The unprecedented coronavirus pandemic was a timely reminder that even black swan events—extremely rare, unexpected events with severe consequences—can come to pass. The pandemic has unequivocally demonstrated that such unforeseen and unplanned-for events can wreak havoc on economies around the world, creating a ripple effect that impacts each one of us.
One of the lessons of this crisis is the realization that we must all prepare for any such eventuality in the future. You must start by ensuring that you are, at the very least, financially protected against a similar event. The only way to achieve this goal is by creating a financial safety net through long-term planning.
You can start with diligent saving under a carefully-designed financial plan that is monitored regularly. A long-term financial plan has many benefits that extend beyond providing security in times of crisis. However, before you understand the need for long-term planning, you must ensure stable cash flow through savings.
Need for Financial Planning
As half of India’s population is under the age of 27 years, any similar crisis in the future has the potential to severely cripple the income streams of this large demographic. The resulting employment losses and financial insecurity can become immediate threats. To combat this, personal savings can prove to be a critical factor in cushioning any fallouts. There is, hence, 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 option is to always let this money work for you. A smart investment plan will include an option to facilitate regular cash flow, where you may be able to see partial returns on your investment after a certain period of time. This will allow you to further build your capital and enhance your financial portfolio.
Plan Financial Goals: With sufficient savings, you can plan for your life goals, such as retiring early or investing in long-term assets such as real estate. You can also put aside funds for short-term goals, like buying a car or planning a holiday, without worrying about crippling your long-term portfolio. A suitable nest egg is essential for your financial stability and independence. In a crisis situation like a pandemic, it can help you tide over a sudden job loss or pay cut, and give you greater freedom to scout for new opportunities.
Discipline Yourself: Financial planning helps build fiscal responsibility and self-discipline where you learn to budget, keep track of your liabilities, pay your taxes on time, and eventually increase your savings. Over time you will learn the trick of maintaining a consistent flow of cash, while ensuring a healthy and diverse portfolio.
Starting a Long-term Financial Plan
A long-term financial plan may seem like a daunting prospect, especially if your savings are generally low and spending is high. It may even seem unnecessary if you are still in your 20s. However, the sooner you start, the more you can gain from an investment plan. You can allow more time for your investments to mature, opt for high-risk-high-return investments without worrying about a looming retirement.
Similarly, it is just as important for those in their 40s or 50s. While age may limit the liabilities you can take on, there are plenty of safer options where you can park your money and allow it to grow. In fact, with age a financial plan becomes critical as your retirement comes closer.
- You can plan your long-term investments 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 their working.
Diversification is the Key
Diversification here means distributing your investments between different assets that react differently to the same financial event, market, or timeline. For instance, 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 critical.
- By distributing your savings among different assets, you ensure that the risks are also distributed, allowing your portfolio to absorb the shock of any financial disruption.
- Diversification also increases your odds of success. Since you cannot accurately predict what will or won’t work out 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 seen as high risk, but have the potential of high returns.
- Bonds are considered stable with lower returns.
Your portfolio should contain both to strike a balance between risk and surety. However, the proportion can change according to various factors. The general rule of thumb when calculating asset allocation is to subtract your age from 100, the result being the amount you should invest in stock. So, a 25-year-old can keep the asset allocation at 75% stock and 25% bonds. On the other hand, a 40-year-old could keep the ratio at 60:40.
However, this is just a rough guide. Today we have plenty of other options to choose from, such as:
- Money markets instruments: These include Certificates of Deposit, Commercial Papers, and Treasury Bills. As G-secs, these are insulated from the markets given the sovereign guarantee they come with. This makes them practically risk-free, but with low returns. They can be easily liquidated.
- Systematic Withdrawal Plan (SWP): You can opt for a mutual fund with a SWP. It allows you to withdraw from the scheme at a set date, either monthly, quarterly, semi-annually, or annually. With a phased withdrawal you can maintain a cash flow. You can also choose to withdraw only capital gains, ensuring that your investment remains undisturbed.
- 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 it can start from as low as INR 500 a month.
- Unit Linked Insurance Plans (ULIPs): ULIPs combine life insurance with investment. The insurance company will put part of your investment in a life insurance policy and the rest in stock or bonds, depending on your preference. It allows you the opportunity to build capital on your life insurance.
The question here is how to distribute these asset classes in a portfolio. Asset allocation depends on your goals, risk appetite, and age. Since the goal here is long-term investment, 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 risky 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 are in your 20s. On the other hand, someone in their 30s with no unusual liabilities, will have a higher risk appetite and can hold the majority of their portfolio in stocks.
Age: As you grow older and closer to your retirement age, you are less likely to risk your life savings. The proportion of bonds in a portfolio, hence, increases with age. The younger you are, the longer the potential lifespan of your investments. You can invest in stocks that may seem high risk in the near future, but are likely to show higher returns later. You can hold your stocks and allow them to appreciate.
Rebalance Your Portfolio
The two main factors of asset allocation—risk appetite and age—keep changing with time. As your earnings increase, your appetite risk will also go up. On the other hand, a sudden loss or cut in earnings will lower your risk appetite. In addition, your liabilities may change with time. For instance, starting a family or buying a house entails regular expenses that will impact your savings, and hence, your investments. Your age will also play a role; as you grow older, your willingness to take risks is likely to lessen. These changes in circumstances mean that your portfolio must be rebalanced periodically.
A long-term investment plan is necessary for a secure future. Whether it is about creating a retirement plan or ensuring comfortable savings, it ensures that your money is secure and growing at a healthy rate. At a time when we have been confronted with unimaginable and uncontrollable events, it becomes even more critical for your personal freedom and in ensuring economic security against another pandemic.