Importance of financial planning
Financial planning is not a new concept since ages people have been doing financial planning majorly in form of capital rationing and investing. However, in the modern world introduction of a vast range of financial products has made financial planning a difficult task. People find it difficult in identifying where to invest and where not to. Also, it has become difficult for people to control spending, though a lot many people I know manage their financials very well; it’s probably not done by everyone.
Day by day almost all the expenses are rising be it education expenses, medical expenses, travel costs, expense related to lifestyle and many other expenses like the maintenance bills, etc. Ever increasing expenses is making it difficult for people to retire with financial freedom.
This article is mainly for beginners who are just about to start their journey to financial freedom.
Let’s start with financial freedom, what exactly is financial freedom?
Financial freedom is not having a hundred crore rupees in your bank account, but it means achieving a financial state where you don’t have to worry about your daily financials (expenses and income) rather you focus on things you like to do. It means having sufficient to retire and do things which you love to do. A lot of people have given an equation for this which stands as:-
Financial freedom = monthly passive income > than two or three times the monthly expense.
Now let’s understand passive income. Passive income is earnt for which you don’t have to work hard or even work full-time, all you have to do is work smart. It includes commission income which comes from part-time sources and income keeps on flowing in your bank account for probably the rest of your life or till your business is alive. Not only a business but also by investing in business one can create a source of passive income, one can start by investing in shares, bonds, real estate, mutual funds, etc. These assets provide a steady source of income in form of returns and dividends. Will touch base on these in a while now.
[Interesting read – Various investment alternatives available to investors]
Investments have one important role to play in financial planning everything related to financial plan revolves around various investment decisions you make. You invest from a perspective of making money in future where your money is compounded and your wealth is created.
Interesting read – The Power of Compounding.
A few places where an investor can invest to build wealth are –
- Real Estates
- Mutual funds and bonds (to a certain extent)
- Investing in startups.
- Debt markets (a proportion of your wealth)
- and a lot more.
4 reasons why financial planning is important –
Inflation – as per Investopedia inflation is a quantitative measure of the rate at which average price level of a basket of selected good and services in an economy increases over a period of time is often expressed as a percentage inflation indicates that decrease in the purchasing power of a nation’s currency.
Inflation is the biggest destroyer of ones purchasing power. A study states that rupees 100 in 1980 is just rupees 6 as of today inflation adjusted. A major cause of inflation is demand is increasing faster then there is an increase in supply.
If this is the case one won’t ever save money they will keep on spending money. In order to sustain the purchasing power, one needs a systematic financial planning which will ensure that you have diversified and invested your funds in various asset classes.
Your future goals – We all have aspirations and goals be it buying a car or buying a home or probably traveling abroad. All this would require one to save money first then invest money in a particular asset class. Financial plan would lay a foundation of where one should invest and how much should be invested today to achieve the goal in future.
It is said that sooner the person starts investing it is better, that’s because of the power of compounding.
Planning for an emergency – A person should have sufficient money kept as surplus in a saving bank account or in a liquid fund which can be treated as an emergency fund. It is generally said that the emergency fund should be at least your 8 months of your expenses.
An emergency fund is one of the most important parts of a financial planning.
Retirement planning – As they say plan today for a better tomorrow. it is recommended for one to start planning your retirement at an early age so that we can reap the benefits of long-term investments and magic of compound interest.
There are a lot of asset classes where you can invest but its recommended to find out which is best suited for you based on your current circumstances. A financial planner can help you determine this with a help of a basic questionnaire, I would soon be writing a post on the same.
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