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Financial Planning

The Financial Planning Pyramid

 The basic rule of the pyramid is to start from the bottom and move up, rather than attempting to address all aspects of it at once

It’s often said that Financial Planning is “simple, but not easy”. Indeed, it’s a fact that the basic tenets of Financial Planning are relatively straightforward – the ease of adhering to them is a different story! While thumb rules and simplistic frameworks for Financial Planning abound, the “pyramid approach” stands out as the clear winner.

What is the Financial Planning Pyramid?

The Pyramid is an approach to managing our personal finances. The basic rule of the pyramid is to start from the bottom and move up, rather than attempting to address all aspects of it at once. The four levels of the pyramid are (starting from the bottom): protection, savings, wealth building and speculation.

Protection

“Protection” forms the base of the Financial Planning pyramid, and therefore must form the base of any good Financial Plan. Put simply, protection involves “covering your bases” by taking out an adequate quantum of insurance coverage to safeguard yourself from the risk of your financial loss arising from damage to your assets or to your health.

Additionally, protection also encompasses having enough life cover in place to indemnify your dependents from the financial loss arising from the loss of your life. Lastly, protection involves having a controlled amount of debt, and steadily reducing (if not avoiding) expensive debt altogether. For instance, it’s an exercise in futility to save money for your future goals while incurring wasteful interest costs on your credit cards – you may as well channelize the savings amount towards retiring your expensive loan first.

Savings

Once you’re done covering your bases, you can consider saving for your future goals. A well drafted Financial Plan should form the cornerstone of your goal based savings, as it would allow you to take a more holistic stance towards your financial goals, keeping your cash flows, liabilities, and goal priorities in mind.

Start making affordable, regular and disciplined savings towards your important life-goals such as purchasing a home, planning for your child’s education, or planning for your own comfortable retirement.

The quantum of savings need not be large – what’s important is that you make a start early on so that you give your funds the chance to compound over time and grow exponentially. For instance, did you know that a monthly saving of Rs 10,600 for 25 years (Rs 32 lakh overall) can grow to Rs 2 crore at a conservative 12 per cent annualized return? What’s more – delaying this savings plan by 5 years will reduce the final savings amount from Rs 2 crore to Rs 1 crore! Ideally, your savings plan should also have automatic step up mechanisms built into it, to ensure that your goal linked investments go up in sync with your increasing surplus.

Wealth Building

Having put your savings plans on autopilot, you should utilize windfall profits (such as year end bonuses, inheritances and business profits) by investing them in a diversified portfolio consisting of high quality asset classes such as blue-chip shares, real estate, long term track record mutual funds and bonds. Consider your unique profile and preferences before you invest for wealth creation. Your investments need to be in line with the asset allocation that best suits your risk appetite.

For example, if you are a conservative investor, you should probably have only 20 per cent of your investments in equities, 50 per cent in debt and fixed income products and the remainder in real estate and/ or gold. A more aggressive investor may have a different asset allocation altogether. Younger investors should ideally adopt more aggressive stances towards their portfolios, even if their risk tolerance levels are low.

Speculation

As the term suggests, speculation is basically no different from betting or gambling! An example of speculation would be trading in shares with the intent of selling them in a week or two, or making speculative, leveraged trades into futures and options with a short-term horizon.

Though speculation may lead to washout losses or windfall profits, one need not avoid it altogether – it is, after all, the only really exciting aspect of Financial Planning! It is advisable, though, to speculate last of all (after taking care of your protection needs, savings and investments).

Another thumb rule of speculation is to do it with moneys that you can afford to lose in entirety. That is, if the money value of these speculative were to unluckily become zero, it will not cause you any significant distress or financial strain. The mistake most people make when it comes to speculation is that first, they speculate with their entire free surplus and second, they speculate before taking care of their higher priority financial planning needs first.

This article is rightfully owned and posted originally by Anirruda Bose.

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15 Steps To Prepare Your Finances For 2017

How many times have you resolved to lose Rp 100.000 or go to the gym more often? Maybe it’s time to make resolutions that you can keep for a better 2017.

The start of a new year is a great time to begin an emergency fund, create a household budget or pay off debt.

Several financial planners share their tips on what resolutions and steps consumers can take today that will result in a healthy financial year in 2017.

Here are 15 steps to prepare your finances for next year:

 

credit: lirneasia

credit: lirneasia

1. Start/build an emergency fund

Wilson Moy, director of financial planning and senior trust officer at AAFMAA Wealth Management & Trust, says that the best move consumers can take is to resolve to build an emergency fund next year.

As its name suggests, an emergency fund is an account — typically a savings account — that consumers can tap to pay for life’s unexpected events, such as a broken water heater or a blown transmission on the family car.

2. Aim to save 6 to 12 months of expenses

Moy says traditionally, financial experts have recommended that consumers keep three to six months of living expenses in their emergency funds. But that might not be enough today, Moy says.

Instead, Moy recommends building an emergency account that holds six to 12 months of living expenses.

“Things change so fast today,” Moy says. “If you’re the single wage-earner for your household, what would happen if you lost your job? Three to six months might not be sufficient. Without that emergency fund, you might be forced to make big changes, such as selling your home, if you do lose your income for any period of time.”

3. Create or adjust your household budget

Drafting a budget for your household doesn’t sound like fun. But Craig Robson, senior vice president of wealth management at the Atlanta office of Merrill Lynch, says doing so is a key step in having a healthier financial year in 2017.

4. Update your monthly income in the budget

Creating a household budget isn’t overly complicated. Start by listing your monthly income. Account for any increases in salary or bonuses your employer mentioned for next year.

5. Adjust fixed monthly expenses

Then list your fixed monthly expenses, items such as your monthly mortgage payment, car payment and estimated utility bill. Note if there are any modifications in these costs, like a new addition to the family or the additional expenses of a longer commute.

6. Set aside money for other household costs

Finally, determine how much money is left over. This is money that you can earmark for entertainment, weekly groceries and eating out.

7. Put money toward financial goals

Use the remaining money to achieve your financial goals, such as saving for college or building an emergency fund.

Once you know how much money is coming into and out of your household each month, you can take steps to either reduce your expenses or boost your monthly income to meet your specific financial goals, Robson says.

“Studies show that those who create budgets are more likely to achieve their financial goals,” Robson says.

8. Target high interest debt

Kevin McCarthy, financial advisor division manager with SunTrust Investment Services, says before making any big financial moves, consumers should resolve to pay off any debts that come with high interest rates.

This usually means credit card debt, which can come with interest rates of 20 percent or higher, making it the most expensive debt you can carry.

9. Limit dependence on credit cards

Kathleen Hastings, portfolio manager with FBB Capital Partners in Bethesda, Maryland, says the biggest mistake people make is running up their debt. The best resolution you can make, then? To use your credit cards wisely.

Consider only making purchases with your cards that you can pay off in full when your bill comes due. Using your credit cards in this way is smart: You don’t have to carry loads of cash with you and you can improve your credit score by paying off your debts on time each month.

“Resolve to stay out of this kind of debt,” Hastings says. “If debt gets out of control, it’s really tough to eliminate. It compounds. It snowballs. The next thing you know, you are $30,000 or $40,000 in debt.”

10. Look into transferring debt to a low interest card

The high interest of certain credit cards make them hard to pay off debt. Some consumers may want to look at the option to transfer their balance to a low or 0 interest credit card. Though the promotional interest rate will not last, they can use this opportunity to pay down the debt. Before moving your balance, compare different cards and be aware of transfer fees.

11. Pay off credit card debt

Financial pros recommend several ways to pay off your credit card debt. Start by paying extra each month on the card that has the lowest balance. Once you pay that off, you can then take the extra cash and begin paying off the card with the next-lowest balance.

Or begin paying off the card with the highest interest rate first, no matter how small or large its balance is. Once you pay off that card, take on your credit card that has the next-highest interest rate.

12. Prepare to max out retirement savings contributions

Kevin Houser, manager partner with Allentown, Pennsylvania’s Houser & Plessl Wealth Management Group and one of the authors of “The Book on Retirement,” says resolving to maximize the contributions to your retirement plans — whether 401(k) plans or individual retirement accounts — is a step that everyone should make.

Most people know this. But they instead let emotion, such as worrying that they’ll miss those extra dollars being funneled from their paycheck to their 401(k) plan, over numerical facts dictate their decisions.

13. Raise retirement plan contributions

Instead of devoting, for example 12 percent of each paycheck to their 401(k) plan, they instead contribute only 8 percent. That ends up costing them big dollars come retirement time.

“So often, emotions drive our retirement decisions,” Houser says. “The black-and-white of the numbers is easy. People know they should contribute as much as possible to their retirement plans. The underlying shade of grey that comes in when emotions get involved is what clouds our judgment.”

To calculate how much to increase contributions to meet your goal, use a retirement savings calculator.

14. Review your insurance

If you haven’t had a chance to look over your insurance, from health to life insurance, make sure to go over costs, deductibles and other expenses for next year. For example, you may want to increase your amount of life insurance if your income is now higher.

15. Consider housing options

Are you renting when you should be buying a home or find yourself in a place that is too small? Assess your current living situation, research new housing options and calculate whether you have the finances to make a move. If not, grow a savings account to relocate or see about refinancing to lower mortgage rates.

 

This article is originally posted by Money Rates.

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