- Date : 27/05/2022
- Read: 6 mins
Knowing the financial planning basics before starting your investment journey is essential. These smart habits will help you plan and design a perfect financial plan for you that is long-term and sustainable.
Since the pandemic has hit the world, everyone has been fascinated about financial planning, investments, retirements plans, etc. But what mistake they might make is not paying attention to the basics of financial planning and accounting.
So in this article, you will go through the details that will help you take proper financial steps and help you learn the basics of financial planning, which is required to ensure that you end up with a large enough corpus at the time of retirement.
1) Finding out what your goals are
The most crucial part about financial planning is that they are, in a way, worthless without having your goals clear in your mind.
Heather Winston, an expert in financial advice and planning, says, "Setting financial goals can help you prioritize things. They're a way of giving you a clear idea of why you're saving your hard-earned money."
This draws down to the point that you should set the goals you want to achieve at a predefined time in the future as they will help you prioritize your needs.
Some of your goals can be:
- You want to fund your child's education in the next five years - Short Term Goal
- You want to buy a luxurious car in the next ten years - Mid Term Goal
- You want to accumulate money for retirement in the next 25 years - Long Term Goal
- Once you set your goals, it is the perfect time to think about how can you achieve them and what things you will need to do for the same.
Also Read: 7 Pillars of financial planning
2) Budgeting & investing, no matter your income level
There is a small misconception about budgeting that it is only for corporates and big companies, but this is a big lie as budgeting is for everyone, whether you have an income of Rs. 10,000 or Rs. 10,00,000.
Budgeting is crucial as it is a potent tool to help you take charge of your money. Thus, no matter your income, it is very important to make a budget as it will significantly help you during financial planning and making investments.
3) Know your assets and liabilities
It is essential to know your net worth. Here, net worth is the difference between what you own and what you owe. Thus the net worth gives you a snapshot of your finances, i.e. if you have a positive net worth, then you are doing good with your finances, but if you have a negative net worth, then you can be in big trouble as you owe more than what you have or earn.
Net Worth = Assets (What you own) - Liabilities (What you owe)
Assets can include your investments, real estate, car, jewellery, the account balance in the bank, retirement funds, etc. Liabilities can include your mortgage, credit cards debt, and various other loans like a student loan, personal loan, home loan, etc. It should be noted that your net worth changes with time, but ideally, it should increase as you grow older.
4) Know your budget – income vs spending
Making the monthly or yearly budget and then moving to investment plans is very important as it will help you make solid plans with realistic numbers. It would be best if you ask yourself questions like:
- What is the monthly income flowing in?
- What are the monthly spending or expenses (outflow)?
These two important questions will help you analyze if you have savings for investment or a deficit that you first need to pay out and then start your savings, financial planning, retirement planning, personal financing, etc.
5) Know your savings rate
When you start your financial journey, saving rate is one of the first components you need to face as it is an essential part of financial planning. It will help you determine the amount of money you save each month as a percentage of your gross or total income.
Saving Rate = Total monthly saving / Monthly gross income
For example, if your total income is Rs. 40,000 every month, you save Rs. 7,000 for retirement and Rs. 5,000 for buying a luxurious home, then your saving rate will be as follow-
Saving Rate = (7,000 + 5,000) / 40,000
Thus Saving Rate = 30%
Based on the above example, you can see that you have a good savings rate as 30% is not a small number. Thus you are assured that you are on the right track, but in the contradictory situation, if the number is below 10%, then you should try to save more else; you may face some difficulties soon.
Also Read: How to build a robust financial plan
6) What is your risk tolerance?
Before starting your investment journey, it is important to understand your risk tolerance. Without it in place, you may make wrong financial decisions that affect your finances, retirement plans, tax saving plans, etc.
Risk tolerance means the ability to withstand the risk in order to gain higher profits. It directly relates to your age because, as per financial experts, if you are young, you can keep your major exposure towards high-risk assets, but as you start growing old, you should slowly and gradually shift toward low-risk assets.
Thus, based on your risk tolerance, you can plan and design your investment portfolio to enjoy long-term benefits and don't end up losing your investments.
7) Know when you want to retire and what you want to spend in retirement
Retirement planning is critical as making a mistake here may lead to significant issues. Thus you should be clear that you want to retire at what age and will you still work for a few hours or part-time, i.e. some people want to retire in their 60s or 70s completely, but some others may be willing to work part-time or just a few hours every day as they don't like to be idle.
Thus it is regardless to say that your decision depends on the answer to these two questions:
- When do you want to retire, and will you retire completely?
- How do you want to spend your retirement life?
Based on answers to these questions, you can plan your retirement; accordingly, i.e. if you want to retire early and travel the world, you will need to ensure that you have large funds and they won't run short quickly. In contrast, if you want to spend time sitting at home reading books, then you need to just think about the day-to-day expenses and some unwanted and surprising expenses.
- You should always focus on net worth, as it will give you an accurate picture of whether you are making the right financial decisions or not.
- You should be aware of the inflows (income) and outflows (expenditures) as it will help you determine whether you are saving money or are in debt.
- You should plan and make an investment strategy based on your risk tolerance as it will help you develop a long-term sustainable investment portfolio.