Financial Planning

August 26, 2020

Before getting deeper into the what and why of Financial Planning, let us understand a few terms :

Contingency Reserve

Contingency reserve is your emergency fund.  It’s important to set aside five-six months' expenses in safe instruments or have liquid cash for rainy days. There can be any emergency at any given point in time. Having an adequate contingency reserve will help you during unexpected and unplanned situations like this pandemic. This resulted in job loss and pay cuts for many. Their income reduced but the expenses remained the same.  An emergency fund will help you jump overcome hurdles with ease.

Tax

Tax planning helps you reduce your tax liability. Taxes can be efficiently saved by utilising various exemptions and deductions available for an individual. Tax saving can be done through insurance premiums under sec 80D, certain mutual fund investments under sec 80C, Payment of specific type of loan under sec 24 etc. Financial planners study your income and expense in detail and help you save your taxes by investing in the right type of investments.

Insurance

Insurance play a major role in managing risk. Insurance is a replacement of your income. It’s important to have a term, medical and a general insurance. Medical emergency can arise anytime. Buying insurance at an early stage will also reduce premiums, when compared to schemes bought at a later stage. Medical insurance also help in tax saving by utilising certain tax deduction. It’s always advisable to get your insurance schemes reviewed for ensuring whether you have adequate insurance.

Financial goals

Financial goal is the future need of an individual. Goal can be anything like buying a house or a car, saving for higher education. Goal might also to be being debt-free or build a retirement corpus. A financial goal is something that has a value and time frame within which it has to be achieved. Let’s look at these scenarios

  • Mr A wants to buy a house in 2025
  • XYZ want to buy a car of Rs 20 lakh
  • Mr B wants to go for a world tour by 2025 which will cost him Rs 8 lakh.

First two scenarios are not financial goals since value of the goal is not mentioned in the first case and time in the second. Whereas the third case is a financial goal as value of the goal and its time are mentioned. To achieve these goals, planning and investments has to be done in advance. There can be short term goals or long term goals. Short-term goals are something that has to be achieved in near future. Let’s say by next year or two. Speaking about the value of a particular goal, it’s always good to consider time value of money. A house might cost you 25 lakhs today but it’s not necessary that after few years the value will still remain the same. Keeping that in mind and planning accordingly will help to achieve your target.

Why planning is important?

We discussed about risk management, taxes and goals. Now to sum up all this, planning is important. An expert will help you to look in every aspect in details and give you a broader picture about your finances. They help you construct a portfolio mix of both equity and debt in the right proportion depending on your financial goals, their time frame, value of the goal, by assessing your risk appetite, expenditure, income and surplus. Not only goals, they also take care about taxes, contingency and insurance.

Here’s a question. When is the right time to start investing?

An investment made at an earlier stage will help you gain financial stability and also reduce your contribution towards each goal. Compounding will also do it’s magic. When it comes to buying term insurance and Mediclaim policies, the premiums are lesser when bought early.

An example to help you understand this better,

Case 1:

Two individual are building a retirement corpus of 1 crore. They are planning an early retirement at the age of 50. Mr ABC starts investing at the age of 25, and Mr xyz at the age of 35. Both invest in schemes which earn 10% returns.

 Mr ABCMr XYZ
Amount required at the age of 501 crore1 crore
Age of initial investment25 years35 years
No of years invested2515
Rate of return10%10%
Total Amount investedRs 9,22,960Rs 23,93,920
No of months invested300180
Monthly investments (approx.)Rs 3,000Rs 13,300

In the above example, we see that by starting earlier the contribution is much lesser than starting at a later stage.

Case 2:

Mr ABC and XYZ invest Rs 10,000 per month towards the retirement corpus. The former started at the age of 25 until the age of 50. The latter started at the age of 35 and invested until 50.

 Mr ABCMr XYZ
Age of initial investment25 years35 years
No of years invested2515
Rate of return10%10%
No of months invested300180
Monthly investment1000010000
Total Value (approx.)3.25 crores75 lakhs
Corpus required1 crore1 crore

By starting late, you might not be able to accomplish your goal on time. Due to which you might have to delay it until its corpus is accumulated. In the above examples, when investment were made to build the retirement corpus, by starting late Mr xyz had to invest more every month in the first case and in the second case, he wasn’t able to build enough corpus as planned.

This is how planning early and investing early help one to gain financial stability, keep you debt free and manage risks.

-Ridhi Sethia


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