5 Mistakes to avoid in Financial Planning

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What mistakes do people make while creating a financial plan? How can one avoid them?

Top 5 Common Financial Planning Mistakes | How to avoid them?

Introduction

Most of us usually think that financial planning is for rich people, which is the biggest misconception that we have. This results in most of the people completely skipping the process of financial planning. In this blog, let us take a look at the mistakes we make while preparing our financial plan.

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5 Mistakes in Financial Planning

1. Not Starting Early

  • If you feel that you do not have enough money to achieve your goals then it is the best time to start financial planning.
  • It is necessary to start as early as possible so as to achieve your various financial goals like children education, retirement planning, etc

2. Risk Management

  • Risk Management mainly deals with expenses that come unannounced. These mainly include medical emergencies.
  • In order to mitigate these risks, it is important to have right amount and right type of insurance. You should have proper insurance to cover the costs incurred due to uncertainties.
  • In the current pandemic scenario, one is exposed to both medical (health) as well as life uncertainties, so it becomes much more important to have a proper insurance.
  • Ideally one should have an insurance cover of at least 10-15 times of the total income earned . So for example, if you earn INR 10 lakhs per anum, then the minimum insurance cover that you should have is INR 10 lakh* 15 which comes to ~INR 1-1.5 crore.
  • Life insurance penetration is very low in India which is around 2-3% and the right amount of life insurance penetration is below 1%.
  • Also, do not buy insurance from an investment perspective. Insurance is used to mitigate the risks that arise from uncertainties and contingencies and not to earn returns.
  • Whereas, investment is done to earn returns and not to mitigate risk.Hence, it is best to not mix the two.

3. Acquiring high debt

  • Most of the times, in the initial years of working, people tend to acquire high debt.
  • Banks generally offer loans where EMI is maximum of 40% of in-hand salary.
  • But, there are different norms for home loan, vehicle loan and education loan. This results in people borrowing above their capacity.
  • Higher amount of loans result in higher interest payments, which eat up savings portion.
  • People generally compromise long term goals for short term benefits. This is a huge mistake which results in their financial goals getting neglected completely.
  • In order to avoid this, one should follow a 50-30-20 rule, which is as follows:
    • 50% of the overall income should be allocated household expenses and EMIs
    • 30% of the overall income should be allocated for long term goals like children education, retirement planning,etc.
    • remaining 20% for short term goals

4. Asset Allocation concentrated in single asset class

  • In India, it is a common mistake that people have concentrated asset allocation is a single asset class i.e real estate. The second most preferred asset class is gold.
  • This results in much lower allocation to financial assets like equity, debt, etc. Such a concentrated asset allocation results in higher risk.
  • Real estate as an asset class has posted a strong CAGR of 35-40%, however post that there is a sluggishness in real estate sector. The major factors for this sluggishness are GST, demonetization , affordable housing projects by government, stricter regulations like REIRA ,etc.
  • Real estate or gold as an asset class are not a bad choice, however there should be proper portfolio diversification to mitigate the risks arising from a single asset class.

5. Financial plan focusing only on tax saving

  • Do not enter into an investment only with tax saving objective. Examples are taking health insurance/life insurance only to get tax deduction.
  • Such investments lead to locking your investment amount for 4-5 years, without yielding good returns.
  • Such investment decisions mainly arise when there is a conflict of objective in an investor’s mind. Objective of investment should be to earn returns and objective of tax saving instrument should to save tax. When an investor mixes the two, it results in earning overall lower returns.
  • Thus, you should prefer an investment through which you can save taxes and not vice versa.
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