To ensure a better future and cope with any financial emergency, improve savings and prepare a contingency fund.
Risk management in finance includes identification, analysis, and prioritisation of risks, followed by an appropriate allocation of resources to monitor and mitigate their impact. While risk management is seen largely in the purview of businesses, it is equally important in the sphere of personal finances.
The basics of personal finance start with understanding one’s net worth, laying out saving goals, budgeting, and ensuring that there are enough funds for crises. Risk management ensures that we take a holistic view at each step, keeping in view both our present circumstances and future needs.
Take Stock Of Assets And Liabilities
Every personal finance plan starts with determining one’s net worth and calculating personal resources like personal liabilities and assets. Liabilities include taxes, utility bills, house rent, loan instalments, grocery, food, insurance or investment premiums, and education expenses. Keep track of all spending over a few months on a spreadsheet to have detailed knowledge about liabilities. It gives a more accurate picture of personal spending, including unplanned expenses, such as buying gifts or dining out.
Assets include all our income sources like salary, any benefits (such as disability benefits), rent from own property, interests or dividends, and any income from sources other than one’s primary employment. Then, if we subtract the sum of our monthly liabilities from the sum of our monthly income, the surplus is the amount that can be further invested for retirement or contingency planning. A negative result calls for immediate action to curtail expenses through careful budgeting.
Define Financial Goals
This includes both long-term and short-term goals. Long-term goals include retirement planning, buying property, or setting aside sufficient funds for children’s education. Short-term goals mostly include a yearly vacation or buying a car. Setting these goals helps in deciding our fund allocation towards each goal and the kind of investment planning one should start. For instance, once we have set the goal to buy a car or set up an education fund, we can start shopping for an appropriate education plan or an affordable car loan.
Make A Budget And Stick To It
Budgeting helps us keep track of our expenses and learn financial discipline over time. It also ensures that we allocate sufficient resources towards the realisation of these objectives. One of the risks in budgeting is overlooking accidental expenses, which may lead to our intended outlay falling short.
One can follow different budgeting tactics to mitigate such risks. One of the most popular is the 50-30-20 framework. Under this approach, 50 per cent of an after-tax income is allocated for regular expenses, such as house rent or grocery bills; 30 per cent is for additional expenses, such as dining out. The remaining 20 per cent is allocated for savings and investments, including an emergency fund. With careful budgeting and mindful spending, one can slowly increase the allocation for investment, cutting down on additional expenses.
Build An Emergency Fund, Pay Your Debts
Once we have defined our funds for further savings, we can prioritise our risk allocation. Some of the risks that can threaten personal finances include loss of employment, a serious injury, or any damages to assets such as a car accident or a house fire. An emergency fund can be critical in tiding over an unexpected mishap. This fund should typically be enough to cover three months’ expenses. Other risks to our personal finances include any pending debts. While certain long-term debts like student loans or house mortgages are best handled through well-planned monthly instalments, it is important to stay on top of smaller debts, such as credit card payments.
Save For Retirement
It is better to start retirement planning at the earliest. It can include life annuity, deferred annuity, immediate annuity, guaranteed period annuity, National Pension Scheme, pension funds, and Unit Linked Insurance Plans (Ulips). When picking an investment plan, one should consider the premium structure and benefits associated. For instance, Ulips allow partial withdrawal of funds, which can be critical in case of an emergency. Many retirement savings plans also offer tax benefits which can further add to our savings.
For financial discipline and a safe future, we not only need to take a hard look at our expenses, but also understand the impact of unforeseen events and risks. This is necessary to ensure that we can exercise risk control in case of any mishap and we have sufficient funds to mitigate these risks. This way, we build our wealth and also ensure a safe future for ourselves and our families.
The author is CEO, India Affiliate, Institute of Risk Management.
DISCLAIMER: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.