Going Back To The Very Basics of Personal Finance

I was talking to an old friend recently. That conversation gave me the idea to do a blog post on the very basics of personal finance planning.

Most times, people rush into discussing ‘where to invest’ as the first thing in a personal finance plan. That comes at the tail end of the plan. There are some basic steps you need to execute before you come to investment planning.

For some of you, these might be too basic and you might have taken these steps already. I do recommend, however, that you go through it to make sure you are sorted.

So, what are the very basics of personal financial planning?

Let me define it with the following model:

Step 1: Understand your current reality

Step 2: Figure all your expenses and earnings

Step 3: Complete the basic housekeeping for your family/dependents

Step 4: Ensure the security of your family/dependents

Step 5: Make an investment plan

Step 5.1: Understand your risk-taking ability based on your life situation

Step 1: Current Reality:

What is the sum total of all your investments and assets to date?

Note down all investments you have ever made. This includes all your LIC, PF, PPF, any Mutual Funds and Fixed Deposits as well. Also, note down the value of your properties, the one you live in and any others you may own.

In parallel, note down your liabilities ex. if you own a house where you are paying EMI, then the outstanding principal is your liability on that house.

Similarly, note down any and all loans that you need to repay or any other liabilities you might have.

The sum total of all your assets, less all your liabilities makes up your net worth.

Knowing this is a great place to start on your personal finance journey.

Step 2: Expenses and Earnings

2.1 Expenses:

You probably know these very well. But let’s take the effort to note them down.

Segregate your expenses into 3 types:

This will help you to understand what your monthly and annual requirements will be.

Knowing the potential future costs of things like a child’s education will also help you plan.

Over here you should be expansive. Include all the things you want to do, such as that trip to Disneyland you want to take your little girl on.

Later on, we will figure out what we need to do to make it happen or whether we need to park a few things for the present.

2.2 Income:

All sources of monthly income. If you have a salary as the only source of income then this is simple enough. You should note down any rentals, investment incomes, dividends you might be receiving.

This will help you to understand how you stack up on a monthly basis. Will the income be enough to provide for all your current and future expenses?

At this point, you should also be able to know if there are any expenses you need to reevaluate.

---

The next step in my hierarchy is basic housekeeping. This is again simple but tedious. Not doing this can result in unnecessary pain for your family.

Step 3: Basic Housekeeping:

This is nothing but sorting out paperwork. It is about ensuring the family and dependents know where things are. This can be done at any point within your financial planning hierarchy. It is an important but oft-neglected step.

• Note down all bank accounts and assign nominees to each one of them.
• Note all insurance related details in an accessible way for your dependents
• Complete your Will
• Complete the ‘After Me’ file

Step 4: Security:

An important part of financial planning is ‘security’ for your family and dependents. This is an easy one to implement but a lot of people miss out on this simple step. If not done, this one misstep can cause untold misery to those left behind.

The two things you need to do as a basic means of security:

• Term Insurance – every earning member of the family should have term insurance
• Health insurance – Covid has taught us all how critical health insurance can be

The above steps form the bedrock of any good financial plan.

It is only once you have completed these should you think of investments.

---

By this stage, you know – i. your current net worth, ii. your total expenses, iii. including the cost of security for your family and finally iv. your total income.

Step 5: Investment Planning

You should now sit down and take a hard look at your finances. Calculate the amount of money you will have leftover for investments.

At this point, you should also look at your life-stage. A single parent with a young child will have a very different risk profile from a young working couple.

Based on your risk profile you can work out an investment plan involving mutual funds. For most conservative investors with a 5-year horizon, Index funds can be the default option.

Do not forget to build a corpus for emergency funds as part of this plan.

Your final aim should be to get to a point of Financial Independence (FI). I will use the words financial independence and retirement interchangeably. You can interpret it as per your life-stage. For some of us FI can be the plan at 45 for others it might be the plan for 65 years old.

For this, you will need to project your expenses into the future, to the point of retirement. What do you think your expenses will be post-retirement?

You should be able to build a nest egg to take care of those expenses after sorting out all your other long term plans ex. kid’s education.

You can use retirement calculators that are available on blogs such as:

Freefincal

The Mad FIentist

and this one is a review and list of multiple retirement calculators online from the Balance.

These will give you a number to shoot for.

Working backwards from this number you can see how much you need to invest every month into SIPs. This will also tell you if you need to revisit your expenses and cut something there.

The most crucial part of the financial plan is the execution. Once you have made the plan you should stick to it. Be disciplined and consistently stick to your plan.

I have discussed most of the above topics across different posts in some detail. I will continue this series on the very basics also. This is aimed to help those who are in the early stage of their financial planning journey.

Key Takeaways:

• Use the 5-step framework to build your personal finance plan
• Figure your current networth
• Understand all your expenses including long term ones
• Do the basic housekeeping of bank account nominees etc.
• Provide for the security of your family
• Plan for your financial independence

---

This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.