At ET Wealth's Investment Workshop held on July 7, Puneet Oberoi, CFP, asked a basic question related to financial planning - do you know how much you spend in a month and do you write it down? Only one person out of the 400-odd present their raised his hand.
This when he stressed on the point that if you do not know how much your expenses are, how can you save? "If we don't know that, there's a bigger question to that - how much should one save?" says Oberoi.
He suggests that one should know one's monthly expenses and should actually write down their monthly expense to know one's surplus.
Oberoi was speaking at ET Wealth Investment Workshop held in Delhi on July 7, 2018. At the workshop topics like tax planning, financial planning, and mutual fund recategorisation were discussed.
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Every professional, businessman or a salaried individual will have their own goals be it in business or profession but when it comes to goals in personal finance, we don't have them. But, to know how much we have to save, we need to know our goals.
Oberoi shared few examples of this. A person starts investing for his child when the child is born and invests in a Rs 5 lakh policy, without really thinking about how much they need. They don't realise the value of the investment when it matures after 15-20 years as the requirement could be Rs 1 crore.
He gave another example: A person with a monthly income of Rs 1 lakh income, has in mind that he has Rs 60,000 expenses. Of the balance Rs 40,000, and with the usual goals in mind like house purchase, children's education, and marriage, he starts investing 10,000 every month. The balance of Rs 30,000 is kept for contingencies but that amount actually goes into petty household expense. This, according to Oberoi, is true with everybody because we don't know our goals and our expenses.
So what is the right way to about planning our finances? Oberoi said that there are six steps to financial planning.
1. Identifying current financial situation
In the first step, Oberoi informs that if we don't know what our income and expenses are, how we will know how much the surplus is. So, all incomes and expenses (no matter how small) have to be accounted for. Even expenses on festivities, vacations, attending marriage functions have to be accounted for. Once this is done over a period of about six months, we will get an idea of the surplus.
Also, as all existing investments are scattered across assets such as debt and equity including shares, mutual funds, fixed deposits, life insurance policies etc., the financial planning process will have to take into account all asset classes, to get the individual's net-worth.
2. Managing risk appetite
Every person will have a different risk appetite which can be 'aggressive', 'moderate', 'conservative', and lastly 'not sure'. However, in reality, most advisors force their own risk appetite on investors.
In practice, while undergoing the financial planning process, a risk profiling questionnaire helps to identify each person's risk taking ability. "Still, we don't strictly go by what the results show and over a period of time we conclude what the person's risk appetite is," said Oberoi. He added that "Initially, we remain conservative and gradually increase risk in the investor's portfolio to make it more comfortable for the investor."
3. Identifying goals
Oberoi said that identifying goals is mostly mis-understood. According to him, we are aware of goals but we talk about goals on today's value. However, value of goals is important and not the current value. For example, if someone who wishes to send their kid abroad to study after 18 years whose current cost is Rs 35 lakh, needs to save for the future value of the course. It is only then can we find how much we have to save towards that goal and invest across investments to achieve it.
4. Mapping of assets
There could be existing investments say earmarked for specific goals. So, we have to map them for the underlying goals and invest only for the shortfall. Therefore, mapping each and every asset with each and every goal is important before one starts investing. Thereafter, according to the current situation, it can be seen where exactly we have to invest, whether its mutual funds , fixed deposits, FMPs. This is where we have to decide on the asset allocation.
5. Identifying risks
Even though planning is required and is done, one needs to account for unforeseen events too. Risk analysing is most important and chasing returns is not the only way. Protection plays an equally important role in financial planning. Life insurance through a term plan (which is the purest form of insurance) is the right plan to opt for. An important thing while buying insurance is for how many years should the term of the plan be. According to Oberoi, almost 90-95 percent planners will tell you to get the term plan for its maximum tenure. While, the thumb rule says to get cover till liabilities exist, Oberoi's take is keeping the cover for 15-20 years.
As far as health insurance is concerned, its importance cannot be undermined but how much to buy is the question. About 95 percent people say to keep a Rs 5 lakh cover and gradually move to Rs 10 lakh. However, according to Oberoi, hospitalisation costs are going up by almost 20 percent annually. Also, increasing risk cover in later years is not easy. If detected with a problem, insurers deny claims, and then there are exclusions. And while getting a cover, don't go cheap. It is just a myth that a higher cover will cost too much. Contrary to popular belief, you needn't pay higher premiums to get more coverage.
Finally, get a disability insurance cover. According to Oberoi, health and disability are more challenging than death as they lead to higher living expenses, i.e., medical expenses.
6. Constant monitoring
Oberoi said that a key element to financial planning is to constantly monitor your plan. "People think creating a plan is financial planning - you create it and it's over. But, financial planning is all about constant monitoring as there are lot of changes every year. There could be changes in valuation of goals as things may not go as planned for. What if the returns expected were 14 percent annually but the actual annual return has been around 6 percent for 4-5 years, then we have to move on and change investments," said Oberoi.
"Financial planning is planning your finances right, that's the key of financial planning," Oberoi summed up.
