In our lives we come across different sets of "dos-and-don'ts" for different situations. A closer examination of such rules reveals that these simple lists are actually a storehouse of wisdom. In the world of finance too, there are certain such set of rules, which can do a lot of good for us.
Here is a compilation of some very obvious yet useful and important dollops of wisdom or financial maxims. Just as the maxim 'apple-a-day-will keep-the-doctor-away', the following words of financial wisdom will keep pecuniary distress away.
Maxim I: Creating an Emergency Fund equivalent to a few months' expenses.
Need: Unexpected twists and turns are a certainty in our lives. An unfortunate calamity or loss of a dear one can leave families devastated. In order to be able to rise after such a mishap, it is necessary to set aside some money as an emergency fund.
Situation: There may be times when one is tempted to draw from this fund to meet non-emergency financial commitments. Sometimes it could cause a dilemma as to whether one should allot priority to the emergency fund or contribute to specific funds for child's education, marriage or retirement.
Solution: The emergency fund should ideally be equivalent to the expenses incurred for three to six months. The best way to handle this is to be diligent in approach and set aside some money regularly for the emergency corpus. As monthly expenses mount the amount of the corpus also needs to increase proportionally. The figure of three-to-six months is not sacrosanct and may vary from one to another situation. A businessman may need to save upto twelve months expenses in an emergency fund while a fresher joining his first job may need just two months expenses as his emergency corpus.
Maxim II: Save from the start
Need: Having a good start always has its advantages. Sprinters train hard to move off the blocks as fast as they can. The same applies to almost every other field as well.
Situation: Twenty-year olds, who are just starting out in their careers, may not be convinced about saving for their retirement from day one.
Many students are beginning their earning cycle already laden with educational loans. Besides this, the ever-rising cost of living and other expenses on entertainment and trendy personal grooming can seriously depreciate individual's saving capacity.
Solution: Start saving as soon as you start to earn. Draw up monthly and yearly budgets, set aside 2% to 3% of earnings and invest them for long term. Also make sure that expenses never overshoot earnings.
Small savings made today, will compound many times over and snowball into a big corpus at the end of the individual's service life. Little drops of savings will create a big lake if not an ocean.
Maxim III: Synchronize your savings and life goals
Need: We need to be adequately prepared in terms of money while nearing certain milestones in life. Marriage, first child's birth, higher education of children, their marriage and of course retirement from active earning cycle need thoughtful considerations and specific financial plans.
Situation: All of the above situations involve costs. Childbirth will mean medical costs, baby related costs, and even temporary reduction of income in cases where one parent has to stay back at home. Similarly for sending children for higher education, parents need to consider the cost of coaching the student for getting entry to a good institution besides the course fee. Cost of travel, accommodation and books etc. also have to be adequately provisioned.
Solution: The best way to take care of these specific cases is to make periodical saving plans. Breaking up the estimated fund requirement and saving in synchronization with such requirements are usually a wise yet easy way to remain happy and contented.
Maxim IV: Make an informed decision on your stock exposure
Need: Financial investments need to be carefully planned in order to get the best results. How much exposure to stocks and equities as a percentage of your overall portfolio is healthy for you? This necessity of correctly assessing it and changing it over time is the key to success in this area.
Situation: Exposure level of equity is dependent on a variety of parameters. Age, risk taking capacity, life's goals and other investments made, all these have a bearing on the percentage of the portfolio that should be invested in equity. A general thumbs-rule followed by some people in determining the percentage of portfolio to be invested in equities, is the figure left after deducting the person's age from 100. Thus, for someone who is 58 years old, 42 percent should be the maximum equity exposure.
However, as stated above, this rule is only indicative and a person, who has high-risk propensity, may wish to deduct the age from say 120 and for one who is conservative, the deductible figure could be 80.
Solution: The best way to assess the equity exposure threshold should be based on the expert advice and evaluation of individual parameters.
Financial Planning is not a onetime isolated plan with limited validity. On the contrary, it is a bigger picture, which spans the entire lifetime of an individual. Everyone cherishes getting it right in financial planning and execution, however in order to derive the best results a lot of thoughtful action needs to be taken.
The maxims, as stated above, if followed with due diligence, is sure to provide good results.
The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Founder and Director of Holistic Investment Planners (http://www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached at email@example.com.