Financial Planning — A simple flowchart for people in tech and others. Part 1.

<Part 1> | Part 2 | Part 3

“I have Rs. 10,00,000 available. What stocks should I invest in?”

“I make Rs. XXX,XXX per month, how much should I put aside each month for my retirement fund?”

“My son is 5 years old now, how should I plan to secure his financial future?”

These are some of the common questions asked on platforms like Quora. Investing and Financial Planning are topics that touch the lives of every individual in every sphere, and yet, unfortunately we are not taught even the basics of accounting or financial management in school. Many people find it very difficult to get a grip on their personal financial planning and I have to admit even I did!

The biggest problem is not the lack of information. The biggest problem is discipline and emotions. There are too many options to choose from and most of the time, taking no action is the safest emotional state to be in because it is a familiar state. Any action, even the most logical one, is difficult because fear that this may be a mistake comes in the way.

Let’s take a simple example. Most people hold on to the stock grants offered by their employers. Over time, this becomes a huge portion of their net worth. It is common knowledge that you should not put all your eggs in one basket. Yet, most of us keep holding onto our company stocks. Instead of those stocks, if we had the same amount of money available in cash, very few of us would choose to buy these same stocks. When it comes to finances, your past actions don’t matter. You have to make optimal decisions from the present time onwards, forgetting the mistakes of the past as a sunk cost.

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Why do we need financial planning at all? In my case, the reason was simple. Unlike my father who worked for the government and now earns a monthly pension, I work for a private company. Once I stop working, I will stop earning.

My goal is simple — I want to have enough money to survive and maintain my present lifestyle for the rest of my life.

I want to ensure there is money for my son’s education. I want to have enough buffer for emergencies. I want to manage my monthly expenses even after I stop earning. I want to travel. I want to take care of my parents.

I am not from the finance background and I want to spend as little time doing finances as possible. I am not a risk taker, when it comes to money. Thus, I want to take as little risk as possible. Yet, I also want to ensure that my savings don’t erode due to inflation. So, I need a financial plan that comes with minimal risk but beats inflation in the long term. Nothing less. Nothing more.

This article is the first of a three part series that will lay the groundwork for your Financial Freedom based on my learnings over the last 2 decades! What I have learnt is far from perfect, but it works for me. If you belong to the working middle class and do not want to spend too much time on this matter, this plan should work for you too.

Financial Planning Vs Investing

Many people use the terms “investment” and “financial planning” interchangeably. They are not the same thing:

• Investing refers to the act of putting money into financial products or assets with the expectation of generating a profit in the future.
• Financial planning is the process of creating a roadmap to achieve your financial goals. Investing is actually one of the many components of the financial planning exercise.

What Are The Main Components Of A Financial Plan?

We will break down financial planning into the following components (see the glossary below for definitions):

• Create an asset register
• Identify your current investment portfolio
• Model your cash flow
• Set your goals
• Determine the ideal investment portfolio based on the goals
• Create a systematic investment plan

Too much information? Don’t worry — it is simpler than it appears. Keep reading. I started managing my finances using the above model about a decade ago. I wish I had started much sooner. Many youngsters that I talk to dismiss financial planning as something that needs to be done in future. However, the more you delay, the more you are losing the power of savings and the power of compound interest.

Let’s Get Planning!

Step #1 — The Asset Register

The Asset Register is going to be your core weapon when it comes to conquering financial planning. Open a new Google Sheet or Excel Sheet and name it “The Asset Register”. This file is going to be where we are going to enter all your assets and all your liabilities. You have to enter your financial details at a very granular level, where each line item is named correctly and valued accurately — every bank account, every stock, every mutual fund needs to be itemised in it in detail.

It is critical that you complete this step with full sincerity, because once it is done, what you see is the comprehensive picture of your financial situation. It gives you a fair idea of where you stand today and what you require to reach your goals.

1. Begin by listing your assets in detail — the name, dates, current valuation, type (liquid or non-liquid) and holding period. Take the time to ensure you cover everything in-depth.
2. Divide the assets into groups like Cash, Gold, Real Estate, Shares & Mutual Funds, etc. Every group should have their own sub-line items. For example — bank accounts — don’t just write HDFC, write the account numbers, the amount of money in the accounts.
3. The house that you live in, the car you drive etc. should ideally be marked as assets with zero value since you would not want to liquidate them ever.

Next, follow the same pattern to list down all your liabilities along with their values.

4. Now, add all your assets and subtract your liabilities and find out your Equity (Net Worth). Consider this to be the starting point of your financial goal setting.

5. Compute your Portfolio Distribution by asset class. For eg. Cash — 5% Gold 5% etc

Step #2: Determining Current Asset Distribution

Now, we begin the next step where we determine the current asset distribution across broad investment classes like cash, debt, equity and real estate. Why should we do this classification? The reason is that for a safe and optimal return on investment, there is an ideal distribution for each person. To get to that ideal state, we first need to understand the current state.

For this step, go back to your asset register. Open the sheet where we calculated your current net worth. In this sheet you have already written down every piece of asset you own. Tag each asset into one of the following classes:

• Cash: This should include things like fixed deposits, savings account deposits, short term debt funds, gold etc. etc.
• Debt: Debt funds, EPF / PPF investments
• Equity: Stocks and equity mutual funds
• Real Estate: Land and properties you own

Ideally, don’t count assets like the house you live in, the car you use in this calculation at all.

Once you have computed this distribution, you will get a clearer picture of your current asset distribution. Some of you might realise that a huge chunk of your funds is stuck in illiquid assets, while others may realise that they have too much liquidity which is prompting them to expend more. We will come back to this soon to change this to an ideal distribution.

What’s Next?

First off, if you’ve figured out your Net Worth by following the above steps, then I want to take a moment to congratulate you.

Congratulations you have officially built the correct foundation for your Financial Freedom.

In the next blog of this series, we will look at how to set financial goals.

Glossary

• Create an asset register: First, you need to document what financial assets have and where they are parked. An asset register is just a detailed line by line itemised record of everything you have that is worth something. To set goals for the future, to decide how much you can spend, you first need to know exactly what your net worth is. Thus, this is the first step in financial planning. Asset register is a record that should be kept up-to-date. This also serves as a useful resource for your successors.
• Identify your current investment portfolio: Using the asset register, classify your net worth into broad asset classes like cash, equity, real estate, gold and more. Doing this is critical because different investment classes come with different levels of returns and liquidity.
• Identify goals: The next step in financial planning is to set realistic future goals and determine the amount of money you need for each goal in terms of present value. This step entails detailed itemization of each goal, the target amount of money for the goal in terms of present value of money, the time horizon for that goal.
• Model your cash flow: While an asset register shows your net worth at a point in time, you also need to understand how it will change over time. A typical way to do that is by modelling your cash flow. Cash Flow model is a detailed line-by-line document that contains your projected money inflow (income) and projected money outflow (spending). Looking at past income and spending is a good way to model this for the future. This also provides information that can be used to project what your asset register will look like a year from today. Everyone has some kind of regular spending. Look at your net worth and cash inflow. Then look at your regular spending. Can you really afford to spend what you are spending? If not, change your spending target. Changing your spending target may require some major decisions like what house you live in, what school your kids go to, what car you drive and more. However, your spending has to match the reality of your earning.
• Determine the ideal investment portfolio based on the goals: Through your life, you may need liquidity in different amounts at different points in time. You need to set up your investment portfolio in a way that gives the best possible return yet ensuring you have liquidity when you need it.
• Create a systematic investment plan: Final step in financial planning is to identify the actions you need to take (e.g. transferring money from one place to another) and creating a systematic plan to take those actions.