The lifespan of people has increased due to financial development, medical advancement, health consciousness, etc. The average lifespan is now 75-80 years according to the latest survey report. So, you need to make proper financial planning to lead a happy retirement life without financial woes and tension. In order to make this happen, you need to avoid financial planning mistakes. Here we will discuss the top 10 financial planning mistakes to avoid for a secure and prosperous life even after retirement.
Top 10 Financial Planning Mistakes to Avoid
Saying yes all the times
After getting first income an average individual does not think about savings and reinvestment of the money. The first thing he does is he goes to the restaurant with his friends and spends lavishly. He makes unnecessary enjoyment with his money. Apart from that this type of person tends to buy unnecessary items owing to attractive EMI options at affordable interest rates. Finally, he is left with no savings at the end of the month.
Solution – You should divide your post-tax income into three parts and allocate every part for every sector. Your income will be divided as 50% on needs, 30% on wants and the rest 20% for saving. Surround yourself with financially educated and conscious people from whom you can learn about financial planning. Also, make sure that your group of friends comprise people who share similar financial goals.
Ignoring retirement planning in the younger age
After getting a job most people think that they are too young to plan for retirement. They believe that they have much time to plan for retirement. They ignore this vital thing that early planning will secure financial needs after their retirement. Like this, they spend years after years and when the age of 60 comes close they find themselves with very little savings for the post-retirement life.
In order to make a perfect retirement planning, you must have a clear view and a good understanding of the expenses that will be required to live after retirement. Let’s make it clear with the following example,
Suppose you have started earning at the age of 25 years and your earning is Rs. 25000/- monthly. So, you have got 35 years to achieve a sufficient amount in order to make a happy and prosperous retirement life.
Your yearly salary is – Rs.3, 00,000/- assuming Rs. 25,000/- a month.
Your yearly Household Expenses – Rs. 1, 80,000/- assuming Rs. 15,000/- a month.
Term insurance premium – Rs. 7,000/- assuming assured sum of Rs. 1 crore for a term of 30 years.
Health insurance premium – Rs. 8,000/- assuming a cover-up to Rs. 5 lakh/ year for a term of 30 years.
Expenses on festive season = Rs. 25,000/-
So, your expected expenses throughout a year is = Rs. 1, 80,000/- + Rs. 7,000/- + Rs. 8,000/- + Rs. 25,000/- = Rs. 2, 20,000/-.
Then, the expenses at the age of 60 years assuming a current inflation rate of 7% will be = Rs. 21 lakh. [Excluding term insurance premium and health insurance premium since they are fixed at the time of buying].
So, you have to accumulate a corpus of [Rs. 21 Lakh × 20 years = Rs. 4.2 Crore] at the age of 60 years assuming you will live at least 80 years.
Does not have any financial goal for future obligations apart from retirement
After getting a job most people think that they are too young to plan for future obligations such as education cost and marriage cost of children. They imply why he should think even when he is not married yet. But you need to think earlier for one day you will get married and have kids.
Suppose at the age of 30, you stay with your family in any rented house and you have got one son and one daughter. So, in order to meet the future obligations like to own a house, the education cost of son and daughter, the marriage cost of daughter you need early planning. Let’s understand it.
Total cost for the higher education of your daughter and son, let’s say after 15 years after they passed 10th standard, = Rs. 50 Lakh.
Marriage cost of your daughter including inflation = Rs. 30 Lakh.
Amount needed to buy a house after 20 years including inflation = Rs. 1 Crore.
Solution – Since they are long term goals, in order to meet future obligations, you need early planning. Let’s discuss,
To meet the education cost
If you start investing in any equity-oriented mutual fund for the period of the next 15 years with just Rs. 4000/- per month then you will get Rs. 50 lakh after 15 years assuming 15% CAGR.
To meet the Marriage cost
If you start investing in any equity-oriented mutual fund schemes for the period of the next 20 years with just Rs. 2000/- per month then you will get Rs. 30 Lakh after 20 years assuming 15% CAGR.
Fund to buy a house
If you start investing in any equity-oriented mutual fund schemes with just Rs. 7000/- per month then you will get Rs. 1 Crore after a span of 20 years assuming 15% CAGR.
Underestimate the insurance and cost of healthcare
Young people have a common perception that they are superhumans. Nothing can do any harm to them. It is because they are full of energy, enthusiasm and can overcome any situation. As most of the term insurance policies have no monetary benefit on the survival of the policyholder, so people consider term plan policies worthless. But here the most vital question arises what will happen if you die untimely or to say suddenly. In addition to this while taking a mediclaim policy, they ignore the fact that they will go old too. Most insurance companies do not offer insurance policy after 45 years if they allow, they will check the medical check-up. After the check-up, they allow or reject the application.
What your family will have to face on your sudden demise if you have taken a home loan or car loan or education loan? It is a big question. Here comes the role of term insurance plans. Term plans can ensure the future of your family. In the case of health insurance policy even if you are young 10-20 day hospitalization costs sway all of your savings. So, take insurance policy at a younger age. You need to pay a lesser premium if you take a term plan or health insurance plan earlier.
In the case of Term Insurance Plan
Suppose, you buy a term plan at the age of 25 and you want to continue this plan till the age of 60 years and a sum assured is Rs. 1 Crore. So, the duration of the term plan is 35 years. If you choose a Term Plan at the age of 25 then you have to pay Rs. 6800/- per year. If you choose a Term Plan at the age of 30 then you have to pay Rs. 8300/- per year instead of choosing a term plan at the age of 35 that costs Rs. 10,200/-. So, you have to pay a lesser premium at the age of 25 instead of at the age of 35.
In the case of Health Insurance Plan
If you take a family floater plan at the age of 30 years of Rs. 5 lakh and the plan consists of self, your spouse and 2 dependent children, you have to pay Rs. 11,000/- on a yearly basis. But if you take the same plan at the age of 40, you have to pay Rs. 16,000/- on a yearly basis. So opt for a family floater plan as early as possible. It is better to take a family floater plan just after marriage and later you can include your children.
Don’t maintain debt judiciously
Usually, an individual takes a loan to build his/her own nest on an easy EMI option either a monthly or quarterly basis repayment from banks or any other financial institutions. In addition to this, the individual applies for a car loan. After the withdrawal of home loans and car loans, people get trapped in a vicious cycle.
In order to fix that problem, we will make use of famous The 20 Percent Rule, The Income Rule, The 28/36 debt Rule, & The 20/4/10 Debt Rule to calculate the money which you are free to put to buy a home or a flat. Let’s illustrate these famous rules to calculate spending to buy a home.
- According to The 20 Percent Rule, an individual should put at least 20 percent down when buying a home. This rule ensures that any individual does not spend more amount while buying a home than what the individual can afford.
- According to The Income Rule, an individual should buy a house cost of which does not exceed his three years’ worth of the gross annual income when buying a house. This rule ensures that any individual doesn’t spend more amount while buying a house than what the individual can afford.
- According to The 28/36 Debt Rule, Debt-to-income Ratio, an individual should not spend more than 28% of gross income on housing expenses and more than 36% of all debt including a car loans or housing loans, etc. In accordance with The 28/36 Debt Rule, 28% represents the monthly principal, interest payable, property taxes i.e. estate tax and insurance payable on the property. The rest 36% represents all recurring monthly debt compared to one’s gross household income including credit card debt, personal loans, EMI on Housing loan, EMI on a car loan, etc.
- According to the 20/4/10 rule, any individual should make down payment of 20% value of the vehicle while buying, repay the whole amount within 4 years, and expenses towards the car i.e. the installment i.e. EMI, insurance premium, fuel expenses, and maintenance in any month should be less than 10%.
Don’t invest in accordance with time horizon and risk appetite
Novice investors invest their money in the equity asset class with a hope for a very short period of time just to say 1 year or 3 years and expect their money to be doubled. But they forget that the share market is volatile in the short run and a wealth builder in the long term. So, after investing their money the market corrects and consequently, they suffer a loss. In this way, they exit the market with a huge loss.
Solution – You need to specify your goals either it is short term or long term because you have to decide your investment portfolio in accordance with your goals. If you are planning for the purchase of a four-wheeler car within the next few years then you need to invest your corpus in debt instruments, because in the short run the stock market is quite volatile. But in the case of retirement planning which is a long term goal you should invest in the equity asset class since the equity asset class outperformed all the asset classes over the long term.
Invests without diversification
Many a person invests the money without diversification i.e. invests in one asset class irrespective of time horizon or risk appetite. This is one of the worst mistakes a retail investor makes.
You need to prepare an asset allocation strategy to diversify your investment portfolio among the different asset classes like gold, equity, bonds, and debt instruments. Asset allocation strategy enables an individual investor to diversify or mitigate the risk by making an investment in different asset classes. A generally accepted trick is that you have to subtract your age from 100 to determine the percentage of your investment to the equity asset class.
Underestimate the tax implications
Do you know if you have a yearly income of Rs. 12 Lakh then you can save at least 1 Lakh per year? That’s the power of tax planning. Many individuals ignore the tax planning and they can no avail the benefit of deductions available under Chapter VI-A of the income tax act, 1961.
If your income is taxable you should calculate your tax liability at the starting of a year. You may consider income tax as an expenditure or you may take your income after deducting your tax.
The most efficient way to take advantage of Section 80C is to invest in Equity Linked Savings Scheme (ELSS). It has the shortest lock-in period as compared to all the other tax-saving options available under Section 80C. In this way, you can save taxes up to Rs. 45, 000 and avail a deduction up to Rs 1.5 lakh. Additionally, the ELSS is a diversified equity fund helps you to achieve your financial goals via investment in the equity market. Apart from 80C, there are various deductions available under Chapter VI-A of the income tax act, 1961.
Does not create an emergency fund
Owing to the temptation to get a credit card, people borrow money from parents, relatives or my friends thinking that they will start repayment when they get a salary increase. So, people do not build their emergency fund. This is the biggest financial planning mistakes to avoid. But when the emergency breaks through and an unexpected money requirement in lieu of health hazard or any unexpected situation arises, people take a personal loan or redeem their portfolio to meet the requirement.
Every person should make ensure to create an emergency fund for any kind of emergency or unforeseen situation. This saving amount may vary from person to person according to his status or requirements. Try to accumulate enough money in this fund so that you can bear your all expenses i.e., foods, clothes, insurance bills, even your sip installments for at least 6 months in an emergency.
How Capitalante can help you
Capitalante has a team of well qualified and professional equity analysts who will help you to prepare an effective investment strategy to reach the desired retirement corpus by proper financial planning i.e. an investment portfolio of stocks, mutual funds, etc. according to risk appetite and time horizon. For more information feel free to contact us.
I hope, this article will help you to fix financial planning mistakes to avoid. If you have found any questions regarding financial planning mistakes to avoid, feel free to comment so that we can have a discussion. If you have found this post helpful feel free to share with your loved ones.