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Financial Planning Basics – Part 2

Part 2 of the previous post on basics of Financial Planning focusing on goals.

Last issue we saw the necessity to first budget our income and expense, then control debt so that our emis are within a comfortable range & having adequate life insurance via a term plan for all earning members of the household and health insurance for all the members of your family. These steps like budgeting, controlling and eventually eliminating all debt except for home loans, being adequately insured for life and health are the foundations and equal to starting on the financial road to a productive work life and a peaceful retirement. Starting without these steps in place is like starting to travel a long journey in a car with little fuel, less money to buy fuel and to top it off the tires not in good condition, it is a recipe for disaster & we should avoid such mistakes in our financial planning journey too.

 

Let us continue where we left off last time on the road to financial planning.

 

Tax Planning: Government gives umpteen number of tax breaks to all of us to alleviate the heavy tax burden the working class heroes to some extent. These start from the well known 80C of 1 Lac, the new 80CCC for Infrastructure bonds to tax free investments like PPF to tax break on children’s education expenses /home loan repayments / charity gifts etc. Ensure that this is used to the maximum so not only you save and invest but you get tax breaks on the investments too.  Easiest thing is to ask a Chartered Accountant but the best is to know it yourself by getting around financial planning blogosphere or buy books on the subject.

 

Finally have your investment papers are in order by ensuring that all your investments be it SB Ac or FD or Shares or Mutual Funds etc have a nominee in place and your spouse knows where these papers / receipts etc are kept.

 

Now let us start the exciting and rewarding journey of Financial Planning

 

Saving, Investing and your basic goals in Life

 

  1. Let savings be your first expense: Every month keep aside some money from your salary account by either enrolling in a Recurring Deposit or monthly investment program by which the amount is auto debited. This ensures that you first get comfortable in the act of savings. This should be a meaningful amount starting at least with say 20% of income or more. People who are very good in budgeting and planning even from rural areas save / invest close to 40% of income which is great.
  2. Fund your retirement plan: Usually this is done automatically for the salaried class via Provident Fund that is deducted from salary but many of us have the tendency to take loans on it or break it when we change jobs. Best is to transfer the account when we change jobs so that it is actually used for the purpose it is meant to be i.e. to fund retirement. Even with the PF savings it may not be enough for retirement thanks to rising healthcare and other living expense. Recently a news paper surveyed retired people whose pensions are way below today’s expense. It is better to save another 10% of income on this goal and estimate how much would be required month on month for retirement so that this goal is taken care of. For those who are not covered by pension and even to those who are covered but feel it is not enough Public Provident Fund offers the best choice, it is better to max out that first and then look at other options such as equity mutual funds etc.,

 

  1. Home purchase

 

Many of us would like to own our home as after all a mans home is his castle as the English say. A generation ago there was no concept of home loan so buying  a home was for the lucky few today with higher disposable incomes and tax breaks buying a home is the first investment that people think of once they are married.  There are many important things to consider before you opt for that home loan.

 

  1. Can you afford the EMI? Since owning your home is a once in lifetime decision for many people they rush headlong to sign on the dotted line and worry later. It would be better to check first if you can afford the EMI’s for next 15 or 20 years.
  2. Have you saved for the down payment? Typically you need about 15% of the cost of the house as down payment. So you need to save this first, I have seen many people not having saved for this but borrowing down payment money too and end up paying EMI as well as repaying loan taken from friends / relatives down payment and unable to pay the monthly living expense bills on time.
  3. Never overextend your home loan – when you see a house the tendency is to overshoot. Many people opt for a bigger house that they can not afford and to top it all spend too much on fixtures etc so that they over shoot their already strained home budget.
  4. While buying a home is one of the best investment that you can make as it gives you peace of mind and could act as a retirement funding investment ( via reverse mortgages or letting out the house for rent etc). It should turn into a burden today.

 

4. Childrens Education

 

Now any saving beyond this ( I can hear you say what savings but have heart, we are a nation of big savers !!) needs to be funded for other goals such as children’s education

 

While this is a laudable goal remember that today there are loans available for education and your child would be more responsible in repaying if he opts for a loan, you can pay a part of the fees if necessary. Again many parents overextend this expense too by aiming very high. Good education does not cost much, what costs much is usually not a very good way to educate your child.

 

It is better to plan separately for this goal, having a PPF account in the name of the children and investing the rest in equity mutual funds via monthly systematic investment plan (SIP) is a better bet in my opinion but you can allocate more or less to both based on your own appetite and tolerance to risk. Most of the child insurance plans etc usually are not a good way to invest since the costs are higher than a mutual fund and naturally returns are lower. Best to have a PPF account in childs name and an equity fund SIP.

Childrens Marriage : This is a goal probably unique to us. We would like to get our children married well if not in style. Marriage costs keep rising higher then inflation thanks to newer line entries that were not done before such as stage arrangement, rich buffett spreads etc. Even a typical middle class marriage today costs a lot and hence it is better to start saving for this goal early on. Best is to set aside some money monthly or to combine with savings for the children in combination of safe and risky but high return long term investments ( PPF+ Equity MFs are my recipe).

 

There are other minor goals such as Holidays or buying a car etc that we need to account for too. However the above goals are major and hence need to be looked at first.

 

Checklist

 

  • Do I have enough insurance cover?

 

1. Life

2. Health

 

  • Do I know what my recurring and non recurring expenses are?

 

  • Do I have some money left after all the bills are paid every month?

 

  • Do I know where I can trim expenses or increase Income? Or better still Both?

 

Taxes

  • Am I utilizing all the tax breaks that im entitiled to?

 

Invesmtents

 

  • Are my investments appropriate for my goals, time frame and my risk taking capacity or have I bought something that I don’t understand?

 

Many No’s to the above questions means that you should really take control of your finances better.

 

Suggestion for planning : Some investment sites offer planning tools, there are also softwares that can take care of budgeting. Actually if we are up to it a spreadsheet can do the job.

The article can be viewed on the magazine’s  site online here : http://www.industrialeconomist.com/January2012/44.html

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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