Personal Finance Planning for the Layman

The Need

Modern science has increased the life expectancy of humans by decades. At the same time, it has also ushered in a plethora of temptations garbed as necessities – needless to say, these temptations do not come cheap. The ever-increasing avenues of spending give today’s man a wholly different perspective on wealth, as compared to even those of just a century ago. While earlier wealth referred to tangible objects such as land and jewelry, today a wide range of tangibles and intangibles have crept into the picture – while owning a Monet is wealth, so is owning a yacht. And the means to achieve either are the greenbacks. However, while money remains a constant to define wealth, destiny is forever fluctuating – what appears as an immense pool of money today may just dry up tomorrow. In such a situation, one needs to plan years ahead to hedge the uncertainty of the future.

The most common situations, which call for financial planning for the average middle class person, are:

Retirement
For any salaried individual, retirement is an eventuality. While many countries provide social security to retired people, the real income that one earns from such schemes may be severely hit by inflationary trends.

For example, over a ten year period considering an average inflation rate of 4%, $1225 would fetch the same value as $1000, provided the growth in prices of all commodities remain fixed at 4%. Thus, a person who subsists on an amount of $10000 today would need to earn at least $12254 to maintain his current living standard ten years hence. In other words, if a person retires with a capital of say $100000 and earns 10% on this capital through investment in bonds, etc, he/she would require a capital of $122540 to earn the same value ten years hence. That, at an age when he/she may not mentally or physically be in a position to engage in constructive, income generating employment. Obviously, such depreciation of real income/capital calls for long-term planning.

Children’s Education
With the steep rise in unemployment the world over, people need to acquire special skills to be assured of even a moderate living. And as the demand for such skills is increasing, so is the cost of acquiring such skills getting pushed up. A person whose child is say ten years old today would require a substantial amount of money a decade hence for his college education, and planning for the same needs to done from today to avoid complications at the last moment.

Medical Contingencies
Medical contingencies have become so much a part and parcel of everyone’s lives, that they can no longer be termed as contingencies. Again, while newer and better medical tools are being developed everyday, the cost of medical treatment is unfortunately on an upward spiral. Thus, while a person can expect to live longer thanks to the modern-day medicine, it is not a very comforting thought when one takes a look at what effect it could have on one’s finances. Even planning ahead may at times not suffice, but it can at least provide a cushion to fall back on when ailments hit.

Apart from the above, sudden cash flow mismatches may occur for numerous reasons – an impulsive tour to Hawaii, for instance. While every such eventuality cannot be anticipated in advance, the least a sensible person can do is to create a buffer for himself for the rainy days. And that buffer can only be created through proper planning of one’s finances while the going is good.

The Planning Aspect
The planning structure may vary widely from person to person. However, there are a few common factors that everyone needs to consider while planning his/her finances:

Age
The age of the individual is an important factor to be weighed in. For example, an executive in his early twenties may not wish to spend too much on his retirement funds; the dreaded day, after all, is a long way away. On the other hand, a person in the forty-something age bracket can see his retirement looming over the horizon; he would naturally have a stronger desire to save. Unfortunately, the time value of money is forever on an upward curve, and saving nominal amounts at an early age is wiser than saving huge amounts at a later age.

Thus, if an investor starts saving at the age of thirty, then at a 10% rate of return on capital, and an annual saving of say $6000, the investor shall have roughly a capital of $1.1 million at the age of sixty when he retires. However, if he begins saving at the age of forty, he would be required to make an annual investment of $18000 to have a similar amount at his disposal at the age of sixty. Thus, if he starts saving at a later age, the annual saving burden is thrice the amount that he would need to forgo every month if he starts saving ten years earlier.

Again, if we assume that at age forty, our investor is in a position to save $15000 annually and not feel the pinch (as against $18000 which he is required to invest), then we find that if he starts saving $6000 per annum at age thirty and thereafter saves $15000 from age forty, at the retirement date he would have a capital of around $1.7 million, half a million more than what he would have if he starts saving at age forty at the rate of $18000 per annum (which would also cause him undue hardship to the extent of $3000 per annum). Therefore, the bottom line is that you should start keeping aside some amount, (no matter big or small) as savings at the end of the month. Ideally, you should be saving 25 percent of your income every month.

Investment Avenues
The available avenues of investment also play a major role planning one’s finances. While different countries have differing rate structures for investment products, the mode of operations and the nature of the investment avenues are generally the same. Thus, while the United States and India, countries at two ends of the economic spectrum, have differing bank rates (the rates in India being almost four times that of the US), the underlying product is essentially the same.

However, the preferred investment mode is certain to vary amongst the two countries owing to the difference in rates, as is observed in the US where the preference is towards mutual funds while in India people are more comfortable with bank deposits. Again, the various investments provide varying tax benefits, ranging from zero to a handsome percentage in the form of tax rebates. One also needs to keep this factor in mind to work out the time value of the savings parked in a particular investment.

Investment Horizon
Probably the most important aspect of financial planning is chalking out the investment horizons for the various requirements. The need to plan for different time horizons arises from the fact that financial requirements vary widely over any given length of time.

For example, the finances required for retirement planning call for a long term, substantial accumulation of funds; children’s college education, on the other hand, provides a much smaller time frame and calls for a relatively lower capital accumulation. While money for all such requirements may be accumulated in a common pool, it is ideal to have separate investments for separate requirements, as this would hedge against the risk of inadvertent mismanagement.

To exemplify, if there are separate retirement and children’s education funds, our investor, in case of any shortfall in the college fund at the time of withdrawal, would prefer to resort to some other, external revenue source such as a bank loan rather than break his retirement fund as well, thereby keeping his retirement money intact. While this may not work out in every case, it does mitigate the chances of mishandling the savings.

Other Planning Tools
Besides personal savings, one needs to try to provide for contingencies through other avenues as well, such as insurance. While our investor might be having all his future income and expenses planned out to a “T”, a freak accident could upset the apple cart, leaving himself and/or his dependents high and dry. To avoid such a situation, one should try to keep as much of self, family and property insured as possible. It is true that the premia paid on insurance seem to be a waste of hard-earned money since they carry little or no returns, but what is a small sacrifice today might yield handsome dividends in times of need.

The Final Word

While planning and monitoring ones finances to provide for as many contingencies and necessities as possible is cumbersome indeed (after all. spending is so much more fun than saving!), the benefits far outweigh the trouble taken. As the old adage goes “A Stitch in Time Saves Nine”; all that is called for is a little disciplined “stitching”. With disciplined planning and regular status reviews, this seemingly daunting task can be expected to become a part of everyday life, thereby providing for a reasonably secure future.

Long-term Financial Planning for Businesses

A probably angry Lee Iacocca was indicating that finance is something that has to be preplanned, planned, re-planned and even post-planned. Financial planning in itself does not involve just setting budgets, wage rates, or deadlines. It is all about getting to know realistic work schedule, the manner in which they can be executed, back up plans that can be used, and the least cost with the help of which the entire project can be executed. So in general, these aspects and growth forecasting, both involve the answers to the four important questions: why, when, where, and how (answers have to be cost oriented).

Steps in Long-term Financial Planning

Step 1: Let us take the example of a coffee shop, where a financial planner has to find legitimate answers to 4 questions, namely:

1. Why should we produce a specific item on the menu card? (consider cost of production and sales price)
2. When should we produce such an item and for what time duration? (bear in mind, seasonal costs, inflation of raw material prices)
3. Where should we produce the item: right in the shop or some production center? (consider transport cost, nature of goods, and selling cost)
4. How should one produce the item, manually or mechanically? (consider equipment and personnel cost)

Step 2: The second step is to assess your business environment. In this step, surveying the competitors’ performance, pricing, and distribution is an absolute necessity. In such a scenario, you may also prepare a cost sheet of the financial features of production, namely the money that you would have to invest as a manufacturing cost, its sales cost, and the profit that it would yield. Logically, the sale price should be more than the cost price, and the return-over-asset ratio/return-over-investment ratio should be healthy. While finalizing these three figures, you will need to take into consideration three important aspects:

1. Average spending capacity of your customers
2. Your competitors’ quality, quantity, and price
3. Popularity of the product, potential market, customer retaining capacity of the product, etc.

Though the trend of such products is more experimental in nature, they might become full-time, public favorite products; hence, it is also important to make a financial provision to recover losses that arise in the experimental period, until the product establishes itself in the market.

Step 3: The third and fourth step are more analytical in nature and from the finance point of view, they are also quite expensive. The idea that you need to implement in the third step is allocation of resources in such a manner that you tend to make a genuine profit in sales during the long run. In this step, you will be using and analyzing cash flow statements on almost a daily basis. The key is to have uniform cash outflows for consecutive days/months/years. Cash outflow is typically all expenses and losses. Losses are quite uncontrollable, but expenses are surely controllable. Hence, search for raw material sources, manpower, and production processes that will help you to maintain uniform and low per-unit cost for the item/product. For example, have regular suppliers, who will supply at an agreed and uniform cost. This uniformity will eventually come in handy to curb and control unexpected losses, and will also help you to keep a good hold over the market.

The second part of the third step is making monetary provisions. This is absolutely essential due to the fact that no business is risk-free. Such provisions include advance to the raw material supplier, insurance, provisions for bad debts, extra services, etc.

Step 4: Retain, sustain, and entertain; this step is quite an advanced one, and typically includes many different aspects that aim at retaining the customers. The first important function of this step is to generate regular data and cash flow statements. With the help of these statements, you will realize whether that very item on the menu is proving to be profitable or not. At the same time, you also need to maintain a statement that records cash inflows and outflows over a longer period of time (in months or a quarter). Thus, you will realize what is profitable for your business and what your customers want.

To sum up the whole theory, it can be said that long-term finance planning is a three-dimensional graph, with customer, product, and market being the dimensions. The essence of cost and time is added to every dimension. After all, the key to success is to facilitate all three dimensions logically, bearing in mind this essence.

The Financial Planning Process

It is essential that all of us have some goals in life. Short-term goals include a good job, great career, and small investments. Long-term goals include buying a house, children’s education, retirement policies, etc. Financial planning is one of the most crucial decision of one’s life. If you start planning early, you can get out of a financial mess that can arise later in life. It is very common to spend more than what you earn. Of course, there are facilities, like credit cards, buy now pay later schemes, installments, etc., which compel one to overlook their finances. At the end of the month, when bills keep pouring in your mail boxes, you find yourself in a sticky situation. And this mounting bill payment adds a semi-colon to your long-term dream of owning your own house. Sometimes, medical emergencies also forces you to dig into your children’s education fund. Marriage plans for your only daughter? You borrow some money from your retirement fund. There goes the trip to Egypt, you have planned all those years!

The answer to all the above mortifying financial situations is ‘Financial Planning’. The planning process helps give a direction to your financial decisions. It helps you decide various investments that can bail you out of your financial problems. For example, investment in mutual funds may help you repay the loan or save enough for your retirement. Once your financial goals are set, it helps make your life more secure and flexible for any financial emergency that may arise.

You can carry out your own financial planning by taking a guidance from self-help books, newspapers, magazines, the Internet, or discussing your financial needs with your spouse. If you feel, you can’t handle it yourself, then opt for a professional financial planner. This Buzzle article, will help explain process related to financial planning.

Six Steps of Financial Planning Process

It is important to be well versed with the entire process of financial planning. This will help you plan major updates of your life as well as unseen occurrences. It is you who needs to be in control of your finances, not the other way round.

Establish Mutual Relation

Develop a relationship of trust and respect with your financial planner. The purpose is to help both parties know what is to be expected. During this stage, the services that the financial planner will offer you should be discussed in detail. It is also the right time to decide how will the financial planner be compensated for his/her services. You can also come to a decision as to who will keep a track of the finances once invested.

Assemble Data

The financial planner will meet you and discuss your financial situation. You should come to a mutually agreed goal regarding your financial and personal goals. You should decide the time period and the expected results from your investments. You should be made aware of all the risks, if any, involved. The financial planner should help you make the financial goals, which can be made possible from utilizing your current income into savings and investment program.

Estimation and Assessment of Current Financial Status

Your current financial situation should be assessed by your financial planner to decide the plan of action. This may include estimation of your current assets, liabilities, and cash flow. The insurance coverage, investments, and tax strategies are also considered.

Presenting Recommendations and Alternatives

The financial planner should prepare an investment program based on the information provided by you regarding your financial goals. The planner should explain the recommendations and inform you about all the minor details. This will help you decide your financial move. He should also be able to come up with alternatives, if you are not satisfied with the recommendations offered.

Execution of Financial Planning Recommendations

The planner becomes your guide during the implementation of the recommendations of the financial goals. He takes decisions on your behalf and coordinates with your attorney and stock brokers.

Management and Auditing Financial Plan

You and your planner should decide who will keep a track of your investments. If your planner is in-charge, he should give you periodic reports on your financial situation. If there are any sudden changes in your life, he should be able to give you alternatives for the same.

It is wise to set goals, which are achievable during the financial planning process. If you understand the importance of becoming financially stable, planning for the future will become very easy. You should take into consideration all the possibilities that can affect your life due to your financial decisions. It is good to start early in life and not wait till you near retirement age. You should get over the notion that financial planning is for rich people. Investments should not be considered as financial planning. You should be in-charge of your money and monitor it at every step. It is wise to plan your finances according to your income. Better be well-prepared financially, before a crisis comes barging at your door. In this unpredictable world, it is best to have a safe financial security, not just for yourself, but for the future of your whole family.

Importance of Financial Planning

A broad definition of personal financial planning can be stated as, “a process of determining an individual’s financial goals, purpose in life, and life’s priorities, and after considering his resources, risk profile and current lifestyle, to detail a balanced and realistic plan to meet those goals.”

Financial Planning

It is a process which presents before an individual, organization, or even a country, the current financial position and the adjustments in the spending pattern, in order to meet the goals.

Importance of Financial Planning

It is important to plan finances in order to reap long term benefits through the assets in hand. The investments that one makes are structured properly, and managed by professionals through financial planning. Every decision regarding our finances can be monitored if a proper plan is devised in advance. The following points explain why financial planning is important.

– Cash Flow: Financial planning helps in increasing cash flow as well as monitoring the spending pattern. The cash flow is increased by undertaking measures such as tax planning, prudent spending, and careful budgeting.
– Capital: A strong capital base can be built with the help of efficient financial planning. Thus, one can think about investments, and thereby improve his financial position.
– Income: It is possible to manage income effectively through planning. Managing income helps in segregating it into tax payments, other monthly expenditures, and savings.
– Family Security: Financial planning is necessary from the point of view of family security. The various policies available in the market serve the purpose of financially securing the family.
– Investment: A proper financial plan that considers the income and expenditure of a person, helps in choosing the right investment policy. It enables the person to reach the set goals.
– Standard of Living: The savings created by through planning, come to the rescue in difficult times. Death of the bread winner in a family affects the standard of living to a great extent. A proper financial plan acts as a guard in such situations, and enables the family to survive hard times.
– Financial Understanding: The financial planning process helps gain an understanding about the current financial position. – Adjustments in an investment plan or evaluating a retirement scheme becomes easy for an individual with financial understanding.
– Assets: A nice ‘cushion’ in the form of assets is what many of us desire for. But many assets come with liabilities attached. Thus, it becomes important to determine the true value of an asset. The knowledge of settling or canceling the liabilities comes with the understanding of our finances. The overall process helps us build assets that don’t become a burden in the future.
– Savings: It is good to have investments with high liquidity. These investments, owing to their liquidity, can be utilized in times of emergency and for educational purposes.

The argument made by people from low income groups is that they don’t need to plan their finances due to the less money they possess. However, no matter how much one earns, better planning of income always helps in the long run.