With growing awareness on managing personal finances, people have started to see the world through a new lens. They are able to create a meaningful difference, never before envisioned. This transformation is initiated from the knowledge that they aspire to gain. They have taken charge of their lives by overcoming the resistance of changing their existing financial behaviour. It is a process of identifying options and changing the entire approach to managing personal finances from random moves to planned ones.
Breaking the traditional pattern
Even though one knows one is not getting the desired results, breaking a pattern of existing financial management may not always be easy as you grow up doing the same thing. Changing your habit to gain more financial control may bring up some resistance within you to create behaviour to the things you have taken for granted each day.
Identifying financial milestones
Every individual needs to spread the available and planned financial resources over their lifetime to maintain a consistent living standard. To figure out the sustainable living standard, it is necessary to identify various milestones coming up in the lifetime. It is important to track the number of people in the family, expected earnings, regular and major spends areas, social security benefits, and other future income sources. Also important are fixed financial obligations which are paid outside the calculation for a sustainable living standard, which includes debt repayment, housing payments, special expenses like paying for a child’s college education, taxes, and insurance premiums. Assumptions about investment returns are also necessary to track the growth of financial assets and the asset income generated on an annual basis. It is important to make assumptions about future earnings and investment returns on a year-by-year basis. This approach provides a clear framework for evaluating different decisions in terms of the impact on sustainable lifetime standard of living.
Stages of the Financial Life Cycle
Essentially there are three phases of the financial life cycle
1. Accumulation phase – achieving lifetime goals such as buying a house, saving for children’s education, retirement while balancing between living for today and planning for tomorrow. This is the phase that needs utmost attention to detailing and laying a strong foundation for a healthy financial life ahead.
2. Retirement Phase – to generate your desired income level and maintain level of assets to accomplish goals and have sustainable income during retirement. The focus changes from wealth creation to wealth preservation.
3. Estate or Distribution and Gifting Phase – having your accumulated wealth dealt with at death exactly as you wish. This phase is actually a work in progress throughout the asset and retirement phases.
Each stage in a life cycle needs focused attention depending on financial proprieties, means to achieve them, acting on the plan and keeping a constant review mechanism to ensure that you derive the desired results. The variables in the entire process may change with the core remaining the same. So the question is how do we get this transformation?
Transforming saving habits
In one experiment, researchers split a larger group of people into two separate groups. They asked half of the subjects whether they thought they could save 30 per cent of their income. Only half of this group said yes. But when they asked the other group whether they could live on 70 per cent of their income, nearly 80 per cent said yes.
There is always potential to save but it is important is to know when and how. The answer to this is to have a thoughtful personal budget. Establish your income, identify your mandatory expenses and keep a check on your voluntary expenses that can be avoided. It forms a significant part of our daily spending habits. This will help in optimising the savings and all you need to do is invest before you start spending. These small investments will help you build a significant corpus to achieve few financial milestones as well.
Envision financial milestones
Identifying goals and setting clear priorities is very critical in the entire life-cycle management. These goals need to be written down clearly taking into account various aspects of the life. The priorities may change with a change in income – expense patterns, an event like the wedding, adding or reducing income source for the family. Important cash flows like loans, insurances, education cost etc. should be factored in while making the comprehensive plan. Identify the existing investments that can help you achieve these goals and invest in the spread of assets to balance the risk and return factor.
Financial planning is now understood by many and it should be implemented as a discipline. An important element here is to seek flexibility to choose the investments, unbiased advisory, regular monitoring the progress and making a correction in case of changed circumstances.
Every individual has his or her own risk tolerance level. One must gauge the same and systematically build the portfolio in diversified assets that suit the risk-taking ability and the duration to achieve the milestones. Tracking the investment progress and having an exit strategy should coexist . An individual will make real money only when he sells. Review the portfolio performance periodically and take actions on what is not getting you enough returns.
Investing systematically is critical in the entire process of transforming the habit of investments.
Other financial hygiene
Setting up a provision for the emergency funds, planning systematically to optimise your taxes and insuring and covering to protect you and your family against odds of loss of income and health are the key factors to maintaining your financial hygiene.
These actions should be accounted in a comprehensive way. The holistic approach to the personal financial management is the key to an efficient transformation from where you are to where you should be.
The author is Founder CEO, 5nance.com