InvestorQ : Can you highlight some of the general financial planning mistakes that most of us tend to make and how exactly can we get over these mistakes?
shrinidhi Rajan made post

Can you highlight some of the general financial planning mistakes that most of us tend to make and how exactly can we get over these mistakes?

Riya Dwivedi answered.
2 years ago

You need to remember that the process of saving, investing and insuring needs to begin with a financial plan. But, what is a financial plan? A financial plan essentially articulates your long term financial goals and then helps you work towards these financial goals using a mix of savings, insurance and the power of compounding. But the entire process of financial planning is based on certain key assumptions pertaining to future costs, escalation of costs and return on investments. These assumptions are extremely important from the point of view of the success of your plan. If you err on these assumptions then you are bound to commit Financial Planning Mistakes. Let us quickly look at some of these common financial planning mistakes that investors tend to commit and see how as prudent investors you can avoid these.

Don’t delay starting off on your financial planning journey

When to start financial planning? What is the right age to start off your financial planning? Frankly, there is no precise answer, but the thumb rule is that, the earlier the better. At least, the moment you start earning income, you need to start the process of financial planning. It is now well documented that time plays a very important role in financial planning. In fact time matters a lot more than timing in the market. The earlier you start, the longer time period you have to invest for achieving your goals. The longer time period you have at your disposal, the longer you have to create and nurture income-earning assets and investments.

The longer you create assets, the longer the income on your assets creates further assets. This is called the power of compounding and always works in favour of the person who saves for the longest period of time. Actually, financial planning is all about making time work productively in your favour and make money work really hard for you. A general Financial Planning Mistake is that people wait till they have responsibilities like a family and loans before starting off on financial planning. But, in the process you lose out precious years!

Taxes are important but don’t try to plan your finances based on tax saving

This is one of the Top Financial Planning Mistakes that most Indian investors tend to commit. They buy insurance to save tax under Section 80C. They look at a property purely from the perspective of the Section 24 benefits. They also tend to load up on PPF and other small savings investments purely for getting the full benefit of Section 80C. What is the downside risk? When you focus purely on reducing your tax burden, you tend to take financial planning decisions that are sub-optimal. You may save tax but in the process miss out on other more relevant investment opportunities. The rule is to make tax management incidental to your financial planning process and not core to your financial planning. This is a Financial Planning Mistake that investors must avoid in the larger interest of long-term wealth creation.

Don’t underestimate inflation and don’t overestimate your returns on investment

Other than tax obsession, this is one of the Top Financial Planning Mistakes that people tend to commit. When we calculate the future cost of payables, you either tend to be too conservative on inflation or apply a rate that is not exactly relevant. In this matter, it is better to factor in slightly higher inflation so that you anyways end up winning. For example, inflation in India may be currently around 4% but it has been around 7% over the longer term. It is better to assume higher inflation. Certain expenses like higher education have gone up manifold. Higher education costs are up by 300% in the last 10 years. You cannot apply your standard barometer here. Your conservative estimates of inflation, if applied to higher education, will leave you grossly underprepared for your child’s future needs.

The other angle to this is overestimating your investment returns. A common Financial Planning Mistake is that people, who started their financial planning at a time when FDs were paying 11% returns, are still retaining the same assumption. But those days are long gone and your investment expectation needs to be toned down. Similarly, equities are high risk and high returns. While you impute higher returns to equities, also factor in the higher risk and higher volatility in equities.

Don’t leave out on managing your expenses smartly

One of the best ways to save is to reduce your expenditure, at least the frivolous expenditure that you can dispense with. One of the Top Financial Planning Mistakes in India is that investors tend to expect that investments alone will take care of their financial needs. That is unlikely to happen if you continue to borrow, keep expanding your EMIs, rely on high cost debt or continue to live an unnecessarily extravagant life. While it is essential to enjoy the good things of life, remember that a penny saved is a penny earned. In fact, financial planning fails in many cases because the person does not save to his/her full potential.

Your job is not over with creating a financial plan; you also need to monitor it

A common financial planning mistake is to avoid monitoring your financial plan once it is made. A few basic rules here! While you must rely on a financial advisor, you and your spouse have to take personal ownership for your financial plan. Monitoring of a plan has various aspects to it. Firstly, you need to ensure that specific funds and assets purchased by you are not consistently underperforming. That may be the time for a switch. Secondly, review your financial plan if there are major changes in your goals. Lastly, try to understand how sensitive your plan is to changes in the macro situation. For example inflation may have shot up; interest rates may have been cut, government may have introduced tax on equities etc. Ask your financial advisor probing questions on each of these matters.

At the end of the day, financial planning is about getting the simple things pertaining to your finances right. One of the Top Financial Planning Mistakes that people make is to not recognize that they are actually committing mistakes in financial planning. You can surely escape that catch!