Financial planning in 2021 – The year 2020 was one of such nightmares which many of us would definitely like to forget at all costs. Nevertheless, this year also taught us a lot about many aspects of life which we almost pay no attention to. In all, with the announcement of the vaccination drive for COVID-19, the year 2021 has rung a bell and has shown us a ray of hope in the gloomy times.
But has everyone learned the lesson for good from the year 2020 and has started acting upon it. New year resolutions have not gone stale yet and we would like to remind you as to how you can make the year 2021 the best year.
As we have steered ahead in Unlock 2.0, now slowly the finances, economy, employment markets, stock markets are beaming up. But until and unless you understand how to carry out financial planning for this new year 2021, you won’t be able to achieve much this year too.
So, let’s learn some quick tips for financial planning for 2021:
- Make financial resolutions for 2021 and stick to it
New year resolutions are really fun and motivating, but how to ensure that we stick to those? Try to mix consistency in your daily routine and reap the benefits of a loyal disciple of your own resolutions.
You could build a budget which may be designed to help you achieve some goals which may be
- Tax saving
- Retirement planning
- Vacation planning
- Emergency fund arrangements
- Wealth building for the long term
- Cutting back on unnecessary spending and shopping etc.
The list is exhaustive but it is always recommended that you should build a financial budget to ensure that at least 3 of your financial goals are achieved. Sticking to the budget is very easy and there are also some tools and apps available for your convenience.
- Tax Planning
Most people usually interpret tax planning as last-minute investments into anything which will suffice the deduction limit. However, there is much more to tax planning. Not all tax-saving instruments are made up to suit everyone’s risk appetite and investment goals. Let’s take the example of Mr. A who needs to invest in tax-saving instruments. Mr. A also wants to make most of it even where he is ready to accept moderate risk. Mr. A should invest in ELSS – Mutual Funds (blue chip or large-cap typically), which would allow him to claim deduction under section 80C. One more advantage is that Mr. A will be able to earn around 12-13% with moderate market risk.
- Investment Goals
If there is no goal, then there could be no financial planning. Ideally, financial planning would be divided into 3 types of goals
- Short Term Goals
Tax planning or contingency fund planning is usually the short-term financial goal. Short Term goals cover the time period of 1-3 years. The investments with a lock-in of 3 years period or investments with maturity for such a short period would be suited to meet certain annual cash flow or expenditure. A most suitable example of such expenditure would be insurance payments or school fees payment etc.
- Medium Term goals
A most appropriate example of a medium-term goal would be buying a house or school fees till graduation. Vacation planning can also be carried out in the medium term.
- Long Term Goals
Retirement planning would be peculiar examples of Long term financial planning. Investments having longer payment periods or with maturity/redemption expected at a much later date than 10 years would mostly be suitable. Equity investments would be also suitable for long-term financial planning.
- Medical Insurance
With COVID 19 in the background of the year 2020, the upcoming year 2021 would also be witnessing some ups and downs in the health security area. Following points to ensure that you are on the safe line.
- Revisiting the medical insurance coverage
- Check whether the current insurance cover is sufficient to cover hospital admission, room rent, etc.
- Check whether the medical insurance covers the major and terminal diseases
- Understand that it is better to pay the premium now and reduce the bigger cashflow at the time of the actual incident.
- Take care of your health
The year 2020 was a lightening effect to make us understand the benefits of good health. If you have good immunity, then you can definitely save yourself from multiple diseases and in turn much of your money too.
Subscribe to the Yoga class, take admission to Gym, take out time for a healthy jog. Break the routine of Work from Home and try to get out for fresh air. This will reduce mental stress and as well as add to the health benefits.
- Revisit the retirement plan
With COVID 19, many of us saw the actual job loss and pay cuts. This shows how critical it is to ensure that we revisit our retirement planning. While you assess the retirement plan, here are few things to check on
- Inflation factor
- Increased expected medical expenditure
- Reduced pay or no income in some cases
- Liquidity crunch etc.
- Create an Emergency fund
It is a known fact that a fund equal to six months of your income should be maintained as a liquid investment so that it could be used in the event of no active income source. Ideally, an emergency fund can be created by investing in short-term fixed deposits or recurring deposits, or mutual funds.
- Learn something
Learn something new which will help you either in getting-
- an increment in the current job or
- a new job or
- promotion etc.
This new skill may also help you add an additional income stream which you could use as an emergency fund.
- Strengthen your credit score
Try to pay off loans with the highest interest rate first. Also, avoid buying things on credit cards. Once you default on loan repayments, it hampers your credit score badly. So always make sure that you are not defaulting on repayments.
- Say no to unnecessary investments and tips
Most of the investors usually go out and make investments based on insider tips or commission agents’ advice. Try to take the help of a professional if you can not do it yourself.
These 10 Tips will help you out in building a sustainable financial plan for the year 2021. These pillars will help strengthen financial health in the coming years. Having said so, just building a plan is not enough. You will need to ensure that you stick to the Financial Resolutions to make it work for you.
Most of the people are unaware of certain basic things or factors to look out for, which are basically warnings towards incoming financial peril. If ignored these may prove to be very costly, but if identified at early stage, they may be corrected to ensure sound financial health and leads the way to efficient and effective financial planning. Let’s see the top 7 signs indicating the need for financial health check up.
Liquidity check for emergency situations
Imagine a situation where you are suddenly face job cut or meet with an accident which will disrupt your income earning capabilities. Most of the people are experiencing the job loss or pay cut currently owing to COVID-19. You can’t predict such events or developments since they are very much unpredictable. You can check your liquidity position by calculating the liquidity ratio as below.
Cash or most liquid assets (include fixed deposits and equity or ETFs)
Regular household expenses incurred or estimated per month
This ratio will give out the time period for which you have surplus funds on which you can sustain without any income during such period. This is the additional liquid funds which are actually your emergency buffer, which should ideally be not less than 3. If you have liquidity ratio of 1-1.5, then there lies times of trouble ahead.
Also, if you have equity investments done specifically for a goal like children education then do not count that amount in this calculation as you should not ideally consider this for meeting emergencies.
Loans without reciprocal asset creation
Credit card loans or EMIs for luxury (simply put unnecessary items) are just an example of unwarranted loans, which do not lead to any asset creation in the long run. So forget about that high end smartphone which will put a hole in your pocket (almost equaling a month’s grocery) and put your finances to use. You can assess your debt position with following ratio.
Total liabilities (loans)
Loans would include long term loans and short term loans like credit card loans etc. Ideally for a person in the age group of 25- 45 years, has higher ratio due to higher long term loans leading to long term asset creation. However, if you are having ratio below 1 or more than 2, then it is time to check and reorganize your borrowers position.
Check the savings ratio
Financial planning starts and ends with savings. Savings should ideally be any amount saved, invested or any surplus earned every month. Any person would be better off with higher savings ratio which can be calculated as below.
Surplus generated or disposable income
Income for every month
If you are encountering ratio below 1, then this is warning sign. It indicates that you are not saving, rather you are spending more. Even ratio more than 2 also indicates that you are borrowing and saving that money (works out only if interest payable is lesser than the interest income on the investment).
Assess where you stand
If you are the person who has already a huge burden of the debt and is responsible for paying up a fixed amount as loan repayment, should assess his liquidity and solvency position. This can be calculated as below.
Monthly predetermined Long term and short term debt repayment commitments
Income earned per month
You need not worry if your ratio is less than 1, rather it indicates effective debt management. However, those of you having ratio of more than 1, have to take a corrective action, as this ratio implies that you have borrowed way over the extent to which you can actually afford to pay off the liability.
Those of you, who have started retirement planning, may well be ahead of all others, may be able to enjoy the power of compounding. This will not only enhance the retirement corpus for you, but will also ensure that you will achieve it within your time frame, even where your cost of investment is much lower due to early entry as compared to others.
Amount contributed towards retirement planning
Total income earned
Ratio of 5-7% indicates that you are contributing to satisfy threshold for tax saving instruments only, while ratio of more than 10% indicates that you are aiming at building up the retirement corpus for early retirement. However, any ratio below 5% would need reconsideration of financial planning, which would maximize the retirement contribution to optimal levels.
Impulse purchases or exceptional spending behavior
Why is that, every time you go to a mall, you need to buy a dress which will make you regret you afterwards (in terms of cost of course!)? Why is that you can’t resist ordering pizza often which is almost equal to two weeks of grocery payment? These are sheer impulse or unnecessary items, which you buy out of sheer laziness or in the heat of the moment.
Impulse / exceptional purchases
Income earned per month
If you are below 5%, then no reason to worry, because your finances can still handle it (but you will need to prevent such impulse shopping). However, those of you landing in double digit ratio, are in deep trouble. This indicates that impulse purchases have rather become your habit and you are giving in to the temptations, which will land you in a situation, where you won’t have enough to pay for the things you need, because you have already spent on things you don’t need.
What is your worth?
Well not you, but your financial assets and investments! Ideally, positive ratio would bring out the extra-ordinary situation, which proves that your net worth is increasing and you will be achieving your financial goals well before the time frame.
Where net worth = total assets (includes short term and long term assets) – total liabilities (both short term and long term). So, this net worth may keep on changing every month, depending upon the commitments. However, if you find out that this ratio is consistently negative for more than 1-2 months, then it’s a warning bell which will suggest that, you have borrowed way more than you can afford to pay off later.
Financial planning is a discretionary and yet quite typical procedure, which is ongoing and needs to consider holistic approach. Above seven indicators will give you outline that it is not just about the saving or about investment. However, you need to evaluate, analyze and put up any corrective and preventive measures, for any aspect of the financial planning.
Emergency Fund as the word itself says it is a fund which can be utilised in case of an emergency. Emergency can come anytime. You will not know in advance what unforeseen event is going to knock on your door. It could be a job loss or medical emergency with any family member or yourself. In the worst case it could be an unexpected demise of an earning member in the family.
The interesting thing about emergencies is that you cannot predict what will come and when. For instance, nobody would have ever imagined the emergence of a highly contagious and deadly disease all over the world and that it would spread exponentially affecting global economies. The impact is not limited to health but also wealth. People are losing their job or experiencing substantial pay cuts or leave without pay. In such a situation, we realise how important it is for everyone to keep an Emergency Fund. It will help you to manage your expenses without borrowing or affecting your other ongoing investments.
Now that we realise the importance of having an Emergency Fund, let’s understand where we should invest this money.
The two most important factors to be considered while making an investment for emergency fund are –
1. Liquidity – One of the most crucial things is that this money should be readily available. Whenever you need, you should be able to encash it immediately. This means that you cannot invest this money in a PPF account or real estate. Because when you will need it, you will not be able to encash it because of no or low liquidity in these options. Therefore, look out for highly liquid assets.
2. Low Risk – The second most important thing is that this money should be invested in a low risk asset class. It implies that you should not be investing this money in the share market. Although the share market is highly liquid, the volatility is also very high. We would not want to withdraw from such investments by booking losses. You should know that equity market investment is for the long term and is highly volatile. So there might be a situation where you need money but the market is down so you will be forced to withdraw at a loss. This is happening currently with investors who don’t have any emergency corpus.
So based on these two factors, what are the options available to us?
1. Saving Bank Account
Many people prefer to keep emergency funds in their savings bank account. No doubt, it is highly liquid but it gives hardly any returns. Currently, the saving bank accounts are offering 3-5% p.a. which is not even covering the inflation cost. So it’s not a good decision to keep your entire money in a savings bank account.
2. Fixed Deposit
A fixed deposit (FD) is a financial instrument provided by banks, that provides investors with a higher rate of interest than a regular savings account, until the given maturity date. The defining criteria for a fixed deposit are that the money cannot be withdrawn from the FD.
The level of liquidity is low. But you have the option to withdraw with the penalty. To compensate for the low liquidity, FDs offer higher rates of interest than savings accounts.
3. Liquid Mutual Funds
A liquid fund is a type of mutual fund which invests primarily in money market instruments, like treasury bills, commercial papers, certificate of deposits and term deposits. They allow Investors to park their funds for a few days or months as they have maturities up to 91 days.
Liquid funds can be made liquid at any time and earn returns for the holding period. Because they earn a return from market instruments, liquid fund’s returns can rise or fall depending on the market rates. For very short debt, Market interest depends on the liquidity situation.
Read More :- Importance of Continuing SIPs Amid COVID-19
Let us compare Liquid Mutual Funds with Fixed Deposits
1. Liquid funds are easily accessible as compared to bank FDs. Bank FDs would penalize you for premature withdrawal. Liquid funds do not have exit loads.
2. As per past records, liquid funds prove to give better returns than fixed deposits. It would range between 6% to 8% per annum. On the other hand, bank fixed deposits offer returns depending on the tenure. Lower the tenure, lower the interest rates.
3. Since liquid funds invest in short-term securities, it has lowest interest rate risks. When interest rates fall, bond prices go up. When interest rates rise, bond prices fall. The negative relation between bond prices and interest rates is stronger for long term bonds. This means that the longer the maturity of a bond, the more it responds to changes in market yields. Since a liquid fund invests only in short term securities, it’s market value does not respond much when interest rates change in the market.
4. Tax treatment: If you sell them before 3 years, any gain needs to be added to your income and you need to pay income tax based on your tax bracket. Fixed deposits are also taxed the same way even if it is more than 3 years. However, if you redeem liquid mutual funds after 3 years so will have to pay tax of 20% with indexation benefit. This will be fruitful for investors in the higher tax bracket.
If you want to park your money for a short term or immediate requirements, liquid funds would be the best bet for you. Consider the above factors before investing in such funds. Investors can choose good liquid mutual funds based on past years performance, low expense ratio, high Assets under Management (AUM) and well diversified portfolio.
So don’t wait any longer, create your emergency fund today by investing in Liquid Mutual funds. You can do this by downloading the Fintoo App.