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Demystifying financial planning: One step at a time
We are all living in a world where availability of money/cash or accessibility to money/cash is what determines the level of luxury one enjoys in life. To be in a position to have sufficient money one has to be productively employed, irrespective of whether self-employed or not. It is possible for a person to work only up to a certain age as productivity tends to come down with progressing age. The productive years can be said to range between 23 to 60 years.
Beyond 60 a person will have to create income resource from her/his earlier savings to serve for the lifetime.
Here we may recollect Maslow's hierarchy of needs model which postulates that every human being looks to fulfill firstly the physiological needs (food/clothing/shelter) followed by safety needs (job security/social security).
Once the basic needs are met individuals needs to secure a standing in society in the form of love/belongingness followed by esteem (recognition/wealth). These four needs are categorised as deficiency needs. Once the four needs are met, man will like to work in a self-motivated manner without requiring directions.
In financial planning we will be concerned with the first four needs as they have a financial connotation in the sense that every one will have to create income resources to meet these needs as long as one lives.
What the above discussion boils down to is that woman/man will have desires/wants continuously throughout her/his life. To meet these needs (also referred to as goals) s/he will have to arrange for finances which may be through 'income generation' either from occupation or savings/investments. An organised approach to creation of necessary finances to meet the goal can be broadly referred to as financial planning.
To understand the nuances of financial planning we propose to look at answers to the questions given below:
- What is financial planning?
- Why should one plan?
- Where can we invest to supplement income?
- How can we achieve the objectives of a financial plan?
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The author is head of knowledge management at Money Bee Institute Pvt Ltd., Nagpur. Money Bee is a corporate training firm associated with NIFM (Ministry of Finance, GoI), SEBI, NSE, BSE, SBI and leading mutual funds in India. He can be reached at ramkiraj@hotmail.com.
A case study
It is felt that the best way to explore answers to the question will be served by analysing a case. Accordingly it is proposed to use facts stated in the following hypothetical case as the base for understanding financial planning and its dimensions. The study will be covered through a series of four articles of which this is the first one.
In this article we will try to get the answer to the first question: What is financial planning?
Case facts:
Ajit Manohar, 35, working with a private sector company is in charge of a production unit and is settled at Chennai. He is married to Swarna, 33, now a housewife.
They have two children Swarit (son), 10 and Aparna (daughter), 7. Both the children are in a public school. Ajit's dream is to make his children engineers. Ajit and his family stay in company-provided house.
The monthly income of Ajit post-tax is around Rs 60,000. The monthly household expenses are Rs 30,000.
The retirement age is 60. The income is expected to rise by 10 per cent and expenses by 8 per cent every year. The life expectancy of the couple is 75 years.
Inflation is expected to be at 6 per cent throughout the life span. Ajit has life insurance coverage of Rs 30 lakh. The family is covered by a group health scheme policy provided by the company.
Their investments as of today are listed in the table below:
| Assets | Amount | Post-tax return per annum |
| Equities including mutual funds | Rs 10 lakh | 12 per cent |
| Debt including mutual funds | Rs 3 lakh | 8 per cent |
| PPF | Rs 5 lakh | 8 per cent |
| Post office/Bank deposits | Rs 4 lakh | 5.5 per cent |
| Bank Balance (CA/SB) | Rs 1 lakh | NA |
Financial planning process
In simple terms we can define financial planning as the process of meeting life goals expressed in monetary terms, through proper management of finances.
Step 1: The first step should therefore be to identify the life goals of Ajit's family.
If we read the case carefully we will see that Ajit will have the following important goals to be carefully looked at:
- Providing for his children's education (engineering) expenses
- Providing for the likely expenses on marriage of the children particularly Aparna's as demanded by our social tradition
- The family does not have a house. Hence provision of finances for acquiring a house down the line
- Given the status of the family they may be looking at purchasing a medium sized car and also require finances for annual trips
- Need to build a retirement corpus at retirement
Step no 2. The second step is to put a monetary figure to the likely expenses and assessing the time when it will be required. Let us put some imaginary figure to each of the goals today. We will look at estimating these expenses in the next article. The figures can be tabulated as under:
| Goals | Amount | Time when required in months (after) | Monthly expense | Allocation of surplus to heads after meeting each expense (after) | |||
| 12 months. | 24 months | 96 months | 192 months. | ||||
| Education | Rs 18 lakh | 96 | Rs 19,000 |
| Rs 25,000 |
|
|
| Marriage | Rs 6 lakh | 192 | Rs 3,000 |
|
| Rs 6,000 |
|
| Car | Rs 6 lakh | 24 | Rs 25,000 | Rs 25,000 |
|
|
|
| Annual tour | Rs 1 lakh | 12 | Rs 8,000 | Rs 8,000 | Rs 8,000 | Rs 8,000 | Rs 8,000 |
| House | Rs 30 lakh | 60 | Rs 50,000 |
|
|
|
|
| Retirement | Rs 45 lakh | 300 | Rs 15,000 | . |
| Rs 22,000 | Rs 22,000 + Rs 6,000 |
| Total |
|
| Rs 1,20,000 | Rs 33,000 | Rs 33,000 | Rs 36,000 | Rs 36,000 |
It can be seen that the surplus of Rs 30,000 per month (earnings of Rs 60,000 less expenses of Rs 30,000) may be enough if accumulated to meet all the expenses except housing for which probably a planning may be required later. Similarly it will be wise to also evaluate the option of education loans also at the material time.
Step 3: The next step is to build a proper strategy for increasing the current wealth by appropriate investments. Detailed investment strategies will be discussed in later chapters. Broadly we can say here that this step envisages allocating money to risky and non-risky assets to grow the wealth (value of investment).
Next week: Why should one go for financial planning?