Process of Financial Planning
24 May 2021
Need of doing Investment
We need to do investment to beat the inflation. Inflation refers to the increase in prices of products and lowers the value of cash savings with the passage of time. The average inflation rate in India is 5-6%. We need to allocate our assets at a right place so that we can beat inflation and build our wealth.
We have already know what are the different investment avenues available to invest. Now the question is how to allocate our funds. Asset allocation in terms of investment works broadly by dividing your investment in a number of different asset classes. You decide how much of your investment
in rupees will go to which assets. Stocks, bonds, gold, and cash are traditional alternatives. By spreading your investments across a number of asset classes, you reduce the risk potential compared to allocating 100% of your investments in one single asset class.
We will understand this concept through a short story.
A Short Story
There were three friends – Ram, Shyam and Sita who lived in small village. All the three friends worked in a cloth factory. One day, a moneylender came to factory and asks Ram to stitch 50 shirts within 2 days and he will pay extra two thousand rupees if Ram completes his work within 2 days. Ram worked hard for two days but he didn’t complete the work on time. The moneylender came after two days and got angry on Ram. Ram apologize and asked if he tells the secret of becoming rich, then he will stitch 50 shirts for free. So, moneylender said “I will teach you financial education tomorrow if you complete my work on time. Ram shows his full dedication towards the work and completes the whole work. Next day, moneylender becomes happy and told ram that if you want to build your wealth, you need to pay yourself first. Ram was not able to understand this concept. So he said, start saving 10% of your income and reduce your unnecessary expenses. From that day, Ram starts saving 10% of his income. After saving some money, he starts looking out different investment options like Bank FD, mutual funds, stocks, bonds. He starts investing in stocks and invests 100% of his savings in stocks. He starts earnings good profits from stock market but one day market crashed and he lose all his savings. He met with moneylender again and told him that he lose all his savings in market crash. Then, moneylender told him you need to understand the concept of asset allocation. Asset allocation is dividing your investment in a number of different asset classes. First, All the asset categories do not fall or rise at the same time. Secondly, all the asset categories do not behave in the same way at the same time to the same market forces. So, if you allocate your assets well, then you will reduce the risk of losing the money. Now, Ram starts saving again and investing in different asset classes. After 20 years of his savings and investing, he is one of the richest man in his village while his friends are still poor. This is the importance of financial education.
Common Myths about financial planning
Myth- I have a very little money, hence financial planning is not for me.
Truth – Financial planning is for everyone. If your income is low, then try to reduce the unnecessary expenses and start saving a little amount. Myth - Financial planning seems to be a tedious and time-consuming process and I am far too busy to spend my time on planning. Truth - Anything new seems to be tedious at first. But it is worth ‘investing’ some of your time on acquiring this skill as it would enable you to worry less about and enjoy more of your hard-earned money. Myth - Number of credit cards in my wallet shows how rich I am—the more the number, the richer I am.
Truth- This is a common misunderstanding especially amongst young people. More credit cards mean you can spend more of ‘borrowed’ money, which may tempt you to spend more. If you spend borrowed money frivolously, then you will lose all your wealth very soon.