Components of a financial plan?
In the last few years, financial planning has emerged as the gateway to your financial future. Here we look at the components of financial planning and what it entails. We also look at the components of a financial plan in terms of the steps to achieve your financial goals in life. Where does financial planning start? Every person has goals in life and these goals have financial implications so they have to be planned for. For example, your retirement has to be planned, the education of your children in premier universities has to be planned, your home loan margin has to be planned and even a foreign holiday needs to be planned. Let us go ahead and look at are components of a financial plan?
Components of a financial plan?
Financial planning is not a one-time activity but a continuous process. One way to understand financial planning is to look in detail at the components of financial planning. The actual financial planning can be done with your advisor or you can also adopt a do-it-yourself DIY model using Robo-advisors. That choice is yours. However, that does not in any way change the components of financial planning. Here is a quick look at 7-steps that act as the components of financial planning.
Needless to say, there is no plan without clear financial goals so start with your financial goals. If you don’t know where you want to reach, it does not matter how fast you run or what strategy you adopt. The next thing about goals is to break up these goals into short-term goals and long-term goals. Typically, short-term goals are the ones you have to achieve in the next 3-5 years while long-term goals stretch from 10 to 25 years.
Once you have done the goals part, the next step is to look at your net worth, monthly budgets, and cash flows. They are the key inputs for your plan. Among the various components of financial planning, this is a preliminary but very important stage. Net worth is the total of your assets less your liabilities. Cash flows are your current earnings from salary, business, dividends, interest and break them into predictable and unpredictable sources.
You can never work your financial plan successfully if you are living under a mountain of debt. Having 7 credit cards and 4 personal loans is not the way to start. Too much debt also impacts your credit score, so keep avoiding high-cost debt and only borrow for creating assets like your mortgage loans.
We all dream of a comfortable life in our sunset years and therefore retirement planning has assumed a lot more important in the current context. Here you need to consider factors like health costs, cost of living, inflation, your ability to earn, life expectancy, etc. With better medical facilities, people are living longer and that is resulting in the need to make your corpus last much longer.
Do you have a contingency fund to fall back upon? There are so many contingencies you need to put up with. You could lose your job or get hit with an unexpected medical bill or may have to support an old relative. In such cases, an emergency fund can help you avoid tapping your long-term savings. It always makes sense to start by putting aside about 5-6 months of monthly spending in liquid assets like a liquid fund or a money market fund for safety, liquidity, and returns that are better than a savings account.
Don’t underestimate the need for insurance. Insurance is not just about life covers, but also about covering your health, assets, and even liabilities. As you get older, you may also want to consider long-term care insurance as well as disability insurance to protect you and your family if you are unable to work.
In India, estate planning is not given too much importance but with growing wealth and complexity, it is best to have an estate plan for the future. It covers how your assets would be distributed among your dependents and who will administer the estate.
Why Should you Make a Financial Plan
Having understood the components of financial planning, let us also look at why you should make your financial plan at the earliest. Here are some strong reasons.
- The financial plan helps you to stretch your money and achieve your long-term goals in life. It is best to do this with professional support to articulate goals and invest.
- Financial planning is timeless in the sense it is applicable at all stages of life. Irrespective of whether you are just getting started in your career or starting a family or you are in the middle of your career or approaching retirement, you need a plan to move things smoothly.
- Finally, remember that financial planning helps protect your family from the unexpected because you want them to be in a position to reach their financial goals if something untoward happens to your income or your investments.
What is Goal-Based Investing?
Whether you buy equities, bonds, insurance, or mutual funds, all these need to fit into a larger plan. In short, they need to fit into your financial goals; both short-term and long-term. You must not make random investments and instead map these with your various financial goals. Ensure that all your actions of buying equities, bonds, mutual funds, insurance, and even tax saving instruments are driven by your financial goals. That is goal-based investing.
Frequently Asked Questions Expand All
In fact, financial planning dictates that you must focus more on managing risk. Once you get your plan right and manage your risk, returns and wealth creation will follow.
There are no fixed charges but depends on your term sheet. Normally, there is an upfront fee and an annual maintenance fee based on assets under custody.