Simple yet effective financial planning in 6 easy steps
STEP 1 - Write down your financial goals
The first (and often overlooked) step towards creating a financial plan is to understand and document your financial goals. Financial planning cannot be done effectively without quantifying and documenting real financial goals. Financial Goals may vary from person to person based on their life situation. For example, a person in their twenties with no dependents will have a different set of financial goals and may need to plan their finances differently compared to a retired sixty year old. A thirty-year-old with a family of four might have very different goals from the first two. Please write these goals down for yourselves. These could be "what-if" goals (life insurance, health insurance, emergency fund), short term goals (for example buying a home in 2 years time) or long term goals like for your retirement or an education fund for your children, twenty years down the road.
STEP 2 – Do some research
There are a wide variety of investment options available in the market today. You have the power to choose whichever ones you like. But along with free will, comes great responsibility. Not all the products out there are good fits for your financial goals. You have to pick the right horses for the right courses. How can you do this? By spending some time understanding the different kinds of investment options available. There are several resources (including our website) that you can use to gather information about the various financial products available - their pros, cons, and fitment, and then decide which ones to use for your financial plan. Read up on the benefits that Mutual Funds provide and what to look for when picking a mutual fund. Also understand the impact of inflation on our lives and how the power of compounding returns can save the day for us.
STEP 3 – Insure yourself
Insure yourself (and your family) financially against the "what ifs" that life throws at you. Like what if you die? What if someone in your family gets really sick? What if you lose your job? Get yourself a Term Life policy (read this post) and build yourself an emergency fund to cover for 6-12 months of living expenses in case you lose your job or for other kind of emergencies. Ensure that you and your family have adequate health insurance. But, do not get suckered into unsuitable insurance products that are harmful to your financial well-being, and do not mix insurance needs with your investment needs.
STEP 4 – Address your Short Term Goals
Short term goals are ones that need to be fulfilled within a short period of time, say 3 years. For example, a down payment on a home 2 years out, or a big purchase 3 years out. Use fixed income instruments such as debt mutual funds and fixed deposits to fulfill your short term goals. Do not use Equity or market linked investment options as they can be extremely volatile over the short term (less than 3 years), and therefore are not suitable for fulfilling your short term goals.
STEP 5 – Set up your Long Term Portfolio
Once you have taken care of your Insurance, Emergency and Short Term goals, the next step is to organize the balance of your assets and your monthly savings thereafter into a structured long term portfolio, so as to outrun inflation, create wealth, and fulfill your long term goals (retirement for example). In order to do this, you first need to decide on your asset allocation (see how you can do this here). Once you have arrived at your asset allocation numbers, invest systematically in debt and equity mutual funds and fixed deposits to create a well diversified, tax efficient portfolio that will stand the test of time. Save as much as you can (LBYM) every month and put these savings to work into your long term portfolio based on your asset allocation.
STEP 6 – Annual Maintenance of long term portfolio
A portfolio constructed on the basis of sound financial planning principles needs minimal maintenance (maybe once a year). Rebalancing plays a major part in this annual portfolio "check up" process. It helps keep portfolio risk in check with every passing year. It also helps your portfolio take advantage of market fluctuations by "buying low and selling high" and helps you avoid the pitfalls that come along with "selling in panic". Read more about rebalancing here.
Follow these 6 simple steps and take charge of your financial life. We firmly believe that no one can "manage" your money better than you, yourself!