Have you ever wondered – whether what you are saving today is enough for all the aspirations you have in your life? Be it an early retirement, exploring alternative careers or going on a world tour – they need no longer be far-fetched ideas or nebulous shapes in the future. They can get as real as you want them to be. On the other hand, they could also help you get rid of fanciful notions, with the numbers speaking for themselves.
Financial Planning helps you map your income and expenses, plan out your entire life expenses and budget for your goals and provisions. So how exactly does a financial planning exercise help you make strategic decisions?
Where’s the money going?
The very first thing that a financial planning exercise makes you do, is to put down your current income and expenses. As you start jotting them all down, you suddenly see a lot of expenses you incur which you hadn’t noticed before. Expenses get bucketed based on the frequency with which it is incurred. Expenses, which many times one tends to strike off as a ‘one off’ case, suddenly start showing a pattern. There are, of course, templates which help you put down your expenses, but at the end of day, it the discipline with which you can track and understand your expenses that will help you nail it down.After you are done with your current income-expense mapping, the financial consultant will then start projecting it into the future. Projection is done by factoring in various parameters like the inflation index, salary hikes etc.
What am I worth today?
As you detail your assets like the cash in bank, investment details, property values and liabilities like the loan EMIs and borrowed capital, you get a good idea of your current net worth. How much are you worth today if you were to monetize all your assets and pay off your liabilities. This is important for the consultant to understand your corpus. There might be some assets which are for consumption like your home and others which can be liquidated, when required. It is this understanding that helps planning for cash adequacy. Would you have enough cash at the age of 90 to live by yourself, in case you want to ?
Makes you think & plan beyond the obvious
There are expenses which don’t stand out. We don’t normally think of expenses which are likely to recur. Buying gadgets like a smartphone or consumer durable is not a one-time activity. These expenses have to mapped in regular intervals and their costing should reflect the price at a future date. If you buy a sofa-seater worth 40K now, it is likely to cost you much more – a couple of years down the line. The exercise forces you to think in directions, which you wouldn’t have thought of before. The amount of income, expense and your corpus is mapped out at each stage of our life with a good amount of realistic assumptions.
Prioritize & plan your goals
Everyone has goals. Goals, in financial planning terms, are anything which is likely to have a monetary impact and doesn’t figure in your routine expenses. Want to buy a cruiser for you son when he turns 18.. well, that’s a goal. Buying a farmhouse, retiring early, pursuing hobbies are all goals which have to be converted to the present value of money and when, in the future are they likely to occur. There are obvious goals and not-so-obvious individual specific goals. The very obvious goals like planning for retirement, child’s education & marriage, health expenses are mostly template-driven. But you have to think really hard so that you don’t miss out on those goals which at times, you don’t even verbalize.
Maximizing your investments & minimizing your risk
Where is all this ultimately leading to? The entire cash flows through out your lifetime is mapped against time, to understand whether your cash adequacy is sufficient at all points of time. The ideal scenario would be to have your income-expenses showing a surplus at any given point of time. But that’s not always possible. Sudden increase in expenses in a particular month/ year will tilt in the negative direction, needing you to dip into your corpus. Your corpus is taken as the amount you can liquidate without affecting your basic living style, like the house in which you live in.
So, depending on the stage of your life, risk taking ability, cash flows, the exercise will tell you, how much you should regularly invest , where you should invest, how much is minimum liquidity required, how to spread your investments across various type of investment options and whether are you sufficiently covered for all types of risks.
Increasing awareness, rethink
At the end of the day, it increases your awareness of your financial capacities. It helps you do a very useful ‘what-if’ kind of scenario analysis. While calculating yearly cash adequacies, it might be a rude shock for you to know that you are in the ‘red’ after 61 years of age. You have exhausted all your corpus. Can you do something to extend your corpus ? Are those annual foreign trips going out of the window ? Probably they can still be accommodated if you do it once in two/three years ? Should you buy a house earlier and rent it out , instead of investing the money in some other instrument.
The list of all the futuristic goals is in front of you. Where should you start cutting back ? Suddenly the goals will resolve themselves into mandatory, nice to have and nicer to have categories.
Where to draw the line….
It is important though to know, that this is not the panacea to all your financial problems.There are some caveats which one needs to be aware of, so what is that pinch of salt ?
It is not a one-time activity. Yes, the plan can be done with what you know now with the most realistic assumptions and approximations. But it is a plan which is valid for a point of time – Today. Things might change which might make a lot of your assumptions untenable. So re-correction and re-planning needs to keep happening to enable you to come back on track. The frequency with which you should re-plan could depend on various factors – some assumptions being proved wrong with time, an important life event which has major implications, changing socio-economic and other environmental conditions.
The all-important assumptions & variables
The entire plan hinges on the assumptions you have made. Assumptions as the name itself implies, can change, implying a change to the variables factored in. It is not possible to accurately predict future conditions, therefore the best probability assumptions have to be made, making the best possible use of information available with oneself at a given point of time.You & your consultant’s foresight to predict some of these, would play a major role in determining how much variance your actuals will have to your plan.
Don’t go overboard
This is probably very important. It is important not to lose focus and perspective of what one is trying to do. Future is uncertain and risk of your priorities changing is very real. So while it does serve as a useful tool to understand, predict and plan for your future, don’t let the plan control you.
So tomorrow, when you think of buying that farmhouse and see yourself growing vegetables.. don’t think , put it down on your goals and make it happen. And while doing all that planning, don’t forget to live your life now.