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 Chapter 2: Financial planning
In the previous chapter, you learned about the basic concepts of investing such as inflation, real return, reinvestment, and compounding. This chapter introduces you to the concept of financial planning and its benefits.

What is financial planning?
Financial planning is the process of developing a personal roadmap for your financial well being. The inputs to the financial planning process are:

  1. your finances, i.e., your income, assets, and liabilities,
  2. your goals, i.e., your current and future financial needs and
  3. your appetite for risk.
The output of the financial planning process is a personal financial plan that tells you how to use your money to achieve your goals, keeping in mind inflation, real returns, and taxes.

In short, financial planning is the process of systematically planning your finances towards achieving your short-term and long-term life goals.

Life goals
Most people nurture dreams of owning a bigger house or car, exploring the world, giving their children the best possible education, a blissful retirement, etc. Basically, these dreams are life goals. Consider this example.
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Mr and Mrs Bhanot, 35 and 32 respectively, have a three year old daughter. Both work in private sector companies. Mr Bhanot plans to retire when heís 50. From their current one bedroom rented suburban Mumbai apartment, the Bhanots hope to move to their own two bedroom apartment costing around Rs 25 lakh within the next five years. They own a small car, for which they have availed of a loan. Mr Bhanot reckons that he will need Rs 15 lakh for his daughterís higher education 15 years later. He also wants to build a corpus of Rs 75 lakh for his retirement.

While distinguishing short term goals from long term goals, you must keep in mind that, as a general rule, any life goal that needs to be met within five years can be considered as short term. Beyond that, any other goal can be classified as long term. By this classification, the Bhanotsí goals can be classified as follows:

Short Term Goals Long Term Goals
2BHK apartment Daughterís higher education
Retirement corpus


Using a similar yardstick, you may classify your own life goals. Each of them needs financing. How you plan your finances, to have the right amount at your disposal at the right time, is what financial planning is about.

Importance of financial planning
Can you manage without financial planning? Many people do, but they may findóoften when itís too lateóthat they donít have the means to achieve their life goals.

For example, people today realize the importance of living life to the fullest. Consequently, many opt for early retirement from full time jobs, as compared to a few decades ago, when most people worked until the maximum retirement age of 58-60 years.

The average person can, today, expect to live a healthy life well into his or her seventies or eighties, which means that retirement life is almost as long as working life. Financially, it implies that savings (after taking into account inflation) should be enough, not just to maintain the same lifestyle for almost 25-30 years, with no new income, but also to take care of medical expenses, which are usually high the older a person gets. Planning for all this is a tall order for anyone. Thatís why itís critical for everyone to plan their finances from an early age.

Benefits of financial planning
Hereís a list of the benefits that a well chalked out financial plan can bring about:
  • Helps monitor cash flows and reduces unnecessary expenditure.
  • Enables maintenance of an optimum balance between income and expenses.
  • Helps boost savings and create wealth.
  • Helps reduce tax liability.
  • Maximizes returns from investments.
  • Creates wealth and ensures better wealth management to achieve life goals.
  • Financially secures retirement life.
  • Reviews insurance needs and therefore also ensures that dependents are financially secure in the unfortunate event of death or disability.
  • Lastly, it also ensures that a will is made.

Financial planning can help you achieve peace of mind since:



The financial planning process
Hopefully, youíre now convinced that you definitely need a piece of the action. What next? When you actually get right down to it, financial planning consists of a series of steps. This section examines each of these steps in detail.

Step 1: Identify your current financial situation
Sit down with all the earning members of your family and gather all information about your sources of income, debts, assets, liabilities, etc. This gives you a picture of your current financial situation.

Step 2: Identify your goals
Ask each member to list what they think are current and future family goals. Prioritize each goal by establishing consensus and put a time period against each, i.e., when will you need the finances to achieve that goal. If possible, quantify each goal. This exercise enables recognition of short term and long term goals, and how much money you need for each.

Step 3: Identify financial gaps
Once you know where you stand financially, and where you want to be, i.e., how much you have or can expect regular sources of income to generate, and how much you need to fulfill various goals.

A simple calculation gives you an idea of the shortfall. This is important, because, identifying the right investments to cover the shortfall depends on you quantifying the income from your investments.

Step 4: Prepare your personal financial plan
Now review various investment options such as stocks, mutual funds, debt instruments such as PPF, bonds, fixed deposits, gilt funds, etc. and identify which instrument(s) or a combination thereof best suits your needs. The time frame for your investment must correspond with the time period for your goals.

Step 5: Implement your financial plan
Itís now time to put things into action. Gather necessary documents, open necessary bank, demat, trading accounts, liaise with brokers and get started.

Most importantly, start investing and stick to your plan.

Step 6: Periodically review your plan
Financial planning is not a one-time activity. A successful plan needs serious commitment and periodical review (once in six months, or at a major event such as birth, death, inheritance). You should be prepared to make minor or major revisions to your current financial situation, goals and investment time frame based on a review of the performance of your investments.

Financially challenged individuals who feel this is just beyond them, can of course always consult professional financial planners, who takes one through the whole process. Being a long term commitment, financial planning goes on until one meets his last goal. It is also a personal decision, which implies that a person must select someone who he is comfortable with, and can build a long term relationship that is mutually beneficial.

Tips for making the most of the financial planning process
  1. Start now. Even if you are in your mid thirties or forties, itís better to start now than dawdle for another five years. Every day counts.
  2. Be honest with yourself. Seek help when needed.
  3. Set sensible, measurable goals for yourself. Be realistic in your expectations of the results of financial planning.
  4. Review your plan and financial situation periodically and adjust as needed.
  5. Always review the performance of your investments; pull out if needed and reinvest the money elsewhere.
  6. Be hands-on. Itís your money and no one else will do your work for you.


Features of a good financial plan
How do you evaluate the quality and effectiveness of your financial plan? Well, hereís a checklist you can use.
  • Does it indicate your current financial situation?
  • Does it list out all your goals in measurable terms?
  • Does it lay out an investment strategy?


If professional help is sought, your financial planner will ensure that your financial plan also contains the following:
  • List of possible risks and a risk management plan.
  • Expected returns from each investment.
  • A mapping between the investments and goals, i.e., how each investment helps you achieve your goals.
  • Details of one time and recurring fees charged by him.


If you noticed, a professional financial planner helps you identify potential risks associated with various investments and explains how those risks are managed. What risks can you expect on your journey to financial freedom? Stay tuned. Chapter 3 will prepare you for all that and more.




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