The unprecedented coronavirus pandemic was a timely reminder that even black swan events, extremely rare unexpected events with serious consequences, can happen. The pandemic has unequivocally shown that such unforeseen and unplanned events can wreak havoc on economies around the world, creating a ripple effect that impacts each of us.
One of the lessons of this crisis is the realization that we all must prepare for any eventuality in the future. You should start by making sure that you are at least financially protected against a similar event. The only way to achieve this goal is to create a financial safety net through long-term planning.
You can start by diligently saving under a carefully designed financial plan that is regularly monitored. A long-term financial plan has many benefits that go beyond providing security in times of crisis. However, before you understand the need for long-term planning, you need to ensure a stable cash flow through savings.
Need for Financial Planning
With half of India’s population under the age of 27, any similar crisis in the future has the potential to severely cripple income streams for this large demographic. The resulting job losses and financial insecurity can become immediate threats. To combat this, personal savings can prove to be a critical factor in cushioning the consequences. Therefore, there is an urgent need to promote long-term financial planning and retirement savings strategies in all age groups.
Create a savings plan: A savings plan is not just about letting your money accumulate in a bank deposit; it has many other benefits. The smart choice is to always let this money work for you. A smart investment plan will include an option to facilitate regular cash flow, where you can see partial returns on your investment after a certain period of time. This will allow you to further build your capital and improve your financial portfolio.
Plan Financial Goals: With enough savings, you can plan for your life goals, such as retiring early or investing in long-term assets like real estate. You can also set aside funds for short-term goals, like buying a car or planning a vacation, without worrying about crippling your long-term portfolio. Adequate savings is essential to your financial stability and independence. In a crisis situation like a pandemic, it can help you get through a sudden job loss or pay cut, and give you greater freedom to pursue new opportunities.
Discipline yourself: Financial planning helps develop fiscal responsibility and self-discipline where you learn how to budget, keep track of your obligations, pay your taxes on time, and ultimately build your savings. Over time, you’ll learn the trick of maintaining a steady flow of cash, while ensuring a healthy and diverse portfolio.
Start a long-term financial plan
A long-term financial plan can seem like a daunting prospect, especially if your savings are generally low and your expenses are high. It may even seem unnecessary if you are still in your 20s. However, the earlier you start, the more you can get from an investment plan. You can give your investments more time to mature, opt for high-risk, high-return investments without worrying about impending retirement.
Similarly, it is just as important for people in their 40s or 50s. While age may limit the responsibilities you can take on, there are plenty of safer options where you can park your money and let it grow. In fact, with age, a financial plan becomes essential as retirement approaches.
- You can plan your investments for the long term with the help of a financial advisor who can advise you on your portfolio and manage it for a fee.
- Alternatively, you can do it yourself. It may take a little time and you will have to study various financial markets, but it can be a very rewarding experience.
Over time, you will develop an understanding of the markets and the factors that influence how they work.
Diversification is the key
Diversification here means spreading your investments across different assets that react differently to the same financial event, market, or timeline. For example, a diversified portfolio will typically include stocks, bonds, mutual funds, money market instruments, commodities, and real estate. When planning a long-term investment plan, diversification is essential.
- By spreading your savings across different assets, you ensure that the risks are also spread, allowing your portfolio to absorb the impact of any financial disruption.
- Diversification also increases your chances of success. Since you can’t accurately predict what will or won’t work in the future, hedging your bets gives you the best odds.
Allocate your assets carefully
Asset allocation is the distribution of different asset classes in a portfolio. An ideal asset allocation should balance the risks and rewards in a portfolio. Assets are broadly divided into stocks and bonds.
- Stocks are considered high risk, but have the potential for high returns.
- The bonds are considered stable with lower yields.
Your portfolio should contain both to strike a balance between risk and security. However, the ratio can change based on various factors. The general rule of thumb when calculating asset allocation is to subtract your age from 100, the result is the amount you should invest in stocks. Therefore, a 25-year-old can keep the asset allocation at 75% stocks and 25% bonds. On the other hand, a 40-year-old might keep the ratio at 60:40.
However, this is only a rough guide. Today we have many other options to choose from, such as:
- Money Market Instruments: These include Certificates of Deposit, Commercial Papers and Treasury Bills. Like G-secs, these are isolated from the markets given the sovereign guarantee they come with. This makes them virtually risk-free, but with low returns. They can be easily liquidated.
- Systematic Retirement Plan (SWP): You can opt for a mutual fund with an SWP. It allows you to unsubscribe from the scheme on a certain date, be it monthly, quarterly, half-yearly or annually. With a gradual withdrawal you can maintain a flow of cash. You can also choose to withdraw only capital gains, ensuring that your investment is not affected.
- Systematic Investment Plan (SIPs): SIPs allow you to invest a fixed amount in mutual funds over a period of time, rather than investing a large amount. It is ideal for small investors as you can start from as little as INR 500 per month.
- Unit Linked Insurance Plan (ULIP): ULIPs combine life insurance with investment. The insurance company will put part of your investment in a life insurance policy and the rest in stocks or bonds, depending on your preference. It allows you the opportunity to build capital on your life insurance.
The question here is how to allocate these asset classes in a portfolio. Asset allocation depends on your goals, risk appetite and age. Since the goal here is long-term investing, let’s look at the other two factors:
Risk appetite: An important part of any portfolio is risk management. Stocks and bonds should be allocated according to the amount of risk you are willing to take while pursuing your investment goals. This is risk appetite and there are multiple factors that influence it. If you have high liability or low income, your risk appetite is likely to be lower even if you’re in your 20s. On the other hand, someone in their 30s with no unusual liabilities will have a higher risk appetite and may keep most of their portfolio in stocks.
Age: As you get older and near retirement age, you’re less likely to risk your life savings. The proportion of bonds in a portfolio therefore increases with age. The younger you are, the longer the potential lifespan of your investments. You can invest in stocks that may seem risky in the near future, but are likely to show higher returns later on. You can keep your shares and allow them to appreciate.
Rebalance your portfolio
The two main factors in asset allocation, risk appetite and age, continue to change over time. As your profits increase, so will your risk appetite. On the other hand, a sudden loss or a cut in earnings will reduce your risk appetite. Also, your responsibilities may change over time. For example, starting a family or buying a house involves regular expenses that will impact your savings and, therefore, your investments. Your age will also play a role; As you age, your willingness to take risks is likely to decline. These changing circumstances mean that your portfolio must be periodically rebalanced.
A long-term investment plan is necessary for a secure future. Whether it’s creating a retirement plan or securing comfortable savings, it ensures your money is safe and growing at a healthy rate. At a time when we have been faced with unimaginable and uncontrollable events, it becomes even more critical for your personal freedom and ensuring economic security against another pandemic.