6 Reasons You Should Consider Planning Your Finances
The Relevance And Need of Financial Planning in Our Lives
“Planning is bringing the future into the present so that you can do something about it now.” — Alan Lakein
Asa kid, I’d remember my mother always telling me to save my money and put it in the piggy bank as I would be able to use that money for something bigger and better at a later date. I remember getting one of those piggy banks as a present around the age of ten and thought it was probably the dullest thing I had received all year. 😜
However, when I look back on that event, it’s the first time the habit of saving money was inculcated in me, making it one of the most important lessons I have learnt. In a minimalistic way of sorts, that’s the first step I had taken towards Financial Planning. The notion of saving your money to use it at a later date for a more significant purchase almost always sounds as good advice, even to a ten-year-old. (I think I was saving up for more Pokemon Cards at the time)
Financial Planning today isn’t as basic as saving money in your Piggy Bank (Bank Account), even though we wish it were. The process has quite a few variables that depict a roadmap towards a sound financial future for your Needs, Wants and Aspirations. Thus, also giving you a big reality check on whether or not you are on track to meet those goals.
We usually focus on planning for something on primarily two significant occasions:
Just before we make a major purchase like buying a house, or purchasing a new car.
During the times of Uncertainty. The most relatable example to give here is the Pandemic, which results in loss of jobs, lower pay, decreasing standard of living, anxiety, etc.
The problem with the above approach is that we are always caught off guard with the decision making process as it involves a degree of risk which we haven’t been able to ascertain. This results in forcing us to make a choice of letting go of one need to have the other (technically known as the Opportunity Cost).
For example: If you have recently lost your job due to the Pandemic and face the probability of not finding another one in the next few months, you will get into the process of making lifestyle decisions based on the Opportunity Cost theory.
Therefore, the Financial Planning exercise to a great extent can reduce the number of times you are faced with the above dilemma. How so, you ask?
Financial Planning is the only concept that guides you in segmenting and prioritising your Needs from your Wants and your Wants from your Aspirations. Let us assume your Need is to reduce the Home Loan on your new house, your Wants are focused on getting a new car, and your Aspiration is to travel abroad for holidays once a year. Evaluating these decisions with your finances will give you clarity on what should be the focus area to deal with first.
The second benefit of this process is that it guides you in setting goals for all the significant milestones in your life that you will encounter in the future, Buying your first house, Saving for your Marriage or Saving for the Children’s Education. Investing your capital when it is driven by an underlying reason always incentivizes you towards it, rather than saving money in the Bank Account without really knowing what to do with it next
While we may have the money to take care of ourselves and our family in the short term, wouldn’t it be delightful to know precisely when can you tell yourself that you can retire from your corporate job or pursue something less rewarding monetarily, because it makes you feel happier or reduces the stress in your life? One of the primary goals of the Financial Plan is to assess based on your current as well as future projections of income, investments, and expenses when you can retire from your job, or begin to pursue your passion as all your basic needs are taken care of by you earlier by planning for them in advance.
Financial Planning also opens your eyes to the world of investments. In most economies today, whether they are developed or emerging market economies, the rate of return on your money idling in the Bank Account is quite minuscule ranging from 0.1% to 2.5% (After Tax). What this means is, that for every $100,000 you have in the bank account, the rate of return over one year will certainly not exceed $2,500.
Now let us relate the above example with one particular country. Let’s assume you have $100,000 in a US Bank. The rate of return your bank makes you is less than 0.1%, capping your return at $100 a year. However, inflation in the US, which is the rate at which prices of goods and services increase varies from 1.5% to 2.25%¹. Simply put, your $100k in the bank will not suffice you to make a purchase of the same amount the very next year as the price due to inflation has increased to approximately $102k whereas the bank has given you interest of only $100 for the money in the account.
Hence the suggestion here is to invest your money in the Equities and Debt markets as Historical Data shows that these asset classes have done much better than the return Cash generates in your bank account across longer time periods.
For example, over the last 10 years, the S&P 500 (which is the major index of the US Economy) has given a compounded annual return of 10% or more for the last 10 years². The reason for investing your money is vital to meet your Financial Goals because your capital is growing at a pace faster than the increase in the value of goods and services which you intend to purchase.
However, please note that investing in Public Markets also comes with its own elements of risk. Before you get into the process of Investing, I’d recommend you try and do some research on Financial Markets and their products. As not having complete knowledge about the subject could be detrimental to your purpose.
The four-letter word that we often dread and probably takes your peace of mind along with your money in the form of Interest is DEBT. In order to avoid taking Debt for major purchases in your life, the planning of your finances is the most critical aspect. You don’t have to always have the exact date and time planned for your purchases as not everything will always go according to your plan. But the process of planning for it will certainly leave you in a better place than not.
Lastly, the Financial Plan also provides you to make contingencies for events that one may not be able to predict. For example, Setting aside funds for a Medical Emergency in the family. This is probably one of those events none of us wants to think of, but there is merit in considering it, as the last thing we want to do is think of the money for the treatment or operations while we are anyways worried about our loved one.
To conclude, there is one other thing that you will develop with this process over time. That would be the disciplined habit of saving your money first, rather than saving what is left after you have spent most of it. This is mainly because once you have a plan, you know exactly what your goal is and what you are saving for.
Once you have created your plan, try and revisit the same every 8–10 Months to gauge whether you are on track or not. If you are looking for the first step towards this journey, try keeping a tab of your income and expenses. There are quite a few options available through Mobile Apps (I personally use Spendee which works great for tracking income and expenses and also gives you the option to link your Bank Account to automate tracking transactions), or you can also choose to record it on your Laptops on a spreadsheet. This will give you a good picture of your cashflows and the first reality check in the process.
See you all next time…
Agreed. Is this why Indians (having a high propensity to save) are comparatively less hurt during global financial meltdowns as compared to other countries having higher propensity to consume ??
Well written 👍