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Securing financial futures and the case for goal based financial planning
Part 2 - How Indian households can turn their financial dreams to reality.
Where were we?
“A goal without a plan is just a wish”.
When the French writer Antoine de Saint-Exupéry said this in the early 1900s, he was probably not talking about financial planning but it rings true in this context all the same.
In part 1 of the blog, we looked at the lives of Suresh and Rekha, their household, and their financial journeys. Here’s a quick recap.
We established some connections between how households like theirs take financial decisions and noted the significant drawbacks of the strong reliance on physical assets (such as real estate and gold).
What’s more, we also saw that as a direct consequence of this, households like Suresh and Rekha’s are unable to get the maximum benefit from their financial resource allocation, consequentially, curtailing them from achieving their financial goals.
So, what does this future entail?
Generally, in thinking about financial futures, households need to address two types of expenses. First, those that are centred around planned life events and prospects. Second, unexpected and emergency requirements cloud over at various times in a person’s life cycle.
Let’s take a look at some of the big-ticket items on Suresh and Rekha’s bucket list as a family.
If Suresh and Rekha can create a plan to fund the above life events and also maintain a buffer for any emergency or urgent funds needed in their life cycle, they will be able to live the ideal life that their circumstances can afford them. However, the path to actually getting to this ideal life is not exactly linear.
So... goal-based financial planning huh?
If it is reasonably clear to a household what their needs are likely to be, a household can achieve some or all of their goals in two simple steps - estimate the potential costs and budget to fulfil these needs and reassign and earmark existing savings or investments choices specifically towards these needs.
This, in essence, is goal-based financial planning. It is a process that begins with the identification of specific goals and needs in the life cycle of the household, moves onto the estimation of costs, budget, risk capacity, and ends with the recognition of investments (physical or financial or a combination of both) assigned towards each of these goals or needs.
Since no two households have the same income and goals, there can never be two identical plans. Furthermore, estimation of costs associated with various needs cannot always be accurately gauged and emergencies and accidents can often derail the most well-intentioned plans.
In the face of such uncertainty, what is the point of such planning, is an absolutely valid question. So let’s game this out a little further.
If the future needs of many typical households are to be bucketed, the financial requirements to meet these needs can be loosely characterised in the following manner.
Expanding and preserving financial value a.k.a. is the ability to generate more value from existing savings or income or at the very least preserving the inherent value in the savings or income.
Amounts dedicated under this head are utilised for improving living standards such as purchasing a vehicle or for reaching medium or long term goal posts such as funding education or marriage costs of children. Simple financial instruments such as fixed deposits or recurring deposits of small amounts on a regular basis in the short term and even physical assets such as real estate or gold in the long term can have the impact of expanding or preserving financial value. The specific concerns in the use of financial assets as investment tools - the inability of low income households to imbibe the risk associated with such investments and their cash flow patterns being seasonal in nature making deposits uncertain limit their uptake at present and bolster the continued reliance on gold and real estate assets.
Safeguarding human capital a.k.a the ability to sustain living expenses in case any member of the household faces bodily harm.
Instruments that help pay for care or necessities in case of accidents or illness are typically bracketed towards protecting human capital. In order to be better equipped to care for human capital, investments in health or life insurance or micro-insurance assets specifically designed for such calamities are deemed invaluable. This should be a high priority for a low-income household where many people are engaged in jobs that require physical labour that increases the risks of bodily harm.
Managing liquidity a.k.a the ability to finance needs on short notice through the disposal of available assets.
There are multiple events in the life cycle of a household that are not premeditated. These require immediate attention and the household should ideally have the flexibility in its available resources when such circumstances arise. These can include a loss of steady source of income, a loss of life of the earning family member, a health emergency which is not covered under insurance or well, a global pandemic. Given the nature of such needs, neither can they be planned accurately nor can they be prevented. But in order to prepare for them, investments in assets that can be easily liquidated such as gold or other basic financial assets should be preferred. Low interest rate backed debt ideally from institutional sources is also a useful source of managing liquidity. However loans taken for emergency purposes often lead to a debt spiral and efforts need to be taken to provide these households with a suitable debt product that does not harm them further.
Despite the macro nature of the above characterisations, Suresh and Rekha’s individual goals and needs are no different. In the regular course, their financial journeys are determined by the usage of their surplus funds for expanding and preserving financial value. All towards achieving the future they envisage for themselves and Kiran (including education and marriage).
However, at different points in their lives, their household has had to rely on uncertain sources of income or dip into their savings. For instance, when Suresh met with an accident, the lack of health insurance forced the family to take an emergency loan at a very high rate of interest from a local moneylender. During the Covid-19 pandemic, the prolonged lockdowns had a direct impact on their available income. Suresh and Rekha have inherited the need to save like many others in India but what is unavailable to them is the knowledge to plan their savings towards their specific goals and needs.
So, where does that leave us?
Well, goal-based financial planning is the crucial first step towards making better financial decisions. But, the systemic issues with financial investments i.e. lack of access to formal financial markets, limited information about products, rigid deposit schedules, and payment structures for most financial products (see part 1 for more details) continue to remain a roadblock in optimising resource allocation, especially for low and medium-income households.
Work on making this access more universal continues in full swing among the fintech community and otherwise. But it is also true that the benefits of this access are likely to be wider if the Indian households can plan their financial journeys (using these newly accessible tools) around their vision of the future. Not to mention, this remains true irrespective of how much or how little a household can put aside in the piggy bank.
Goal-based financial planning presupposes that no matter the character of the future need of a household or the financial resources presently available with them, the value derived from these resources can be optimised. This is especially beneficial to those that already have limited resources and will need to rely on more strategic planning to achieve that value expansion in the future.
Finally, as with most open-ended questions that our society faces today, technological tools hold a key to solving financial security for low-income households (despite their uncertain income and increased possibility of unexpected future costs). Financial tools such as lending, micro-insurance or even pensions can be relied on to materialise the best possible outcomes for a household on the basis of a goal based plan. With the right tailored fintech products, a goal based financial plan and the age-old savings mindset, Indian households such as Suresh and Rekha’s can march onwards to a financially secure future.
All illustration by Prajna Nayak.
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