By N.K.A. Ballal, Retd. Sr. Vice-President, ITDC
What is financial planning? The apt definition in the net is: “Financial planning is a comprehensive evaluation of an investor’s current and future financial state by using known variables to predict cash flows, asset values and withdrawal plans.” A complicated answer to a simple question. This is the problem with management schools. Instead of a simple explanation, they complicate matters and give definitions which nobody understands.
Is financial planning essential? The answer is a definite “yes.” With nuclear family norm, sharing the cost of any emergency is out and one has to fend for himself or herself. We are aping the west, in making our Bharat an insurance hub. Slowly but steadily a time will come when “no insurance, no medical benefit” syndrome will hit us. Except for some countries like Norway or Sweden, old age care is a problem even in developed countries. It is not pleasant to see old people of 80-plus working to make two ends meet and take care of their medical care.
What is the solution? Simple. Financial planning. Government servants, bank employees or defence personnel have the benefit of pensions taking care of their old age needs but what about the majority of others?
Most people want to handle their own finances since they get full personal satisfaction from that. Most persons have some goal when they start financial planning. For some it may be purchase of a flat or a car or holiday travel. To achieve this one requires a certain amount of planning. The process of managing money is called financial planning. Money in a bank and that too in one’s savings account makes only the bank rich.
Every person, family or household has a unique financial position and any financial activity therefore must be carefully planned to meet specific needs and goals. A carefully made financial planning can reduce your old age anxiety. Money can buy most of the luxuries and help required at one’s old age.
We all make hundreds of decisions each day. Some are simple and some of consequences. Some even complex with long- term effects on our finances. The financial planning process is a logical, six-step procedure:
Step 1 – Determining one’s current financial situation: In this first step of financial planning process, you will determine your current financial situation with regard to income, savings, living expenses and debts. Preparing a list of current asset and debt balances and amounts spent for various items gives you a foundation for financial planning activities.
Step 2 – Fixing financial goals: You should periodically analyse your financial values and goals. This involves identifying how you feel about money and why you feel that way. The purpose of this analysis is to differentiate your needs from your wants. Specific financial goals are vital to financial planning. Others can suggest financial goals for you; however, you must decide which goals to pursue. Your financial goals can range from spending all of your current income to developing an extensive savings and investment programme for your future financial security.
Step 3 – Checking alternative courses of action: Developing alternatives is crucial for making good decisions. Creativity in decision making is vital to effective choices. Considering all of the possible alternatives will help you make more effective and satisfying decisions.
Step 4 – Evaluating alternatives: You need to evaluate possible courses of action, taking into consideration your life situation, personal values, and current economic conditions.
Consequences of choices: Every decision closes off alternatives. For example, a decision to invest in stock may mean you cannot take a vacation. A decision to go to school full time may mean you cannot work full time. Opportunity cost is what you give up by making a choice. This cost, commonly referred to as the trade-off of a decision, cannot always be measured in terms of money.
Evaluating risk: Uncertainty is a part of every decision. Selecting a college and choosing a career field involve risk. What if you don’t like working in this field or cannot obtain employment in it?
Other decisions involve a very low degree of risk, such as putting money in a savings account or purchasing items that cost only a few rupees. Your chances of losing something of great value are low in these situations.
In many financial decisions, identifying and evaluating risk is difficult. The best way to consider risk is to gather information based on your experience and the experiences of others and to use financial planning information sources.
Step 5 – Creating and implementing a financial action plan: Relevant information is required at each stage of the decision-making process. Changing personal, social and economic conditions will require that you continually supplement and update your knowledge.
In this step of the financial planning process, you develop an action plan. This requires choosing ways to achieve your goals. As you achieve your immediate or short-term goals, the goals next in priority will come into focus.
To implement your financial action plan, you may need assistance from others. For example, you may use the services of an insurance agent to purchase property insurance or the services of an investment broker to purchase stocks, bonds, or mutual funds.
Step 6 – Re-evaluate and revise your plan: Financial planning is a dynamic process that does not end when you take a particular action. You need to regularly assess your financial decisions.
Regularly reviewing this decision-making process will help you make priority adjustments that will bring your financial goals and activities in line with your current life situation.
Is there a solution for someone who does not know how to invest ? The answer is simple. It is the “sip”, short for Systematic Investment Plan. One can start with Rs. 500. If an individual had invested Rs. 5,000 in a month in an sip 20 years back, his investment would be worth a whopping Rs. 2 crore now, not a bad return for an investment of Rs. 12 lakh ! The power of compounding. This should be an eye-opener for our youth earning handsome salaries but absolutely careless about their savings.
One has to just go to any hospital for a small ailment and what is the bill? A cool Rs. 30,000 or more for a minor ailment. So plan your finances, take an expert advice. In stock markets, only long term investors make money, traders do not. To give an example: The face value of a share of MRF was Rs. 10 when it was listed. Now it is Rs. 60,000. Tempted? There are hundreds of such shares which have made long term investors richer.
Another option, of course, is to purchase land as an investment. Purchase of gold is no more considered an investment option.