Financial Planning and the name of famous scientist Albert Einstein has got some similarities.Albert Einstein once said compound interest is the eighth wonder of the world and compound Interest is the most powerful force in the universe or man’s greatest invention.
Lets analyse the name of Einstein in the context of financial planning.
E : Emergency Fund – Create and maintain an Emergency (or) Contingency Fund. You can accumulate a fund which is around 3 to 6 times of your monthly expenses. Everyone has wants, needs and desires when it comes to spending money. Make sure you have atleast three months’ worth of emergency income available for the ‘NEEDS’. You can save this fund in Short-term Fixed deposits or Keep it in Sweep-in Accounts or just keep cash in hand (a portion of the fund). Avoid letting unexpected expenses or events lead you to financial ruin. Build your emergency fund.
I : Insure your Life – This should be your second step in creating simple and effective Financial Plan. You should have sufficient Life Insurance Coverage. It is not ‘how much premium’ you pay, but it is ‘how much Life insurance coverage’ (Sum Assured) you have which is more important. So, do you need to pay high premium to get sufficient coverage? Yes, if you opt for money-back or Endowment policy. No, If you opt for a good and affordable Term insurance Plan.
N : Non-Life Insurance Coverage – The third step is to identify your non-life insurance (General Insurance) requirements. These can be your motor / vehicle insurance, personal accident coverage, mortgage insurance, home insurance, mediclaim etc.,
S : Systematic Investment Plans – The fourth aspect of financial plan is to save and invest in Systematic Investment Plans periodically. These investments can be done in various avenues like Mutual Funds, Fixed Deposits, Equity, Bonds etc., But, before selecting the financial products, it is prudent to first identify and set realistic Financial Goals. As per your goal requirements, you have to choose various investment products with different risk profiles, to achieve your goals. These goals can be, Your Retirement Plan and accumulation goals like Kid’s Education goal (or) Kid’s marriage goal (or) Vacation planning etc.,
T : Tax Planning – While creating your investment plan, try to identify and invest in tax-efficient products. But, kindly note that Tax saving should not be the sole criteria for choosing the investments.
E : Estate Planning – This is also known as ‘wealth distribution or transfer.’ Let us assume that you have created a good protection plan and good wealth accumulation strategies. But, what is the use of building assets and buying insurance policies if you have not mentioned proper nominations on your investments. Estate Planning is the process of making a plan in advance and naming whom you want to receive the things you own after you die. Write you Will
I : Inflation – Creating a Financial Plan is dependent on few assumptions. One of the most important assumptions that we have to make to create a good Financial Plan is ‘Inflation.’ In simple terms, it can be defined as either a rise in prices or a fall in the value of money. You need to be aware of prevailing ‘inflation’ rates. The Retirement corpus, Kids education goal etc., are totally dependent on the assumption of certain rate of Inflation. You have to review and modify your Financial plan (if required) based on the prevailing inflation trends in the Economy.
N : No of Years / Compounding Periods – To make an effective Financial Plan, it is of utmost importance to understand the importance of Time Value of Money. Components of Time value of Money formulas are investment amount (payment), Future Value / Present Value, Rate of Interest and No of Years (N). Out of all the components, N is very important. The earlier you start investing, the more you can benefit from compounding. Also, align your investment planning according to the time-frame of your goals. For example, if you are planning for your Retirement which is 20 years from now, you should not be conservative and should not invest in Fixed Deposits alone. If you do so, inflation will eat away all your savings/investments. You need to take risk depending on the investment time-frame of your goals.