The unprecedented coronavirus pandemic has been a timely reminder that even Black Swan events – extremely rare and unexpected events with serious consequences – can occur. The pandemic has demonstrated unequivocally that such unforeseen and unforeseen events can wreak havoc on economies around the world, creating a ripple effect that affects all of us.
One of the lessons of this crisis is the realization that we must all prepare for such an eventuality in the future. You need to start by making sure that you are, at the very 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 with diligent savings as part of a carefully designed and regularly monitored financial plan. There are many benefits to having a long-term financial plan that go beyond 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 risks severely crippling income streams for this large demographic. Job losses and the resulting financial insecurity can become immediate threats. To combat this, personal savings can prove to be a critical factor in cushioning the fallout. There is therefore an urgent need to promote long-term financial planning and retirement savings strategies in all age groups.
Create a savings plan: A savings plan isn’t just about letting your money accumulate in a bank deposit; it has many other advantages. The smart option is to always let that 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 strengthen your capital and improve your financial portfolio.
Plan financial goals: With sufficient savings, you can plan for life goals, such as early retirement or an investment in long-term assets such as 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 wallet. A suitable nest egg is essential for your financial stability and your independence. In a crisis situation like a pandemic, it can help you get over a sudden job loss or cut in pay, and give you more freedom to seek new opportunities.
Discipline yourself: Financial planning helps build fiscal responsibility and self-discipline where you learn how to budget, keep track of your debts, pay your taxes on time, and eventually increase your savings. Over time, you will learn the trick to maintaining a constant cash flow, 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 expenses high. It may even seem unnecessary if you are still in your twenties. However, the earlier you start, the more you can earn from an investment plan. You can give your investments more time to mature, choose high-risk, high-yield investments without worrying about impending retirement.
Likewise, it is equally important for people in their forties and fifties. While age may limit the responsibilities you can take on, there are many safer options where you can park your money and allow it to 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.
- You can also do it yourself. It may take a little while and you will need to study different financial markets, but it can be a very rewarding experience.
Over time, you will develop an understanding of markets and the factors that influence how they work.
Diversification is the key
Diversification here is about spreading your investments between different assets that react differently to the same financial event, the same market or the same 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 among different assets, you ensure that the risks are evenly distributed, allowing your portfolio to absorb the shock of any financial disruption.
- Diversification also increases your chances of success. Since you can’t accurately predict what will or will not work in the future, hedging your bets gives you the best odds.
Allocate your assets carefully
Asset allocation is the allocation of different asset classes in a portfolio. An ideal asset allocation should balance the risks and rewards of a portfolio. Assets are broadly divided into stocks and bonds.
- Stocks are considered high risk, but have the potential for high returns.
- Bonds are considered stable with lower yields.
Your portfolio should contain both to strike a balance between risk and surety. However, the proportion may change depending on various factors. The general rule of thumb when calculating asset allocation is to subtract your age from 100, the result being the amount you need to invest in stocks. So a 25-year-old can maintain the asset allocation at 75% equities and 25% bonds. In contrast, a 40-year-old could keep the ratio at 60:40.
However, this is only a rough guide. Today we have a lot of other options to choose from, such as:
- Money market instruments: These include certificates of deposit, commercial papers and treasury bills. As G-secs, they are isolated from the markets given the sovereign guarantee they have. This makes them virtually 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 plan on a fixed date, monthly, quarterly, semi-annually or annually. With a phased withdrawal, you can maintain a cash flow. You can also choose to only withdraw capital gains, ensuring that your investment is not disrupted.
- Systematic Investment Plan (SIP): 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 INR 500 per month.
- Unit Linked Insurance Plan (ULIP): ULIPs combine life insurance and 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. This allows you to build up capital on your life insurance.
The question here is how to allocate these asset classes in a portfolio. Asset allocation depends on your goals, your risk appetite and your age. Since the goal here is long-term investing, let’s look at the other two factors:
Risk appetite: Risk management is an important part of any portfolio. Stocks and bonds should be allocated based on the level of risk you are willing to take while pursuing your investment goals. It is risk appetite and multiple factors influence it. If you have high liabilities or low income, your risk appetite will likely be lower even if you are 20 years old. On the other hand, a person in their thirties, with no unusual liabilities, will have a higher risk appetite and be able to hold the majority of their portfolio in stocks.
Age: As you get older and nearer retirement age, you are 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 high risk in the near future, but are likely to show higher returns later. You can hold onto your stocks and allow them to appreciate.
Rebalance your portfolio
The two main drivers of asset allocation – risk appetite and age – change over time. As your income increases, so will your appetite for risk. On the other hand, a sudden loss or reduction in income will reduce your risk appetite. In addition, your responsibilities may change over time. For example, starting a family or buying a house comes with regular expenses that will impact your savings and therefore your investments. Your age will also play a role; as you get older, your willingness to take risks is likely to decrease. These changes in circumstances mean that your portfolio needs to be rebalanced periodically.
At the end of the line
A long term investment plan is necessary for a secure future. Whether it’s creating a retirement plan or ensuring comfortable savings, it ensures that 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 for ensuring economic security against another pandemic.