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Friday, October 22, 2010

3 Basic Steps to Financial Planning

Step 1 - Put your finances in order

We spend more than half our lives working and saving, but hardly spend any time planning on how to put that hard-earned money to work more effectively. So, how do you plan your financial life?

Put your (financial) house in order

Financial planning starts with a review of your overall financial profile, and not at investing. Before rushing to build an investment portfolio, you need to address the following issues:

Insure your health, life and assets

Start by protecting your family’s current lifestyle against events/expenses beyond your control. Buy appropriate insurance policies for your medical expenses, life and other important assets.

Repay high-cost loans

Paying credit card bills on time can save you more money in interest costs than most of your investments could earn you. Ditto for borrowings that cost you more than 15% pa. So, put high-cost loans behind you, and only then start building your investment portfolio.

 Put money aside for emergencies

Deploy some money in short-term investments that can be encashed on demand to help you tide over unforeseen needs and emergencies.

Draw up a savings plan

Income - Expenditure = Savings

Do not leave this equation to chance – make a savings plan. Put away as much as you can, as regularly as you can, aim to save at least 15% of your take home annual income.

Step 2 – Prepare to invest

Investment planning is simpler than you think, and more rewarding than you would imagine.

Your age and investment size does not matter, nor do you have do be a money whiz – just do it NOW. So where do you start?

Identify your financial goals

What are your goals? What are you saving for – A house? Child's education/ marriage? New car? World tour? Retirement? Quantify this in terms of amount of money needed, and time horizons.

Understand your risk profile

Depending on our income and needs, we all have different capacity for risk. We also have a different risk tolerance, based on our individual psychological make-up. Understand your risk profile and plan your portfolio accordingly.

Plan your asset allocation

Returns should not be your primary objective; you could end up taking more risk than you are financially/ psychologically capable of. It helps seek expert advice and create a portfolio with the right spread across asset classes to minimise risk of incurring a loss.

Step 3 – Start investing

The only thing worse than investing late is not investing at all.

Use the power of compounding

Compounding is the best reason for starting early. The sooner you begin investing the better – every day that you are invested is a day that your money is working for you.

Invest as per your needs

If you know you will need cash next year (down payment for a house, child’s college fee etc), opt for a shorter term, low capital risk investment (such as liquid/ gilt/ money market funds, bank term deposits or top-rated company deposits/ fixed income investment options).

Similarly, invest money that you will not need for 3-5 years in the stock market.

Evaluate your investing skills

Finding the right money manager for your investments is important. You could manage your money yourself, use professional money managers, or invest through mutual funds.

Financial planning is not about financial expertise and hard work. All it needs is the right approach and discipline.