While the awareness around the importance of financial planning for a better future is rising, there still prevails confusion around how to go about it. Here is a 4-step guide that will help you plan your future.
While the awareness around the importance of financial planning for a better future is rising, there still prevails confusion around how to go about it. Essentially, there are 2 parts to financial planning. The first one is about safeguarding you and your loved ones against unforeseen circumstances, like loss of job or a medical emergency. The second aspect is to building corpuses to meet financial goals, like buying a house, taking care of your children’s education etc. Here is a 4-step guide that will help you financially plan on both these fronts.
Step 1- Creation of contingency/emergency fund
The first and foremost step, before you put away your hard-earned money to any other use, is creation of an emergency fund. This fund assists an individual in handling financial exigencies such as sudden job loss, an accident or severe illness. The size of your emergency fund must ideally be at least five to six times your monthly recurring expenses. Since the money that forms your emergency fund would be required instantly, on any particular day and time, it’s advisable to park such fund in high yielding savings account, providing interest rates as high as 7.25%. Savings accounts provide the highest form of liquidity and convenience, as the individual can withdraw the parked funds instantly, whether through ATMs or online banking as well. However, make sure that the size of your emergency fund must proportionately change in accordance with rise in your monthly expenses, upon events such as marriage, birth of child or lifestyle changes in general.
Step 2- Purchase adequate term and health insurance
The next step post creation of your emergency fund is the purchase of adequate term as well as health insurance. Both of these are essential to guard your family from uncertainty and cope up with high medical bills in case of any unfortunate events like medical emergency, death etc.
In case of your untimely demise, term insurance would protect your family financially by providing an assured sum to them, which would act as a replacement income. This amount would financially assist your family to continue repaying the existing debts, such as loans, and enable to meet life-goals like fulfilling your child’s educational aspirations.
Moreover, in comparison to the benefits and cover amount offered In return by term insurance, the premiums are very low, making their purchase all the more necessary. Ensure you purchase a term insurance amounting to at least 10-15 times your current annual income, and increase the cover as and when your income rises.
Apart from term insurance, it’s vital for each individual to purchase health insurance to tackle rising medical costs. Do not solely rely on your savings or employer’s health policy, since a single case of hospitalization is capable of wiping off your entire savings. If you have a family, consider purchasing a family floater plan and get your parents, spouse and children included in it. You may even choose a top up medical policy to cover high medical costs in case of disability or accidents.
Additionally, premium paid towards term insurance qualifies for tax deduction under section 80C, whereas, premium paid towards health insurance for yourself as well as your parents can be claimed for tax deduction under section 80D of the Income Tax Act.
Step 3- Investment to fulfill short-term goals
Short-term goals are usually the ones which are to be achieved within a few months or may be within the next 1-2 years, such as a family vacation or saving for car’s down payment. All such goals would require investments according to investor’s risk appetite, financial position and expected returns. For achieving such short-term goals, consider investing either in fixed deposits providing returns as high as 9%,or debt mutual funds, which involve low to moderate risk, along with moderate one year returns, revolving around 7% generally.
Step 4 – Investment for medium to long-term goals
These refer to the goals which are to be realized in about three to five years or more, and usually include accumulation of corpus for child’s higher education and marriage, and building retirement corpus. To achieve these goals, merely investing in traditional investment avenues such as Public Provident Fund, fixed deposits etc. may not suffice, as they are unable to provide inflation beating returns, and may even fail to accumulate the required corpus.
Instead, equity mutual funds have been consistently outperforming other investment choices by a wide margin consistently, by providing inflation beating returns, along with the availability of a wide range of schemes and funds, such as ELSS for tax benefits. In case you are hesitant to invest entirely in equity, due to its risk factor, mutual funds also offer balanced funds as well, which involve a mix of both debt and equity, and are primarily aimed at balancing the risk-reward ratio for the investors.
(By Naveen Kukreja, CEO & Co-founder, Paisabazaar.com)