The Financial Planning Process: A Step-by-Step Guide
A well-structured financial planning process ensures financial security today while preparing for future goals. 🌱 Start with Emergency Readiness for protection, define Financial Goals for direction, and plan for Retirement to secure lifelong financial independence. Learn how to balance these three pillars for a stress-free financial journey.
Before planning for investments and retirement, ensure you have a financial safety net in place. The key components of emergency readiness include:
- Emergency Fund
- Maintain 3 to 12 months' worth of expenses in an easily accessible account.
- Split funds between bank accounts (for instant liquidity) and arbitrage/low-risk debt funds (for tax efficiency and stability).
- If you have unstable income (e.g., self-employed), aim for a higher buffer.
- Health Insurance
- Ensure you have adequate health insurance coverage to prevent medical expenses from depleting savings.
- Choose policies that cover hospitalization, critical illnesses, and rising medical costs.
- Read here: Is your emergency fund bigger than it needs to be?
- Life Insurance
- If you have dependents, secure a term life insurance policy to cover at least 10–15x your annual income.
- Avoid endowment and ULIP plans—stick to pure term insurance for maximum coverage at minimal cost.
Allocate 1–1.5% of your annual income for insurance costs—this ensures adequate coverage without overpaying.
Why It Matters?
Without an emergency plan, any unexpected event (job loss, medical expense, family emergency) can force you to break investments or take high-interest loans, derailing long-term goals. Setting aside 1–1.5% of income for insurance ensures affordability while securing your financial future and protects from sudden financial shocks.
Once your emergency fund and insurance are in place, define your short-term, mid-term, and long-term financial goals. However, it’s crucial to think of all goals in sync rather than in isolation—this ensures that today’s asset allocation decisions also align with future needs.
🎯 Short-Term Goals (0-2 years)
- Buying a car, vacation, emergency fund buildup.
- Invest in low-risk, high-liquidity assets.
🎯 Mid-Term Goals (2-5 years)
- House down payment, higher education, business expansion.
- Invest in balanced strategies.
🎯 Long-Term Goals (5+ years)
- Retirement, wealth creation, legacy planning.
- Invest aggressively for long-term compounding.
Thinking of all goals in sync ensures that your asset allocation today supports both short-term liquidity needs and long-term wealth creation. For example:
- If your portfolio is too equity-heavy, you may need to sell at the wrong time for short-term goals.
- If your portfolio is too conservative, long-term growth may suffer.
By maintaining a holistic view of all financial goals, you ensure an optimized risk-return balance across different time horizons.
Retirement planning ensures that you never outlive your wealth. The key to successful retirement planning is:
🔹 Define Your Lifestyle Comfort Multiple (LCM)
Estimate your retirement corpus using the 25x+ rule, where:
Target Corpus = Expected Annual Expense × 25
Example: If your expected retirement expenses are ₹10 lakh per year, aim for a corpus of ₹2.5 crore.
🔹 Investment Strategy for Retirement
Read here: Retirement Strategy: How to Invest Your 25x+ LCM
- Invest 10x in Debt: This earns close to inflation, ensuring 10 years of stability.
- Invest 15x in Equity: Allows your wealth to grow, riding out volatility over the long term.
🔹 Withdrawal Strategy
- Withdraw from debt if equity returns (cumulatively since last equity withdrawal) are less than 10%.
- Withdraw from equity when it outperforms to fund expenses while preserving the debt buffer.
🔹 Use Tax-Optimized Vehicles
- NPS (National Pension System) for tax savings and structured annuity.
Read here: Decoding NPS: Why? When? How much? All of it
Mutual funds with Systematic Withdrawal Plans (SWPs) for lower tax impact.
Read here: Tax-efficient Debt Allocation through Mutual Funds
Why It Matters?
- Early planning ensures compounding works in your favor.
- A structured withdrawal strategy protects against market downturns.
- Proper allocation balances stability (debt) and growth (equity).
- Emergency Readiness First → Build a safety net (emergency fund + insurance).
- Define Financial Goals → Align investments with short, mid, and long-term needs.
- Plan for Retirement Early → Ensure a structured withdrawal plan and tax efficiency.