Plan right to save right

The onset of COVID 19 has forced us to question several fundamental assumptions. Key among themare assumptions about our financial well-being. Were you saving to buy a house and now are not sure if you will sustain your job? Did you buy the latest iPhone on a loan and now are not sure how to repay the loan? You never had a financial plan and are you now wondering if indeed you should have one? If these questions are on your mind, this article is for you.

Any financial plan should consider four elements:

1. Objective: The financial plan needs to have as its cornerstone a set of objectives. It could be buying a house, a foreign trip once in two years, funding your daughter’s higher education or creating a corpus for your retirement.

2. Amount: Know how much money you will need to achieve your objectives

3. Time: The time for your financial plan to fructify. This should be in line with your goal. If you wish to take the vacation next year and your financial plan delivers the money after 5 years, it is not of much use.

4. Instrument: Which instrument you choose to save or invest in depends on your objective and how much risk are you willing to take. Risk appetite could differ by objective – for example, you may not want to take a lot of risks to sustain basic expenses, as these are ongoing needs. On the other hand, when planning for a starter pot for your kids you may want to consider slightly higher-risk instruments as this is a long-term goal.

Ok, so now how should you create your financial plan? Lets’ understand this with the help of a framework.

The financial planning hierarchy

This framework tells us that needs lower down in the hierarchy need to be taken care of first before satisfying needs that are higher up. Let’s look at how our financial plan should align the needs hierarchy with the four elements outlined earlier.

[Also Read: Why this is the best time to review your portfolio]

Essential expenses

These are the most basic needs and hence our first objective for the financial plan. Needs are fundamental for your life, wants are those that make your life enjoyable. Needs are – food, clothing, rent and loan EMIs (which if you don’t pay, will impact your credit score creating problems for the future).

Objective: Sustain basic expenses in case of unforeseen events such as loss of job, unforeseen illness, etc.

Amount: The first step is to identify your monthly expense for essentials. Look at your bank statement and your credit card statement for the last 3 months. Identify how much you spent on groceries, food, rent/EMI and other essentials. For a typical Indian household, basic expenses would be 40-50% of monthly post-tax income.

This number could vary – for instance for those with home loans this number could be higher. A good ballpark on how much you need is 6-9 months of monthly expenses. So if your essential expenses per month are Rs. 50,000 – you need to save Rs 3-4.5 lakh to meet your objective.

Time: You need this money always. This pool is like an insurance against risk events since you do not know when the next COVID pandemic happens or when the next financial crisis takes over.

Instrument: Given the nature of this objective, the money needs to be in highly liquid and low-risk instruments. Ideal instruments to save for this objective are to keep money in your savings accounts, fixed deposits (1 year or less duration) or liquid mutual funds.

Security and safety needs

Ensuring your and your family’s safety and security is next in the hierarchy of needs. Since the article is about financial security, we will look at spends on healthcare, life insurance, general insurance and health insurance.

Objective: Secure ourselves and our families

Amount: Typically, between 10 and 20% of income should be allocated to these needs.

Time: In terms of timing healthcare expenses are similar to basic expenses – they are required to be available always

Instrument: One must save for this objective in liquid instruments such as savings accounts, FDs or liquid MFs. One should also include in this life and health insurance-related products. Ideally, choose a combination of insurance and investment for your healthcare needs.

Goal-based investments

The next step of financial planning should involve your goals. Based on your lifestage, you may have any number of goals. Planning to buy a house in 5 years – goal #1, buying a car in 3 – goal #2, foreign vacation – goal #3. Don’t forget to add retirement planning as one key goal. Given inflation and rising life expectancy, this is a critical goal everyone needs to save for.

Objective: Build a savings pot each for each of your goals

Amount: Next, figure out how much you need to meet each of your goals. Typically, one should invest 20% of their income toward such goals. This is in addition to natural investments that happen via the PF route if you are employed.

Time: The time will depend on the goal. Short-term goals could be a vacation or buying a car, while long-term goals could be buying a house or planning for your retirement.

Instrument: While responsible leveraging (e.g. taking a home loan to buy a house) will likely help your financial position, overleveraging could leave you in a spot of bother. Next, based on your goal, set up a savings plan, where you put aside money every month towards your goal. For short-term goals such as a vacation or buying a car, choose low-risk instruments – FDs, low risk mutual funds. For longer-term goals you can invest in riskier asset classes such as equity mutual funds. Invest in equities only if you understand the asset class. For FDs and low-risk mutual funds – you should expect a 5-7% annualised return post taxes. While higher risk assets could yield you 10-15% returns.

Consumption expenses

As against the “needs”, these are the “wants”. Wants are – the meal at the restaurant, the designer dress you wanted to wear at the next party. These are discretionary, and hence the last set of needs one should cater to.

Objective: Discretionary consumption expenses

Time: These are ongoing expenses, without any fixed time limit.

Amount: Typically 20-30% of income should be allocated to this bucket.

Instrument: Since these are discretionary expenses, spend money only when you have it.

To summarise

When planning your savings, move up the needs hierarchy – plan for basic expenses first, security next, goal-based investments after that and for consumption expenses at the end. So yes – the iPhone can wait for a few months, get insured first!

The reverse logic also applies equally – when you need to cut expenses go from top to bottom. Should things go bad – e.g. you end up losing your job, the first cut in expenses should be in the consumption bucket and so on.

So you are all set to create your financial plan. Use Axis Bank’s FD Calculator and SIP Calculator to know how much you need to save for each goal and the likely returns you can expect. Axis bank offers you the full set of products to secure your financial well-being.

Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Lth. and its employees. Axis Bank Lth. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.