“Strategy without tactics is the slowest route to victory; Tactics without strategy is the noise before defeat”
- Sun Tzu
“Saving for a rainy day” is an age-old idiom used to underline reserving money for a time of unforeseen difficulties marred with financial challenges. Having a contingency fund helps overcome temporary setbacks during “rainy days” and bounce back to normalcy. That’s just one of the various reasons you should have a financial plan. Contingency funds have to be highly liquid so that you can encash on them quickly to meet your urgent needs. Illiquid assets such as real estate may not help because disposing them off to get money in hand would take time. As a thumb rule, you should have money to manage expenses for at least 6-8 months. This will give you breathing time to plan out your next steps.
Contingency planning is only one part of overall financial planning that should also cover lifestyle goals, retirement forecasts, healthcare costs, children’s education, and financial security for the family in case of death or disability of the income earner. An impactful financial plan should generate wealth in the long term, improve your lifestyle and give you peace of mind.
Financial planning is not about setting aside some money each month into a savings account. Wealth creation is possible only when the investment not only beats inflation but also gives sizeable returns. Inflation is one of the biggest impediments to wealth creation and a robust, laser-focused investment plan is needed to ensure that the purchasing power of your money is not destroyed.
If you have just embarked on your professional journey and are seeing salary credits since very recently, you must think forward and start your financial planning. The following five (5) financial planning rules can help you navigate and chart out the best plan for yourself:
1. Define Your Goals with Money
Unless you define your goals, you will never know what to chase. Without a clear focus, you would end making random choices. If you are a 25-year-old married gentleman and wish to retire at 50, what percentage of your preretirement income would you need after retirement? Whereas opinions differ, you can safely presume a need for 80% of your pre-retirement income.
If you have or plan to have children, you must factor in education costs in your financial plan. Although childhood dreams keep evolving, you must closely observe your child’s aptitude and passion so that you can invest in specific child investment plans to support his/her education.
2. Learn About Taxes
Income, Investments, and Taxes go hand in hand. Every investment has 3 components
a. Invested Amount
c. Maturity Value
If the invested amount is deductible, from your taxable income, it can be said that the amount is Exempt (E) from tax. If the interest from the investment is taxable it is termed as Taxable (T). The amount received on maturity may be taxable (T) or exempt (E).
i. EEE: Insurance Plans, Unit Linked Insurance Plans (ULIPs), Equity Linked Savings Scheme (ELSS), and Public Provident Funds (PPFs) fall under this category. This is the best place to be in as all components of the investment are exempt from taxes.
ii. ETE: In this category, the interest is taxable whereas the invested amount is deductible from taxable income thus reducing the tax payable. Even the amount received on maturity is exempt from taxes.
The 5-year tax-saving Fixed Deposit (FD) offered by Scheduled Commercial Banks is the best example of tax exemption on investment and withdrawal.
iii. EET: The National Savings Certificate (NSC) exemplifies the Exempt-Exempt-Tax (EET) mechanism where only the maturity proceeds are taxed.
Needless to say, option (i) EEE is the best because of the opportunity to save taxes at every stage. Moreover, the investment opportunities and financial instruments are more in this category.
3. Always Save
Saving is a journey, not a destination. Let this become a force of habit such that you never forget to save, and you save before you spend. Your formula should be Income-Saving=Expenses. Unless it is an emergency, do not compromise on your monthly saving. Thumb rules suggest a saving of at least 30% of your monthly income.
4. Work on SMART Financial Goals
Define your Goal: What cannot be measure, cannot be monitored. Quantifying goals and periodically measuring progress is the most practical way to reach your target destination. SMART goals are Specific, Measurable, Attainable, Realistic, and Time-Bound (SMART).
Goals should not be generic especially when finances are involved. Makes sure you chart out a goal that is Specific, Measurable, Attainable, Realistic, and Time-Bound (SMART). An example of each is mentioned below for ease of understanding.
a. Specific: You have made a down payment for your new house. You have to pay the balance amount 20% of the balance amount after 2 years. Rest will be given by your bank as part of the home loan. This 20% works out to approximately Rs. 10 lakhs.
b. Measurable: If you are planning for retirement, you must ensure you get at least 80% of your current income as cash flow then (in present value) from your retirement corpus. Ergo, if your current income, is Rs.1lakh/month, and you aspire to retire at the end of the next 20 years, your kitty should have at 250 times your current monthly income i.e., INR 2.5 Crores. Progress is now clearly measurable
c. Attainable: If your current net worth is less than INR 1Crore but you aspire to hit INR 1000Crores net worth in the next 12 months, it looks a tad impossible. Your goals must always be attainable else those will remain as daydreams which cannot be reached in practice.
d. Realistic: You wish to start your venture somewhere in the Caribbean Islands within the next 2 years. You are a qualified Chartered Accountant with a stable job in India. You have started earning about 2 years ago and will be married soon. Although flying off to the Caribbean is not impossible, it seems to be unrealistic unless you want to risk and sacrifice everything you have in hand.
e. Time-Bound: Goals cannot have unlimited time to attain. You will lose sight and interest when there is no time limit because you know time can be relaxed. It is best to define a timeline when you define a goal.
5. Automate Your Savings to Investment Conversion Process
The key to automating your savings to the investment process is having a defined allocation process. You must be clear where your money goes first. If you are 25, invest a larger proportion into equities. Invest in portfolios managed by credible fund managers. You should adjust your investment portfolio for the Post-COVID world, so that you are prepared for any contingency that follows. This will ensure your money works harder than you and grows by taking advantage of the bull run. The secret sauce-find the right investment plans such as ULIPs offered by credible investment or insurance companies.