Financial planning is the systematic approach towards managing one’s finances by allocating resources in a systematic and disciplined manner in order to achieve one’s financial goals and objectives. A sound financial plan is important as it helps reduce and possibly eliminate financial distress that may arise from various responsibilities and unexpected situations.
It is an overly discussed topic but in light of the ongoing Coronavirus pandemic that has wreaked havoc in individual’s businesses, savings and financial planning efforts, it is vital to reiterate it keeping in mind the new operating environment. The novel Covid-19 has greatly affected the world with the International Monetary Fund projecting the global economy to contract by 3% in 2020, a worse outlook than the one seen during the 2008-2009 financial crisis, where growth contracted by 0.8%. Due to these effects in the economy, livelihoods have been affected in one way or another and as such, people have had to adjust financially to the new environment.
Financial Planning Process
It is a process consisting of the following steps:
Assessment: You determine your current financial situation by identifying various factors that may affect your financial plan. You may look at whether you salary is enough for you to pursue your financial objective, and also at your spending habits. Your financial plan is likely to be informed by your risk profile, age, income or number of dependents. In most cases, people with fewer dependants have more freedom to make riskier investment decisions while those with a lower risk appetite tend to avoid riskier investment decisions and as such, they will be geared towards safer investment plans.
Goal Setting: You outline the financial goals you want to achieve in the long run. These goals ultimately provide a clear roadmap towards the achievement of your financial objectives. However, the goals should be measurable and achievable, or a combination of the following four practices: Savings; it requires discipline and as such, you should treat it as a necessary expense and have a plan. You should have at least six months of living expenses saved up but with the pandemic, there is now need to look at a larger time frame: Investing; it is an asset or item acquired with the goal of generating income or appreciation. In investing, investors take risk by investing in certain investments assets such as equities, private equity, real estate or the fixed income asset class, that have the possibility of making losses while in savings, there is no risk involved and as such, the return is lower: Budgeting; a plan that estimates the expenses and revenues over a specific period. A simple one can help in tracking all sources of income, expenditures as well as track all the savings such as retirement savings or what is portioned out for an emergency fund. Through a budget, you are able to know your financial flexibility for the month. It gives you a good starting point towards financial planning, and, lastly, debt and debt management; you should always know when to get into debt and ensure that you are taking on good debt. Not all debt is bad. Good debt is an investment that has the potential to grow in value and yield future financial gains such as business, education or property.
Plan and execution; A financial plan is developed based on the goals identified in the step above. The financial plan will detail how the goals will be achieved, the time factor as well as the next actionable steps to take towards achieving the goal. A well laid out plan should highlight two things: Suitable channels and investment instruments that will assist you in achieving your goals. This may be through saving, budgeting, cutting on expenses, and through investing, and, Timelines: This will indicate how long you are willing to invest in a given investment instrument. Long-term investments may be most suitable for long-term goals. This is because, long-term investments offer higher returns, and long-term goals often have higher cash requirements.
Monitoring and Reassessment; This is the final step in financial planning. Given that goals and priorities change over time, it is important to monitor the financial plan created and readjust it when necessary. Before reassessing or adjusting the financial plan, consider the status of the goals earlier set, change in income levels, changes in risk appetite and risk tolerance and, number of dependants.
The Novel Covid-19 has brought an economic downturn with most firms scaling down their operations. Consequently, this has affected people’s disposable income due to salary pay-cuts, unpaid leaves and employment termination, consequently disrupting their investments and savings plans. As economic contraction continues, most individuals have been forced to take a more conservative stance in their investments plans in order to minimize the losses incurred, maintain adequate liquidity as well as re-evaluating their short term and long-term financial goals.
The reduction in income levels for individuals who have lost their jobs, taken pay cuts or unpaid leave, has set a stage for loan defaults. Given that debt management is among the goals of financial planning as discussed in the above section, the reduced income levels has put a strain on people’s ability to make their monthly financial obligations to their banks. Additionally, despite the income levels declining, most monthly expenses such as rent and transport have not come down putting a strain on the personal finances.
Maintaining your finances at manageable levels during this time is essential as most people are on a survival mode given the reduction in their income. You will need to, firstly, scale back on spending. You can achieve this by prioritizing your expenditure by only spending on the needs, seeking alternatives that will give you the same level of satisfaction but will cost much less and by looking for and taking advantage of bargain purchases.
Secondly, you will need to restructure your loan. The CBK announced in March that banks would provide personal reliefs on loan repayments for up-to one year to individuals affected by the effects of the Coronavirus. You can choose to restructure in loans by either seeking personal relief, which places moratoriums on both intersst and principal payments for three months or longer or by loan consolidation for those with more than one loan facility and even request for a longer loan repayment period as it reduces the cash outflow from them. Loan relief however, is determined at your bank’s discretion.
You can also reformulate your budget. Usually described as the first step towards financial freedom. It tells you as an individual where your money is going rather than wondering where it went. Given the reduced disposable income, a budget will ensure that you determine whether the available resources are sufficient to cater for your monthly expenses and if not, it provides a clear picture on where you can scale back in order to live within your means. Sticking to a laid out budget requires discipline and making a really good budget, more so in this economic downturn, requires you to be honest about where your weaknesses are, most especially in areas you can be saving more money.
Review and update your Investment Plan.It is important to ensure you are comfortable with your investment allocation in the various investments asset classes. Individuals whose income levels has been affected should revaluate their investment strategies to a low risk plan. Given that liquidity is the most important goals at the moment, investors should focus on short-term investments such as Unit Trusts as opposed to investing in long term illiquid assets such as the Real Estate Sector. The economic downturn has seen most investors recorded losses in their portfolios and as such, rebalancing your financial plan will help in minimise the loses in your portfolio as well as assist you in staying the course of your short-term financial goals.
Lastly, you will need to re-evaluate your emergency fund. It is important to have an emergency fund that is easily accessible and can cover at least three months of your living costs. With the slow economic growth anticipated globally, emergency funds will come in handy during this time. With companies scaling back their operations and cutting costs, most people have found themselves either taking paycuts, being laid off or taking unpaid leave. If you are lucky enough to not have lost your job or if you took a pay cut, given the scaling back of expenses, your residual income can be directed towards an emergency fund. Think of it as your SOS (distress) fund should anything go wrong.
Even in the middle of the pandemic, it is important to ensure that we continue investing in a bid to ensure we are growing wealth or at least preserving value. It is important to ensure that investors are getting at least a return above inflation in the long term. A lot has changed due to the ongoing Pandemic with various assets classes being impacted differently. It is important than ever for investors to ensure that they are making the right investment decisions. Below are some of the factors to consider while making an investment.
Return; your choice of investment should depend on the returns available and your preference towards generating a stream of income or capital appreciation in their portfolio.
Risk tolerance; generally, the higher the risk, the higher the return. It is important that before investing, know your risk tolerance. Not everyone is comfortable in investing in risky assets classes such as the equities market. It is therefore important to take on calculated risks and stick to a risk/reward ratio suitable for your risk appetite
Liquidity; how quickly can you convert an asset to cash? Liquidity varies from one asset to another. For individuals looking for liquidity amid the pandemic, it is important to consider investing in short-term liquid assets.
Time horizon; what you hopes to achieve will determine the type of investment you venture into. Before investing, you must evaluate the target for the investment chosen and the length of time for which they require illiquid assets. The investment horizon determines the your income requirements and desired risk exposure, which then helps in choosing the appropriate investment product.
Lastly, consider you investment capital. It often affects your choice of investment given that some investments require higher capital, thus making it harder for those with lower capital to venture. In the current market, you can invest in the equities market either directly on your own or via collective investment schemes (CIS) such as equity funds (which buy ownership in businesses most often in the form of publicly traded common stock), with as little as Sh1, 000 or invest in government papers using collective investment schemes such as money market funds with as little as Sh100 in select money market funds.
Once you have decided what you want to invest in, the next step is to determine how you would like to invest. You can choose to invest directly or through a collective scheme. CIS are pools of funds that are managed on behalf of investors by fund managers. The amounts invested in the CIS are pooled and utilized by fund managers to buy stocks, bonds or other securities that are in accordance with the funds objective, with the aim of generating returns for their investors. Direct investors on the other hand, own particular investment assets and are responsible for the management of their portfolio/investments. Direct investors reap all the rewards and assume all risk as opposed to investing in a CIS.
In light of the current economic conditions, with CIS, investors with low levels of income are able to access various investment avenues such as the money market fund. They, for instance, have continued to record higher returns as compared to bank deposits and saving accounts during this economic downturn.
As the global market continues to show signs of distress and fluctuation, financial planning will provide a clear path on navigating the stressful situation caused by the pandemic.