FINANCIAL PLANNING

“Failure to plan is planning to fail”

Personal financial planning refers to the proper planning and implementation of well-
coordinated plans to achieve financial objectives. The savings and investment made today
should match the future goals. Personal financial planning involves:

 Taking conscientious and systematic steps towards fulfilling one’s financial goals.
 The process of meeting life’s goals through proper management of finances. Life
goals can include buying a home, saving for child’s education or planning for
retirement.
 Personal finance involves much more than managing and investing money. It also
includes making all the pieces of your financial life fit together; it means lifting
yourself out of financial illiteracy. Like planning a vacation, managing your personal
finances means forming a plan for making the best use of your limited time and
money.

Importance of personal Finance Planning

Seeing the Future with a Clear Vision: When we have a goal to be achieved, we will be
clear about the future, and through financial planning, we would be able to follow the steps
needed to achieve the goal. Without a financial plan, it would be like groping in the dark and
everyday crisis management.

Ensuring Financial Discipline: Proper planning helps one to limit his/her expenses within
the budget. It also ensures that planning is done for the various events in one’s life and the
money required for meeting them.

Giving the Person a Direction: Planning sets forth the future vision of the individual. It
helps him to attain various goals in his life.

Improving a Person’s Financial Decision Making: Financial planning helps a person in

making right decisions about the spending and also investments and availing of loans at the
appropriate time.  Assessing the Person’s Risk Tolerance and Develop an Asset Allocation
Strategy: All people are not alike when it comes to taking risk in investing. Some may be
aggressive while others may be conservative. There may be few others who may be balanced.
Financial planning helps in finding out the risk appetite (risk bearing capacity) of each
individual, and on the basis of the risk appetite, suitable investments can be recommended.

Helping in Tax Reduction: It also helps in planning the taxes one has to pay on his income.
By proper planning, one can reduce his tax burden.  Safeguarding Self and Family against
Financial Crises in the Event of Death or Disability: As already understood, financial
planning takes into account not only the individual’s needs but also his entire family
members. Financial planning in the form of obtaining insurance protects the family in times
of distress (death or disability).

Tracking Investment Performance with Respect to Set Goals: Financial planning is not a
onetime exercise. Constant monitoring of the investments’ performance vis-à-vis the goals set
would help in taking corrective action at the right time.

Providing Peace of Mind: It is said that a person who borrows without proper planning ends
up in a debt trap. When he is unable to pay the debts, he loses his sleep and thus peace of
mind. Efficient financial planning would ensure that the individual enjoys peace of mind.

Question

Why the knowledge of personal finance very poor at all ages in Zimbabwe?

MISCONCEPTIONS ABOUT FINANCIAL PLANNING

It is a One-time Exercise: Financial planning is thought of as onetime exercise which is not

true. Financial planning requires close monitoring regularly and readjust or rebalance the
asset portfolio so that the planned goals can be achieved within the time frame work drawn.

2. It is Only about Tax Planning: Tax planning is only one aspect of financial planning.
Financial planning deals holistically and takes care of investment, protection and estate
planning in addition to tax planning.

3. It is to be Done When One Reaches Retirement Age: Another wrong notion is that
financial planning has to be thought of only when one is about to retire or nearing retirement.
If one asks what is the right time to start one’s financial planning, the answer would be
yesterday. That means it should be done at the earliest, as soon as one starts earning money
4. It is Meant Only for Very Rich or High Net Worth Individuals: Another
misconception is that financial planning is meant for only rich people. Financial planning
takes care of the goals of every individual whether rich or common man.

5. It is Only about Investments: As already seen, financial planning covers not only the
investment aspect but also other aspects like insurance, tax planning, retirement planning and
estate planning.

6. Financial Planning Does not Need a Professional’s Advice: Financial Planning is a

specialised job. It requires deep knowledge of the various investment options, regulatory
guidelines, legal aspects, etc. This can be done only by a professional qualified financial
planner.

7. Financial Planning Advice is Too Costly: It is true that one has to pay professional fees
to the financial advisor. One should not forget that the benefits which one derives from this
advice would be much more than the nominal fee one pays.

Principles of Personal Finance Management

The three key principles are prioritization, assessment, and restraint.

Prioritizing means that you're able to look at your finances, discern what keeps the money
flowing in, and make sure you stay focused on those efforts to keep money flowing.

Assessment is the key skill that keeps professionals from spreading themselves too thin.
Ambitious individuals always have a list of ideas about other ways they can hit it big,
whether it is a side business or an investment idea. While there is absolutely a place and time
for taking a flyer, running your finances like a business means stepping back and truly
assessing the potential costs and benefits of any new venture.

Restraint is that final big-picture skill of successful business management that must be
applied to personal finances. Time and time again, financial planners sit down with
successful people who somehow still manage to spend more than they make. Earning
$250,000 per year won't do you much good if you spend $275,000 annually. Learning to
restrain spending on non-wealth-building assets until after you've met your monthly savings
or debt-reduction goals is crucial in building net worth.
GOOD PERSONAL FINANCE TRAITS

Discipline
One of the most important tenets of personal finance is systematic saving. Say your net
earnings are $60,000 per year and your monthly living expenses—housing, food,
transportation, and the like—amount to $3,200 per month. There are choices to make
surrounding your remaining $1,800 in monthly salary. Ideally, the first step is to establish an
emergency fund.

Then, there's investing discipline; it's not just for thick-skinned institutional money managers
who make their living buying and selling stocks. The average investor would do well to set a
target on profit-taking and abide by it. As an example, imagine that you bought Apple Inc.
stock in February 2016 at $93 and vowed to sell when it crossed $110, as it did two months
later. But you fail and ended up exiting the position in July 2016, at $97, giving up gains of
$13 per share and the possible opportunity for profit from another investment.

A Sense of Timing
Three years out of college, you have an emergency fund established and it is time to reward
yourself. You can either buy a second hand car which costs $3,000 and that means investing
in growth stocks can wait for another year. You think; there is plenty of time to launch an
investment portfolio, right? Putting off investing for one year, however, can have significant
consequences. The opportunity cost of buying a second hand car can be illustrated through
the time value of money. The $3,000 used to buy the car would have amounted to nearly
$49,000 in 40 years at 7% interest, a reasonable average annual return for a growth mutual
fund over the long haul. Thus, delaying the decision to invest wisely may likewise delay the
ability to retire at age 62, as you would like.

Doing tomorrow what you could do today also extends to debt payment. A $3,000 credit card
balance takes 222 months to retire if the minimum payment of $75 is made each month. And
don't forget the interest you're paying: at an 18%, it comes to $3,923 over those months.
Plunking down $3,000 to erase the balance in the current month offers substantial savings—
about the same as the cost of the second hand car.

Emotional Detachment
Personal finance matters are business, and business should not be personal. A difficult but
necessary facet of sound financial decision-making involves removing the emotion from a
transaction. Making impulsive purchases or loans to family members feels good but can
greatly impact long-term investment goals. Your cousin who has burned your brother and
sister will likely not pay you back either—so the smart answer is to decline his requests for
help. Sure, sympathy is hard to turn back, but the key to prudent personal financial
management is to separate feelings from reason.

Millennials and Personal finance management

Millennials are so named because they were born near, or came of age during, the dawn of
the 21st century – the new millennium. As the first to be born into a digital world, members
of this group are considered "digital natives." Technology has always been a part of their
everyday lives – it's been estimated that they check their phones as many as 150 times.

Challenges faced by Millenials in personal Finance Management

 Turbulent economic environment for the past 20 years

 Extremely high Unemployment levels - 90% unemployment rate
 Retarding trend in salaries and wages due to the fact that legislation now favours the
employers. This is different as in 1980 workers were untouchable
 They live from pay check to pay check
 Too many economic recessions have led to millennials not to believe in the formal
money market, or stock market. They have seen their parents getting burnt or losing
out their hard earned money

Solutions to challenges faced by Millennials

 Pay for you tuition , avoid debt

 Start investing in your early 20’s
Advantages are 1. You can get into risky investments which if they don’t work out
well you have your whole life ahead to pay for them. 2. You can take advantage of
compound interest as you have a longer time span to invest
 Making your money work for you is a good idea no matter what your life plans are. If
you're young, it doesn't take much: Investing $100 per month in the stock market for
the next 30 years would give you $117,000, assuming a 7% return; make that
investment for the next 40 years and you’ll end up with more than $248,000.
 Many Millennials see themselves working forever, but not because they expect to be
forced into that situation by a bad economy or poor financial planning. They envision
a lifelong career because of their passion for what they do

 Another smart financial move is buying long-term disability insurance while you’re
young and healthy, which qualifies you for better premiums.

Personal Finance Planning Process

We all make hundreds of decisions each day. Most of these decisions are quite simple and
have few consequences. Some are complex and have long-term effects on our personal and
financial situations. The financial planning process is a logical, six-step procedure:

(1) determining your current financial situation

(2) developing financial goals

(3) identifying alternative courses of action

(4) evaluating alternatives

(5) creating and implementing a financial action plan, and

(6) Reevaluating and revising the plan.

Step 1: Determine Your Current Financial Situation

 In this first step of the financial planning process, you will determine your current
financial situation with regard to income, savings, living expenses, and debts.
Preparing a list of current asset and debt balances and amounts spent for various items
gives you a foundation for financial planning activities.
 For example Jane currently has a net income of $20,000 per month, living cost of
$16,000, one car valued at $110,000, retirement fund balance of $25,000 and savings
account balance of $60,000. Outstanding on her Car loan is $75,000. Let calculate
Jane’s financial position.

Amie Net worth = 110,000+25,000+60,000 – 75000

 = $120,000

And she currently saving 20% of her net income.

Step 2: Develop Financial Goals

 You should periodically analyze your financial values and goals. This involves
identifying how you feel about money and why you feel that way. The purpose of this
analysis is to differentiate your needs from your wants. Our attitude towards money
influences how we spend, save and invest
 Most people who have built wealth didn’t do it overnight. They set financial goals and
push themselves to reach them.
 Specific financial goals are vital to financial planning. Others can suggest financial
goals for you; however, you must decide which goals to pursue. Your financial goals
can range from spending all of your current income to developing an extensive
savings and investment program for your future financial security or they could be
short term like saving a holiday or acquiring assets, saving for emergency as well as
investment for your future financial security. It is important you define your financial
priorities based on social and economic conditions
 Your financial goals should be SMART and must be stated in monetary terms
 Goals are first established and then prioritized. Once the set of priorities is
determined, individuals can develop plans to meet those financial goals in the desired
order. Financial goals often create conflicts because individuals have limited
resources to achieve their goals.
 Your financial goals change as you navigate through life. When you are young and
single, your financial goals are generally related to your own personal growth..
During most of your working years, your financial goals are focused on maintaining a
family, accumulating assets and providing for your eventual retirement. When you do
retire, your financial goals are concerned with maintaining a secure and enjoyable
lifestyle. This evolution of financial goals over a lifetime is called the financial life
cycle.

Step 3: Identify Alternative Courses of Action

 Developing alternatives is crucial for making good decisions. Although many factors
will influence the available alternatives, possible courses of action usually fall into
these categories:

a) Continue the same course of action.

b) Expand the current situation.
c) Change the current situation.
d) Take a new course of action.
  Not all of these categories will apply to every decision situation; however, they do
represent possible courses of action.
 Creativity in decision making is vital to effective choices. Considering all of the
possible alternatives will help you make more effective and satisfying decisions.
 For example Jane could consider the following options:

- Increase the savings amount to 25% or 30% of net income

- Move the balance in savings to bond or money market investments for higher returns
- Consider additional sources of income (part time lecturing)

Step 4: Evaluate Alternatives

 You need to evaluate possible courses of action, taking into consideration your life
situation, personal values, and current economic conditions.
 Consequences of Choices. Every decision closes off alternatives. For example, a
decision to invest in stock may mean you cannot take a vacation. A decision to go to
school full time may mean you cannot work full time. Opportunity cost is what you
give up by making a choice. This cost, commonly referred to as the trade-off of a
decision, cannot always be measured in dollars. Financial goals often create conflicts
because individuals have limited resources to achieve their goals.
 Decision making will be an ongoing part of your personal and financial situation.
Thus, you will need to consider the lost opportunities that will result from your
decisions.
 You ought to Evaluate Risks as you evaluate alternatives, and your risk
tolerance Uncertainty is a part of every decision. For example Selecting a college
major and choosing a career field involve risk. What if you don’t like working in this
field or cannot obtain employment in it?

Other decisions involve a very low degree of risk, such as putting money in a savings
account or purchasing items that cost only a few dollars. Your chances of losing
something of great value are low in these situations.

 In many financial decisions, identifying and evaluating risk is difficult. The best way
to consider risk is to gather information based on your experience and the experiences
of others and to use financial planning information sources such as Changing
personal, social, and economic conditions will require that you
In the case of Jane, we can evaluate the options as follows:

 If you want to save 30% of your salary, it means you need to manage your spending.
This can be challenging when cost of living is sky rocketing (inflation).
 If you want to consider additional sources of income, such as weekend lecturing, it
means less time for party and more time to work hard. Your children, partner, parents
may need more time from you.
 You could lose your money if you invest in mutual funds compared to government
Treasury bills. Generally, the higher the return, the higher the risk of losing money.
 Whiles the interest on time deposit and savings may be subject to withholding tax,
government Treasury bills are not usually subjected to withholding tax.
Consider the liquidity of your assets or investments. Liquidity is the characteristic of an asset
that can be converted readily to cash without loss of principal

Step 5: Create and Implement a Financial Action Plan

 In this step of the financial planning process, you develop an action plan. This
requires choosing ways to achieve your goals. As you achieve your immediate or
short-term goals, the goals next in priority will come into focus.
 To implement your financial action plan, you may need assistance from others. For
example, you may use the services of an insurance agent to purchase property
insurance or the services of an investment broker to purchase stocks, bonds, or mutual
funds.

Step 6: Reevaluate and Revise Your Plan

 Financial planning is a dynamic process that does not end when you take a particular
action. You need to regularly assess your financial decisions. Changing personal,
social, and economic factors may require more frequent assessments.
 When life events affect your financial needs, this financial planning process will
provide a vehicle for adapting to those changes. Regularly reviewing this decision-
making process will help you make priority adjustments that will bring your financial
goals and activities in line with your current life situation.

HUMAN LIFE CYCLE

From Birth to your student day, there will be no income but only spending. This portion
would be taken care of by one’s parents.

Earning Period: From the time of getting a job (say at the age of 25 years), the individual
starts earning. Normally, during the age of 35-45 years, his income would be highest but so
also the spending. Spending will be mainly on the education of children, loan repayments,
marriage, etc. In the olden days, the retirement age was 60 years. The earning years used to
be 30 to 35 years. In the modern days of stressful working life and working for over 12 hours
daily to reach the targets given by the employer, the earning years is going to reduce to 25 to
28 years because of the burnout. This concept can be understood through the example of Life
of the LCD Projector bulb. We cannot say projector has so many years. It is on the number of
hours we have used the projector that determines its life. Hence, it is to be expressed as the
number of hours of use. Similarly, when an individual works for over 12 hours daily, his
working life reduces to 25-30 years.

Post Earning Period: The normal life expectancy period has been going up due to
advancements in medicine. We keep seeing and hearing that people live upto 85-90 years.
Hence, life post retirement works out to 40 years. During this period, your earning will stop
but your spending will continue. Lot of emergencies in the form of operations, cataract
surgery, cardiac problems, kidney failure, etc. occur necessitating huge expenditure which
would act as a drain on our savings. Hence, huge amount of savings are required to have a
“Happy Retired Life.”

Life cycle and earning power table

Stage Number of years Earning power

Childhood 22-25 years No Earnings
Pre-Retirement 25-28 years Earning period
Post retirement 30-35 years No earnings

Financial planning process and Goal setting

We have seen earlier various milestones in one’s life. Each of the milestone becomes a
financial goal. For example, buying a car, buying home, getting married, etc. Most important
step of financial planning is goal setting. This is a serious exercise and requires long-term
thinking on an individual’s part. We have to in fact plan our life cycle. The goals help us to
know where we have to reach from where we are now and by which period the same shall be
achieved. Let us learn something more about the Goal setting process. Important Aspects to
be Taken into Account in Goal Setting The financial goals that one sets shall follow the
“SMART” principles.
1. Specific: The goal should be specific and not vague. For example, “I want to be a wealthy
person” is not specific because we are not sure for how much amount of money one can be
termed wealthy.

2. Measurable: “What gets measured gets managed” – Peter Drucker. If we have no

measurement, we will not be sure about the quantity. Hence, we have to quantify the goal in
monetary terms, “I want to have ` 5 crores”.

3. Achievable: It is said that the goal we set should be such that it is a little beyond reach but
not that level to discourage. Hence, it should be challenging but within reach.

4. Realistic: The goal that we set should be realistic. I want to have ` 100 crores in the next
two years is not realistic.

5. Time-bound: While setting a goal, we should specify the time by when it shall be achieved.
For example, if one says that I want to buy a three bedroom house costing I million dollars .
This goal satisfies all other aspects of SMART goal except the time. If we add “in the next
four years”, it becomes complete.

Illustration of a SMART Goal

Goal: I want to purchase a Residential Flat

Specific: I plan to save for the down payment for purchase of a flat.

Measurable: The down payment required is ` 10 lakhs.

Achievable: I plan to save every month ` 40,000 from my salary.

Realistic: I can save this amount from my current salary of ` 90,000 p.m.

Time-bound: I want to purchase this flat in the next two years from now.

Goals can be classified into three types namely Short-term: Upto 1 year, Intermediate Term:
More than 1 year up to 5 years and Long-term: Beyond 5 years

Financial goals need to be prioritised. Each goal should be prioritised as High, Medium or
Low (H, M, L). This rule applies when we prepare a financial plan for an individual who has
many goals under each of the above category. The categorisation into short, intermediate and
long-term and the goals that we seek is different for different individuals and it depends on
the age and stage at which the individual is seeking to plan. The following table gives some
examples of goals for individuals at different stages of their life:
 Type of individual Short term Intermediate term Long Term
Just jot a job Rent an apartment- Repay educational Start investing for
(H) loan in 3 years(M) retirement planning
Purchase a small car (H)
(M) Go abroad for higher
Get married (H) studies (M)
Just married couple Have a kid (H) Child schooling (H) Buying a house (H)
with no kids Buy the latest car Starting an
(L) investment portfolio
(M)
Married couple with College admission Buying a house (H) Diversify investment
school going of children (H) Purchase of second portfolio (M)
children Review life and car (M) Save money towards
general insurance children’s education
(M) abroad (L)
Elderly couple Buy new furniture Review general Decide on retirement
nearing retirement Visit married insurance and age (H)
on a single income children medical aid Decide on where to
insurance for stay when you
sufficiency and take retire(M)
necessary action (H)

Financial Planning and Personal Financial Life Cycle

Stage 1 Young Singles/ accumulation stage

• Young singles represent the first stage in the financial life cycle. Finding that first job
and becoming financially independent top the list of financial concerns that are mostly
focused on personal, educational and financial development.

• Current expenses: The most pressing task at this stage of the financial life cycle is
simply finding enough money to pay your expenses. It is likely to be the time when
you first learn how to budget your money.
 • Saving: This is a good time to establish savings habits. Putting a little money away for
emergencies and saving for things like a car or an overseas trip are important
priorities.

• Borrowing: This is the stage when you initially go about establishing credit. You need
to find out how to borrow money and what you have to do to get a credit card.

• Insurance: Consider the pros and cons of private health insurance and disability
insurance to protect your income if you suddenly cannot work. Make sure that your
first car is adequately insured.

• Investing: Money is short and investing is not really an issue. However, this is an
excellent time to learn about investing so that you are ready when the high-income
years arrive.

• Retirement: Retirement is probably too far away to contemplate. The provisions of the
Superannuation Guarantee Scheme mean that you will automatically begin to
accumulate something towards your retirement. If you are self-employed, you are not
covered by the Superannuation Guarantee Scheme and you may want to consider
making a start on your own retirement savings program.

Stage 2 Young Couples

• This second stage of the financial life cycle is a period of personal and financial
adjustment for two people who have decided to be together. There are no children at
this stage and there are often two incomes. Important considerations are adjusting to
each other’s needs and agreeing on present and future financial goals.

• Current expenses: If there are two incomes, cash flow is suddenly very good.
Budgeting revolves around how to allocate this spending power between household
purchases, entertainment and saving.

• Saving: Now is the time to establish your savings program. Couples who defer
buying their first home will be able to save much faster than those who are paying off
a mortgage. Establishing a nest egg now is going to pay big dividends when you enter
the next stage of the financial life cycle.
• Borrowing: You find it hard to resist the temptation to borrow in order to buy
household goods and perhaps a home in which to put them. You have enough income
to service the debt, so you find it easy to borrow. However, too much debt, especially
too much short-term debt, can rob you of your financial flexibility.

• • Investing: This is an excellent time to consider investing as part of your savings

program. You will need extra cash in the next stage of the financial life cycle, so stick
to investments that are easily liquidated.

• • Taxation: Tax returns at this stage come as a shock when you discover that you are
now funding the Government rather than the other way around. It is time to look for
ways to minimise taxation, such as salary packaging and other tax incentives.

• • Retirement: Retirement planning is likely to remain on the back burner. While the
Superannuation Guarantee Scheme is making some contributions, this will not be
enough on which to retire comfortably. For dual income couples, this is an early
opportunity to top up their superannuation savings.

Stage 3 Young Families

• This stage of the financial life cycle is characterised by the leap into total adult
responsibility and dominated by caring for dependent children.

• Current expenses: This stage sees the return to a tight budget. There are so many
expenses brought on by having a family, and there are so many things that new
parents feel they must provide for their children. Dropping back to one income,
childcare expenses and increased repayments on new borrowings cut savagely into
income.

• Saving: Saving is generally limited to finding a deposit for a new house. Any savings
accumulated earlier come in handy now. Further attempts to save money will
probably be postponed in order to pay current expenses.

• Borrowing: A big mortgage emerges with the purchase of the first home, and a car
loan is needed to buy a bigger family car. In addition, the need to furnish and equip
your new home may call for more consumer credit. Now you really know what it is
like to be in debt.
 • Investing: If there is anything left in your savings, you may want to invest now for
later expenses like your children’s education. However, for most young families,
investing will be deferred until the cash flow catches up with the expenses.

Stage 4 Maturing Families

• This is the stage in the financial life cycle when your children grow up and you can
look forward to some relief from your financial worries. You will begin to earn more
than you spend because your earning power is at its peak when the pressure on the
family budget is easing.

• Current expenses: Now it is easier to pay the bills. Spending priorities at this stage
include things like upgrading your home, replacing some of your furniture and
appliances, education for the children and perhaps more expensive holidays. This is
also the stage when you may find yourself looking after your aging parents.

• Saving: Saving money is also easier and you realise that it is important to put some
away during this prolonged period of high earnings. Your savings goals become part
of a wider strategy that includes your investment goals and retirement planning.

• Borrowing: Your credit reputation is established and you can borrow whenever you
wish. However, your house and car are probably paid off and your other borrowings
are minimal. An exception may be investment borrowing

• Insurance: You have learned to use insurance to protect your assets as well as your
family. You have health insurance, disability insurance and life insurance to protect
your family, and you have home and contents insurance, car insurance and public
liability insurance to protect your assets.

• Investing: Your investment goals get serious. You may be interested in property, you
may like the stock market or you may prefer managed investments. You feel the
pressure of time slipping away and you want to accumulate investments that will
work for you in the future.

• Taxation: Minimising your taxes is a major consideration. You are paying an

enormous proportion of your earnings in tax and you want to take advantage of every
legitimate means to minimise it. You discover that this is not a do-it-yourself exercise
and you get some professional advice.
 • Retirement: Suddenly the penny drops: unless you get serious about planning for your
retirement, it may not be what you expect. You realise that you have not put enough
aside so far and you are running out of time. With higher earnings and fewer
expenses, you may be able to close the gap by seriously increasing your
superannuation savings. At this stage, it is essential to get professional advice about
planning for your retirement.

Stage 5 Retired people

• This stage of the financial life cycle consists of people who are no longer working.
The age at which you are able to retire is largely influenced by how well you have
provided for it. The main financial goal is to ensure that you have enough income and
reserves to maintain your standard of living once you are no longer working.

• Current expenses: Your living expenses are lower, and as a result of ‘downsizing’ you
may have some unexpected cash. You investigate your eligibility for retirement
benefits, including the Age Pension and other concessions. You may need to cut your
expenses in order to match your retirement income.

• Saving: You are no longer concerned with saving money, but you are concerned with
managing the savings that you have accumulated.

• Borrowing: You no longer borrow money unless there are exceptional circumstances
that require it. Rather, this is the time when you clear your debts so they are not
hanging over your head in retirement.

• Insurance: You continue to review your insurance regularly. You may no longer need
disability or life insurance, but you still need most other forms of protection. Health
insurance is very important, especially protection for any expensive treatments or a
long stay in hospital or a nursing home.

• Investing: You are liquidating many of your investments because you have become
income-oriented rather than growth-oriented. You are much less likely to take risks
because you are more concerned with preserving your money than accumulating
more.
 • Taxation: Taxation is no longer a pressing issue, but you have your affairs regularly
reviewed by an adviser. Most of your taxation plans are in place and some have
already served their purpose. Your main concern is that the politicians don’t upset the
apple cart by making radical changes to the tax system. If you are supplementing the
pension with investment income, or if you are a self-funded retiree, then you are
careful to plan for provisional tax.

• Retirement: Your working years have come to an end and you are ready for many
more years of active enjoyment. It is a bit late to make major changes to your
financial situation now, so you concentrate on making the most of what you have and
your entitlements from the Social Security System. You also make sure that you have
taken the necessary steps to protect your assets for your spouse and other heirs.

MACRO ECONOMIC FACTORS THAT INFLUENCE PERSONAL FINANCIAL

PLANNING

1. Government: Government is one of the major influencers in the PFP environment. The
policies of the government towards employment, education, etc. have great influence on the
business

2. Monetary and Fiscal Policy: Monetary policy is primarily concerned with the
management of interest rates and the total supply of money in circulation and is generally
carried out by central bank of the country (RBI). Fiscal policy is the collective term for the
taxing and spending actions of governments. Monetary policy determines the amount of
money in circulation. By varying the Repo rate, RBI increases or decreases the money in
circulation which will impact the spending pattern of the consumers. Taxation policies
determine the surplus available for investment in the hands of the individual.

3. Business Cycle: The business cycle or economic cycle is the downward and upward
movement of Gross Domestic Product (GDP) around its long-term growth trend. These
fluctuations typically involve shifts over time between periods of relatively rapid economic
growth (expansions or booms), and periods of relative stagnation or decline (contractions or
recessions)

A business cycle has four phases namely:

Boom/Prosperity: When there is an expansion of output, income, employment, prices and
profits, there is also a rise in the standard of living. This period is termed as boom.

(b) Recession: During a recession period, the economic activities slow down. When demand
starts falling, the overproduction and future investment plans are also given up. There is a
steady decline in the output, income, employment, prices and profits.

(c) Depression: When there is a continuous decrease of output, income, employment, prices
and profits, there is a fall in the standard of living and depression sets in. The economy
almost comes to a standstill.

(d) Recovery: The turning point from depression to expansion is termed as Recovery or
Revival Phase. During this phase, there are expansions and rise in economic activities. When
demand starts rising, production increases and this causes an increase in investment. There is
a steady rise in output, income, employment, prices and profits.

4. Inflation: Inflation is defined as a sustained increase in the general level of prices for
goods and services. During times of boom, there will be high inflation as people will have lot
of surplus in their hand and would drive demand for goods and services. As the supply does
not catch up with demand, the price of goods and services go up.

Personal financial statement

We know that when any person starts a business, he would like to know if the business is
running well and earning profits; what are the various assets (what the business owns) and
liabilities (what the business owes) as on a particular date. To know these, a business
prepares a Statement of Profit and Loss (Income Expenditure statement) and a Balance Sheet.

Even in the case of an individual, we prepare financial statements to know the income and
expenses of a particular period and the resultant surplus/deficit (we do not call it as profit or
loss) and the assets and liabilities as on a date. In addition, we also prepare a Budget to
estimate the income and expenses of one year.

Thus, there are three financial statements under Personal Financial Planning:

1. Income and Expenditure Statement - Actual Financial Results

2. Balance Sheet

3. Budget - Monitor and control income, living expenses and savings

INCOME AND EXPENDITURE STATEMENT

This statement details the various sources of income of the individual and the expenses he
normally incurs. The expenses are classified into fixed expenses which remain same month
after month and variable expenses which differ from month to month. The excess of income
over expenditure is called “SURPLUS”. The surplus gets reflected as part of “Net Worth” in
the Balance Sheet

PERSONAL BALANCE SHEET

Balance Sheet is a statement which shows what an individual owns (Assets) and what are the
various amounts/dues to various people he owes (Liabilities). The excess of assets over the
liabilities is termed “NET WORTH”.

Net Worth and Balance Sheet

To view one’s entire financial picture, an individual must find out his or her general situation
by applying the concept of net worth. This concept helps individuals to categorize their assets
and their liabilities. Asset is what one owns. It can be money, investments, real estates, cars,
paintings, etc. Liability is what one owes, like mortgage, student loan, credit card debt,
money borrowed from somebody, and so on. By subtracting the sum of liabilities from the
sum of assets, one will get one’s net worth.
Net worth= sum of assets-sum of liabilities
This formula shows the wealth that an individual has accumulated for the given period. If
one’s net worth is negative, then it means he spends more than what he earns. In this case,
he is considered as insolvent. In order to make net worth more clear, a balance sheet is
commonly
used.

PERSONAL BALANCE SHEET

Cash flow, saving, and income statement
As it is shown above, a balance sheet provides general information on one’s financial
situation. However, if an individual wants to trace his money and learn more details about his
personal finance, he will need a tool called income statement. An income statement shows
where one’s money comes from and where it goes in an assigned period. An income
statement is also called cash flow statement, in which income is the cash inflow, and
expenditure is the cash outflow

Personal budget

A personal budget is an excellent tool for monitoring if the actual financial activity is going
as one has planned and how the expenses are allocated. It can help individuals to spend less
by arousing their awareness of additional spending. A personal budget is a finance plan that
determines the distribution of future income towards spending, saving, and investing. A
personal budget is made based on the past expenses and personal debts. When one is making
his personal budget, he should try to keep it simple. A redundant personal budget tends to
make a person to give up during the process. For instance, identifying the income and
expenses does not need to be too specific, a user should categorize more generally. Flexibility
is another tip that one should keep in mind. Because some spending does not happen every
month. Like people may spend more money on ice cream in the summer time than in the
winter. The variation in budgeting needs to be made accordingly
Problems on Personal Financial Statements
1. With the following data, prepare a personal Income Statement and Balance Sheet.
(Amounts in Dollars)
Salary 25, Bonus 2.0, Interest Income 0.5, Housing (rent) 1.2, Household expenses
2.0 ,Recreation (vacations) 0.5, Taxes 4.0, Vehicle loan instalment (annual) 1.8 ,Utilities
0.3 ,Educational loan (annual payment) 0.5, Medical 0.25, Credit card balance 1.5, Savings
Account Balance 0.75, fixed deposit 2.0 ,Mutual Funds 1.5, Stocks 1.5 ,Jewellery 2.5

Solution
INCOME EXPENSES STATEMENT
INCOME
Salary 25
Bonus 2.0
Interest income 0.5
Total Income (A) 27.5

EXPENSES
Housing 1.2
Household expenses 2.0
recreation 0.5
Taxes 4.0
Motor vehicle instalment 1.8
Utilities 0.3
Educational Loan 0.5
Medicals 0.25
Total Expenses 10.55

Net income/surplus/savings 16.95

Balance Sheet

Current Liabilities Current Assets

Credit card balance 1.5 Savings account balance 0.75
Fixed deposit 2.0
Mutual funds 1.5
Total 4.25
Investments
Net worth(8.25-1.5) 6.75 Stocks 1.5
Jewellery 2.5
Total investments 4.0

Total liabilities 8.25 Total assets 8.25

Question
With the following data, prepare a personal Income Statement and Balance Sheet.
Salary 25000, Bonus 2000, Interest Income 500 Housing (rent) 1200 Household expenses
2000 Recreation (vacations) 500, Taxes 400, Vehicle loan instalment (annual) 1800,
Utilities 300, Educational loan (annual payment) 500, Medical 250, Credit card balance
1500, Savings Account Balance 750, Fixed deposit 2000, Mutual Funds 1500, Stocks 1500,
Jewellery 2500

Tracking Financial Progress: Ratio Analysis

Each time you prepare your financial statements, you should analyze them to see how well
you’re doing on your financial goals. For example, with an income and expense statement,
you can compare actual financial results with budgeted figures to make sure that your
spending is under control. Likewise, comparing a set of financial plans with a balance sheet
will reveal whether you’re meeting your savings and investment goals, reducing your debt, or
building up a retirement reserve. You can compare current performance with historical
performance to find out if your financial situation is improving or getting worse.

Calculating certain financial ratios can help you evaluate your financial performance over
time. What’s more, if you apply for a loan, the lender probably will look at these ratios to
judge your ability to carry additional debt.
Four important money management ratios are (1) solvency ratio, (2) liquidity ratio, (3)
savings ratio, and (4) debt service ratio. The first two are associated primarily with the
balance sheet, the last two with the income and expense statement.

When evaluating your balance sheet, you should be most concerned with your net worth at a
given time, REMEMBER you are technically insolvent when your total liabilities exceed
your total assets—that is, when you have a negative net worth.

Solvency Ratio

Solvency ratio = Total net worth

Total assets

Solvency ratio shows, as a percentage, your degree of exposure to insolvency, or how much
“cushion” you have as a protection against insolvency. Assuming you have a solvency ratio
of 21%, it means that they could withstand only about a 21% decline in the market value of
your assets before you would be insolvent. Consider that the stock market, as measured by
the S&P 500 index, fell about 37% during a financial crisis in Zimbabwe. Also, the average
home’s value fell about 18% during that crisis year. It means that in such a year you will be
technically insolvent hence such a low solvency ratio suggests that you should consider
improving it in the future to better manage a potential decline in the value of your assets.
In short the solvency ratio indicates the potential to withstand financial problems

Liquidity Ratio

Liquidity ratio = Total liquid assets

Total current debts

liquidity ratio, which shows how long you could continue to pay current debts (any bills or
charges that must be paid within 1 year) with existing liquid assets in the event of income
loss. For example having a liquidity ratio of 13% means you have 1½ months of coverage (a
month is one-twelfth, or 8.3%, of a year). If an unexpected event cut off your income, your
liquid reserves would quickly be exhausted

The amount of liquid reserves will vary with your personal circumstances and “comfort
level.” Another useful liquidity guideline is to have a reserve fund equal to 3 to 6 months of
after-tax income available to cover living expenses.

Savings Ratio

Savings ratio = Cash surplus

Income after taxes
You can relate the cash surplus (or deficit) to income by calculating a savings ratio, which is
done most effectively with after-tax income. This ratio measures your ability to save
assuming Bob and Cathy saved about 20% of their after-tax income, which is on the high side
(Zimbabwean families, on average, save about 0% to 5%). How much to save is a personal
choice. Some families would plan much higher levels, particularly if they’re saving to
achieve an important goal, such as buying a home.

Debt Service ratio

Debt service ratio = Total monthly loan payments

Monthly gross (before-tax) income

The debt service ratio allows you to make sure you can comfortably meet your debt
obligations. This ratio excludes current liabilities and considers only mortgage, instalment,
and personal loan obligations. Assuming monthly loan payments account for about 20% of
John and Tatenda’s monthly gross income. This relatively low debt service ratio indicates
that the John and Tatenda should have little difficulty in meeting their monthly loan
payments.

In your financial planning, try to keep your debt service ratio somewhere below 35% or so,
because that’s generally viewed as a manageable level of debt. Of course, the lower the debt
service ratio, the easier it is to meet loan payments as they come due.

Managing Your Finances in Tough Economic Times

Tough economic times can be due to broad macroeconomic trends like a recession, or they
can be brought on by more personal, local developments. The effects of recessions and
financial crises divide people into three groups:
(1) those who are directly and severely hurt through job loss,
(2) those who are marginally hurt by reduced income, and
(3) those who are not directly hurt.
If you are in either of the first two groups, you must make significant lifestyle changes to
reduce spending. Even if you are in the last group, a recession affects you indirectly. For
example, retirement accounts typically drop in value and financial plans must be revised. And
everyone’s expectations are at least temporarily affected, which causes most people to be
more cautious about their expenditures during a recession or crisis.
The financial crisis of 2008 and 2009 was a macroeconomic challenge of historic global
proportions. It drove home the benefits of having a sound financial plan—and dramatized the
cost of not having one. The precipitous decline in stock and home prices and the many people
laidoff from their jobs made everyone think a lot more about financial planning in general
and how to survive a financial crisis in particular. Although we all hope that such broad crises
will be rare, it is important to plan for a possible recurrence
How to plan to survive a broad-based financial crisis
• Spend less than you earn.
• Keep investing so your money continues to work toward your goals.
• Know where you are and plan for the unexpected. You cannot know where you are
financially unless you carefully, and frequently, update your family’s budget. And it is
important to set aside money for an emergency fund, (cash to last between 3-6months)
 Continue to invest for the long term but keep in mind how close you are to achieving
your financial objectives. For example, if you pull all of your money out of the stock
market when it has fallen, you will not be positioned to take advantage of its eventual
recovery.
You can take specific actions in your day-to-day life to deal effectively with a financial crisis
or recession. Consider the following ways to manage expenses in times of stress:
• Postpone large expenses. For example, hold on to your old car rather than buying a new
one. And you could wait on that new refrigerator or big-screen TV.
• Cut back on the number of times you eat out.
• Take your vacation at or around home.
• If you rely mostly on a cell phone, consider cancelling your landline phone
• Cancel nonessential subscriptions.
Recessions and financial crises can be challenging. A financial plan that considers such
contingencies will help you weather the storm

Seven Principles of Good Personal Financial Planning

1. Make Saving a Habit: The first principle is that we should make savings a habit. Savings
should not be at random on months when the expenses are lesser than income. We know the
saying “Habits die hard”. Good habits are welcome and it should be practised. If savings
become a habit, then it would help in building the long-term corpus and help in meeting the
various financial goals.
2. Maintain a Personal Diary: It is always good to have record of events in the form of a
diary. It is suggested that we have two diaries, one to record the events at the office and the
other to record that of family/domestic life. Maintain a diary of due dates of various deposits
and investments (month wise) and see it before the beginning of the month and take
appropriate action.
3. Prepare a Budget: Budget helps in knowing in advance the income and expenses that are to
be received in the ensuing period. This helps in planning the source of funds for months when
a deficit is anticipated or to reduce the discretionary expenses in the months where the deficit
might occur. 4. Have Separate Files for Various Important Items: We should maintain file for
important documents pertaining to family. A separate file should be kept for income tax,
house property, bills and receipts of assets purchased, statement of account of Savings
Accounts, demat account statements, all guarantee/warranty cards of assets acquired etc.
5. Diversify Your Investments: Do not invest all your money in any one type of asset say
bank deposits, shares and securities, real estate, gold, etc. It is good to have investment in all
class of assets so that the risk is spread. Remember the proverb “Do not put all eggs in one
basket”.
6. Enjoy ‘Present’: Yesterday is History, Tomorrow is a Mystery and Today is the ‘Present’.
Too much of tightening of expenses at the cost of health or enjoyment (moderate level) is not
good. After all, whatever we earn during our lifetime, we should also enjoy and only keep
some balance for our kith and kin.

7. Help Others When You Can: Doing charities (whatever little one can) is like individual’s
social responsibility. Lot of organizations have been celebrating a month in a year as ‘Joy of
Giving’. Participate in them or do your own way like giving donations for studies of a poor
student.