"Are You Prioritizing Expense Estimation in Your Financial Planning?"

Financial Planning includes a wide range of activities; however most of the focus in financial planning and wealth management is toward:

• Asset allocation

• Tax planning

• Insurance planning

• Identifying assets that beat inflation

• Mutual Fund Scheme selection

• AUM maximization

Least amount of attention and detailing is drawn toward the expenses of the Client or despite attention drawn towards it, Client just make a high estimate of his expenses. Does this part also require more attention? I think this part also requires careful consideration and detailing from the Client.

So typically, any person is definitely aware of his total income, more so if in a job then he is aware of his CTC and in hand pay. However; for the majority of the people they only have a very rough idea of their total expense. What happens then is, when you are planning your finances, you have an accurate information of your income which let’s say is INR 10 lakhs per annum after taxes. Then the Client would estimate his expense to be INR 7 lakhs per annum. Based on this, a plan would be made for the Client assuming he has INR 3 lakh surplus every year.

Now, imagine the actual expense of the Client turns out to be INR 8.5 lakhs. What this means is he will be left with only INR 1.5 lakhs to invest through the year. Now say if he has already started SIP of INR 20,000 per month, there will be a point during the year where he does not have  the cashflows to make SIPs for a few months. Worst his emergency fund may be calculated based on the false estimation of expenses. Under estimation of annual expenses would lead to the following:

• Under insurance, in case you have based your insurance amount on annual expense instead of annual income

• Lower emergency fund

• Negative cash flows, resulting in the need to liquidate investments or borrow

• Lower estimation of retirement corpus

• Incorrect asset allocation

• Above all else, a false feeling of saving more portion of your income and feeling comfortable about your finances and future

In the entire process of financial planning, there are lot of assumptions that go in related to your future income, inflation, return on various assets, future expenses, etc; however the only thing that can be accurately assessed are your current expenses and your networth.

Anybody looking to kick start the financial planning process, it is critical to have an accurate picture of your finances in order to avoid the pitfalls as discussed.