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 investment 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.
Steps of Investment 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
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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.
Conclusion
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.
Disclaimer:
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.
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