A Money Roadmap

Financial planning is the process of charting out the money course of your life. It is a two-step process: first, you protect your current financial position; two, you build wealth towards financial goals, keeping the tax impact of investment decisions in mind.

The financial planning approach takes a ‘big-picture’ look at your life-cycle of income, expenses, saving, investment, taxation, housing, insurance and estate planning needs. The financial planning approach asks and answers questions like: how much insurance do I need? How much do I need to save today to meet all my future financial goals? In which instrument(s) should I put my savings? How does my tax position get affected by my investment decision? What is a good strategy to pass on my assets to my family after I am gone? In short, the planning process recognises that each person has a unique situation and needs a unique financial plan to get to his unique goals. The earlier one-size-suits-all approach is abandoned in favour of a customised and strategic way to plan a person’s money life.

But why are we talking of financial planning today and not earlier? Simply because our financial market was not mature enough for the planning approach. Ten years ago, you would go to a government-owned institution for most of your saving, investment and protection needs. You would bank with the State Bank of India, invest in fixed deposits of public sector banks, buy insurance from lic and gic, buy mutual fund units from uti.

Today, you can bank with a foreign bank, invest in private sector mutual funds, even buy insurance from a private company. When dealing with government-owned institutions, you got an unsaid promise that even if the institution failed, your money was safe. When you go to a private player, you know no such guarantee exists and you evaluate the decision on the basis of the risk you’re prepared to take for the returns you seek.

You are doing this because the markets have changed. The government has realised that it cannot carry the weight of interest payments for much longer and cannot hope to assure returns to an increasing population. It is gradually withdrawing its stranglehold and its responsibility from the market, and allowing private players to offer products and services. This means that the individual can no longer depend upon the government to provide gilt-edged returns. The responsibility of managing money is increasingly shifting to the individual. This is why you have to move from an ad-hoc product-centric approach to a more structured approach that takes into account your unique financial situation.

Financial planning is a six-step process—quite like a journey you take.

Step 1: Where am I?

Or current assessment. When you begin a journey, you know where you are starting from. Similarly, you need to find out your current financial position. What is your total income—salary, business income, investment income, any other? What are the total liabilities—car loan, home loan, credit card loan, any other? How much is your tax liability? How much do you have in savings and other investment instruments? How much insurance do you have? Only when you have a grip on your current financial position can you begin to predict where you will go. The starting point is as important as the destination.

Step 2: How do I protect my current position?

Or buying protection. Just as you ensure that your car is roadworthy before you set out on a long journey, so also with your financial life. Before you set out to improve your financial position, you need to protect your current place on the ladder of growth. You need to ensure the safety of your current assets, net worth and income stream. When you use the financial planning approach, insurance will move from being an instrument that gets you a tax rebate to being a tool that protects you from unpredictable events that can ruin your financial life. You will insure assets like your home, vehicles and valuables against theft, fire or other damage. You will insure the principal breadwinner against premature death. You will insure the family against medical emergencies that may be too expensive to fund out of current income or savings.

Step 3: Where do I want to reach?

Or goal setting. Now you have to convert savings from a residual amount into a targeted amount. Generally, people earn an income, part of which goes to sustain their living expenses, and whatever is left is called savings. The planning process turns this on its head, and makes savings a target. When you make your annual investments, do you know what you are investing towards? Is there a goal in front of you? Planning gets you to answer this question. It makes you write down your short-, medium- and long-term financial goals. You said you wanted to save for your child’s higher education. Planning makes you write down how much you think you will need and in how many years. It makes you say: "I want Rs 5 lakh in five years to send my son to the US to complete his mba." You say you want to save for your ‘comfortable’ retirement. Planning will make you put an amount to your ‘comfort’ level and will make you forecast your approximate retirement age. It turns ‘comfortable’ retirement into: "I want to retire in 25 years in my ancestral home in Pune with a monthly income that is equal to Rs 20,000 a month in today’s rupees." Financial goals, once quantified and time-framed, look more real and achievable.

Step 4: What vehicle do I choose?

Or product choice. Once you fix the beginning and the ending points, the question becomes: how do I reach there? Take the car, a train or fly? The choice of the vehicle depends on your time and money availability and the feelings of safety and comfort you get in them. Although the plane will get you there faster, it is more expensive and the risk may be greater. Similarly, before you buy a financial product, you need to determine how much risk you can take and which goal you are saving for. For example, though two people may have the same time horizon and current position, they may choose very different instruments. One could be a 40-year-old person who is saving for his retirement and the other could be a 60-year-old who has just retired who wants to invest to fund his retirement. Both have a two-decade time-frame, but since the 40-year-old is accumulating, he should choose higher risk instruments like equity or property that can build wealth, while the 60-year-old should stick to lower-return and lower-risk instruments like debt products. Therefore, correct product determination is not an ad-hoc move-with-the-crowd decision, but depends on factors that may be unique to you like your goals, your current situation, your savings potential, the time you have for the investment and your risk profile.

Step 5: Do I need to pay toll on the way?

Or tax implications. Each investment decision you make will have a tax implication. Other things being equal, products that reduce taxes legally or defer to a low-tax year should be chosen. While products should not be chosen just because they give a tax break, the tax impact of products chosen is important. For example, when dividends of mutual funds became taxable, investors who were in the highest tax bracket should have shifted from a dividend reinvestment plan to a growth plan. Both reach the same end, but one has a higher tax implication than the other. So, an efficient financial plan will look at the tax implication of each financial decision. Budget 2003, for instance, has removed payment of long-term capital gains tax on shares bought after April 1. But that doesn’t mean every one jumps and buys equities—that decision should factor in the higher risk that goes with equities; only for a person comfortable with and equipped to evaluate shares does this tax break lend an added advantage.

Step 6: Do I need to take diversions?

Or plan modifications. You need to re-evaluate the plan as you go along. Your needs will change with time, as will your risk-return profile and your investment and insurance needs. For example, when your children grow up and move away from home, insurance needs go down and the savings potential suddenly goes up. This would mean a change in the way you invest. Or, if interest rates have fallen, you may need to change the instruments to maximise return. It is a good idea to revisit the plan at least twice a year to see if you are still on track.

Here’s a parting thought. You spend over 2,000 hours at work each year. You spend another 500 hours travelling to or from work. Another 150 getting ready for work. How much time do you spend on taking care of the reward of all these hours of work? Spend just an hour a week (or 52 hours a year) and see your financial life get on the fast track.

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A Money Roadmap

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