Finances are essential to meet monetary expenses at present and in the future. It is also necessary for the accomplishment of several important events in life. But limited source of income and countless expenses generates the need for financial planning, as it allows you to have an organised way to maintain savings and expenditure.
Contingencies play a major role in drawing a financial plan as you can save for events such as a child's higher education, weddings, buying a home, and retirement. There are numerous reasons that you need a financial plan. If, you wonder how to do it, then below are the points to consider for financial planning.
1. Contingency Planning
Contingency planning is your first step towards a solid and comprehensive financial plan for your life. It is like building a moat around your life such that an emergency cannot affect your long-term wealth.
Life is full of uncertainties and many such events demand financial support, such as medical emergencies and accidents. Contingency plan consists of the following two factors:
- Life insurance plans
- A large pool of funds
While insurance plans will cover contingencies like, hospitalization, accidental injuries, loss of property etc., the fund pool will help you in other situations. You can look for the following insurance plans:
- Term life insurance cover 10 - 15 times your annual income
- Health insurance cover, both Mediclaim and Critical Health
- Accidental Cover, you can add accidental disability and death covers as riders with term life or health insurance plans
- Asset insurance, like house, vehicle, etc.
The second part of your contingency plan is to build a corpus to support you in situations like job loss, income loss etc. The ideal emergency fund should help you meet your necessary expenses for 6 to 12 months.
Which Expenses to Include?
Your next question could be, ‘which expenses?’ So, here’s a list of probable expenses you should consider and to what extent:
- Kitchen expenses 100%
- Utility (phone, internet, electricity, etc.) bills 100%
- Life and health insurance premiums (6 months’ if paying a monthly, annual premium if paying annually)
- Loan EMIs (for 6 – 12 months)
- Travelling/ Fuel expenses (at least 50%)
- Children’s school fee (6 to 12 months)
Let suppose, Mr Amrut has a stable career. He needs a contingency corpus for a minimum of 6 six months. His monthly household expenses are as follows:
|Expenses||Total (Rs.)||to Emergency Fund (Rs.)|
|Kitchen & food||20,000||20,000|
|Life & Health insurance premiums||5500||5500|
|Children’s School Fee||3000||3000|
|Transport & Travel||6000||3000|
So, Mr Amrut’s emergency fund savings should range between Rs. 3.3 lakhs to Rs. 6.6 lakhs
Where to Save Your Emergency Fund Money?
An emergency fund pool is not a small amount of money. However, it is also not for a short period. Thus, you must not put any of this money into investments that will be difficult to convert to cash at a short notice (or immediately). Also, these investments must not change their value overnight or frequently.
Thus, only a few options will qualify for parking your emergency funds:
- Savings account
- Supersaver deposits
- Online fixed deposits
- Liquid Mutual Funds
You can convert any of these investments into cash very quickly and use your money for emergencies. You can also relinquish some of this responsibility on credit cards. But make sure, you have funds parked to repay the card in time.
2. Retirement Investment
Retirement investments should ideally start at the same time as your income and contingency planning. You can keep on planning your retirement in detail and start to fill up the gaps after your emergency funds are settled. But the retirement investments should start with the first paycheque.
Learn these 5 retirement concept that you must know.
If you have subscribed to EPF (Employee Provident Fund) or NPS (New Pension Account) with your employer, you have nothing extra to worry about. However, if you have not subscribed to any of these retirement saving accounts, you should either subscribe to NPS tier-I account or PPF.
You can also start investing in ULIPs if you are comfortable investing online. One benefit ULIPs have over all the other retirement investment plans is that the maturity value is free to use for any purpose. Unlike NPS and EPF where you will need to invest at least 40% of your corpus in annuity plans, you can invest your ULIP corpus anyway you need.
Starting early is one of the essential steps of a strong retirement plan. So, start with your paycheque and improve along the way.
3. Savings for Important Goals
Once your retirement and emergency plan are settled, you can start focusing on your long-term financial goals. If you are married these goals will include:
- Children’s higher education
- Children’s marriage
- House purchase
- Car upgrade / purchase
- Family vacation
- Wealth building / business capital
You will need to define all of your long-term financial goals with two more data points – how much time and how much money?
Once you have, you can use online calculators available on the websites of life insurers to estimate your monthly saving need for them. If you have to make a choice, you can start saving for the closest goal first.
4. Understand Tax-Saving Investments
Two factors that work against your wealth are inflation and taxes. While any good investment will easily beat inflation, it’s the taxes that you should worry about, although just a little.
Almost all long-term investments offer one or the other tax benefit. However, while selecting investment options for your long-term goals, you would want to opt for EEE investments as much as possible.
What Are EEE Investments?
An investment can attract tax exemption at three stages – investment, growth, and maturity. Depending on their stage of tax-exemption, the investments are classified in the following three categories:
- EEE, i.e., Exempt at all three stages, most life insurance savings plans, ULIPs, retirement plans
- EET, i.e., investment and growth are exempt, but maturity is taxable, for example, real estate or gold
- ETT, i.e., the only investment is exempt, growth and maturity values are taxable, for example, 5-year tax-saving deposit
Thus, as much as possible you should try to put your money through EEE investments.
Learn about tax saving investments in INDIA.
5. Budget Financial Needs & Start Investing
There are two ways to save and invest money
1. Save first and spend later
2. Spend first and save later
The path you take will have a significant impact on your financial future. Needless to point that the first choice leads to a more prosperous and satisfying future.
However, it does not mean that you should just put all your income into investments and then think about your monthly expenses. It only means that you need to budget your expenses carefully, and once you have stick to that budget.
For example, you sit down with your spouse and have accounted for each and every expense head for your house for a year. Both of you conclude that you will need to dedicate 40-45% of your monthly income towards running your household and managing the lifestyle you want.
After this discovery, you can simply direct 55% of your monthly income towards savings and redirect the savings to:
- Short term large financial needs
- Medium-term financial goals and responsibilities
- Long-term goals
Also, remember, that these saving heads do not count your retirement corpus that you are building. You will need to count your income after the retirement savings for this purpose.
Thus, you can lay the foundation of a solid financial plan for your life. One thing you should note that a financial plan is not a piece of paper with a lot of numbers. A rock-solid financial plan will take about 6 – 12 months to settle down and sustain.