How to create a good Financial Plan

If you have no idea about financial planning and don’t know where to start, then you are at the right place. Following these 5 steps can help to build a good financial plan for your future.

Given the priorities in our life at different stages, most of us do not even get time to think about financial planning until our mid life. But if we are aware of the importance of having a financial plan at young age, we will definitely be in an advantageous position. 

Step #1: Buy a Life Insurance

When it comes to financial planning, the first thing to do is, buying a life insurance. 

Many I know, who is the sole bread winner for the family, do not have life insurance at all. They know that their whole family is dependent on their income. But still, they have not found the motivation to buy a life insurance for them yet. 

Up until a tragedy strikes, we will not realize the seriousness of it. Few years ago, a family of dad, mom and a 6 year old son was living in the same apartment complex as me. The dad was just fine, but one day fell unconscious while shopping in Walmart. But he passed away on the way to the hospital in the ambulance. 

His family was in total shock. Bigger shock is that he did not have any life insurance. It is just not the emotional stress of his loss for his family, but now they have to face the financial stress for the rest of their life as well.

We are seeing many incidents like this. At least one gofundme request coming in our whatsApp groups and facebook posts every week. But how long can a family survive with those funds?

Do not see life insurance as optional. It is a must. If loss of a family member will bring financial stress to the family, then that family member should definitely have a life insurance.

When it comes to life insurance, we should not be buying insurance products mixed with investments, like universal plan, endowment plan and ULIPs. We should be buying simple and straight forward Term Insurance. It is very cheap too. 

Buying a term insurance is not complicated at all as we think. For more information on how to buy a term insurance, watch this episode. If you are in US, White Coat investor’s guide for buying term insurance is an excellent resource.

We should be buying Term insurance for a coverage of at least 25 times our annual expenses and for a term (period) till we retire. Do not skip buying life insurance just because you are already covered in your office. Their coverage can serve for only few years, which will not be enough for the family for their life time. 

So when it comes to financial planning, regardless of whether you are doing other things or not, definitely buy life insurance. 

Step #2: Pay Off Debt

Next thing to handle is “Debt”. While a debt could slow down the growth for some, it could totally destroy others. 

Watch this episode to understand the difference between a good debt and a bad debt and also to learn some tricks to pay off debts faster.

It is not smart to invest for 8% return when we have a debt that sucks up 10% interest. That is why it is important to pay off our bad debts before proceeding to the next step in financial planning. 

Step #3: Build an Emergency Fund

Our life never goes smooth as we expect. It always throws in few surprises and shocks here and there. An emergency fund will give us the safety cushion to handle those surprises. 

At least have 6 months of expenses as emergency funds. Many think that they can handle all their emergency needs with their credit card. Bad idea. All the hard work we did in step 2 to get rid of the monkey “debt” will go waste. The debt monkey will be on our back again if we use the credit card for emergency.

I don’t know about you. But I would not like to carry around a monkey on my back. I will try my best to keep it as far as possible. Emergency fund will help with that. 

Many ask the question of where to invest the emergency fund. Emergency fund is meant for handling emergency, not for investments. So always have the emergency funds in an easily accessible liquid accounts like in a savings account. 

If you have completed the first 3 steps – buying a life insurance, paying off all bad debts and also have an emergency fund, then you can pat yourself on your back. Just doing these three will put you ahead of most in financial planning.

Step #4: Saving for Retirement

Most of us do not even think about saving for retirement until we hit 40. But by that time half of our life is gone.

As we saw in “Power of Compounding”, the sooner we save and invest for our retirement, the better the final growth amount will be. So do not take retirement planning for granted until it is too late. 

Also remember the impact of inflation. Inflation rate in India is around 5% on average. That means, if our monthly expense is ₹50,000 now, then in 10 years, we would need ₹82,000 to maintain the same life style. In 20 years, the same need will become ₹1,33,000. 

We should know how much to save Today and which assets to invest those savings so that we can generate an income of ₹1,33,000 per month after retirement. Saving just in a Fixed Deposit is not going to cut it.

We should learn to take calculated risks and invest in assets that has potential to beat the inflation. Watch this “Asset Allocation” episode to understand the risks and return potential of different assets in the market.

Having equity exposure is key to have enough money on our retirement. General rule for retirement savings is, invest your age % in assets like bonds (debt instruments) and (100 – your age) % in equity (stocks). If I am 40, I should have 60% of my portfolio in equity and 40% in other assets.  Adjust those percentages to fit your comfort.

US residents can watch these 401K and IRA episodes to understand more about the retirement plans available in US.

If you need help building an equity portfolio, read this post. 

Step #5: Saving for Children Education

Next in our priority list is saving for children education. 

For all those emotional parents who give higher priority to saving for children education than to saving for their retirement, remember, there is always loan available for education, but not for retirement. We should not forget that fact.

Education cost inflation is about 8%, both in India and in USA. For our calculation purpose, it is better to assume the college fees to rise at a rate of 10% every year. A 5 lakhs cost Today would become 13 Lakhs in 10 years and 34 lakhs in 20 years. 

Some of the YouTube episodes on this topic:

• Calculating Children Education needs and Investment options
• College Expenses in USA
• 529 Plan Explained (USA)

These are 5 critical steps in basic financial planning. We can take it to the next level by buying proper health insurance, writing will etc. We will cover those topics some other time.

Professional Financial Planners:

If you think that this basic financial planning itself is too complicated, then you definitely need a professional financial planner’s help. Don’t go to your bank’s regional manager or financial advisor. They will try to hit their sales target by selling products you do not need. To be fair, it is not their mistake. They are doing their job. 

Look for fee only financial planners like here, who do not earn any commission from selling products. If you are in US looking for professional financial planning guidance, Mari from Samatva Wealth Management can help you.

Hope this is helpful. Don’t hesitate to share this with your friends and family. Thank You!