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Financial planning: Is yours a Test match or T20?

In the long-term we are all dead: so said John Maynard Keynes the famous British economist. Agreed! But, if we do not plan well enough for the long-term, we might be as good as dead even in the short-term!

From T-20 cricket to expecting quick returns on our investments, the short-term game is catching-on. In the bull market, many of us made money quickly, but, in the market fall, lost it much quicker. What we need to recognise is that most individual needs are long-term; which makes it imperative that financial planning should also be long-term. Therefore, it is a good idea to plan for retirement even if it is 30 to 35 years away.

The magic of compounding will start working for you early, when you start planning early.

We need to keep in mind the following basics while we are planning for the long term:

• Mapping financial goals
• Managing risk
• Beating inflation
• Tax optimisation
• Conducting regular reviews
• Maintaining liquidity

Mapping financial goals

Long-term financial planning starts with outlining our financial goals clearly. While doing so, we need to estimate the amount we need and when are we likely to need it.

We take the example of Raghav, who decided to undergo a detailed financial planning exercise. He was 29, newly married and wanted to have all his goals sorted out from a financial perspective. I captured his needs as shown in the adjacent table:

• Raghav fed me with further inputs, such as:
• Parents, both aged over 65 years, were dependent on him
• His wife was currently not employed. However, she may consider working in about 2 to 3 years

His company offered a cover of Rs 3 lakh for medical purposes wherein his parents & spouse were covered. However, he was of the view that this was grossly inadequate

On his investible surplus, he was able to save up a decent amount:

• Monthly investible surplus of Rs 25,000 (post all existing commitments and a small portion set aside as buffer)
• Savings bank balance of Rs 75,000

Managing risk

It is important to understand one's risk appetite and decide on the appropriate 'asset allocation'. Use a combination of assets, without holding too much of your investment in one single avenue. Have a good mix of debt-equity; a way to achieve optimal returns at appropriate risk levels.

Considering Raghav's age, he could afford to take a decent equity exposure. Equity was appropriate for him keeping in mind the long-term nature of his needs, because, in equity investments, risk is starkly lowered when one increases the tenure. This was in contrast with Raghav's earlier portfolio that mostly had bank deposits and no equity exposure.

For the down payment towards his proposed home, he could partially use a combination of equity mutual funds, debt (debt mutual funds, deposits) and balanced funds. About 15-25 per cent can be brought-in as down payment and avail home loan for the balance, where tax benefit can be gained for the interest and principal component.

His current asset allocation (before financial planning) was as shown in Table 1:

It was suggested that over a period, he build up a balanced asset allocation, as shown in Table 2:

The diversified investments would help provide that balance to his portfolio. If the equity markets were down, the debt options and gold would support his portfolio. On the other hand, if markets did move up, his equity mutual funds would fuel growth.

Hedge life / health risk: While planning for the long-term, sometimes, one fails to take into account some inherent risks, which can throw the family off-balance. The world could come toppling down in case the breadwinner is rendered disabled or meets with an unforeseen eventuality. Assessment of human life value is pertinent for all ages. Younger people can avail a term cover. In Raghav's case, this was the first point that required attention, because he was grossly short of insurance cover. Evaluation of life cover has to be done based on the corpus required to ensure that the family continues the same lifestyle in case of an eventuality.

Raghav's parents have already crossed the insurable age, hence one cannot avail health insurance. Given this fact, he can utilise the company cover claim exclusively for his parents and avail additional health insurance for himself and his wife. He can use a family floater, which will work cheaper as well. The premiums paid towards such a plan can be availed as tax benefit u/s 80D up to a maximum of Rs 15,000.

Tax optimisation

One of the first steps towards financial planning is tax planning. If one optimises on taxes then the rest of it should fall into place. While tax planning, it is important to consistently align all investments with financial goals. Taking advantage of tax saving investments enhances the 'take home'. A higher take home results in being able to invest higher amounts towards achievement of one's financial targets.

Taxes could eat into a significant part of the returns, if planning is bad. Raghav planned for tax saving investments through ELSS funds; and one reason for wanting to go in for the home loans was to take advantage of the tax breaks. The investments he used were also tax efficient. Mutual funds, insurance and PPF would provide tax efficiency to his portfolio.

Beating inflation

Inflation can have a significant impact on the chances of one achieving his / her financial goals.  All the requirements mentioned in the table of needs are as of today. Therefore, one has to adjudge the future value after factoring-in average inflation (for a developing economy like India, it can be in the range of 5.5 per cent to 7.5 per cent). Further, as one grows old, the expense pattern may not remain the same, with healthcare needs requiring greater allocation.

Conducting regular reviews

Considering the long-term nature of the goals, one would need to make a lot of assumptions. It would be impossible to predict the exact amounts required, because there are too many variables to deal with. Therefore, periodic reviews of the financial goals, and of the assumptions that form the basis of financial planning, would help provide a mechanism that ensures fulfillment of financial goals without deviation.

Maintaining liquidity

Long-range financial planning requires one to keep some liquid assets, which could be the 'safety capital' that one could draw into, in case of emergency. In the downturn, job losses caught a lot of people unawares. Those who had liquid assets were saved from great difficulties. Raghav chose to use debt funds to take care of his liquidity requirements. The equity mutual funds and gold funds also provided liquidity without compromising on returns.

The 'long' and 'short' of it:

Rome was not built in a day. Financial planning, especially in the long-term is not just about getting the desired returns, but about managing risks as well. Towards that end, a combination of conservative and market-linked avenues can be used. It calls for consistent monitoring and realignment.

For instance, exposure to equity should be gradually reduced with age, to ensure that one is not over-weight on equity holding at the time of retirement. Health / life cover should be an intergral part of fund allocation. A debt-equity analysis can be conducted every five years to de-risk the portfolio and achieve the desired asset allocation. Using tax efficient avenues and planning for liquidity are essential components of long-term financial planning.

Life, to use cricketing parlance again, is a 'test match'. Long-term financial planning is about planning a long-innings that can give you big gains at the end of it.