Monday, December 29, 2008


A request came to me for explaining the Basic Principles of Financial Planning for beginners, which can help today's rich youngsters. Financial Planning is no rocket science, its pure common sense- never keep all eggs in one basket. For saving money the common baskets are:-
  1. Debt
  2. Equity
  3. Asset Creation[Property, car,two-wheeler]
  4. Pure Life Insurance Policy/s maturing at the age of 60 or 65.
  5. Gold and other jewellery/precious metals
  6. Commodities and Foreign Currencies.
Before understanding the baskets let us understand the special features of the thing called MONEY.
  • Money is like a cricket pitch-action takes place at both ends and all round it.
  • It is a science as well as an art.
  • Money can be invested or gambled in the name of investment.
  • Money is the laziest thing created and also a rocket which goes up and down at the craziest of speeds imaginable.
  • Money can make or break you, it does not respect age, status, power or wealth. YOU RESPECT MONEY AND IT WILL KEEP YOU LIKE A KING.
Let us understand these traits in some detail:

Managing money goes on simultaneously in all areas depending on individual circumstances.
The saying goes "the science of investment" and "art of managing money". Economists and financial wizards realised that higher the risk-greater the return is the science behind money. The risk factor brings in an element of fear which leads to irrational behaviour, hence cannot be science alone. A scared person will not listen to reason and the art of managing is based on perceptions. Mature persons manage money in a scientific manner which is investing, whilst others follow the herd mentality which is gambling. When dealing with money, never be greedy or in a hurry.

This becomes the basis of next trait of money. A very very thin line separates investment from gambling. There is nothing wrong in gambling for fast returns. But here invest only what you can comfortably lose. Do not invest your life savings but create a small corpus separately for sake of excitement and thrill and indulge yourself as long as some money remains in this fund. Once it is wiped out[which it would] you would have hopefully matured and grown up to respect money.

Money is very docile when kept in form of cash or bank saving accounts. Money in fixed deposits of Companies are normally safe but can become dicey, hence gets you a higher return than bank deposits. The risk element keeps increasing when investing in various debt instruments hence better returns. Money comes in its glorious best when invested in equity. The Stock Markets up to January 2008 had given returns beyond widest expectations. The subsequent crash [see my post[GLOBAL MELTDOWN-A LAYMANS VIEW] has wiped away life saving of many even before they could blink.

This meltdown has not affected everyone the same way. I came very close to grief but fortunately the safety net[see post EQUITY- FRIEND OR FOE, THE REAL MONEY PLANT and MONEY PLANT REVISITED] which I had put in place held and all my investments are safe. My respect for power of investing is keeping me like a KING - so far.

Now let us understand the baskets through which financial planning is given shape and body. The amounts mentioned for each baskets would differ from person to person and are my own guesstimates not based on any study. The baskets are arranged in order of my priority.

Investment in debt should be the starting point for anyone. Bank Fixed Deposits is the place to start with. I recommend Rs 10 lakhs as fixed deposit[FD] over a period of time. HDFC and Bank of India allow Over-draft[OD] facility on FDs which should be availed of. This has lots of advantages explained in my post THE REAL MONEY PLANT. Once Rs 2 to 3 lakhs are in place, the next basket can be used. Of course for Income Tax purpose second basket can be availed of first, as deductions upto Rs 1 lakh under Sec 80 C saves tax outgo. This amount should be invested in equity dominated tax saving schemes of Mutual Funds. This process should be repeated year after year till your target of Rs 10 lakhs FD is achieved.

Basket No.3 should be thought of only after meeting the demands of Basket Nos.1 and 2. Two or Four wheeler should always be purchased by availing loan as paying interest works out cheaper in the long run. Property should be thought of only when surplus remains after Auto loan. Before actually investing in property find out the loan amount which would be required. Take a pure life insurance policy for an amount which covers all your loans, including ODs [Basket No.4] and then only finalise the property deal.

In my assessment when today's youngster retires they would be requiring Rs 1.5 crores in saving to survive his/her old age in comfort. Pension schemes are a part of Basket No.1 and should have separate target over and above Rs10 lakhs FD. Personally I prefer Mutual Funds to Pension Funds. The target for life insurance policy should be Rs 50 to 75 lakhs. The purpose of this policy is not investment per se, it is part of the safety net. The logic behind spending this money is that in a worst case scenario the loans would get paid by the insurance money without adding to the miseries of the family, in the best case scenario the maturity amount would help in meeting the target of retirement fund.

By the time I could think of Baskets No.5 and 6 my funds had run out on me. I have no knowledge about these investment baskets. Anyway any beginner who reaches these baskets would be requiring the services of a professional financial advisor who would be knowing about these baskets.

Before closing this post I would repeat the guru mantra which is always balance your investments 50-50 between debt and equity. This gives you the safety net. Those who wish to live on the edge can alter this ratio as per their capacity of absorbing loses.

Do you think this is the time to exit Indian stock markets?