Financial Planning: baby steps with perspective

Ask, answer, and act!  In the previous article of this series, we saw that financial planning is an activity that ensures an individual and his loved ones can face planned/unplanned expenses at any point in time.  This defines a fiscally fit family.

Most people get interested in personal finance or begin their financial planning foray with an aim to ‘save tax’.

Unfortunately, tax planning is considered as a stand-alone exercise, to be conducted each year only after the annual note from the accounts section about deductions is received.

Buying the wrong tax-saving product without carefully evaluating the purpose, chasing after instruments with ‘maximum return’, low lock-in period etc. can prove extremely harmful.

Financial planning is a journey.  One that entails constant learning, scrutiny, and adaptation.

We simply cannot buy a tax-saving pension plan or children’s education plan and hope to achieve our goals by simply the necessary premium.

In order to have enough money for all our immediate and future financial goals, we will need to get the basics right.

Aristotle the Greek philosopher is supposed to have said (2500 years ago!),

‘Well begun is half-done’.

So let us make an attempt to begin and hopefully being well.

Here are few baby-steps that an individual should follow before purchasing any financial product – tax-saving or otherwise.

Unification: Money flows in and out of our life in several ways: salary, rent received, rent paid, EMI, dividends, premiums, etc. Let us recognize that all of these can be organized into:

Cash received
Expenses
Debt
Cash available for investment

This classification brings about a sense of order. For decent fiscal health, the middle two categories must be kept as small as possible relative to the outer two categories.

Risk: The simplest definition of risk is the lack of money when you need it.  This can happen two ways.

• Absence of money – loss encountered because of a bad investment. For example, choosing an instrument with fluctuating returns for short durations.
• Absence of value – the money you have may have lost its value because the cost of what you need is higher than anticipated, thanks to inflation. For example, choosing an instrument with an assured return and unfavourable taxation for long durations.

List your expenses

• Pleasant expenses.  What you need this year, the next, 5 years from now, 10 years from now, when your children are born, take a coaching class, leave school, get married, after you retire etc.
• Unpleasant expenses. Now this requires some dark imagination …. a lot of it! Think of all the bad things that can happen you and your family. Death of the breadwinners, hospitalization, loss of income due to any possible reason, sudden/emergency expenses – appliance breakdown, sudden increase in monthly expenses due to expensive medication …
• Trust me, darker your imagination the more secure your financial life can be, provided you follow it up with reasonable and logical action.

Ask & Answer:
Stare at your expenses list and ask what you have done about each entry.
Can you handle the hospitalization of a family member whether you work or not?
Will your family be independent if you drop dead this second?  More questions can be found here
Against each entry, mark the kind of risk involved – loss of capital (absence of money) or inflation (absence of value)

Once these baby steps are completed, choosing the right investment, tax-saving or otherwise will become obvious to you, as we shall see in the next part.