save at least 10% of your income, towards your retirement.

    However, considering the rising cost of living, this isn't going to be enough. Take a look at the corpus built over a period of time based on the proportion saved, in the figure below:
 
Particulars Mr A Mr B Mr C
Monthly Income (Rs) 30,000 50,000 1,00,000
Percentage Saved 75% 35% 10%
Amount saved per month (Rs) 22,500 17,500 10,000
Rate of return 10% 10% 10%
Years to retirement 30 30 30
Retirement Corpus (Rs) 5,12,84,820 3,98,88,193 2,27,93,253
Note: Only equity oriented NFOs are considered
This table is for illustration purpose only
(Source: PersonalFN Research)
 

Although, Mr A earned Rs 30,000 per month, he was able to accumulate a higher retirement corpus than Mr B & Mr C because he saved 75% of his monthly income. To start off, make a point to save at least 20% of your monthly take-home (net) income. In due course of time, you can continue increasing the amount you save. We believe your retirement is as important a goal as planning for your children's future needs. In a world where we've witnessed the evolution of nuclear families, banking on your children for your retirement needs might be myopic. Hence, it is better to plan and save for your retirement.

 
  • Asset Allocation is the key: As mentioned above, asset allocation is the foundation of financial planning. A right mix of equity and debt will help you achieve your financial goals in the time horizon you planned. A common rule of thumb used to decide the proportion of equity in an asset allocation is 100 minus your age (100 – x years). To state it simply, the proportion of debt should be equal to your age.

    So by this rule, asset allocation for various age groups would be as under:
 
The proportion of equity and debt
Age Proportion of equity
in the portfolio
Proportion of debt
in the portfolio
30 70 30
40 60 40
50 50 50
60 40 60
70 30 70
(Note: Only equity oriented NFOs are considered
This table is for illustration purpose only
(Source: PersonalFN Research)
 

"This rule of thumb helps investors keep in mind that their portfolios need to change as they age, becoming more focused on avoiding risk in their investing than on higher growth."- John C. Bogle, Founder, Vanguard Group.

The rationale behind this rule is: the older you get, less time you have to recover if the stock market tumbles and your risk appetite recedes as well. As you enter retirement, taking all your money out of equities could slow down the growth of your portfolio too much, preventing you from keeping pace with inflation and possibly deplete your retirement savings.

Although this isn't the optimal approach to structure one's asset allocation, it could be a good starting point for beginners in the investment arena.

 
  • Review your financial plan regularly: An annual review (or bi-annually in some cases) will increase the possibility of fulfilling your financial goals by allowing you to incorporate any personal or economic changes in your financial plan. A review also allows you to analyse your individual investments and determine if they are worth keeping. For example, if you have invested in equities, then it would be prudent to check the current standing and potential of stocks and equity mutual funds in your portfolio from time to time. It could be possible that a stock or equity mutual fund may be underperforming; and in the case of an equity mutual fund scheme, there could be a change in its investment objective or style, which no longer meets your purpose of investment.

We are soon going to come up with a program that will help you learn the art of financial planning and manage your finances better. The program will be completely online and will focus on self-paced learning. Every chapter will be followed with a quiz to assess your understanding. Watch this space for further details.



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