Steps In Financial Planning

Dynamics of financial planning

Financial independence is now an integral part of our complex lives. Gone are the days when it meant having enough to tide over one's personal needs without really having to struggle. In current times, due to various reasons like a fast-paced life, job insecurities and high inflation rates (that erode the value of money), being financially competent in the present as well as the future should is of prime importance for every individual.

However, it is widely observed that most individual's spend their life in earning money and saving it but ignoring the third most important aspect, financial planning, i.e. managing money. The process of financial planning entails understanding an individual's present and future earnings ability, analysing future financial requirements (like buying a house) and developing a path to create wealth and reach those goals as per the individual's ability to tolerate investment-related risks. Further, financial plans must be dynamic to reflect the ongoing changing market environment and the changing needs of the individuals.

Why is financial planning important?
Financial planning is important for all individuals as it not only helps in meeting the present and future goals but also in dealing with unforeseen emergencies in life; in short, it provides the much needed financial security. Further, in a high inflation economy like India, rising prices erode the value of savings and financial planning can help in growing money at protecting a portfolio from such rampant erosions. Financial planning via diversification also helps to harness the power of compounding and reduce the uncertainties arising from a volatile market scenario.

While financial planning is important, it requires an understanding of various terms and processes - understanding the investment opportunities in the current financial system, creation of an optimum asset allocation / portfolio mix, tracking and reviewing the investments among others. Hence, we will try to simplify the financial planning process through a few steps (Chart 1):

Chart 1: Steps of Financial Planning

Define current financial state and financial goals
Individuals must clearly understand their current financial state which will give them an idea about their earnings and expenses. This analysis will reveal the annual cost of living and indicate the savings (income less expenses) or surplus money available for investment. After getting an idea about the current financial standing, investors must analyse the financial needs and goals which will help them to understand what they hope to attain. Commonly observed goals include buying a house, funding child's education, retirement planning, etc. The process doesn't end in just identifying the needs and goals but also find out the resources and the time frame required to fulfill them. Any financial need or goal would translate into determining the tenure of the investment i.e. short-term (< 1 year), medium-term (1 - 5 years) and long-term (> 5 years).

Analyse the risk profile
Analysing an individual's risk profile is an important component of financial planning as the asset allocation in a portfolio critically depends on this; remember each asset class carries different types of risks like market risk, credit risk, liquidity risk and interest rate risk. For any investment, a certain amount of risk cannot be ignored. But while investing in asset classes which offer higher returns, individuals must analyse their own risk taking (depends on the objective, time horizon, income level and age) and risk tolerance abilities (capacity to lose some or all of initial and subsequent investments in exchange of greater potential returns). E.g. an individual of over 40 years of age but with a stable long term income source can look at investing a relatively higher portion of the portfolio into risky assets such as equities unlike an individual unlike someone of the same age but with a not-so-stable long term income source.

Pick the right asset allocation mix
Traditionally, the three main asset classes are equities, fixed income (debt) and cash and equivalents. There are non-traditional asset classes such as real estate, gold, and commodities, to gain additional returns even though these assets carry additional risks compared to traditional assets. By allocating capital across several asset classes, the benefits of diversification can maximize gains and minimize the losses. After deciding upon different asset classes, individuals must develop an asset allocation plan which will determine the proportion of investments in each of the major asset classes. A right asset allocation plan means apportioning the investor's surplus across the various asset classes and their instruments based on the individuals' risk return profile. Mutual funds in India invest across most of the traditional as well as non-traditional investment classes and provide an ideal medium for investors, while also offering the benefit of professional management at low costs.

Given the ongoing market volatilities, it is important that individuals must have a disciplined approach to investments which can be acquired by following the above steps. Besides, individuals must keep in mind a simple modern day adage-Start Early, Invest Regularly and Be Updated-be it on their own or with help from a professional financial planner.

The article on Financial Planning has been prepared by SBI Funds Management (P) Ltd, the Asset Management Company of SBI Mutual Fund for the purpose of investor education only. SBI Funds Management Pvt Ltd. / SBI Mutual Fund / Trustees, its directors and employees will not in any way be responsible for the contents of these articles. This is not an offer to sell or a solicitation/ recommendation to buy any securities. Investors must make their own investment decision based on their own investment objectives, goals and financial position and based on their own analysis and consult their financial advisors / consultants before taking any decision of investments.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

  • Market Overview by
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