Seven steps on managing your personal finance
A good financial plan begins with awareness and understanding of basics such as risk, return, liquidity, taxation, etc. So, it is always a good idea to learn what these concepts are and how they apply to your life. A financial plan is also specific to each person because the needs and goals of Person X cannot be the same as the needs and goals of Person Y. So, ask yourself three questions before you start making your financial plan.
First, what is the period for which you are making this financial plan? (For example, is this to plan your retirement, which will be longer term, or to start your business after leaving your job, which might be comparatively shorter).
Second, is your family included in this financial plan? (As we progress through our life, some of us choose to get married and have children. Therefore, how extensive is your financial plan and does it include provisions for your family?)
Finally, most importantly, what is your risk-return profile? (Risk-return is usually understood as the amount of risk you are willing to take for a target rate of return; some of us prefer to take lower risk and hence value capital safety, others are willing to take higher risk with their capital in the hunt for potentially higher returns).
Once you have comprehensively answered the questions, these are seven steps in financial planning:
1. Income: Make a list of all sources of your income, from salary to income from investments (including basic things like interest on savings bank accounts, on fixed deposits, etc)
2. Expenses: Make a list of all expenses and classify these on the lines of recurring and non-recurring, or essential and lifestyle – choose a classification that makes sense to you. So recurring (or essential) would be expenses on, say, rent, groceries, etc. and non-recurring (lifestyle) could be, say, vacations, indulgences, gadgets, etc.
3. Savings: Warren Buffett famously said ‘do not save what is left after spending, instead spend what is left after saving’. Thus, after making a list and estimates of income and expenses, you will get a fair idea of how much you are saving. Your savings rate must be aligned with your goals, otherwise eventually you will have to adjust on either one of them.
4. Emergency corpus: This is a critical aspect of financial planning since an emergency corpus helps you to survive tough times. Depending on your needs and wants, you must keep aside a sum of money for emergency expenses.
5. Insurance: Medical (health) insurance is necessary for all of us, and life insurance is critical for replacing income for people dependent on our income. Choose coverage as per your specific needs.
6. Investments: Once you have sorted through important aspects such as savings rate, insurance, and emergency corpus, you are now ready to plan your investments. This is where your risk-return profile and liquidity requirements will come in handy, for example, if you have a very low appetite for risk, you should be careful in allocating your money between equity and debt. Or, if you need to plan for a short-term goal (like, say, a foreign vacation), you should invest in instruments that are appropriate for that time frame.
7. Asset allocation: Experts believe that returns on a portfolio depend very importantly on asset allocation. Thus, instead of being obsessed with finding the next multibagger, understand how to allocate your capital across various categories of assets (such as equity, debt, etc).
These seven steps are broad indications on how you can start planning your finances. Remember that a financial plan is not a static document so keep reviewing your financial plan once in a quarter to ensure that your goals and asset allocation are aligned. Major external events (like a stock market crash or change in taxation policy) and internal events (a life event like marriage or having children) can also have a major impact on your financial plan. Finally, always consult a financial advisor for help and guidance in making your financial plan. All the best for your journey!
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