Financial Planning for Future Needs

Financial Planning for Future Needs

To lead a decent life one needs money. Financial planning deals with this money management.

An individual or a family must have sufficient money to meet their current expenses and also future expenses. But from where this money will come?

People generally work to generate income. There are people who work for salary. There are people who has their own business. No matter what ever is ones profession, to lead a decent life ones source of income must be predictable.

Generally, people focus too much on their immediate needs. In this process, people fail to forsee the future requirements. These requirements may be future now, but when it arrives, they become unavoidable. Few examples of such requirements are retirement, medical emergency, higher education for child etc.

It is essential for people to have a financial plan in place for such future requirements. One cannot afford a delay to start arranging for finance for such future needs.

There is a typical peculiarity of most future needs, all of them are extremely capital intensive. Hence it becomes even more imperative to plan “very early” for their realization. A delay will only ensure that sufficient funds are not available at the right time.

So the first step of financial planning is to set aside a preplanned amount towards fulfilment of future needs.

But what one should do with this set aside amounts?

These amounts should be used to accumulate assets. These assets in turn helps in capital appreciations or additional income generation.

A “complete financial plan” not only deals with capital appreciation or income generation. The scope of financial planning is much wider:

  • It ensures emergency fund creation
  • It deals with adequate life insurance coverage
  • It evaluates what saving is essential to fund all needs (current & future)
  • It deals with purchase of specific assets to manage all current and future needs

Financial planning is a process which makes people aware of the present and future. It identifies all present and future goals (needs). It then does a scrutiny on ones income and expense pattern to understand if the person is saving enough on not. Selection of right investment products (assets) & its systematic inclusion in investment portfolio is also a part of financial planning.

Before we go deeper into the meaning and implementation of personal financial planning, lets know about following terms:

– Assets

– Liabilities &

– Net Worth

For a person who wants to improve his personal finances, must know and use these terms in a right way. People often confuse between asset and liability.

There are majority living in this world who know only income and expense. But in order to improve ones finances, one must focus hundred percent on building a decent net worth.

Like big companies manage balance sheet, individuals must manage their net worth.

Financial Planning & ASSETS

how to build asset

All financial transactions has its origin in income. A person whose income is high, will spend more and also save more. A person whose income is low, will spend less and save less.

No matter whatever is ones level of income, a portion of income is used to fulfill current expenses. The balance portion is set aside as savings. These savings are essential to manage future needs.

When person is earning more than he/she is spending, their finance is said to be in order. But it may happen that even for such people, financial dis-balance may creep in. Such short term imbalance can be managed by resorting to bank loans.

But if a person has to resort to “high debt” to fund their current needs, it indicates that, at some point in the past the financial planning was not done properly.

Ideally, people must accumulate assets with objective to sell them in future when need comes. Systematic purchase of assets over a period of time comes in the purview of personal financial planning.

There are two types of assets that people can buy:

  • Physical asset (real estate, gold etc)
  • Financial assets (bank deposit, stocks, mutual funds etc)

Traditionally people love physical assets as they are things that people can see and feel. The feel of ownership is more dominant in case of physical assets. This is one reason why physical assets are always in demand. Hence, they provide excellent inflation hedge for the investors.

Financial assets are instruments that are bounded by strong government regulations. Hence information available related to these financial products are very reliable.

These information (like stocks data) people can use to evaluate these types of assets in a much better way.

Financial Planning & LIABILITIES

Liability

Ideally people must buy assets from their savings. But more often than not, people resort to bank loans to buy assets. Loans substantially decrease the potential return of an asset.

There are some assets which are very difficult to buy solely on basis of savings (like a house property). In such cases availing a loan becomes necessary because acquiring a house property requires a huge one time investment.

As a rule of thumb, even the costliest of asset must be purchased with minimum 50% financing from savings and 50% from loan.

If this rule is maintained, liability management becomes a piece of cake.

So next time when you go to buy your car, make sure that you make 50% down-payment and balance is loan.

Financial Planning & NETWORTH

Net Worth

Financial health of people is estimated by calculating their net worth.

The calculation of net worth is done by this formula: Asset – Liability = Net Worth.

Target should be to keep improving ones net worth month after month. This can only happen if one increases his assets base and decreases the loan of liability.

The overall purpose of financial planning is to assure growth of ones Net Worth year after year. Purchase of more and more assets in ones portfolio will assure net worth increase.

How to do Financial Planning for future needs?

Generally people look for experts advice for personal financial management. I think its better to take advice of experts when it comes to money management.

But I will suggest my readers to do a small home work before approaching an expert.

Preparing a rough financial plan for oneself will give a great deal of clarity to an individual. Once this rough plan is in place, talking to a financial advisor will become more effective.

Answering the following two questions for SELF can take one a long way into depths of financial planning.

#1) What is my Financial Position?

To understand ones current financial position, it is important to evaluate following things:

a) Quality of income.

b) Quality of net worth

If a person scores high in ‘quality of income’ and in ‘quality of net worth’, it means that his financial position is good.

What means by high scores? Lets read more…

QUALITY OF INCOME (Grades Required: 90%)

One may be earning very handsomely, but still he may get poor grades in terms of “Quality of Income”.

Similarly, an average earning person may fare very well in quality of income. How? Lets read more…

There can be 2 source of income for anybody:

  • WORK INCOME – Salary income or income from business
  • PASSIVE INCOME – Income from assets (rent, interest, dividend etc)

A financially dependent person in more dependent on income from work income. The reason why such people are called dependent because, if for any reason they cannot continue working their income will stop. This is undesirable.

A financially independent person in free. His source of income is more from passive income. The reason why such people are called independent because, to generate passive income they need not work regularly. This is why such income is also called as passive income. This type of income will continue to build even when you are asleep.

A good financial planning motivates people to increase their passive income as much as possible year after year.

So, first a person must understand how dependent he or she is on work income.

Suppose a person total monthly expense is Rs 100,000. Out of these Rs.100,000, Rs.45,000 are those expense which are unavoidable. If the person generates Rs.15,000 from passive income, his is only 33% independent (15K/45K).

To earn high grades in quality of income, the person must be at least 90% independent.

QUALITY OF NET WORTH (Growth Requiried: min 12%)

Net Worth = Asset – Liability.

Ideally a person must keep liability to zero. As a rule of thumb asset liability ratio must be greater than two (2).

Generally people track their performance of investment portfolio. But I will suggest people to keep a track of their Net Worth.

When a persons net worth is growing at a rate more than 12% per annum, it can be considered good.

I will advice my readers to main their asset liability chart in an excel sheet.

A typical net worth must look like this:

Financial Planning for Future Needs

#2) What are my Goals and how to achieve it?

Identification of financial goal must be done with care. There are three components for any goal:

  • a) Clear Description of Goal
  • b) Associated Value to the Goal
  • c) Time in hand before realization of the goal.

A typical example of goal listing is as below:

SL DESCRIPTION OF GOAL PRESENT VALUE TIME
1 CAR PURCHASE 6,00,000 3 YEARS
2 HOME LOAN CLOSURE 35,00,000 5 YEARS
3 HIGHER EDUCATION 25,00,000 12 YEARS
4 RETIREMENT 1,00,00,000 20 YEARS

Future Value = Current Value x (1 + Inflation Rate) ^ (time in years)

This way the future value of goals will be as follows (inflation@ 6% p.a.):

SL DESCRIPTION OF GOAL FUTURE VALUE TIME
1 CAR PURCHASE 7,15,000 3 YEARS FROM TODAY
2 HOME LOAN CLOSURE 35,00,000 10 YEARS FROM TODAY
3 HIGHER EDUCATION 50,31,000 12 YEARS FROM TODAY
4 RETIREMENT 3,20,00,000 20 YEARS FROM TODAY

In order to fund future goals one can do the following:

  • Sells accumulated assets
  • Take loan

If one has sufficient assets to fund their future goals, this is a ideal condition. But it takes time for assets to build. Hence it is imperative that one must start early the process of asset accumulation.

Now, in order to accumulate assets worth as indicated above one must select a suitable investment vehicle. Based on the time horizon and value one needs to gather, following investment option should be preferred:

SL DESCRIPTION OF GOAL FUTURE VALUE VEHICLE
1 CAR PURCHASE 7,15,000 BALANCED FUND
2 HOME LOAN CLOSURE 35,00,000 BLUE CHIP MUTUAL FUND
3 HIGHER EDUCATION 50,31,000 DIVERSIFIED EQUITY FUND
4 RETIREMENT 3,20,00,000 DIVERSIFIED EQUITY FUND

Potential investment return that one can earn on above investment vehicles are as follows:

SL VEHICLE POTENTIAL RETURN
1 BALANCED FUND 12% P.A.
2 BLUE CHIP MUTUAL FUND 15% P.A.
3 DIVERSIFIED EQUITY FUND 16% P.A.
4 DIVERSIFIED EQUITY FUND 16% P.A.

With the above reasonable assumptions, lets use my SIP Calculator to calculate what monthly contribution will be required to build the corpus:

SL DESCRIPTION OF GOAL FUTURE VALUE POTENTIAL RETURN TIME MONTHY CONTRIBUTION
1 CAR PURCHASE 7,15,000 12% P.A. 3 YEARS 16,557
2 HOME LOAN CLOSURE 35,00,000 15% P.A. 10 YEARS 13,286
3 HIGHER EDUCATION 50,31,000 16% P.A. 12 YEARS 12,506
4 RETIREMENT 3,20,00,000 16% P.A. 20 YEARS 21,269
63,618

This table will highlight how a monthly contribution of Rs.63,618 at an average return of 12.66% will help in achievement of goals:

Year Monthly Contribution Average Return of Portfolio Appreciated Value of Portfolio Redemption from Portfolio
1 63,618 12.66% 8,60,080 0
2 63,618 12.66% 18,29,063 0
3 63,618 12.66% 29,20,738 7,15,000
4 63,618 12.66% 33,45,109 0
5 63,618 12.66% 46,28,746 0
6 63,618 12.66% 60,74,918 0
7 63,618 12.66% 77,04,204 0
8 63,618 12.66% 95,39,790 0
9 63,618 12.66% 1,16,07,797 0
10 63,618 12.66% 1,39,37,656 35,00,000
11 63,618 12.66% 1,26,19,352 0
12 63,618 12.66% 1,50,77,294 50,31,000
13 63,618 12.66% 1,21,78,436 0
14 63,618 12.66% 1,45,80,549 0
15 63,618 12.66% 1,72,86,818 0
16 63,618 12.66% 2,03,35,755 0
17 63,618 12.66% 2,37,70,748 0
18 63,618 12.66% 2,76,40,680 0
19 63,618 12.66% 3,20,00,622 3,20,00,000

Appreciated Value of Portfolio





Thanks for reading my blog. I really appreciate your time. If you can also put your comments or subscribe us below, it will be an excellent feedback for us. Please also consider sharing posts of getmoneyrich on facebook or twitter.....You are awesome!

Disclaimer: All blog posts of getmoneyrich.com are for information only. No blog posts should be considered as an investment advice or as a recommendation. The user must self-analyze all securities before investing in one.

About the Author

Mani
I am a Blogger with a passion for investment education. I started blogging in 2007-08. Blogging didn’t happened to me as a coincidence, it was a conscious decision. The idea with which I started blogging still stands true. In my starting days my finances remained tight. I was reading heavily about how to manage finance. One day I got hold of a book which my father gifted me in 2003. It was stacked below my graduation books. It was a small-thin book with its cover named "Rich Dad Poor Dad".....more

2 Comments on "Financial Planning for Future Needs"

  1. Hi, just read your article and it gave me an encouragement to save my income. I presently have some cash in hand and I am thinking to invest them. Can you tell me some good investment options so that I can proceed?
    And also do you think Peer 2 peer lending is a good investment option?

    • Hi. I did some research on Peer 2 peer lending sites in India and found out about http://www.loankuber.com/. It is a very transparent and easy platform. It even provides me a list of borrowers and gives me the authority to choose from them whom I want to lend. Please let me know your views about it.

Leave a comment

Your email address will not be published.


*