Warren Buffett said, “SoÂmÂÂeone is sitting in the shade today because someone planted a tree a long time ago.” But a good gardener knows that you must nourish the soil if you want healthy plants. You must water the plants adequately, especially when seeds are germinating and sprouting, and they should be planted in a nutrient-rich soil.
Same is the case with financial planning. While it is critical to make a financial plan, it is even more important to review it regularly and stick with the plan. Let’s take a look at how a financial plan is created and few steps that can ensure the success of the plan. At its core, a financial plan aims at matching your assets and liabilities. Assets comprise all your investments and liabilities comprise all your financial goals. A successful plan ensures that you have enough assets at the time when you need them for a goal.
A financial plan also takes into account the risk you take in achieving this goal. For any critical goal, like your retirement or children education, your investments should take a more conservative path to ensure that you are almost assured of the funds when you need them. For a discretionary goal, like a second house, the investment path can be a little aggressive. Your investment path for a goal can also be aggressive if the time horizon is longer. Remember that equity investments become more predictable in their returns as the investment time horizon increases.
At the end of a financial plan, you should have a target asset allocation, a target savings rate and a target portfolio. These three components are the pivots that define the success of you financial plan. However just knowing about these three targets is not good enough. It is important is to track and act on them. Matching your investments to the recommended asset allocation is critical. Rebalancing investments to match the target allocation not only keeps your investments on an optimal risk and return path but also helps you buy at lows and sell at highs.
Next most important component is your savings. Savings essentially mean that you are forgoing an expense today so that you can spend in the future. Every additional sum that you save will help further secure your preparedness for your life goals. However it is important to save at least what you have targeted, which in turn should be based on the requirement and ability. These savings need to be invested as per the target asset allocation.
Once you start implementing your financial plan, you need to check to make sure that you’re staying on track. Returns on investments can vary from expectations and goals can change with time. Therefore your portfolio value needs to be reviewed against the expected portfolio value. Minor variations of 5-7 per cent do not really matter but this is an important component to be tracked.
The best way is to decide to review your plan and your progress at regular intervals — every six months or at least a year. It's best to review with your planner or an expert. A review helps to realign to plan to new information. You may run into unexpected obstacles or expenses. Your goals may change, or your resources may vary. You may even receive money that you didn’t expect. Therefore, you should review your plan whenever you have significant changes in your life.
(The writer is senior vice-president, financial planning and customer service, ICICI Securities)
