What is Financial Literacy
Financial literacy is the ability
to understand how money works in the world: how someone manages to earn or make
it, how that person manages it, how he/she invests it (turn it into more) and
how that person donates it to help others.
Financial literacy is having the
knowledge, skills and confidence to make responsible financial decisions.
Knowledge refers to an understanding of personal
and broader financial matters
Skills refer to the ability to apply that
financial knowledge in everyday life
Confidence means having the self-assurance to make
important decisions
Responsible financial decisions refers to the
ability of individuals to use the knowledge, skills and confidence
they have gained to make choices appropriate to their own
circumstances.1
Being financially
literate can help to: decide
how they will spend their money and meet their financial obligations
make sense of the financial marketplace and buy the
products and services best suited to their needs
manage their personal finances and plan ahead for life
events, such as home ownership or retirement
ask and understand how they can benefit from local,
provincial and national government programs and systems
assess the financial information and advice they receive
from relatives and friends, professionals or the media, and
maximize the use of the resources they have access to,
including workplace benefits, private and public pensions, tax credits, public
benefits, investments, home equity, and access to credit.1
Research studies across countries on financial literacy
have shown that most individuals (including entrepreneurs) don’t understand the
concept of compound interest and some consumers don’t actively seek out
financial information before making financial decisions. Most financial
consumers lack the ability to choose and manage a credit card efficiently, and
lack of financial literacy education is responsible for lack of money
management skills and financial planning for business and retirement.
Most potential retirees lack information about saving and
investing for retirement. Many people fail to plan ahead and they take on
financial risks without realizing it. Problems of debt are severe for a large
proportion of the population because of financial illiteracy. Youth on average
are less financially capable than their elders.
Financial education can benefit consumers of all ages and
income levels. For young adults just beginning their working lives, it can
provide basic tools for budgeting and saving so that expenses and debt can be
kept controlled. Financial education can help families acquire the discipline
to save for their own home and/or for their children’s education. It can help
older workers ensure that they have enough savings for a comfortable retirement
by providing them with the information and skills to make wise investment
choices with their individual pension and savings plans. Financial education
can help low-income people make the most of what they are able to save and help
them avoid the high cost charged for financial transactions by non-financial
institutions.
Your level of financial literacy affects your quality of
life significantly. It affects your ability to provide for yourself and family,
your attitude to money and investment, as well as your contribution to your
community. Financial literacy enables people to understand what is needed to
achieve a lifestyle that is financially balanced, sustainable, ethical and
responsible. It also helps entrepreneurs leverage other people’s money for
business to generate sales and profits.
Financial Planning Overview
Financial Planning
We all try to plan our lives as much as possible. We
expect to finish studies in our early 20s, get a job, buy a house by the age of
27, get a car by 29 and so on. Our capacity to dream and aim is unlimited. This
needs thorough planning and execution. More than that, it needs money. Not
simply earning, but also saving and investments. And to fuel our dreams, we
need financial planning.
Here's all you need to know:
What is financial planning?
Making money is not just about earning from a job or
multiple sources. It is about effective money management, saving and then
investing in the right financial assets to earn more profits. Simply put, you
need to make money out of money through investments. This is the only way to
roll around in money.
Financial planning is the act of managing your income;
setting your financial goals and then allocating your assets across investments
keeping in mind your limitations and requirements.
What are the broad areas in which
financial planning can be undertaken?
Financial planning is not a simple task. You need to take
into account multiple factors about your life – past, present and future – in
order to form a feasible financial plan. Remember, for a plan to be effective,
it has to be well-thought, comprehensive and with an eye on the future.
Simply put, a financial plan has to be planned by individuals keeping in mind their stage in life cycle and their needs.
Simply put, a financial plan has to be planned by individuals keeping in mind their stage in life cycle and their needs.
Who requires financial planning?
Everyone. Whoever has money and wants to utilize it in
the best possible way, then financial and investment planning is a must.
As the old adage goes – If one is failing to plan, they are surely planning to fail.
As the old adage goes – If one is failing to plan, they are surely planning to fail.
How it is different from wealth
management?
Wealth management and financial planning are
fundamentally similar. However, there is a key difference – you can only manage
wealth if you already have it. Financial planning, on the other hand, is even
for those who aim to amass wealth.
Why should you make a financial
plan?
Not enough can be said about the need for financial
planning. We list some of the advantages, which can have far reaching positive
effects on one's life.
What should a financial plan
include?
Every financial plan differs. This is because it has to
be tailored to suit an individual's needs and wants. That said, there are some
components every plan should cover.
While these factors should have precedence, care should
be taken than other things that may affect your financial goal should also be
covered.
What is goal setting?
How can you plan a journey without
knowing where you are going? A goal is the first and most important step in
financial and investment planning. This acts as a foundation of all the
following parts of the planning process. For this reason, the process of
setting your goal is important.
Why is goal prioritization
important?
We rarely have only one thing to
achieve in life. While planning your finances, you have to take in
consideration all your goals, be it something as large as a Rs 100
crore-retirement allowance or as small as that branded T-shirt you have been
eyeing on your way from work.
This is why you need to prioritize
your goals. They are not equally important, and some need to be achieved first.
Efficient prioritization is the key to good planning.
Assessing the current situation.
Dreams and imagination are
wonderful, no doubts. But we live in the reality. So, everyone has to
understand their current state of life before planning for the future. Simply
put, the financial plan is like a bridge connecting your today and future. So
your goals and current assessment act as the platform. And you cannot have a
strong bridge on rickety bases.
For this reason, introspection of
your current situation is the starting point to bridge the gap between the
present and the future.
What is Financial Planning?
Money is very important, as
materialistic as it may sound. Without it, you can’t access to even the basic
necessities in life, forget about the comforts and luxuries we dream about.
Making money is still comparatively
easier than maintaining it or doubling it. It is not just about getting a
stable job and earning; it has got much more to do with managing your earnings
well and saving it for the future. And if you have bigger aspirations, then
investments are a must.
All this requires financial
planning. Let’s look at what it is all about:
- What is financial planning: It is the act of managing your income; setting your financial goals and allocating your assets across investments while keeping in mind your limitations and requirements.
- Differs for everyone: Financial planning may mean different things to different people. This is because the end goal may differ. For you, it may mean planning investments to provide security during retirement. For another, it may mean planning savings and investments to provide money for child’s college education.
For someone else, it could mean
ensuring a steady secondary source of income. Financial planning may even mean
making career-related decisions or choosing the right insurance products. In
reality, financial planning is the process of meeting financial goals through
the proper management of finances.
- Not just saving : Again, simply saving money is not enough. It has to be invested in the right financial products to ensure their value increases with time. This is even more imperative in a country like India where inflation remains high. This price rise eats into the value of your money. So, Rs. 100 may not have the same value tomorrow.
For this reason, investment is a
must. Financial planning helps you here too. Once you have an idea about your
goals, financial and investment planning can be undertaken to understand where
you stand currently and how to reach your final goal. Planning can thus be done
by anyone with a clear assessment of one's inflow of funds and the goals that
need to be achieved from time to time.
- Roadmap to stability: It is all about preparing a sequence of action steps to achieve a specific financial goal. A financial plan is a roadmap to achieve your life's financial goals. It is like a map, where you can always see how much you have progressed towards your projected financial goal and how far you are from your destination. .
- Saving money right: People often have a misconception that financial planning is about saving more and spending less, but that is not the case. It is more about saving the right amount so that future goals can be met. The objective of financial planning is to ensure that the right amount of money is available in right hands at the right point of time in the future to achieve the desired goals and objectives.
It, thus, provides direction and
meaning to your financial decisions, and allows you to understand how each
financial decision you make affects other areas of your finances. .
- Risk profiling: A key part of financial planning is risk profiling. This includes analyzing your current situation and likely future scenarios to understand your financial limitations. Using this, you can determine how much risk you can take.
For example, you have high liquidity
needs and many dependents, you cannot take high risks. This would be especially
so if you did not have a big contingency fund to help you in emergencies.
Financial planning thus helps you give perspective to your limitations and
capabilities.
- Financial planning process: Financial planning is important because it guides and controls the financial decision making process. While making a financial plan, your objectives and constraints are included so that it represents the long-term roadmap. Planning is a dynamic process. So, if there are any changes in your circumstances, they can be incorporated into the financial plan.
It, thus, consists of the following
activities:
· Assessing present assets and resources to
understand the current situation.
· Setting goals and objectives – both in terms
of returns and risks.
· Determining constraints and financial
planning areas like taxes, legalities, time horizon, liquidity, as well as
unique circumstances that may differ from person to person.
· Determining appropriate plan and strategy to
achieve financial goals.
· Evaluating the plan regularly.
· Adjusting and modifying the plan if there is
a change in conditions.
Broad areas of financial planning
Your life has multiple aspects –
your family, your work, your social life, your hobbies, and so on. Money
touches all of these aspects. For this reason, financial planning is not a
simple task. It has to be all-encompassing to be an effective plan. Moreover,
you need to consider not just your present, but also your future.
Here is a seven-point checklist
covering the broad areas in which financial planning can be undertaken:
Cash flow planning: In simple terms, cash flow refers to the inflow and outflow
of money. It is a record of your income and expenses. Though this sounds
simple, very few people actually take time out to find out what comes in and
what goes out of their hands each month. Cash flow planning refers to the
process of identifying the major expenditures in the present and the future
(both short-term and long-term), and making planned investments.
This is to ensure you have the
required amount whenever needed. Cash flow planning is the first thing that
should be done prior to starting an investment exercise. Without this planning,
you will not be in a position to know how your finances look like, and what you
can invest in without stretching your liquidity. It will also enable you to
understand if a particular investment matches with your cash flow requirement.
Investment planning: Saving and investing are two separate activities. One has
to do with your expenditure, while the other has to do with financial
instruments. Your wealth will only grow over time if you have invested it in
assets. Investment planning deals with the kind of instruments an individual
should invest in to get the best out of his wealth.
The first part of this planning has
to do with your risk and return profile. This is where you set your limits in
terms of the risk you are willing to take and the minimum return you expect.
This is done based on your life stage, spending requirements with respect to
your income and wealth, time horizon, liquidity requirements, and various
individual specific constraints. Investment planning is important because it
helps you to derive the maximum benefit from your investments.
Tax planning: Tax evasion is illegal, but tax minimization is legal.
Thus, you can reduce your tax liability by planning effectively. With proper
tax planning you can increase your after tax income. This could also decide
your investment decisions.
For example, if you want to save
tax, you may prefer to hold stocks for at least a year before selling. That way,
you could avoid the short-term capital gains tax. This would change your
trading strategy altogether. Similarly, you could prefer instruments that offer
tax-benefits like Public Provident Funds (PPF) and so on.
Retirement planning: This kind of planning means making sure you will have
enough money to live on after retiring from work. Retirement should be the best
period of your life, when you can literally sit back and relax. You are
essentially reaping the benefits of years of hard work. This is easier said
than done. To achieve a hassle-free retired life, you need to make prudent
investment decisions during your working life, thus putting your hard-earned
money to work for you in future. Planning for retirement is as important as
planning your career and marriage. Life takes its own course and from the
poorest to the wealthiest, no one gets spared. We get older every day, without
realizing. However, we assume that old age is never going to touch us.
The future depends to a great extent
on the choices you make today. Right decisions with the help of proper
financial planning taken at the right time will assure your peace during
retirement. Retirement planning acquires added importance because of the fact
that though longevity has increased, the number of working years haven't.
Children’s future planning: It is essential to plan for the future of your children.
The purpose of planning for your child or children’s future is to create a
corpus for foreseeable expenditures such as higher education and wedding.
Thus, you will be able to provide an
adequate security cover during their growing years. For ensuring adequate
funding of your child's education, you as a parent need to not just save, but
also invest systematically and at regular intervals.
Insurance planning: You never know what surprise life will throw at you.
Insurance planning helps you provide a safety net that can come handy in times
of trouble. This type of planning is concerned with ensuring adequate coverage
against insurable risks. Calculating the right level of risk cover requires
considerable expertise.
Proper insurance planning can help
you look at the possibility of getting a wider coverage for the same amount or
lower premium. Insurance enables you to live your lives to the fullest, without
worrying about the financial impact of events that could hamper it. In other
words, insurance protects you from contingencies.
Estate planning: Everyone acquires a considerable amount of real estate
during his lifetime. In case of death or during lifetime, this can be
transferred to either heirs or to institutions and charities. Planning this
transfer in the most efficient way is termed as estate planning.
Who requires financial planning?
Financial planning is about managing
your finances to achieve your financial goals in the most optimum manner. It's
not about making huge savings or less spending nor does it mean having lots of
money for huge making investments. It is about prioritizing your financial
goals and achieving them in the most efficient manner to derive maximum utility
out of your decisions.
For this reason, almost everyone
requires financial planning. As the old adage goes – if one is failing to plan,
then they are surely planning to fail. Good and thoughtful investment planning
is the cornerstone of an individual's good financial health.
Whoever has financial goals and
wants to achieve them in the most efficient manner requires financial planning.
You don't have to be mega rich to have a financial plan. Neither do you have to
be very old and approaching retirement. It does not matter how much you earn or
what your age is. In fact, your financial situation influences almost every
aspect of your lives – from the type of house you live in to the type of car
you drive, to how many vacations you can take. Regular financial planning can
help give you peace of mind.
Let's look at how financial planning
differs with people in different life stage:
Youngster: You are quite likely in your 20s. You may have just gotten
a job and it feels like a new-found independence. You finally feel one step
closer to success. But, life requires self-generated, goal-oriented action – a
plan.
This extends to every area of your
life, including financial. The degree of your planning will determine at least
in part the degree to which you are successful. And, although a financial plan
does not guarantee success, it is necessary for it in the long-term. All too
often, people delay planning for the future. They may feel such planning should
take a back seat to staying financially afloat in the present.
However, even those living from
paycheck to paycheck can benefit from financial planning by creating a budget.
A budget can be used to determine what is actually spent each month and find
ways to trim or even eliminate unnecessary or out-of-control expenditures.
Working adult: You may have enjoyed your youth, without a care in the
world. But now, you are laden with responsibility – including financial ones.
You may have to support your parents, spouse and children and are wondering how
to do all of that with your salary income.
Create a financial plan right now.
Start immediately. No matter what your income level or what your hopes for the
future, you need a solid plan to achieve your goals. Drifting through life
without carefully set goals and well-researched methods of achieving them is a
recipe for disaster.
To enable your money to offer you
more of what you want out of life, start creating a financial plan today.
Retired: You have hung up your boots and are planning to retire
peacefully. But there is a thought nagging you at the back of your mind – how
will you be financially stable without a source of income?
You may have to depend on your kids
or relatives. A financial plan could help you get a steady stream of funds to
help you through retirement. This could act as a passive source of income..
Planning for your child: Yes, even children need financial planning. This is usually
undertaken by parents. Your child has a long road ahead – college, higher
education, university abroad, travel plans and so on.
This is apart from the other wants
and needs like the latest gadget or funds for medical emergencies. A proper
financial plan can come handy here.
How financial planning is different
from wealth management?
Before we understand the difference
between financial planning and wealth management, let us first understand what
wealth management is all about:
What is wealth management:
As the name suggests, wealth
management is all about managing one’s wealth. This predominantly deals with
preservation of wealth and further accumulation. As part of wealth management,
investors often actively try to identify and take advantage of profit-making
opportunities.
Difference between financial
planning and wealth management:
Financial planning and wealth
management are inherently very similar. Yet, there are some key differences.
The biggest difference is that you already need to be wealthy to ‘manage’ your
assets. Financial planning, on the other hand, is even for those who aim to
amass wealth.
Financial planning, thus, is
required by everybody, whatever your financial goals may be.
Financial Planning v/s Wealth
Management
Let us look at when wealth
management is required depending on the phase of your life:
Education Phase: This is the phase in which you gain knowledge and education
about investment, but you may not have a lot of financial wealth. So, no wealth
management is required. However, even at this time, you will have to do
financial planning to make the best use of your money.
In such a case, financial planning
includes decisions regarding how much to save for your daily expenses as well
as investments, how much loan can be taken, how it will be paid off etc.
Accumulation Phase: This is the phase in which you start enacting your strategy
and accumulating financial wealth. Here, wealth management may not be required
at the start, but may be needed at later stages once a significant amount of
assets are accumulated. Financial planning, however, is required even at this
stage. Planning involves re-evaluating your strategy and changing it if
required.
Decisions in this phase will be
related to accumulation of financial wealth, calculating how much to spend now
and how much to accumulate for future spending etc
Retirement Phase: In this phase, if individuals have accumulated wealth
already, then wealth management is required. But, if they do not have large
financial wealth, then it is not required.
On the other hand, financial
planning is still required with decisions relating to investment planning
(where to invest money) and estate planning (how to transfer real estate
assets).
Thus, we can say that wealth
management is required only by affluent investors, but financial planning is
required by all at all stages of life. We can also say that in broader terms,
wealth management is a part of financial planning.
How its Different from Wealth
Management?
What should a financial plan
include?
Now that we have gone through the
whats and whys of a financial plan, let’s get down to business – how to
actually make a financial plan. Depending upon an individual's needs and wants,
a financial plan should include various components.
It should include everything, which
helps in the attainment of your financial goals in the most efficient manner.
Some things might have precedence over the others, but anything that even
remotely affects your goals should be considered.
A financial plan differs from
individual to individual, as something important for one may not be important
for others.
However, broadly, we can say that it should include the following activities:
However, broadly, we can say that it should include the following activities:
Assessing present: This part of the planning has to deal with taking stock of
all the assets and resources you own currently. This helps you understand your
current financial situation. It is the most important thing to do while doing
financial planning.
As this is the starting point,
utmost care should care should taken while assessing the present situation.
Setting objectives or goals: Now that you have your starting point, figure out your
ending point – set your goals and objectives. This should be both in terms of
the return you expect on your strategies and investments as well as the risk
you are willing to take. That said, remember that a financial plan can consist
of multiple goals of varying durations.
For example, your short-term goal
may be buying a car or going on a month-long Europe trip, while your long-term
goal may be to have a retirement corpus of Rs 100 crore. However, be realistic.
Do not have a goal that is too far-fetched.
Design your goals on the basis of
your current situation and desired future conditions. Since there can be
multiple goals, prioritization is also important. This can be done on the basis
of time, urgency and sheer importance.
Determining constraints: Everyone has some limitation or the other. These could be
because of familial responsibilities, lack of access, government regulation and
so on.
These need to be taken into
consideration while forming your financial plan. Determine constraints in
financial planning areas like taxes, legalities, time horizon, liquidity, risk
appetite and obligations. There may also be unique circumstances that differ
from person to person that should be taken into consideration.
For example, you may want to avoid
companies making tobacco or alcohol for ethical reasons. This is a unique
constraint. Nonetheless, it should be taken into account before designing a
plan.
Determining appropriate plan and
strategy: After analyzing the goals and
constraints, various alternative strategies are designed. Compare these and
find out the pros and cons of each plan.
The best plan – which achieves the
goals in the most efficient manner – should be chosen.
Adjusting and modifying the plan: After evaluating the plan, if a change is required, the
plan should be altered keeping in mind your current situation.
Appropriate modifications are an
absolute must.
Evaluating the plan regularly: A financial planning is a dynamic process and not a static
one. This is because individual circumstances keep on changing. For example, 10
years ago when you made the plan, you had no monthly loan liabilities. Today,
you have to spend almost Rs 40,000 in installments alone.
This changes your liquidity
constraints and requirements. For this reason, your financial plan should be
evaluated on a timely basis.
Why should you make a financial
plan?
There are many advantages of
financial planning which can have far reaching positive effects on one's life.
Here are some reasons why a
comprehensive financial plan is important:
Safety net for the future: Financial planning helps give a direction to your financial
decisions. It helps you decide various investments that can bail you out of
your financial problems.
For example, investing in various
funds may help you repay the loan or save enough for your retirement. Once your
financial goals are set, it helps make your life more secure and flexible for
any financial emergency situation that may arise. Financial planning thus acts
as a safety net for the future.
Always be prepared: Suppose you save 5% of your salary or Rs 10,000 every
month. Suppose your after-tax savings consist of Rs 1 lakh. You are saving this
to buy your own car three years later. What if a sudden medical emergency crops
you, and wipes out your savings? Not only does it affect your wealth, but it
could also fall short in an extreme case. Marriage plans of your only daughter?
Let's borrow some money from the
retirement fund. There goes the trip to Egypt you have been planning all those
years! Financial planning will come to your rescue here. It takes into account
all your needs and goals, and helps you be ready for any eventuality.
Helps decision-making: Financial planning takes stock of your present as well as
your future. It thus facilitates decision-making. Take the above example, if
you had a proper financial plan in place, you would never be short of funds for
your daughter’s marriage or for buying your car.
Thus, you would not take any wrong
decisions that would affect your financial well-being. This is why financial
planning is the key to success, as it provides a direction for your decisions.
Always be prepared: Suppose you save 5% of your salary or Rs 10,000 every
month. Suppose your after-tax savings consist of Rs 1 lakh. You are saving this
to buy your own car three years later. What if a sudden medical emergency crops
you, and wipes out your savings? Not only does it affect your wealth, but it
could also fall short in an extreme case. Marriage plans of your only daughter?
Let's borrow some money from the
retirement fund. There goes the trip to Egypt you have been planning all those
years! Financial planning will come to your rescue here. It takes into account
all your needs and goals, and helps you be ready for any eventuality.
Optimum use of resources: A financial plan also helps you form a strategy. This helps
you allocate your resources to different assets.
Thus, you use your money more
wisely, leading to optimization of resources.
Better standard of living: With a realistic financial plan in place, you will never be
short of funds. Liquidity will rarely be tight. All those month-end woes?
Forget about them.
Thus, you can achieve your goals
without compromising your standard of living.
Disciplined life: It is very common to spend more than what you earn. Many
facilities like credit cards, ‘buy now, pay later’ schemes, installment
services and so on, compel you to overlook finances or spend more than
necessary. At the end of the month, when the bills keep pouring in your mail
boxes, you find yourselves in a sticky situation.
The mounting bills only take you
further away from your long-term dream of owning your own house. If you start
planning early, you can get out of whole a lot of financial mess arising later
in life. Financial planning thus helps infuse discipline in your life.
Expert advice: Financial planning if often undertaken with the help of an
expert. It is wise to seek expert advice from professionals. If not, you could
end up with poor financial information and decisions that can prove disastrous.
In the case of the working individual, insufficient or random saving for
retirement can lead to a poorer lifestyle later.
Similarly, in the case of the
businessman, poorly managed tax preparation could culminate in unexpected debt
and a loss of carefully accumulated wealth.
Source-
© National Centre for Financial
Education (NCFE) 2015 -
