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8 easy steps to financial planning

May 5, 2009 16:51 IST

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We all know that making a financial plan plays an important role in wealth generation. However, for some reason or the other we find excuses for not making one. If you have not yet made a financial plan that charts your future earnings, expenses and returns from your investments then perhaps it's about time you made one.

Here are eight easy steps that will help you make your financial plan.

1. Identify and list down your future needs/ objectives

Each individual aspires to lead a better and a happier life. To lead such a life there are some needs and some wishes that need to be fulfilled. Money is a medium through which such needs and wishes are fulfilled. Some of the common needs that most individuals would have are: creating enough financial resources to lead a comfortable retired life, providing for a child's education and marriage, buying a dream home, providing for medical emergencies, etc.

The first step in a making a financial plan is to identify the goals which have to be met. These goals are the needs and the objectives of the individual. Clarity in this respect would be the starting point to help an individual work out the journey on the financial road which needs to be followed.

Disclaimer: The explanation in this article is directed to help a person understand in a broad sense the financial planning process. Specific skills and knowledge other than discussed above maybe needed in creating a financial plan. The approach may vary based on the unique circumstances specific to different individuals.

The author is a financial planning specialist based in Pune. He can be reached at

2. Converting needs into financial goals

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Once the needs/ objectives have been identified, they need to be converted into financial goals.

But how do we convert the needs into financial goals?

Two components go into converting the needs into financial goals. First is to evaluate and find out when you need to make withdrawals from your investments for each of the needs/ objectives. Then you should estimate the amount of money needed in current value to meet the objective/ need today. Then by using a suitable inflation factor you can project what would be the amount of money needed to meet the objective/ need in future.

For example, let us consider the need to create an education fund for your child which is needed 15 years from now. Let us assume that the current cost of education today would work out to around Rs 4 lakh. We can project what is the amount needed after 15 years for your child by applying a suitable inflation factor to the current cost of education assumed as Rs 4 lakh.

Assuming that cost of education would rise at 7 per cent per annum over the next 15 years, the total amount required after 15 years would work out to Rs 11.03 lakh.

Similarly you need to estimate the amount of money needed to meet all such objectives/ needs. Once you have all the values you need to plot it against a timeline.

This is very easily done by using spreadsheets. It will give you a broad idea about when and how much money you would need during your life in future.

3. Getting a grip of your current financial state

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To get clarity on your current financial state, it is necessary to create a family budget. As part of this budget, you need to list down your income and expenses.
  • Income should include the husband and wife's income as well as rental income if any
  • The expenses part should be split under monthly expenses and annual expenses
  • Under monthly expenses you should list down the regular monthly expenses like groceries, phone bills, electricity, petrol, etc
  • Under the annual expenses you need to include non-regular expenses like school fees, car insurance, vacation, etc  

This enables you to get an idea of the pattern of cash outflows (expenses) during the year. Accordingly you can plan to keep adequate money liquid for the necessary expenses during the course of the year. All Loan EMIs (equated monthly installments) paid should be kept separate under the monthly expenses head, as after a finite number of years they will no longer be part of your regular living expenses.

The most important information that you get from the above study is your current annual cost of living (that part of expenses which supports your current lifestyle).

An analysis of the above figures would enable you to understand the amount of savings (income less expenses) that you are left with on an average. This in turn will give you an idea of surplus regular money available for investment. This is the savings that will take care of you and your family when income from your work stops.

Hence it is extremely important to understand what is happening to your savings. A strategy to invest the savings in the most appropriate way is critical for you to meet your financial goals.

4. Stage I of the financial plan: Risk planning

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The first component of the financial plan would cover the aspect of risk planning. The two major risks are that of illness and death. The role of insurance is to cover risk (in financial terms only). A suitable health insurance cover is worked out after taking into account the situation of the family and information about the availability of any cover from the employer.

The next step is to estimate the amount of life insurance cover required. Loss of income in case of death of an earning member may put the rest of the family into financial discomfort (especially where he/ she may be the primary bread winner).

The role of insurance is to take care of this financial discomfort. The most suitable life Insurance cover for this is a term cover. Information on financial goals and your current financial state, when suitably modified, becomes a base from which to work towards estimating the amount of life insurance and the tenure of the cover.

Once the risk planning is in place the cash flows for long term financial planning is worked out.

5. Stage II of financial plan: Core cash flow study

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You now have the basic inputs needed to work on your financial plan. The needs/ objectives have been converted into financial goals. You know the amount of money and the time when it is required for each of your financial goals. These financial goals will be met through creating financial resources by investing your savings.

You have a basic understanding of your current cash flow (income and expenses statement) through creating a family budget. From this you can get an idea of your potential savings. By projecting your income and expenses into the future you can get an idea of the kind of savings you can have each year.

By assuming that savings grow at different rates you would get an idea of how your investment pool would grow into the future. You will have to work out at what rate of growth of your savings would all your financial goals be met. If the rate needed is very high then it gives you an idea that you may have to save and invest more or alternatively sacrifice some financial goals.

In case the return needed is very low, you can explore the possibility of achieving financial freedom earlier in life. You can mix and match and work out different scenarios and then finalise a plan that suits you most. As this is a part that involves a lot of number crunching, spread sheets make it easier to work.

6. Determining a suitable asset allocation strategy

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Based on a projection of the estimates of long term cash flows done you know the rate at which you need to grow your investments. The financial plan thus lays the broad investment parameters in terms of an asset allocation strategy.

Different assets classes like debt, equity, real estate, etc. grow at certain natural growth rates over the long term. You have to work out an investment strategy to invest the saving across various asset classes in a suitable ratio so that you meet the targeted return as per the financial plan.

If a higher return is needed then accordingly a higher exposure to higher growth assets like equities is needed. Discipline in maintaining the asset allocation is the key to achieving success in the long term.

7. Product selection and plan execution

Image: A visitor admires a gold necklace on display at the Gem & Jewellery India International Exhibition 2009
Photographs: Babu/Reuters

Only after the asset allocation strategy as per the financial plan is in place does the question of product selection and execution arise.

This strategy guides us on the allocation of money to various asset classes (example: debt, equity, gold, etc). For each of the asset classes, suitable investment options are evaluated. A thorough understanding of how different products work and the costs associated with them is critical for this evaluation. The most suitable product which will help you meet the expected returns as estimated in the financial plan is selected.

By growing the money at the expected rate you would be able to build enough financial resources to fulfill your objectives and needs in life. A lot of individuals invest into an investment option without understanding its overall long term impact on their lives. Due to this reason they may find out that they are left with inadequate financial resources during their later years.

They generally have to depend on someone (like their children) or have to drastically reduce their lifestyle to lead a financially viable life. Hence it is extremely important for people to evaluate before hand, the amount of financial resources they need to accumulate, in order to lead a comfortable life post their working years.

8. Monitoring and evaluating your financial plan

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The success in financial planning is achieved only when all the financial goals are met. Hence financial planning does not end as soon as investments are made. It is a continuous process where regular monitoring and periodic evaluation is necessary to ensure that things are happening as per the plan. It is essential to ensure that planned contributions from your savings are happening towards your investments.

In addition to this the returns being generated by the investments should be monitored and rebalancing of investments should be made as per the asset allocation strategy. Based on the above evaluation the financial plan should be fine tuned if necessary.

Adjustments to the financial plan maybe needed in certain scenarios. Any permanent change in lifestyle over and above the estimated level would impact on your long term financial situation. Similarly any major change in your existing situation -- new member added in the family or reduction in income due to one member of the family taking time off from work to raise children -- would require a reworking of the financial plan.