Financial Planning: Basic Things to Get in Place Before You Start Your Financial Planning Journey

What Is Financial Planning?

The process of financial planning involves take a broad view of an individual's current finances and laying a roadmap for securing the future. It consists of assessing the current financial resources and allocating a part of them towards financial goals to achieve them. It is an ongoing process of evaluating the progress of existing financial goals and accommodating new goals as and when they arise.

Steps in the Financial Planning Process

Some of the steps in financial planning include the following.

1.  Assessing the individual’s current finances and making a cash flow statement and networth statement. Preparing a budget for the allocation of income towards expenses and investments. 
2.  Building and managing an emergency fund
3.  Buying term insurance for family bread earners, health insurance for all family members, and general insurance for assets like house, vehicle, etc.
   
4.  Setting financial goals, making a goal plan for every financial goal, implementing it, and tracking it till it is achieved.
   
5.  Making sure all the investments are tax-efficient
   
6.  Adding nomination for all financial products, and make a will to ensure a smooth transfer of all assets to intended beneficiaries after the owner’s passing away.
   

Now that we understand how to do financial planning, let us look at the types of financial planning.

Types of Financial Planning

Comprehensive financial planning addresses all the financial requirements of an individual. However, within that, an individual can do different types of financial planning. Some of these include the following.

1) Cashflow Planning

It involves adding all cash inflows and allocating them towards expenses, savings, and investments. You can do it through a budgeting method like 50/30/20 budgeting. It allocates 50% of your income towards needs, i.e. essential expenses, 30% towards wants, i.e. discretionary spends, and 20% for savings and investments towards financial goals.

2) Insurance Planning

It is essential for all family bread earners to have life insurance protection. You can buy a term life insurance plan as it can give you a bigger cover at a low premium. All family members can be covered under a family floater health insurance plan.

3) Investment Planning

You should make SMART (specific, measurable, achievable, relevant, time-bound) financial goals. Investment planning involves making a plan to achieve goals. The process of how to make a financial plan involves taking the current cost of the financial goal, calculating the future cost when the money is required, calculating the regular amount to be invested, starting the SIP plan, and tracking the progress till the goal is achieved.

4) Retirement Planning

Retirement planning involves building a retirement fund that can sustain an individual during their retirement years when the active income has stopped. The fund considers the impact of inflation and the growth in investment during the retirement years. It ensures the individual is financially independent and doesn’t have to rely on their children or others to meet their living, medical, and other expenses during retirement years.

5) Tax Planning

While investing towards financial goals, you should make sure you avail of maximum deductions available under Section 80C and other sections of the Income Tax Act. Similarly, you should make sure the maturity/redemption proceeds are either tax-free or entail minimum taxation.

Expert Tips on How to Make a Financial Plan 

If you are starting or have started your investing journey recently, some financial planning tips you should consider include the following.

1. Start the journey as soon as you get your first income. The sooner you start, the faster you will reach your financial goals.
2. While making your financial plan, consider the impact of inflation on the future cost of your financial goals. Inflation is a silent monster that erodes the purchasing power of your money.
3. Invest for the long term to benefit from the power of compounding.
4. For long-term goals, invest in equity mutual funds as they have the potential to give inflation-beating high returns and create wealth for you.
5. Rather than taking a do-it-yourself (DIY) approach, seek the help of a qualified and experienced investment expert to make a financial plan for you.

Why Financial Planning Is Important?

Financial planning is important as it helps you identify your financial goals, quantify them, plan, invest, and track them till they are achieved. Once you identify the financial goals, you can categorise them into short, medium, and long-term goals and priortise them if required. If financial resources are inadequate for investments, financial planning helps identify where you can cut expenses and channel the savings towards investments. It also helps to save taxes through various exemptions and deductions under various sections of the IT Act.

Basic Things to Get in Place Before Starting Your Financial Planning Journey

Before you embark on your financial planning journey, some basic things to get in place include the following.

1) Financial Health Check

You should always start with a financial health check which tells you your current financial position. It analyses cash inflows and outflows, assets and liabilities, etc. While doing a financial health check, you should look at three ratios.

Reserve to surplus ratio: It is the percentage of income that you are not spending. To start with, your reserve to surplus ratio should be at least 20%. If it is less than 20%, you need to analyse your expenses and check where to cut down. If it is at 20% or slightly higher, over a period of time, as your income increases, you should try and take the ratio higher. The higher the reserve to surplus ratio, the better.

Savings to surplus ratio: In the above section, we saw how you should work towards a good reserve to surplus ratio. However, just having a good reserve to surplus ratio is not enough. You should invest this money towards your financial goals. Aim for a savings to surplus ratio of more than 75%. Investing through the systematic investment plan (SIP) mode ensures that savings are automatically channeled into investments.

Debt to income (DTI) ratio: The DTI ratio measures the percentage of income going towards paying debt. A higher DTI leaves less money for expenses and savings. If your DTI is higher, you should work towards bring it down to create room for savings and investments. 

While the above three ratios are important, the financial health check can involve other personal finance ratios.

2) High-Cost Debt Repayment

If you have any high-cost debt, you should focus on repaying it first before getting started with investments towards financial goals. For example, the interest rate charged on credit card outstanding carried forward usually ranges between 3 to 3.5% per month (36 to 42% per annum). Debt at such high interest rates can make it unsustainable. Hence, you must focus on repaying it first.

3) Emergency Fund

You should always maintain an emergency fund to tide over any unexpected or unplanned financial emergencies. The fund may have an amount equivalent to 3 to 6 months of expenses.

Getting the Basics Right Will Help You Excel in Your Financial Planning Journey

The financial check will ensure you save sufficient money and channel it towards investments. A low DTI ratio will ensure your debts are under control. An emergency fund will ensure, the money meant for financial goals is not diverted during times of financial emergency. Thus, getting the above financial planning basics in place will lay a strong foundation for your financial planning journey ahead.

FAQ's

Why Should One Get a Personal Financial Plan?

Everybody’s financial goals are different. Hence, a generic financial plan will not meet everybody’s requirement. A personal financial plan is customised to an individual’s financial goals.

How Can Financial Goals Be Categorised?

Based on the time horizon to achieve them, financial goals can be categorised into short (to be achieved in 3 years), medium (to be achieved in 3 to 7 years), and long-term (to be achieved beyond 7 years) financial goals.

How Frequently Should a Financial Plan Be Reviewed?

You should sit with an investment expert and ideally review the progress of the financial plan once every six months to a year.