Key Components to be included in the Financial Plan…

Financial planning lies at the core of achieving your long term goals. Before you start running it is essential to know what your goal is and the direction you are going to take. In the absence of that, it does not matter how fast you run. While financial planning is a continuous process, it starts with identifying your long objectives and translating them into monetary targets. To understand financial planning better, it is necessary to understand the key components of a successful financial plan. These may not be exhaustive but largely indicative from a financial planning perspective…

  1. The cash flow plan…

The most important component of the financial plan is your cash flows plan. It is all about ensuring that liquidity is available when you require the same. Here are some pointers. If you are planning for your child’s education the fees will be payable in intervals. Your cash flows have to match with that. If you are planning your retirement, your cash flows must have an annuity component to it. Your investment mix is determined based on cash flow requirements. If you require liquidity to pay your home loan margin after 1 year, then no point parking the money in equity. It should be in debt funds or in liquid funds.

  1. The Wealth Creation Plan…

This is another very important component of your financial plan. The main purpose of your financial plan is to create wealth over the long run. Obviously, you cannot create wealth by investing money in debt funds and bank FDs. You need to be in equities and equity funds to create wealth in the long run. For wealth creation, two things need to be designed to work in your favour. Firstly, time value must work in your favour. Therefore, the earlier you start, the longer you invest and greater the benefits of time value in your favour. Secondly, your asset mix is important for wealth creation and any long term wealth creation plan must be biased in favour of equities.

  1. Assessment of risk and insurance needs…

This may appear to be quite innocuous but a very casual approach to assessing your insurance needs can derail the financial plan. You do not want to create wealth for 10 years and then see all the wealth evaporating just because you did not plan your insurance needs properly. Here are a few thumb rules. Firstly, your long term life cover must be sufficient enough to take care of your family’s monthly cash flow needs through risk-free investments. Secondly, medical costs have gone through the roof and so you must ensure that all your family members are adequately insured. Thirdly, ensure that your assets are adequately insured and the payables against your liabilities are also covered. Lastly, endowments are not too smart. Focus more on term plans that are pure risk covers. The amount saved can be better reinvested in equities and mutual funds for the long term.

  1. Creating a smart tax plan…

It is very important to ensure that your financial plan is tax-smart. The Income Tax Act offers sections like Section 24 for home loan EMI, Section 80C for specific investments; Section 80D for medical insurance, Section 80G for donations etc. Your financial plan needs to be built to factor in all these benefits to maximize your post-tax income. You also need to apply this principle in your investments. Remember, interest on FDs is taxed at your peak rate but dividends on equities and mutual funds are tax-free in the hands of the investor. Your entire financial plan needs to be structured as to optimize your post-tax returns. There is a subtle point to understand here. Your investment plan must never be driven by tax limits available, but wherever you have a choice of investments to make, always make them based on post-tax returns.

  1. Estate and Succession planning…

This is an area which is not focused on by most people but the earlier you start this process the better. You have worked hard for your wealth over your lifetime. Ensure that your succession plan clearly lays out how you want that wealth to be allocated. While your children must get a fair share, you also need to clearly articulate who has the decision making powers after you. You also need to articulate, how much if any, you want to allocate for the purpose of charity. The process becomes a lot more complicated if you are a businessman. Then you need to plan how the business will be carried on after you. You must clearly articulate the roles as part of your succession plan. It is not just enough to write a will. It is essential to get the will vetted legally and also to get it registered so that it has legal sanction.

The above 5 are the principal components of a financial plan. Of course, these can be broken up into more granular components. But, they broadly form the pillars on which the entire process of financial planning is predicated.

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