Most of my conversations with people who know that I’m passionate about personal financial planning go like this

Q: Hey Krishna, Which is the best investment option right now?

Me: I don’t know, never did actually. Why do you want to invest? Any specific goal?

Q: Nah, just heard that stocks/mutual funds are doing good these days, how much return can I get?

Me: Well that depends on the tenure, If you stay invested in equities for more than 10 years, you can expect ……………….

Generally, This is where I can feel their attention drifting away.

The end of my sentence will be followed by an awkward silence and we move on to the next hot topic.

The reason these questions come up the most is because they are the most exciting ones to ask!!!

Who doesn’t want to know the next best investment and earn 100x returns? Isn’t that what the financial planning professionals are supposed to know? No.

Infact, choosing an investment is only a part of a comprehensive financial plan. But unfortunately, that’s where we focus most of our efforts.

Pareto principle in Financial Planning

In any field, 20% of the efforts will give you 80% of the results.

And similarly, 80% of your efforts will only give you the remaining 20% of the results.

Here, I’ll list down the basic tips to follow in financial planning (the 20%) that get you 80% of the results.

Tip 1 – Stay away from Bad Debt 

If you can stay at zero debt, then that’s the perfect place to be.

But I know its not for everyone. So if you have to take on debt, ensure that it’s for appreciating assets only.

That would narrow down the list to just home loan and education loan (spending on good education appreciates your child’s income earning potential)

Even here, ensure that your EMI doesn’t exceed 30-40% of your monthly net income. 

Anything more than this will make you live paycheck to paycheck and be asset rich but cash poor. You’ll sleep much better in a smaller home that you can afford/rent than in a bigger one that eats up half of your income. Social status/ Peer Pressure is not worth giving up your peace of mind.

Avoid credit card debt, personal loans at all costs. If you need to take these to make a purchase, accept the fact that you can’t afford whatever your wish for. Take it as a target and work your way up to saving that amount over time.

Delayed gratification is a good thing in personal finance.

If you already took on a bad debt ( high interest), your first priority must be to pay them off. Remember that the high interest rates ( ranging from 18-36% p.a) will add up to huge amounts over time.

When you have a leaking bucket, your first priority must be to fix the leak, not pour more water into it.

Think in terms of compound interest : The Eighth Wonder of the World

Tip 2 – Get adequate Insurance

Health insurance is mandatory for everyone. Compared to the current medical costs of being hospitalized, the insurance premium is a small price to pay. Take one if you haven’t already.

If you have family members who are dependent on your income, take life insurance as well. A simple rule of thumb is to have a life cover of at least 10 times your annual income.

Tip 3 – Setup an Emergency fund

At all times, have 3 to 6 months worth of expenses parked in liquid instruments. i.e If your monthly expenses are Rs 40 k, then have at least Rs 1.2 to 2.4 Lac parked in savings account/fixed deposits/liquid funds.

If you don’t have enough savings, work towards building up to it. Save a fixed amount every month until you reach this target.

This fund is for emergencies only i.e job loss, hospitalization etc and nothing else.

Contrary to popular belief, buying the latest iPhone, down-payment on your favorite automobile etc are not emergencies and this corpus shouldn’t be touched for those purposes.

Tip 4 – Focus on “Conscious Spending”

We all heard the age-old cliches “Spend less than you earn” and ” Make a monthly budget ”.

I used to take these very seriously. For many months, I tracked each and every expense and was meticulously following my budget. But it just felt too cumbersome. It also felt like I was working for my money. It’s supposed to be the other way around.

I want you to focus on “conscious spending” instead. This idea was introduced by Ramit Sethi, author of ” I Will Teach You to be Rich“

List down the things that make you 10x happier when you spend 10x more money on them.

Spend on these items lavishly, but strictly cut down expenses on all the others.

For me it’s food. I spend thousands on eating out without any second thoughts, but I count every penny when it comes to spending on clothing or electronics. To my wife, its Travel.

It’s different for everyone. Once you understand this, It’ll improve your quality of life and help you be frugal at the same time. Also, you’ll be less judgemental about other’s spending habits.

But, this doesn’t mean that it’s ok to spend away all your income. Keep your total expenses within 30-40% of your net monthly income.This is apart from the EMI’s, if you have no outstanding loans, feel free to spend/invest more.

Tip 5 – Do Goal Based Investing

Now, check if you have implemented all the above tips. If yes, only then can you think of investing the remaining  20-40% of your income. If not, go back to work on the above points

Always invest based on goals and not on returns expected. Remember that the main goal of a sound financial plan is to reach all your financial goals by making the best use of your resources. 

It’s not to earn the highest return possible or to go on a treasure hunt for the next Google/ Microsoft like stocks.

For a Young earner/ Newlywed couple, financial goals in their order of priority must be as follows

– Retirement planning 

– Child’s education

– Home down payment/ Annual vacation/ Charity/ Child’s marriage etc (anything personalized to you)

Use any of the goal planners available online to figure out the monthly investment required to reach each of these goals.

Take inflation as 6-8% and expected returns on investment not more than 8-10%.Trust me, 10% p.a is a good enough return if you can invest as much as you can and stay invested till your goal arrives.

Once you arrive at a monthly number. Invest 50% of that amount into an Index fund and the rest 50% into any fixed income instrument (FD,PF,RD etc) every month. Set it up to be auto-debited from your account. That’s it !!!

Unless you’re passionate about finance or business analysis, Its ok to simply invest 50% in equity & 50% in debt and focus on other aspects of life.

Don’t break your head thinking about multibagger stocks, highest rated mutual funds, macro/micro economics etc. Stay away from financial media/newspapers, you’ll start mistaking information/noise with practical wisdom.

Tip 6 – Monitor your Finances

Once every six months, monitor your plan. Here’s a checklist that might help

1.Is the insurance coverage still adequate? Have my expenses increased? 

If the expenses have increased, re-calculate your insurance coverage and emergency fund amounts. Plan accordingly.

2.Any changes in my goals?

If some new unplanned goal has moved up in priority for you, make room for it within your plan.

3. What’s the current asset allocation of my investments?

 If it’s strays away from 50% equity – 50% debt, re-balance it annually, i.e if it’s 60% equity &  40% debt after a year, simply move 10% from equity to debt. This one exercise will keep your portfolio risk in check.

It helps if you can keep track of your Net Worth i.e (Assets – Liabilities) every year. But this step is optional. If you strictly follow all the other steps, your net worth has nowhere to go but UP !!!

All of these are pretty intuitive. Everyone and their grandmother knows them, but I’m yet to meet someone who follows these tips 100% in person. We often miss the basics in pursuit of the advanced stuff.

Keep it simple, stick to the financial plan and move on.

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