As you plan your journey before you start a tour, the journey of investment also begins with financial planning.
As you plan your journey before you start a tour, the journey of investment also starts with financial planning. You should make your financial plans as soon as you start earning, as saving is as important as spending to fulfill the life goals and to keep the spending ability intact in future.
The first step of financial planning is to determine the need of investments by identifying the financial goals. The goals may be higher study for self, own marriage, honeymoon trip, buying a car, buying a house, foreign tours, child education, marriage of son/daughter, building retirement corpus etc.
Once the goals are identified, it has to be determined how soon or later each goal to be fulfilled. Once the time gap is estimated, each goal has to be quantified in monetary terms taking into consideration the present cost and rate of inflation. The rate of inflation may vary from goal to goal as rate of inflation in education sector is very different from the rates in automobile sector or real estate sector and so.
After the goals are quantified, you may select investment avenues to reach the goals on time respectively, by taking minimum possible risks. Shorter the duration to reach a goal, lesser risk you may take and vice versa.
For example, you can’t take any risk while parking your money for emergency, while to build you retirement corpus, you will have enough time to plan your exit and withdraw money when the return is high enough.
It’s mainly due to duration and urgency, you need to select different investment avenues depending on their risk perspective.
Depending on the risk on capital invested, investment avenues may be categorised as Post Office savings, bank fixed deposits (FD), debt mutual funds, equity mutual funds and direct equity. Once the risk profiling is done, you have to see how liquid the investment options are, before finalising the options.
Liquidity is important because you may have to withdraw emergency and short-term money in quick notice. So, while Public Provident Fund (PPF) is safest mode of investment, you can’t choose it to park your emergency fund, simply because you may fully withdraw your investment only at maturity after 15 years, with partial withdrawal option beginning only from seventh year. Hence, you have to choose either a liquid fund or a bank FD to park for your contingency fund.
You may, however, choose a low-risk short-term investment option to park your long-term money, but you will have to compromise on return, which may either need exorbitantly high investment or missing the goal.
But before you start investing, you first need to transfer your own life risks by taking insurance cover, so that your dependents don’t miss out the financial goals and maintain the standard of living in case of any unfortunate mishap.
So, you do need to choose different instruments to fulfill different financial goals, like – liquid fund or FD for emergency fund, insurance to transfer risks, debt funds for short- and medium-term goals, diversified funds for medium- to long-term goals and equity for very long-term goals. Even for two financial goals of similar durations, better not to mix investments and choose two separate funds.