Financial Planning-True opportunity to create wealth
This Article was originally published in The Global Analyst
Among many mistakes investors make, not having an independent financial planner assist your investment planning can be the main one. There are many reasons why we don’t approach a financial planner to assist us in our financial planning. Before that, let us first understand what is financial planning from the lens of income and expenses.
We generally depend on our career to feed us with income. In some cases, there may be other sources of income as well (like generational properties and wealth). However, for most of us, our job or business is the main source of income. In accordance with this income, we commit certain expenses. In what remains of this is called savings which we invest. So the equation is
In other words, whatever is left after expenses is considered to be our savings which we invest whenever possible.
However, this is not financial planning. True financial planning will shift this equation a bit as follows:
In short, instead of investing what is left after savings, we will be spending what is left after investing. That probably is the true meaning of financial planning and can lead to long-term outcomes that will create significant financial wellbeing.
Now let us look at some reasons why we don’t resort to financial planning or seeking the services of a professional financial planner.
Over confidence: Like how we are endowed with innate overrating of our driving skills, we tend to do the same when it comes to managing our money. For some reason, we believe we can do it ourselves. This belief cuts across professions be it a doctor or lawyer. Everyone strongly believes that they can do a better job of managing their wealth until something terribly goes wrong.
Not sure where to go: Sometimes it may be clear that some financial planning help is certainly useful but one may not know where to go and who to ask.
I am too small: Many of us think that we are too small to have an advisor assist us. This game is only for the riche rich and not for ordinary folks like us!
Things are ok as of now: As long as things are normal and good, why have unnecessary layer of an advisor. This is like going for a periodic medical checkup only for the doctors to say that “all is well”.
Reluctance to pay: Independent financial planning means we need to pay fees to the financial advisor. Not too keen.
However, the merit of financial planning will be clear once we understand the sequence involving income, expenses, savings and investments and complexities surrounding each one of them.
In the case of income, the popular narrative is that our job/career is the main source of income. However, financial planning itself can become another source of income thanks to the power or magic of compounding. A good financial planner would explain to you the benefits of starting early and how disciplined investments can produce outsized returns in the medium to long-term. Thus, while during our initial career days, income from job/career can be the only source, in the medium to long-term income from wealth accumulated can be a much higher source of income than job/career.
Since most of us invest only what is left after expenses, let us dwell a bit on expenses. Thanks to credit card (the easiest but costliest source of money), it is now possible to indulge in shopping binge that includes buying things on “sale” or buying fancy stuff even when we really don’t need it. (And you thought shopping binge is a female thing only!). Sometimes, we may erroneously associate such fancy buying (be it expensive watch or car) to an asset. A true asset is generally income producing and growing in value (like real assets) while fancy assets are either non-income producing (like gold) or income and value depleting (like car involving maintenance and depreciation). Such lifestyle expense habits through credit card can cause what is termed as “lifestyle inflation” which erodes your savings. Since access to money is now easy (though not cheap), it may quickly result in debt. EMI’s are a troublesome part of this expense equation for many. Even if one does not resort to binge buying, aspects like not having a medical insurance for self and family or children marriage can drain away money in record speed. In other words, expense planning and management is a key aspect of financial well-being. Well, you will certainly not consult your financial planner to buy a Rado watch, at least he/she can explain the outsized influence of growing EMI’s or debt on your finances.
Assuming we earn well and manage our expenses well (double pat), here comes the main question: Are you wisely investing your savings? This is where the role of financial planner is extremely valuable. Traditionally, savings are either invested in fixed deposits (even though they pay interest lower than inflation) or real estate (how can one go wrong on this) or gold (best hedge in times of crisis). It is also possible that within these choices, we will be skewed based on our risk perception. For example, a conservative approach suggests that you should safely park your money in fixed deposits (Really, ask PMC depositors!).
In the absence of professional financial advice, it is very common to see one making investment mistakes. Did we not invest in an insurance product mistaking to get a return in the future? Did we not buy XYZ stock based on a tip? The list can go on. Our investment mistakes can lead to undiversified portfolio of assets.
Also, the emotional aspect of investment alternates between greed and fear. Given a choice, we all want to double our money in 6 months’ time (greed). Also, once we lost money say through a bad stock choice (thanks to tips) we fear investing again in stock market. Our emotions will alternate between greed and fear throughout our lives.
In summary, a professional independent financial advisor can help you to flip the equation in favor of disciplined investing and manage your emotions. He/she will caution you when you turn greedy and will encourage you to take risk when you are afraid. The amount paid to a financial advisor as fees to manage this process will be worth its weight in gold in the medium to long-term.
The question then turns to “How to identify a good independent financial advisor”? Like how to identify a good doctor, a professional advisor should be qualified in their chosen field through recognized accreditation. Some informal inquiries with his current and past clients can also help. More importantly, he/she should be independent. In other words, he/she should take the fees from you and not from product providers. If some advisors claim that they can help you for free, remember there is no free lunch. Also, a periodic performance evaluation of the advisor is necessary (like our job appraisals!).
In this entire process of managing one’s savings, the cardinal mistake all of us do is not to involve our spouse in this. Especially, men believe that it is a “man thing” and since they make the money they have the right to decide where to invest. Nothing can be far from truth on this. Ultimately, the wealth creation is done keeping the family wellbeing into account and hence it is a bad idea not to involve the spouse in conversations with financial advisors. In fact, one should actively encourage their spouse and children to be part of this conversation as a good training ground.
In summary, I would say financial planning is like health consulting. You can rush to a doctor when you have a mild heart attack or you can have regular master health checkup which will avoid the heart attack itself in the first place. The choice is yours.