 | « Back to article | Print this article |
4 steps to build a solid financial plan
These basic things if not done properly can shatter your financial goals.
The motive behind creating a financial plan is to have a roadmap to achieve your financial goals; a plan that distinguishes between your realistic goals and unrealistic dreams. A plan that tells where you will be financially five years, 10 years, and 20 years from the day you start your plan.
A strong foundation is important for a long lasting construction. Similarly when you are constructing a financial plan there are four basic things that can make or break your financial dreams.
1. Current savings and investments
You need to take into account your current savings and investments. It could be cash in hand, cash at bank, investments in financial assets, real estate investments and other investments. However, this will not include assets which you are keeping for your personal use like jewellery, self-occupied house, car etc. This exercise of assessing your current savings and investments is done in order to understand and realise where do you stand financially.
The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the director and chief financial planner of Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached atramalingam@holisticinvestment.in.
4 steps to build a solid financial plan
2. Future savings potential
You need to take into account your family's current income and at what rate this income is expected to go up till your assumed age of retirement. This growth rate of your income can be guessed to certain extent by considering your past increment experience and your standing in the industry. Based on this predicted growth rate of income, you should project your income till your assumed age of retirement.
Also you need to project your expenses. Take your expenses and project these expenses till your assumed age of retirement. Expenses can go up because of two reasons: Inflation and change in lifestyle and life stage.
Once you project your income and expenses till your assumed age of retirement, then you will be able to assess how much you will be able to save year after year till retirement. Identifying your saving potential helps determine where you can reach financially and how fast you can reach there.
4 steps to build a solid financial plan
3. Future financial commitments
Other important foundation work is to list down the future financial commitments for goals. First you need to list down the financial goals to be achieved on a timeline. That is you may want to buy a car three years from now, you may want to buy a property five years from now, you may need to meet your first kid's higher education 10 years from now, second kid's education 13 years from now, you want to retire 20 years from now and in between you would like to go for a few international vacations... the list can go on
Once you list down the goals on the timeline, you need to find out the approximate future value of these goals. Finding out the future value of the goals is little difficult but possible if we follow a few simple steps. Try to figure out what would be the present value of these goals if you were to meet these goals today.
That is, what would be the value of the goals in today's cost of living? Then project this present value with inflation to find out the approximate future value of these goals.
Say one of your goals is to buy a property at the end of five years from now. Visualise and get more details about this goal. In which location you will be likely to buy the property? What would be the size and other specifications of the property? Once you have found out answers for these kinds of questions then you need to find out what would be the cost of such property now. As you have arrived at the present value of your goal, you need to project this present value of the property with assumed inflation rate for five years and you will be getting the approximate future value. Say the present value of the property is Rs 70 lakh, then the inflated value at the end of five years may be Rs 1 crore.
We need to do this exercise for each and every goal. End of this exercise, you will have what are all the goals you are planning to achieve, when you are achieving each one of them and what would be the approximate future value of these goals.
4 steps to build a solid financial plan
4. Viability check
Now you need to check, with the current savings and future saving potential, is it possible for you to achieve all the goals. If it is possible, you can go ahead and create a financial plan. If it is not possible, then what is the alternative? The alternative may be to retire at 58 instead of 55, to buy the car after five years instead of three years or to buy the property worth Rs 50 lakh instead of Rs 70 lakh.
You need to create a few alternative scenarios which are achievable. After going through these alternative scenarios, depending on your priority you need to choose a scenario which suits best for you. You may like to choose a particular scenario and fine tune it. Like this you need to finalise a scenario which would be achievable by a financial plan as well as acceptable to you.
Once you finalise this scenario, based on that a sound financial plan can be created. This viability check makes you understand the shortfall or gap between your realities and dreams.
You can't ignore these basic things while creating a financial plan. Ignoring these basics will weaken your financial plan. You need to pay enough attention to these basic things which makes the foundation very strong and the financial plan very sound.