How to construct a financial plan with a strong foundation?

The motive behind creating a financial plan is to have a route map to achieve your financial goals. A plan that tells you what are all your realistic goals and what are all your unrealistic dreams. A plan that tells where you will be financially 5 years from now, 10 years from now and 20 years from now.

A strong foundation is important for a long lasting construction. Similarly when we are constructing a financial plan there are some basic things to be given more attention.

Current Savings and Investments:

We need to take into account what are all the current savings and investments you have. It could be cash in hand, cash at bank, investments in financial assets, real estate investments and other investments. However, this will not include assets which we are keeping it or maintaining for our personal use like personal jewels, self occupied house, car etc. This exercise of assessing our current savings and investments is done in order to understand and realize “where do we now stand financially?”

Future Savings Potential:

We need to take into account what is your family’s current income and at what rate this income is expected to go up till your assumed age of retirement. This growth rate of your income can be guessed to certain extend by considering your past increment experience and your industry standards. Based on this predicted growth rate of income, we need to project your income till your assumed age of retirement.

Also we need to project your expenses. Take what are all your expenses and project these expenses till your assumed age of retirement. Expenses can go up because of 2 reasons. One is inflation and the other is change in lifestyle and life stage.

Once you project your income and expenses till your assumed age of retirement, then you will be able to assess how much you will be able to save year after year till retirement. Identifying your saving potential helps us determine where we can reach financially and how fast we can reach there.

Future Financial commitments:

Other important foundation work is to list down the future financial commitments for goals. First you need to list down the financial goals to be achieved on a timeline. That is you may want to buy a car 3 years from now, you may want to buy a property 5 years from now, you may need to meet your first kid’s higher education 10 years from now, second kid’s education 13 years from now, you want to retire 20 years from now and in between you would like to go for a few international vacations…

Once you list down the goals on the timeline, we need to find out the approximate future value of these goals.
Finding out the future value of the goals is little difficult but possible if we follow a few simple steps.

Try to figure out what would be the present value of these goals if you were to meet these goals today. That is, what would be the value of the goals in today’s cost of living? Then project this present value with inflation to find out the approximate future value of these goals.

Say one of your goals is to buy a property at the end of 5 years from now. Visualise and get more details about this goal. In which location you will be likely to buy the property? What would be the size and other specifications of the property? Once you have found out answers for these kinds of questions then you need to find out what would be the cost of such property now.

As you have arrived at the present value of your goal, you need to project this present value of the property with assumed inflation rate for 5 years and you will be getting the approximate future value. Say the present value of the property is 70 lakhs, then the inflated value end of 5 years may be 1 crore.

We need to do this exercise for each and every goal. End of this exercise, you will have what are all the goals you are planning to achieve, when you are achieving each one of them and what would be the approximate future value of these goals.

Viability Check:

Now we need to check, with the current savings and future saving potential, is it possible for you to achieve all the goals. If it is possible, we can go ahead and create a financial plan. If it is not possible, then what is the alternative? The alternative may be to retire at 58 instead of 55, to buy the car after 5 years instead of 3 years or to buy the property worth 50 lakhs instead of 70 lakhs.

We need to create a few alternative scenarios which are achievable. After going through these alternative scenarios, depending on your priority you need to choose a scenario which suits best for you. You may like to choose a particular scenario and fine tune it. Like this we need to finalise a scenario which is achievable by a financial plan as well as acceptable to you.

Once you finalise this scenario, based on that a sound financial plan will be created. This viability check makes you understand the shortfall or gap between your realities and dreams. This makes you keep realistic expectations in your financial goals.

You can’t ignore these basic things in creating a financial plan. If these basics are ignored then your financial plan will become weak. You need to pay enough attention to these basic things which makes the foundation very strong and the financial plan very sound.