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Foremost, ask yourself this question - Why should I invest / Why do I need an investment
plan?
Reality Check
Undertaking planned investments
Advantages of financial planning
Creating a financial plan
Keep in mind…
Reality Check
Few of us ever adopt a planned and systematic approach to investing. The approach has always been largely ad hoc in nature. For instance, most of us wake up in the month of March every year in order to primarily save taxes and consequently make investments that give us a tax break and help us to reduce our tax liability.
But, are these investments aimed at realising your long-term financial goals? Most probably your answer is a ‘No’. This simply implies, that there is no reasoning and purpose backing up your investments. And, this will, in turn, leave you totally directionless as far as creating financial security for you is concerned! Therefore, in order to attain your long-term financial goals you need to undertake a logical and a planned approach to investments.
Undertaking planned investments
To adopt a systematic approach towards investing, it is very important to undertake a financial planning exercise.
Financial planning involves setting and estimating financial goals and managing your income, expenses and wealth in order to be able to achieve these goals.
Advantages of Financial Planning
It not only helps you combat inflation by catering to the rising costs of living, in the long term, but also enables you in meeting higher standards of living. Financial Planning enables you in meeting specific financial goals from time to time while also reducing your tax burden.
Generally, an individual’s life can be broadly divided into three phases:
(1) Childhood and education (birth to about 22 years of age),
(2) Earning age (approximately between 22 years and 60 years) and
(3) Retirement (60 years to death).
Thus, in approximately 38 years of your earning life, you will have to provide for approximately 63 years of your post education life (assuming your life span is up to 85 years of age).
Additionally during the earning years, over and above your regular living expenses, you have to take care of some significant life events such as children’s education, marriage, buying a home, etc.
Creating a financial plan
Financial Planning is a step-by-step process and involves the following:
Step 1 - Identifying your goals and placing a time frame and money value to them.
Step 2 - Estimating your earnings/receipts during your lifetime - For this, you need to consider all your income streams – earnings from your employment or business/profession as well as returns generated from your present investments. While computing your investment income, you need to take into account inflation. Inflation eats into your investment income and lowers the ‘real return’.
Step 3 - Estimating and coping with the financial gaps (the difference between your financial needs and your incomes/receipts) - This situation can be addressed be either re-aligning the cost of your goals downwards so that your financial plan is compatible with your earnings capacity or undertaking a more aggressive investment strategy entailing greater risks but also earn higher returns. Alternatively, you can save more to generate higher wealth in the future.
Step 4 - Understanding your investment risk personality - Before making any investments, you need to assess your risk personality to understand the amount of investment risk you are capable of tolerating.
Step 5 - Investing based on your risk personality. - Your risk personality will determine your asset allocation i.e. how much you should allocate to equity and debt.
Step 6 - Reviewing your financial plan - In order to make the plan successful, you need to constantly review and monitor it, to provide for the changes that take place in your life.
Keep in mind…
Each individual will have his/her own individual financial plan. The process of organized planning and investing is not complicated. All we need to have is the right framework, discipline and a clearly chalked out strategy. You can take each step at a time but what is more important is to make a start.
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