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Introduction to Financial Planning for Beginners

At my first job, I was saving around 40% of my salary, that too after paying my education loan EMIs. I was convinced that I am very good at personal finance, but so wrong I was. I seriously thought that spending less and pumping the savings into the so-called best mutual funds is financial planning, which was a huge mistake.

So, what is financial planning? Financial Planning is the process of determining how much your saving and spending should be, considering your particular situation. It also determines the optimal way to use the savings in such a manner that you have enough money to tackle planned and unplanned situations that will arise in the future. At the same time ensuring a decent lifestyle in the present and in the future.

What is Financial Planning?

In the last para, I have already given a basic definition of financial planning, in this section, I will explain the same in a more detailed manner.

Financial planning starts with determining how much you earn. For a salaried person, this is quite easy to determine, but a non-salaried individual needs to make some effort to determine his average earning. The next thing is to check and establish spending and saving levels. Many of us have no plan regarding our expenses and at the end of the month we end up with zero to minimal savings. This is the first issue that is tackled in financial planning. You should distinguish between needs and wants, and minimize the amount you spend on wants as much as you can. But, that doesn’t mean you should stop enjoying life, the financial plan should be made in such a way that your present and future both are comfortable.

Once you have decided how much your saving can be, while maintaining a decent lifestyle (I am using the term decent lifestyle, not luxurious lifestyle), you are already ahead of the majority of people. Make a monthly budget with room for adjustment and stick to it with discipline. I think making a budget and following it is a very crucial aspect of financial planning. But at the same time if you make a budget which is too restrictive in nature you might fail to follow it for a long time. Treat it as a guide, but a very serious guide which should be followed as far as possible.

After determining the amount an individual can save, the task of ensuring a comfortable life for you and your family using this saving is the main aim. This is the part that also deals with investment planning but is not limited to it. Your plan should be based on the following:

  • Expected emergencies – Death of earning member/s (life insurance), medical emergencies (medical insurance)
  • Unexpected emergencies – Emergency fund
  • Life after you stop earning – Retirement planning
  • Life goals – Higher education of children, the marriage of children, buying a house, buying a car, recurring goals like a family vacation, etc
  • Debt – Managing existing debt and keeping the debt to the minimum

While planning these you should not prioritize anything above insurance and emergency fund. Even if you have to postpone or drop completely some of your goals for fulfilling insurance and emergency fund requirement.

Where you need to invest for your future goals including retirement is the next issue. It is determined mainly by the amount of money you will need and when you need it. This will include some trial and error while planning, but one crucial thing is to keep your return expectations from different assets low. You plan for each goal and then combine these to get an overall investment plan. If ever you think you might not achieve some goals with low return expectations, don’t run after risky assets and high return expectations better increase your investment and increase the term of the goal if possible.

Now your budget is made to ensure a comfortable present and means for a comfortable future. Your insurances and an emergency fund are for emergencies, and your investment plan is for your future comfortable life. Next is implementing this with discipline, monitoring it, and maintaining it. Further, your financial situations will change in the future and thus your financial plan will need to be altered as per those situations. Thus financial planning will require continuous efforts, you need to review it at least once per year but the rewards are way more than the efforts required.

How to Make a Financial Plan

As the theoretical aspect of financial planning has been explained question arises, how to actually make a financial plan. If you do a google search for “how to make a financial plan” you will find articles giving some broad points/steps to make a financial plan. While they can not be blamed as financial planning differs a lot from person to person but I will try to give a more detailed framework for making a financial plan.

This method and steps are purely my personal opinion and method. I am writing what I have been doing for my own financial planning. Some of the points might not apply to your situation.

STEP 1: Determining where you stand?

Before you start planning and taking action for your future you should have a clear idea about where you stand at present. For this, the first thing you will need is to determine your cash flow. By cash flow, I mean a statement, of money coming in and money going out. Do this for the last couple of months, you will have a clear picture of how much you are earning and how much you are spending.
The second thing you should do is to make an asset and liability statement. Every investment you have made is an asset, we will take care of whether it is a good investment or not later. Every loan you have is a liability which is to be paid off. Now remember this is just to have an idea of your investments and loans, thus things like your first house and your vehicle will not be added to the asset. Only investments that you can liquidate will come under assets.

STEP 2: Planning your present

After you have a picture of your earning and expenses it’s time to analyze your spending and savings. This is where you make a budget, you look at the item you have been spending money on, some of these are necessary expenses, like rent, groceries, utilities, etc. The way I make my budget is I divide my expenses in needs, wants and unnecessary. For every expense, I ask myself ‘can I wait for three weeks before spending money on this’, if I can’t wait chances are this a need. If I can wait I do wait and if even after those three weeks I find the expense is justified it is a want otherwise it is unnecessary.
While making your budget you cannot avoid the necessary needs, so you just have to spend on them. In case of wants, you try to reduce them, not to the bare minimum, but to a level that you can afford. In case of unnecessary expenses, well it is in the name, they are unnecessary. For example, having a smartphone has become a need, but having the latest one every year is unnecessary, but changing your phone when it becomes slow and hard to operate comes under want and you can buy a new one.
The budget will make your present much better, you will be able to spend on your justified wants without any guilt. At the same time curbing the unnecessary expenses will leave you in a position to save for your future.

STEP 3: Being prepared for emergencies

An emergency can hit at any time, and it never gives a notice before arriving. If you are prepared for emergencies you can forsee, you can handle even completely unplanned emergencies in a better way. Although all emergencies are not financial in nature but having financial means to tackle emergencies always helps. So before you take the savings that you have due to you following a budget and jump into investment planning, it is necessary to be prepared for emergencies that can hit even tomorrow.
I divide emergencies into two categories just for the sake of explaining the planning aspect, emergencies that can be planned, and unexpected emergencies. The emergencies you can plan for are tackled mainly by insurance and for unexpected emergencies, you maintain an emergency fund.

Insurance Planning

The bare minimum is having life insurance for earning members and medical insurance for all family members. After this, you can look into accidental insurance (for accidental death or dismemberment), critical illness insurance, theft and burglary insurance for a house, vehicle insurance, etc. In this article, I will be talking only about life insurance and health insurance.

Life Insurance: Being underinsured is a common occurrence in India. Because people don’t take insurance based on their needs, rather they take insurance for saving tax and for investment. This is a huge mistake, you take an expensive policy with low insurance and end up getting low returns and low insurance. The simplest way to calculate how much life insurance you need is,

Insurance required = (annual income * no of years you want your dependents to be supported) + your total outstanding debts

This is the minimum amount, people also add some amount for their kid’s education or any other future goal, this totally depends on you. After calculating the required amount you should go for a term plan and not some expensive insurance+investment plan. For more detail about why insurance+investment plans are not good for you, read this.

Health Insurance: For health insurance, you have to consider all the members of your family. The amount of insurance will depend on the average cost of treatment in your city. You also have to consider the expense of major medical procedures like organ transplants and complex surgery. Now if you try to take normal health insurance for a big amount the premium might not be affordable, a better alternative is to take a base plan and a top-up/super top-up plan. This will give you enough coverage at a lower premium.

Emergency Fund

An emergency fund is for those emergencies which you can’t even imagine, forget about planning for them. But how much emergency fund one should have and where to keep it. A simple answer is you should have at least 12 times your monthly expenses in a savings account (you can put it in saving account with a sweep facility). Before you reach this benchmark do not look for any other instrument to invest emergency funds, and do not start other investments. You can read more about the emergency fund here.

These three steps should be completed before moving any further with your plan. In my opinion, until your insurance and emergency fund requirements are met you should not even think about investments.

STEP 4: Planning for your goals

Now before I start writing about this step and the next step I like to make a disclaimer. Both these steps require a lot of explaining for a beginner, and doing so in the same article would not be practical. I will be writing detailed posts about both, and here I am just providing a simplified introduction to these. In the meantime, you can read the basics here and can visit freefincal for further learning.

Goal-based investing is best suited for the majority of investors. It introduces a structure to your entire investment. Most investors run after so-called high return products without any planning, they have no plan of when they will redeem the money invested or how much minimum return they should make and how much risk they can take. Goal-based planning helps you avoid these mistakes. Goal-based planning needs you to do the following tasks for every goal.

Defining the goals

When we are talking about financial planning a goal should have two things, a target amount/corpus and the time period in which you want to accumulate that amount. To calculate these you should first calculate the amount needed at present for your goal and the time in which you want to achieve this goal. Then using future value formula and rate of inflation you can calculate your target corpus.

Future Value (FV) = Present Value * (1 + (Inflation in percentage / 100)) ^ Time period in years

So your goal is now to accumulate X amount (FV) in Y years for a specific purpose like kid’s higher education.

Assets to invest in

You should be concerned with two types of assets. Those which can give inflation-beating return but are more risky/volatile and those which might give low returns but are less risky/volatile. For simplicity and because I only invest in these two asset classes, I will be talking only about debt and equity. The main purpose is to use different assets to generate acceptable returns while keeping the risk low. You will do fine if you too only invest in these two asset classes.
Your time period and the importance of your goal determines the percentage of each asset class. Higher the time period more can be the percentage of risky assets, more important the goal lower the percentage of risky assets.

  • Upto 5 year term – 100% debt asset (low risk asset)
  • 5+ years to 10 years – 40% to 50% in equity (40% for more important goals) rest in debt
  • 10+ years to 15 years – 50% to 60% in equity (50% for more important goals) rest in debt
  • 15+ years – 60% in equity

One more thing is that, as you come close to your goal you should bring your equity exposure to zero. You can do it gradually or you can do it 3 to 5 years before you reach your goal.

How much to invest?

You have your target corpus, your time period, and your asset allocation. Now based on what returns you expect from different assets you can calculate the amount you need to invest. You can use various goal-based investment calculators available online, but in my view excel is the best tool for financial planning.
You should also take into consideration the increase in your earnings, if you estimate that your earning will increase year on year, your investment should also increase. So include the percentage by which you can increase your investment every year in your calculations.
But the main point is that you should be mindful of your return expectations. I have seen people making a financial plan, expecting 15% from equity and 10% from debt. In my experience, 10% from equity and 5% from debt should be your maximum expectations.
Do this for all your goals and you can find out your monthly investment requirement.

Where to invest?

As I invest only in equity and debt assets, I can only advise on these two. For equity you have to options.

  • Mutual funds
  • Direct equity

I am not the right person to comment on direct equity as I am not experienced in it. For equity mutual funds you can check out my mutual fund guide. Or you can just invest in index funds, one NIFTY/Sensex fund and one NIFTY NEXT 50 fund is all you need.

For debt portion the options are

  • Bank deposits
  • Post office deposits
  • Mutual funds

For goals up to 3 years, only a bank or post office deposit should be considered. For goals of 3 to 5 years bank/PO deposits and debt mutual funds can be considered. For goals of 5+ years debt mutual funds are a good option. EPF/VPF can be a part of your retirement planning. PPF should be considered only for long term goals as withdrawal of money from PPF is not smooth. Again for debt mutual funds, you can read my mutual fund guide or you can choose liquid funds for short term goals and money market funds for long term goals.

STEP 5: Planning for your retirement

Retirement planning is a bit different than planning for any other goal. The main difference is how the corpus is used, unlike other goals, the retirement corpus has to last for many years and this has to be considered while planning.
Retirement planning has two major component.

  • Post-retirement planning (which mainly deals with determining the corpus required at retirement and post-retirement investment)
  • Pre-retirement planning (which deals with planning for the accumulation of corpus)

Post retirement planning

The main factor that sets the retirement planning apart is that your corpus is used over a long duration. Thus you can invest part of your retirement corpus to generate returns and thus reducing the corpus required at the time of retirement. The main thing to be considered is, how much corpus you will invest in risky assets like equity, this is determined by the size of the corpus you can accumulate till your retirement age. To make it simple let’s first decide the total corpus you would need after retirement.

  • You would need to calculate the present value of your post-retirement annual expense. This can be done by calculating your present annual expense and remove those expenses which will not be there after retirement, like EMIs and expenses related to children. This is the present value of your post-retirement annual expense.
  • Now you need to calculate the future value of your annual expenses for each year after your retirement till you expect to live, using future value formulae and inflation. Like in my case I want to retire at 70 and expect to live till 85, so I will calculate the future value of annual expense for all 15 years.
  • From your annual expenses reduce any earning you might have like pension, business profit, etc. Do this for every year and you will have the net expense for each year.
  • If you add the net annual expense of all years you will have the total corpus you need for your post-retirement life.

Now the corpus you can accumulate depends on how many years you have left till retirement and how much you can invest until retirement. The closer your accumulated corpus is to your total corpus required less risk you would need to take in your post-retirement planning. Thus you should aim for a corpus as close as practically possible to total corpus needed.

You can plan a post-retirement investment strategy wherein you invest some small amount in high risk/high return assets, some in medium risk/medium return assets, and a majority in safe assets.
For example, I have divided my retirement years into groups of 3 years. The corpus required for the first three years will be in FDs in my bank(except for first-year which will be consumed in that year only). The corpus for the last three years will be 30% in equity, thus it will grow more as it will have more time and more exposure to equity. Taking a 3% return from FD/RD, 4% from debt MFs, and 8% from equity I have calculated the corpus I will require at age 70 (my retirement age).

Pre-retirement planning

Now you have a target corpus and a time period. You can now plan your investment just like you did for other goals.
But remember retirement is a very high priority goal. You should not take excessive risks. I have more than 30 years for my retirement and I have 65% equity exposure in my retirement portfolio. Even this can be considered high risk but as I will be reducing equity every 3 years I have started with a higher percentage.

STEP 6: Debt planning

I have seen people overcomplicate this step. There can be two conditions, first where your debt and loans have become a serious problem for you. Second, you have some loans and want to have a planned approach towards your existing and future debt. Let’s address both.

If you have taken a lot of debt and you are currently unable to handle it, it is hard for you to repay these loans.

  • No new debt. I have seen people, they keep taking new debt to repay old debt, this cycle never breaks only the person break. Stop taking new debt.
  • Reduce your expenses. If you can postpone an expense for a month without any repercussions, chances are that it is not a need. Try and only spend on needs.
  • Make sure you have life insurance and medical insurance. You can not handle any more emergencies on your own.
  • All the money that is left put some of it in an emergency fund and use rest to repay the loan.
  • Talk to people/organizations you have taken a loan from. Explain the true situation, tell them what you can pay, and keep making regular payments no matter how small.
  • Try and increase your income, take part-time jobs in addition to your main job/business. Ask your family member to work for increasing the earnings.

If your debt situation is under control and is not an issue.

  • Pay EMIs regularly.
  • Don’t take loans for stupid reasons, like I will save tax on interest and the money I can invest and make more return than interest.
  • Plan for future goals and try to achieve them without any loan as far as possible.
  • If you want to repay the loan earlier do so after taking care of insurance, emergency fund, and important goals like retirement and child education.
  • When repaying a loan early, select the loan with the highest rate of interest like credit card and personal loan first.

STEP 7: Monitoring and managing

What is required now is to implement and follow your plan, apart from some extraordinary circumstances you should not deviate from your plan. These extraordinary circumstances can be some emergencies like job loss wherein you have to pause the investment, zero or low increase in earning, etc. Beware of running after new and attractive investment schemes and never compromise your plan for these.
Now you have a plan for managing your present, future, and emergencies. Calculate the insurance you need every year, as with time this will increase if the increase is substantial make changes in your policy. Recalculate your emergency fund requirement and bring your fund to the level of your requirement. You will also have these three details,

  • How much you will be investing?
  • How much your investment should grow for you to achieve your target?
  • What should be your asset allocation?

You will have these for every goal, for your retirement, and for your entire investment portfolio (by combining all goals and retirement). Each year you have to compare the actual performance of your investment to your plan and take the following actions.

  • If your investment is not performing according to your plan – Do you have very high return expectations, if yes lower your return expectations and make necessary changes. If your return expectations are oaky, is it only your investment or this is happening to the entire markets. Like in the case of a mutual fund is your fund not performing or all the funds of that category are facing a downward movement. If this is a market-wide downturn stick to your plan, if not you might need to switch to a better performing investment. But remember even if your investment is performing lower than a few others but as per your plan, you should stick to your investment. (Give 3 years to your mutual funds before you start judging their performance).
  • If your asset allocation has deviated from your planned allocation – This happens all the time. This due to the fact the different assets grow at different rates, thus while you started with 50-50 investment in debt and equity you might end up with a 60-40 asset allocation. In such a scenario you need to rebalance your assets, it might look counterproductive to sell high performing assets and buy low performing assets, but this is necessary to keep the risk under control. Otherwise, you might end up with a higher percentage invested in risky assets and one crash will wipe out your years’ worth of gains.
  • Some goals have been achieved – Allocate the money you have been investing for these goals to some other goals, or any new gaol which you might want. This is a happy occasion so give yourself a pat on the back.

Do this for every goal and retirement separately, then check your entire portfolio, if you did it correctly your total portfolio will not be needing any more correction.

Issues People Face in Financial Planning

I have given a theoretical definition for financial planning, I have explained that definition, and I have tried my best to provide a step by step roadmap for preparing a plan. Yet there are some issues you might face while making a plan for yourself. I will be explaining some that I have an idea about, but there are numerous other issues that might arise. If you face any problem you can always put your issue in the comment section I will try my level best to provide a solution.

I don’t have enough money to invest, do I need financial planning?

First of all, as stated previously financial planning is not only about investing. It involves so many other factors that you should take care of if you want a better life than today, or you don’t want to be in a worse situation.
Secondly are you sure, because as far as I know, establishing where you stand is the first step. If you have this question chances are you have not undertaken that step. Analyze your earnings and spending, check how much you spend on needs, wants, and unnecessary. Take unnecessary expenses to zero and reduce expenses on wants, you will end up with the money for your future.

I am making enough money, do I need financial planning?

First of all congratulations. Secondly are you immune to change in circumstances? What will happen if something happens that affects your earnings? What will happen in case of some major medical emergency in the family? What will happen when you retire? How much money will it require for your kids to attend top universities? Do you know the answer to each and every such question, financial planning can provide the answer to these.

I don’t have enough money for all my goals

You have made a plan, you have some goals figured out which includes your retirement goal. But you now realize the amount you need to invest monthly for all your goals and retirement is more than your monthly savings. Relax, this happened to me, it happens to a lot of people.
Now in this situation I never suggest people to reduce their expenses, you can take another look on your budget if you like, but sacrificing too much of your present comfort for future is not a thing I like. What you can and should do is,

  • Make a list of all your goals and arrange them according to priority. Your retirement and goals related to your child are some examples of high priority goals.
  • You will have to forget or postpone some of the less important goals.
  • Increase the time period of some of the goals, like if you were planning to buy a car in 5 years, you can make it buy a car in 7 years. This will reduce your monthly investment requirement, freeing some money.
  • Do these adjustments, until your investment requirements are within your budget.

Never choose riskier products and increase your return expectations to lower the investment required. This is plain stupidity and wasteage of all the efforts you made in preparing the plan.

I have already made some investments, what to do with them?

If you followed STEP 1 properly you will be having a list of all your investment with you. Some might tell you to stop investing in all of them and slowly/immediately transfer to new instruments that suit your plan. Others might suggest you to plan, taking them into consideration. I don’t like both ideas, these investments were made by you in the absence of any holistic plan thus taking them into consideration might affect your current planning process.
What I suggest is make a plan as if you have zero investment currently, choose your assets and instruments properly with realistic return expectations, and proper risk assessment. Once you have done that, check if any of your old investment suits your plan, if yes include them and keep investing in them. Withdraw all the money you can (there might be lock-in periods in some investments) from old investments and invest in products you have selected now. I am not a fan of systematically switching over, these were mistakes according to your own plan, get out of them as soon as possible.

I am already invested heavily in debt, what to do?

This happens to many of us, we come from families where equity was treating as gambling. We were advised to choose FDs, RDs, PPFs, LIC policies, etc safe avenues for investing. On top of that EPF is deducted, the majority of people end up having a debt-heavy portfolio. Again, make the plan, that will give you a target asset allocation. Short term goals are 100% debt, and long term goals can give you time to achieve your targeted asset allocation. The only solution is, slowly increase your equity allocation. So, from now on invest more in equity you can also rebalance some amount from FDs and RDs.

I have made a plan and I am following it, I recently received a good amount of money, where to invest it?

I have seen this question being asked many times, people who are following a plan with discipline get an unexpected amount of money. It can be in the form of bonuses, incentives, prizes, gifts, etc. Now the question arises in their mind about investing some of this money rather than spending it all. If this is the case with you, first of all, congratulations you are doing good if you are thinking about investing this money. Second, why do you need a new avenue for investment, you already have an investment plan, distribute this money in your most important goals.
But there are few people who want to experiment with investing/trading according to a certain strategy which they think might work but have no proof for it. There is no harm in it, you have a plan and you are taking care of your present and future financial need with discipline. You can use this money to experiment and learn, but use only that money, which you are ready to loose completely. You might end up with a lot of experience and zero money.

I understand what is financial planning, but I lack the time/knowledge to do it on my own.

Well, you are better than a lot of people, you are ready to accept that you might not be able to do it on your own. For you, a good solution will be to hire a financial advisor. I am sharing two links that can help you to look for a good financial advisor.

This article has already crossed 5000 words and thus I will be ending it here, there are still a lot of details that are not covered, I will try and cover them in coming articles. Meanwhile, you can ask any doubt you have in the comment section.

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This Post Has 3 Comments

  1. kalai

    I would like to know the unified portfolio approach for all long term goals(in my case all goal are between 11 and 22 years from now). Because handling 6 different goals with different portfolio seems to be lot of management work. Unified seems to be easy to me. Your views please.

    1. Ashish

      First of all thanks for raising a very good query.

      I would not go into too much technicality, rather I will tell you what I am doing. I am just investing in 3 mutual funds and in each of them, I have a single folio. I don’t bother what is my overall asset allocation or how to balance different goals and overall portfolio. I have planned all my goals using excel, so I just add up the monthly investment in equity and debt for all goals and invest. At the time of rebalancing, I again add up the equity and debt for all gaol, calculate the percentage and implement in my actual portfolio.
      I don’t bother maintaining AA in my overall portfolio I just concentrate on AA of different goals and simply add the equity and debt of each goal.

      Hope this suffice for now, I will be writing a detailed article about portfolio maintenance and monitoring both of your queries will be cover there. In the meantime, if you like further explanation you can mail me at [email protected]

  2. kalai

    When we combine all these goals in unified portfolio, Little bit of confusion, how to manage AA for the earlier goals(Son UG) in the whole list of goals where we are keeping AA 50:50 (EQ:Debt) as combined. Goals are :
    Son UG
    Son PG
    Daughter UG
    Daughter PG

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