Financial planning is often taken up with a view of making money quickly. As a result, the attention is more towards selecting asset classes and specific investments within those to achieve the target rate of return.
This is where the entire planning process can go haywire. Most people, who undertake planning, want too many things at the same time and this puts a severe strain on finances.
For instance, a plan that provides for a vacation, a house, a car and a horde of expensive electronic goods, all to be achieved by the end of the third year is a rather difficult task to achieve.
For starters, the earnings/monthly inflow needs to be taken into consideration. And the rate of increase over the years would be an important factor to achieve all the goals. That is, a plan might assume that the income of the individual will rise by 15 per cent per annum over the next 15 years. Clearly, there is a danger.
This growth rate may be unsustainable. In the last two-three years, the average salary rise has been substantial because of a very high demand and lack of quality labour.
However, if the economy were to slip into some kind of recession, we could be looking at tough times ahead. So the entire assumption of salary rise at the rate of 15 per cent can go completely wrong.
It is also important that you take a realistic view of the rate of return from the portfolio. Any portfolio would consist of debt and equity, besides other asset classes like property and gold. Also, there would specific rates of return attached with each of these asset classes to estimate the amount that would be accumulated over the years.
Often, there are long periods of time when there is strong overall performance of the markets. There could be a real danger of overestimating the returns from equity, but in adverse times, this could really become a problem and make goals tough to achieve.
In such times, the investor would have to rework their targets and goals. For instance, the stock markets were returning a good 40-50 per cent a year in the last four years. However, most experts would ask you to prune the expectations this year.
Buying a house is another area, where one can make unrealistic expectations. Most people have a desire to buy a house, a large one at that (3-4 bedroom place), and often in an area that is really costly.
As a result, when translated into monetary terms, the planning has to account for a requirement that is completely out of reach. That is, a person with a Rs 5 lakh annual salary wanting to buy a Rs 40 lakh house will find it difficult, not only, in terms of accumulating money but also in terms of getting finance.
Another problem faced when dealing with the target is that people tend to include several luxury items in the requirements. For instance, going in for a car worth Rs 12 lakh because of status symbol, as against a Rs 7 lakh car, when both of them will achieve the same objective is usually a bad idea.
Such demands from your finances give rise to situations where the income is always chasing needs. So no matter how much the income, there is always going to be a shortage of money to achieve objectives. This can result in a situation where some important needs have to be left out for the sake of frivolous needs.
The writer is a certified financial planner
