There is no end of financial priorities in our lives- some we plan while some come unplanned. We all have a vague idea of what we wish to do when we have enough money. Common expenses and investments such as owning a house, raising children and sustaining the retired life are something that we can plan skillfully. But what about those unplanned expenses like a broken down car or an emergency hospital bill? With a proper financial plan and wealth management we can keep things under control regardless of what life throws at us.
Many people still wonder is there really any use of financial planning when you have sustainable income. The answer, according to me, is that the benefits of financial planning are manifold. It not just helps us to achieve our long and short term financial goals but also-
- Teaches us to develop a healthy habit of earning, spending, saving and most importantly, investing
- Helps us live comfortably with a sense of financial security
- Manage our financial milestones
- Incorporates discipline in our daily living
- Helps in allocation of assets and retirement planning
Procedure of Financial Planning
Once we know how indispensable financial planning is, we should get into the detailed process of the same. The first step of financial planning is setting up of goal which can be further broken down into short term, medium term and long term goal. Then comes estimating the spiluated time required for fulfillment of each goal followed by impact of inflation. Next, we have to deduce the estimate of available resources and lastly, invest and allocate the funds in debt and equity as per our preferences.
Understanding the Effect of Inflation on Cost and Savings:
Inflation has two major negative impacts. First it leads to an increase in the price of goods and services and second, it reduces our savings to a considerable extent. The present assumed rate of inflation is around 6 percent in India. This means that if a product or service is available at 1000INR in 2020, it will reach 1800INR in the next ten years by the inflation rate of 6 percent.
So what can be a probable solution in this crisis? I believe investing in financial products that offer a higher return on investment compared to the inflation rate can beat this issue. This type of investment includes bonds, mutual funds and equity among others. Let's delve deeper into the importance of financial planning.
Emergency Fund Planning
I often face the question how much fund should be allocated for emergency situations. Actually it is very difficult to assess how each one of us can handle crises like loss of jobs, medical emergency, accidents and other unexpected scenarios. The general rule is to save the expenses of about 6 to 12 months which can be a bit lesser for people who have government jobs. The safest option of investment is keeping liquid funds dedicated for such situations or investing in savings bank and fixed deposits.
1. Tax saving investment under 80C and 80CCD
The investments under Section 80C is widely favoured in our country as it helps in saving our hard earned money. Under this section, civilians can claim deductions of upto 1.5 lakh for all the investments in a particular financial year. Some of the reliable investments that are eligible for tax deductions are-
- Tax saving FDs: These fixed deposits come with a lock-in period of 5 years and give interest rate of around 5 percent.
- PPF: These funds have a lock-in span of 15 years and the best part is that the interest earned from this scheme is also tax free.
- NSC: National Savings Certificate also comes with a lock-in tenure of 5 years and the interest this earned is tax free if other investments are not reaching up to the upper cap limit.
- LIC: The premium paid for various types of insurance such as term insurance, life insurance and ulips ect. also falls under the category of tax deductible of Section of Income Tax Act.
- ELSS: The funds kept under ELSS have at least 80 percent of the assets in equity. It comes with a lock-in span of 3 years and the interest is subject to current market condition.
- NPS: The National Pension System falls under Section 80CCD and offers exemption upto 1.5 lakh made for the National Pension System account. But the lock-in period of this scheme is extended till the retirement of the individual.
- Investments under Section 80EE: This section of the income tax act allows individuals to enjoy deduction of tax on the interest paid for home loan for people who have opted for a such a loan for the first time. You can claim a deduction of up to 50,000 INR under this section. And this deduction is over and above the deductions that are offered under Section 24 and Section 80C under the Income Tax Act.
- Savings account: Many people are not aware that the interest earned from the savings bank is tax free up to 10,000INR under Section 80TTA. But before you enjoy this benefit, I would advise you to calculate your funds to save on your tax.
2. Protecting assets through insurance planning
Insurance requirements of individuals can be categorised under life insurance, health insurance, travel and car insurance and finally, house hold insurance. When it comes to our assets and investments, we would always want the best of everything. Therefore, it is very important to choose the best property insurance on the basis of the coverage you want and the premium you can afford.
Apart from the common insurance, I would suggest some special insurance like fire and special perils policy which offers protection to your property against damage caused by fire. It is suitable for your house, shop, hospital and places of worship. This insurance gives protection against fire damage along with other perils that are covered by the specific insurance policy. There are certain exclusions in fire policy such as damage caused as a result of war, invasion and other civil operation, loss or damage caused short circuit, electricity leakage, pressure build-up in electricity line and damage or loss caused by theft or burglary.
Before you claim against this kind of unwanted situations, it is important to intimate with your insurance provider. Later, you will have to show the damage you have incurred in detail and you must cooperate with the surveyor in case he asks for more information.
Next comes the burglary insurance which is available for both house and business firms. It is useful in covering for assets such as cash, valuable, security and stock or goods. If you live in a burglary or theft prone area, then I would suggest this type of insurance for you. It is because this insurance offers protection against loss and damage caused due to housebreaking or burglary, armed robbery, hold up and forced entry within a protected place. Though many people ignore how crucial burglary insurance is, I believe, this kind of insurance is a real saviour when someone steals our valuable documents or assets. Without a full coverage insurance, we will have to incur huge financial loss.
3. Planning for redemption of loan
In the recent times, as I have noticed, technology has altered various options for the lending industry. With the aid of the online aggregators customers can find the cheapest loan while banks and other financial institutions less than a minute in the approval and disbursements of loan. But that doesn't mean the canon of effective borrowing has also changed. It will never make sense to borrow more money than you can pay off. Your EMI for car must not exceed more than 15 percent while personal loans should be within 10 percent of total monthly income.
The next advice is to keep the tenure for payment as short as feasible. The maximum span for home loan repayment us 30 years. The general rule of thumb is the longer the span the lower will be the EMI. As a result, many people opt for 25 to 30 years of time for loan repayment. But the prudent option would be to go for the shortest tenure possible. This is because in a 10 year loan, the interest that you will have to pay is 57 percent of the amount you have borrowed. But when this is extended by another 10 years, the interest rises up to 128 percent. But if you are young and have low income, then it will not be plausible for you to go for shorter duration of repayment. In such a case, you must opt for increasing the EMI amount from time to time with rise in your income each time.
Nobody should ever borrow money for investment or unnecessary expenses. Safe investments such as bonds and FDs will never be able to give off the interest rate in which you are having to pay the loan. And when it comes to investment with higher returns such as mutual funds and equity, the market is extremely volatile. So, when there is a decline in the market, you will not just suffer losses but also have to pay the loan amount with high rate of interest.
Opting for insurance with large investments is another safe option to play. When you are taking a home or a car loan, it would be wise to take up suitable insurance cover as well. This will make sure that your family will not suffer a debt in case anything wrong happens to you.
Lastly, you should strive to substitute the high cost loans if you have any. When there are many loan repayment hovering over your head, you should aim to consolidate them into a single low-cost loan. A loan against any property is typically used for repayment of outstanding loans. It would also be good for your finance if you can prepay those costly payments as early as possible.
Another phenomenon I have observed with borrowers who are also tax payers to avoid ending the loan since they offer tax benefits. When it comes to education loan, the total interest paid on the loan is tax free for a span of up to 8 years. But this cannot be the only reason why you should continue keeping the loan running. It cannot be denied that tax exemptions can bring down the actual cost of loan. Many people do not understand that they can easily get rid of an expense that they are incurring simply by keeping the loan. So, if the money that you are paying as EMI can earn you better returns, then you must consider repaying the loan as early as possible.
4. Investment planning
Investors pay much attention to the safety of their investment as a result of which they select short duration funds for the purpose. But long term debt funds has better returns though it has more risks involved. So, when you are planning your investment, there are a few factors to consider:
- Objective of the fund: This is perhaps the most crucial of all considerations. Mutual funds are good for diversifying your portfolio for increasing the profit while decreasing risk factors. Therefore, you must check whether the objectives of your funds are in line with one another.
- Understanding the risks involved: In general, there are three basic kinds of risks and they are credit risk, liquidity risk and interest rate risk. You should take a look at the credit ratings of different agencies and you should opt for low-credit security as they have higher chance of default. When you are not able to sell off your assets to arrange for money, it is called liquidity risk. Lastly, when there is a fluctuation of interest rate leading to increase in the interest rate, the condition is called interest rate risk.
- Horizon of investment: Every mutual fund comes with a varying period of maturity and therefore you should opt for the scheme that matches your personal investment horizon. If you are looking for regular income from your investment, then you should go for finds with dividends.
Evaluating funds before investment is a crucial step that should never be avoided. Before you decide to invest, you should check the returns of that fund, history such as whether it has been providing substantial return for many years. Lastly, costs and financial ratios should also be checked before investment.
Financial Goal Planning and Allocation of Funds
I have noticed many people that they tend to earn enough but are failing to achieve their financial goals and allocate the resources properly. Ignorance on part of the investors can be deemed as the primary reason behind this. With goal based planning, you will be able to meet your personal as well as specific financial objectives with ease.
For this, it is important to chalk out a detailed plan so that you can tie up every single investment with a particular goal. Also, you should see how much you need to earn and invest in order to reach that goal. The next step is to classify your financial goals into short, medium and long term goal.
Then, the next phase is allocation of funds and assets and so you must identify the assets that are going to make up your portfolio as per your financial goals and investment horizon. Then you should weigh the options of investments and finally review the portfolio from time to time. you may come across certain products that are tailor crafted to suit your financial needs while other may not suitable to your portfolio. You should keep your eyes and ears open to understand financial risks and benefits better. Reviewing one's portfolio helps in staying on track and go for finance related behaviour that aligns with the financial goals.