Financial planning is often looked at, or considered to be done, at a later stage in one’s life. This is a myth that needs to be busted early on, since there is no time like the present to start investing and saving for a better future. The earlier one starts to properly manage one’s finances, the bigger the corpus at the end of the period.
Fix the goal
The first step to planning your finances is to list out one’s goals according to priority and time frame, as this will give you a clearer picture of how much needs to be saved and in what time. For example, saving for a marriage or retirement are two different goals and each have different time horizons and, hence, different investment requirements.
Once your goals are fixed, one needs to make a budget taking into account all your expenses and income. A budget is nothing but keeping spending under control and ensuring that the monthly expenses are lower than the monthly income. It is very important to understand and monitor one’s cash flows, i.e., from where the cash comes in and where it gets expended.
Prepare a budget based on past expenses and predicting the probable future income. Also, it is important to factor inflation into the budget. If your income exceeds your expenses on a consistent basis, your financial plan is working for you — else it is time to revisit the plan.
Earlier you save the more the benefit of compounding at a later date. For example, if a 25-year-old saves Rs 5,000 per month at 10% interest, his corpus will be around Rs 1 crore when he is in his mid- 50s. On the other hand, if one starts saving Rs 5,000 a month at 30 (with the same 10% interest), the corpus after 30 years will only be Rs 60 lakh. Hence, it is advisable to start allocating money towards savings and investments as early as possible.
Longer investment horizons yield better returns. While making the financial plan, it is advisable to invest (and stay invested) for as long as possible. For example, if you have a financial goal of reaching Rs 50 lakh as your target amount in 10 years at 14% rate of interest, you need to invest Rs 18,853 every month for 10 years; however, if the time period is increased to 15 years, you need to invest only Rs 8,316 every month. This is the power of compounding.
Invest via SIP
While investing, it is best to use the systematic investment plan (SIP) route. By investing via a SIP, one gets benefits from both an up-market as well as a down-market. Investors purchase more units when the market falls, while the price per unit increases in rising markets, therefore the average cost per unit is lower than a lump sum investment.
An important aspect of building wealth is tax planning. One should consult a tax expert to see the best investment and savings avenues through which one can save on taxes.
This is another area that is often neglected. Ideally, one should have a minimum of 10 times their yearly income as the covered amount, i.e., if one’s annual income is Rs 10 lakh, one should have a minimum cover of Rs 1 crore. Other factors such as age, medical condition, etc, also play a role in deciding the amount of risk cover one should have, which will ensure financial stability of your family.
It is imperative to keep between three and six month’s income in a savings account. This should be used only in emergencies and kept aside from other investments and savings. One can use this to fall back on in case of any unforeseen situation that leads to loss of monthly income.
The writer is CEO & founder of Right Horizons