Financial security; is it a state of mind or a state of finances? Actually, it is a mix of both. Financial security is the state of mind that emanates from the state of your finances. Financial security is the mental peace and the feeling of confidence that stems from the belief that the needs of your future and your family’s future are taken care of. Why is financial security so important? That is because, financial insecurity is a difficult situation to be in.
Financial security may be a state of mind but it is also a process that requires planning and methodical savings. The importance of financial security stems from what do you understand by financial security. There are 5 key steps to ensure financial security for yourself and for your family. Here are some financial security examples:
1. Ensure that your life is adequately insured as are your assets:
How much insurance is required by an individual? That largely depends on how much of income flows you want to replace. Take a simple example. If you are earning Rs.1 lakh monthly, then you need to replace nearly Rs.12 lakhs worth of annual income. Assuming that your family cannot afford to take risk in your absence, the corpus will have to be invested in liquid funds giving returns of around 6% per annum. That means you will require a life cover of Rs.2 crore just to cover annual home expenses. Then your life cover needs to cover other commitments like your child’s education, your spouse’s old age etc. Also, any outstanding liabilities like home loans, car loans, and personal loans must have a term cover so that assets are not compromised. This is your first step to financial security. Also ensure that valuable assets are insured to avoid impairment.
2. Let your goals be covered by a comprehensive financial plan
Once you have identified your insurance needs, the next step is to sit down with your financial advisor and work out a comprehensive financial plan. Involve your spouse in the financial planning exercise right from the beginning. This should cover key milestones like your retirement, child’s education, child’s marriage, home loan margin etc. The purpose of a financial plan is to have a documented pathway to your financial goals. This will be a great source of financial security as there is a clear path defined.
3. Focus on savings as a commitment rather than as residual
Commit yourself to saving as much as you can each month. Be systematic and disciplined. The best way is to treat savings as a commitment and not as a residual item after your expenses are met. That is a sure shot way to splurge unnecessarily. Create a savings target with two basic principles in mind. Firstly, your savings target must be set so as to ensure that you review your budget and squeeze the maximum out of your income. Secondly, ensure that your savings are consistently increased in tune with rising income. Static saving plan is tantamount to not realizing your full potential when it comes to savings. The more you save and start early the greater your financial security.
4. Ensure that your money is working hard for you
This is perhaps the most important part of financial security approach. You need to divide your investment outlays into 3 broad categories. The short end requirements must be in liquid funds. These include your emergency savings for a rainy day. This is a great source of financial security. Secondly, your medium term assets should be in bond funds which are tax efficient, give higher returns and also ensure security and steady returns. You do not have to worry about asset volatility in the medium term. Lastly, in case of long term assets, you must be invested in diversified equity funds. Equity is the best asset class over the long term since empirical studies have proven that beyond 10 years holding period, the risk of downside volatility is almost Zero. The best way is to adopt a phased SIP approach, but the moral of the story is to make your long term monies work hard for you.
5. Have clear milestones so that your financial security is measurable
This may appear to be quite a routine item but is very important from a financial security point of view. Financial plan is highly amorphous till the time it actually fructifies many years later. How do you measure your financial plan performance in between. That is where milestones in terms of risk and returns come in handy. When you are able to meaningfully measure your plan performance against targets, it is a source of financial security since you can be sure that your long term financial plan is on target.
As emphasized earlier, financial security is a state of mind but it is achieved through diligent financial planning, emergency planning and having a clear saving agenda. The time to start is now!