Financial planning is one of the most important tools for reaching your financial goals; especially your long-term goals. However, your resources and means are always limited, but your dreams are infinite. Can financial planning alone bridge this gap? The answer is that you need to go beyond just planning your future and allocating your investments. Nothing works on auto-pilot. Hence, you need to consciously align your goals with your finances. Here is how you do it.
Take a systematic approach; it works best in the long run
We have heard of the merits of systematic investment planning (SIP). Rupee cost averaging is one of the major merits of systemic investing which leads to creating wealth in the long run. Over time, the volatility evens out in your favor. However, there is a more fundamental logic to the systematic approach. You inflows are normally periodic; normally on a monthly basis. When you design your SIP outflow also on a similar periodicity, there is no liquidity concern that you really have. Further, a systematic approach impels you to squeeze the maximum out of your savings and that adds up in the final analysis.
Make money work really hard
How exactly do you make money work hard? Basically, you have to make the power of compounding work in your favor. The earlier you start investing the longer you money works effectively for you. The power of compounding works best when you stay invested for longer. Secondly, ensure that you are into high risk assets like equities. Only they can ensure healthy returns for you. When you compare your saving capacity and your goals, they may appear to be prima facie misaligned. This alignment is worked out with the help of time and risky assets.
Be conservative in estimating the inflows
Your inflows in the form of salary, commissions, and investment returns are going to grow over time. But, don’t expect the growth to be a secular uptrend. There are going to be negative surprises and macro shocks. If equities have given 15% annualized returns, then work your goals with the realistic assumption that these returns could come down. Further, debt market returns have been consistently coming down over the years. A lot of Americans did not see any income growth over the five year period between 2009 and 2014. These are real risks, and you need to work them into your calculations.
Keep a margin for outflows
Your planned outflows may look perfect on paper today, but they may change drastically. For example, inflation may go up sharply and make a mess of your cost estimates. Certain costs such as education and healthcare have gone up exponentially in the last 20 years. Then, there are shifts in your standard of living and you unconsciously end up overstepping your budget. Quite often, even as your plan is in progress, you don’t adjust your lifestyle with your volatile inflows. These are real problems to be avoided if you want your finances to stay aligned to your goals.
Keep a tab on regulatory and tax changes
This is not entirely in your control. For example, the 10% capital gains tax on equity funds imposed by the Budget 2018 means that you either need to plan for 10% higher savings or be satisfied with 10% lower corpus. Similarly, when the definition of long-term gains on debt funds was shifted from 1 year to 3 years in 2012, it ended up putting a huge tax burden on bond fund investors. This is why, Plan-B becomes essential in these cases.