Personal Financial Planning: Concept and its attributes

Let’s understand what is Financial planning at first.

Financial Planning refers to the process of streamlining the income, expenses, assets and liabilities of the household to take care of both current and future need for funds.

Financial Planning aims at ensuring that a household has adequate income or resources to meet current and future expenses and needs. The regular income for a household may come from sources such as profession, salary or business. The normal activities of a household and the routine expenses are woven around the regular income. However, there are other charges that may also have to be met out of the available income. The current income of the household must also provide for a time when there will be no or low income being generated such as retirement period. There may be unsuspected expenses which are not budgeted such as a large medical expense, education of children , their marriage expenses or buying a home all of these require an adequate fund to be made available at the right time. A portion of the current income is therefore saved and applied to creating assets will meet these requirements.

Understand this concept in detail with the following Example:

Rajiv is 40 years old and earns Rs. 2 lakhs a month. He is able to save about Rs 40000 a month after meeting all the routine expenses of his family, paying the loans for his house, car and other needs. His investments include those for tax savings, bank deposits, bonds and some mutual funds. He pays premiums on life insurance for himself and his wife. Rajiv is a sole earning member of his family, and he believes he takes care of his finances adequately to take care of his current and future needs. How would financial planning help him?

Following are the set of indicative issues that financial planning will help Rajiv resolve

Does he have adequate insurance cover which will take care of his family’s requirements in the event of his untimely demise?

Given his current income and expenses is he saving enough to create the corpus required?

What are his specific future expenses and how will he fund them?

If Rajiv has to create a corpus to fund large expenses in the future, what is the size of the investment corpus he should build?

Will he have to cut back on his current expense or can he increase his current income so that his expenses in the present and the savings for the future are met?

What is the wealth Rajiv has so far build from his savings and how can he best use it to meet his needs?

How should his savings be deployed? What kind of investment are suitable for Rajiv to build the required corpus?

How much of risk is Rajiv willing and able to take with his investment? How would those risks be managed?

How should Rajiv ensure that his savings and investments are aligned to change in his income, expenditure and future needs?

A formal treatment of the issues Rajiv faces will require a financial planning process to asses

To asses the current situation,

Identify the current and future needs,

Determine the savings required to meet those need,

Put the savings to work so that the required funds are available to meet each need as planned.

Review the process periodically

Rebalance portfolio when required according to your asset allocation.

So from the above discussion we can state following 6 major areas of Personal Financial Planning.

  1. Analysis your current Financial Health by preparing
    1. Cash flow statement
    2. Net Worth Statement
    3. Financial Asset Allocation Chart
    4. List down current available resources to achieve financial goals

2. Goal based Investing : You should first identify your life goals. Investing without a goal means investing randomly which may not be sustainable and can be stooped any time if any emergencies happened. Goal-based investment helps to be focused and disciplined in investing until the goal is achieved.

List down your life goals: Second step will be to pen down each and every of your goals. Sometimes you may find you have high goals but your current financial status may not be sufficient to achieve those. Still pen it down. Its very important to know your wishes. They will keep you motivated to achieve those in the future.

Priorities your life goals: As I discussed in our life at certain stage of life we may not be in a position to achieve all the listed life goals in this situation you should prioritize your goals. Always give priority for retirement over any other goal then kids education and marriage , house purchase car purchase etc will come.

3. Risk profiling: It is one of the foundation steps of successful financial plan. Before starting investing always do your risk profiling. It is a process by which you understand what type of investor are you whether conservative, moderate or high-risk taker. It helps you to chose proper financial products according to your risk appetite.

4. Chose right financial instrument: Every asset class has different types of financial instruments. Wise investor chooses those financial instruments which he understands he/she knows the pros and cons of these instruments. For example in Equity you can have stocks as well as mutual funds. In mutual funds too large cap, multi cap, mid and small cap , hybrid funds etc. Same in debt category debt funds, FDs, RDs, PPF, EPF etc. So choose those financial products whose characteristic is known to you.

Before that

Decide your asset allocation: Once you know which type of investor you are you need to decide your asset allocation for each and every goal. Asset allocation not only depend on risk profiling of the investor but also on the time horizon of that particular goal. Asset allocation is a process of deciding proper mix of different asset classes such as equity, debt, real estate, gold and cash equivalents etc.

5. Fix your monthly saving amount and Map each of this mix of financial instruments to your life goals: This step is very important. Now as you have decided the right mix of financial instruments as per your asset allocation now to need to map each of that instrument to every goal. This process will help to tract the performance of investments pertaining to each life goal.

6. Review the overall portfolio performance periodically : This activity needs to be done once in a year. Review is very important to know the performance of your chosen financial assets. If needed you can change it in annual review process but frequent churning of the portfolio is not advisable. Don’t churn your portfolio based on share market fluctuations. It hampers the long term earning capacity of your portfolio.

Financial Planning is thus a process that enables better management of the personal financial situation of a household. It works primarily through the identification of key goals and putting in place an action plan to realign the finances to meet those goals. It is a holistic approach that considers the existing financial positions, evaluates the future needs, puts a process to fund the needs and reviews the process.

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