Tuesday, February 15, 2011

The Art of Financial Planning

In the previous article "Plan for a Better Future" we saw the importance of financial planning. In this article we are going to dig deep into step 3 which is “Design a Plan” to help you all formulate a plan that would help you achieve your financial goals.

Lets get started!!!

Things to consider while formulating a plan

Some of the things you need to consider while designing or rather formulating a financial plan are:
a. Liquidity – How liquid is the investment? Can we get money when we want?
b. Rate of Returns – How good is the investment? How much money would I earn with this investment?
c. Risk Involved – How risky is this investment? Will I get all my money back or will I suffer losses?

All the 3 above mentioned points are equally important. An investment that does not give good rate of returns to beat the inflation rate is bad and so is an investment that is too risky which may result in you losing all your money and so too is an investment that is illiquid and you cant sell it when you want the money. So we need to keep in mind all the above aspects when we plan for the future.

Asset Allocation:

Asset Allocation is very very important when it comes to financial plans. An old saying goes “Never put all your eggs in the same basket” and this is 100% true for financial investments too. For ex: when the stock market crashed a couple of years back, everyone who had investments in the market suffered losses (unfortunately I did too). Luckily some of us did not put all our money in the stock market and had some exposure to other investments like gold or bank deposits which helped us offset our losses. So it is extremely important that you have a balance asset allocation.

You can take a look at some of my articles on investment portfolios to get a good idea of the different types of them using the links below:

What is an Investment Portfolio?

Conservative Portfolio

Aggressive Portfolio

Balanced Portfolio

You can choose any of the 3 types depending on your risk appetite.

Choose your Asset Class based on your goals:

Choosing your asset class must be dependent on the goal you intend on achieving with the investment. For ex: Stock markets are very good in the long run as an investment but they are pretty risky and you may end up suffering huge losses if the market turns volatile in the short term. So if you are planning to achieve your goal of buying a car next year by investing in the stock market, you may end up with losses and not be able to fulfill your goal of buying the car.

The preferable assets classes depending on your investment/goal horizon are:

1. Short Term (< 1 year) – Stick to fixed income instruments like bank deposits and liquid cash 2. Medium Term (1 – 3 years) – Have a healthy exposure to fixed income instruments and have little exposure to stock markets 3. Long Term (> 3 year) – Have a good exposure to stock markets with a decent exposure to fixed income instruments.

Planning how much you can Invest every month:

Planning how much you can spare to invest every month is an important aspect of the financial planning life-cycle. Every month we have fixed expenses like groceries, house-rent or home loan EMI, childrens school fees, petrol expenses for car/bike etc. So, in order to arrive at the amount you can invest every month, you need to do the following:

a. Total your Earnings – Include your income (and your spouse’s income if they are employed) and all other earnings like rental income, bank interest etc
b. Assess your monthly expenses – Include all fixed monthly expenses like rent, electricity bill, telephone bill, petrol expenses, school fees etc
c. Subtract monthly expenses from earnings
d. Subtract any extra expenses – for ex: scheduled car maintenance/service, trips to the doctor, holiday/festival related purchases etc
e. Keep a cushion – Always keep a fixed sum (say 5% or 10% of your monthly salary) as liquid cash in a bank account to meet emergency expenses. This is to ensure that, you don’t eat out of your investments that are designed to achieve a long term financial goal to meet your current cash requirements
f. Subtract cushion from the amount remaining after subtracting monthly & extra expenses from your earnings

This is the amount you can invest every month for your financial future.

Time for Action:

Once you know how much you can save every month, you can then decide on the instruments you wish to invest this amount and then voila!!! You are on your way to a good financial future.

Happy Investing!!!

1 comment:

  1. @ financial planners orlando

    Sorry, I dont have any of them that are used by professional financial planners.

    ReplyDelete

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