Most of us switch off when someone says “Hey..Let’s create your financial plan”. Those dreadful excel calculations, long term projections, future goals, inflation assumptions blah blah…
No worries. I completely get it!
But what if we simplified this whole complicated financial planning business to something that you could just do it in your head while you are waiting at the next traffic signal.
Not a bad deal right. This is exactly what this post is all about. Be with me for the next 5 minutes and you can create your entire life’s financial plan while you are returning back from office tomorrow.
A financial plan is simply three things put together:
- How much are your future expenses? (adjusting for inflation)
(for various goals such as kid’s education, retirement, buying a home etc)
- How much to save for these future expenses?
- Where to invest whatever we save ?
We will explore the first two questions for today and address the 3rd question in our future posts.
1.How much are your future expenses?
We have already addressed this in detail in our earlier post here.
Here is the quick summary:
In India, historically rise in costs (i.e inflation) has been around 7 to 7.5%.
Rule of thumb 1:
The rough math for a 7 to 7.5% inflation implies prices will approximately go up by
- 1.4x or 40% up in the next 5 years
- 2x in the next 10 years
- 3x in the next 15 years
- 4x in the next 20 years
From here you can build for all incremental 5 years using the logic that prices double in every 10 years. So for 25 years, we know that in 15 years prices are 3x and hence for 25 years it is 3×2= 6x. For 30 years it will be 4x (for 20 years)*2 (for the next ten years) = 8x
So if we remember 1.4x, 2x, 3x and 4x we can calculate an approximate value for all of our future expenses!”
2.How much to save for future expenses?
A reasonably well designed equity portfolio should provide me with ~15% returns for time frames above 10 years.
(This is based on history and your guess is as good as mine when it comes to predicting future returns. So just in case you think my assumption is optimistic then you can refer to the annexure of this post and adjust your calculations accordingly.)
I will be able to increase my savings by at least 5% every year
(Assuming a static monthly savings for the next 10 years and more is being a little too conservative as our salaries normally are expected to increase at least to keep up with inflation)
Rule of thumb 2:
We need to spend some 2 minutes and memorize the below numbers. The table tells us how an investment of Rs 1000 every month which is increased by 5% every year and provides a return of 15% will fare over different time periods.
(this table will be different based on your return assumptions. Refer annexure)
How do we use this?
If you have an expense of 40 lakhs after 15 years, how much will you have to save every month?
Simple. For every Rs 1000, you end up having Rs 8 lakhs after 15 years. So for accumulating Rs 40 lakhs in need to save 40/8 lakhs = 5 and hence 5*1000 = Rs 5000 every month.
Now this is all we require for our financial plan. Let us put the entire thing into action
A simple financial plan
Let us take the case of Rahul, aged 30. He is recently married, has a 2 year old daughter Sandya and earns around a lakh every month. How does he go about doing his financial plan while driving back from office ?
Traffic signal 1:
Rahul’s mind voice:
“Let me get done with my daughter’s education first
A decent 4 year engineering degree roughly costs around 10 lakhs today. My 2 year old daughter will be in college at around 17. So I have another 15 years left.
Now based on the above table, the cost of education will become 3x in the next 15 years i.e Rs 30 lakhs.
So how much will I have to save every month?
Looking at the above table, every Rs 1000 invested per month (and increased by 5% every year) gives me Rs 8 lakhs in 15 years. So I need to save around Rs 4,000 every month which will give me approx 32 lakhs in 15 years.
The traffic light turns green and Rahul is done with the plan for his daughter’s UG education!!
Takeaway: He needs to start saving around Rs 4000 every month for his daughter’s under graduation
Traffic signal 2:
Rahul: “Now let me also decide on her MBA expenses. Assuming she does her MBA at 22. That is around 20 years. An MBA today costs around 25 lakhs. So the cost of an MBA 20 years hence is 25*4 (the inflation multiplier) = roughly Rs1cr.
Looking at the above table, every Rs 1000 invested per month (and increased by 5% every year) gives me Rs 18 lakhs in 20 years. So I need to save around Rs 5,500 every month which will give me approx 1cr in 20 years.
So, Rs 4000 for UG and Rs 5,500 for PG – in total let me round off and start saving Rs 10,000 every month for my daughter’s education.”
Traffic signal 3:
“Now I would also like to buy a home after 20 years. The current cost works out to be around Rs 80 lakhs. This implies the cost after 20 years accounting for inflation would work out around Rs 80 lakhs * 4 = Rs 3.2 cr!
Looking at the above table, every Rs 1000 invested per month (and increased by 5% every year) gives me Rs 18 lakhs in 20 years. So I need to roughly save around Rs 18,000 every month which will give me approx 3.2 cr in 20 years for the house that I am planning to buy.
Traffic signal 4:
“I would also want to save some corpus for retirement. Approximately, the math says I need around 20 times current earnings to create a similar annual income stream which can grow along with inflation.
Since my current salary is Rs 1 lakh per month, or Rs 12 lakhs per year, I would need around Rs 12 lakhs * 20 = Rs 2.4 cr if I were to retire today. Thus this implies adjusting for inflation after 20 years I need Rs 2.4 cr * 4 = 9.6 cr for retiring with the current lifestyle.
Looking at the above table, every Rs 1000 invested per month (and increased by 5% every year) gives me Rs 80 lakhs in 30 years. So I need to roughly save around Rs 12,000 every month which will give me approx 9.6 cr in 30 years for my retirement corpus
Traffic signal 5:
Thus summing it up:
- Daughter’s education: ~10k per month
- Home: ~18K per month
- Retirement: ~12K per month
Thus overall, Rahul will need to roughly save a total of Rs 40k per month for all his goals. And the waiting time in 5 traffic signals is all that it took 🙂
And there you have your simple financial plan !!
What if you have already saved up some amount. No worries, we have a solution for this too.
Thumb Rule 3:
At 15% your money doubles every 5 years.
So if you have saved let’s say around Rs 10 lakhs, it will be Rs 20 lakhs in 5 years, Rs 40 lakhs in 10 years, Rs 80 lakhs in 15 years and so on..
Do let me know if you found this helpful and if you had any issues while implementing this.
Please remember that these numbers are rough approximations and hence don’t get too obsessed on precision. The idea is to get you started with a simple plan 🙂
If your return assumptions are different from my 15%, then refer to the table below for the appropriate values (and round the values off to make it easy)
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