How to Manage Big Future Expenses Successfully

By ketkih | September 16, 2015

How_To_Manage_Money_cashflow

Money management is always a challenge. When it comes to managing money for big cash flows, it gets even more challenging.

Big expenses include expenses for wedding, house construction and higher education expenses for children. While it may be easy to opt for a personal loan for big expenses, a more prudential way to plan finances would be to prepare for such big expenses before hand.

While managing big ticket cash flows needs planning and discipline in saving, it is not as complex as it is made out to be.  But there are 6 financial planning gaffes that you should avoid.

Here’s how Pratik handled his expenses:

Pratik, 30, is married and recently had a daughter. He estimates that his daughter will go to college in 19 years and will get married in 25 years. Although these dates are not accurate, Pratik wishes to plan for these big ticket expenses, keeping these broad timeframes in mind.

Pratik works on his plan keeping the following factors in mind:

Cost of higher education – Present value terms (Rs.) 15,00,000
Annual rate of inflation 7%
Corpus needed for higher education after 19 years  (Rs.) 54,24,791
Investments to be made in Equity mutual funds
Annual equity returns expected till goal date 12.00%
Monthly equity returns expected till goal date 0.95%
Monthly savings needed  (Rs.) 6,698
Cost of marriage – Present value terms  (Rs.) 15,00,000
Annual rate of inflation 7%
Corpus needed for marriage after 25 years  (Rs.) 81,41,149
Investments to be made in Equity mutual funds
Annual equity returns expected till goal date 12.00%
Monthly equity returns expected till goal date 0.95%
Monthly savings needed  (Rs.) 4,783

 

The above example assumes constant inflation of 7% per annum and equity returns of 12% per annum until the goal date. Although this may vary on a yearly basis, on an average, the long term rates could hover around these assumptions. It is seen that the corpus needed at the end of 19 years for higher education, and at the end of 25 years for marriage is quite substantial.

However, when this is broken down to calculate monthly savings, the amount Pratik needs to save per month is quite manageable.

If there is a windfall which can be used towards the goal, then the amount needed to be saved will fall further. Since the goals are long term in nature, it would be best for Pratik to plan for the corpus in the form of Systematic Investment Plans in diversified equity mutual funds.

As Pratik nears the goal date, he can withdraw his investments from the equity mutual funds and move them to a fixed deposit or any other short term debt instrument.

Additional read: Must have saving schemes for savers great and small

Tips to manage money for big cash flows 

  • Make goal based investments: Big ticket expenses are usually not unexpected and therefore, can be planned for in advance. Higher education costs or marriage costs for your children can be estimated with a fair degree of accuracy. For instance, suppose you need to accumulate funds for your child’s higher education in 17 years time and for the wedding in 22 years, estimate the amount needed in present cost terms. Apply an inflation factor for 17 years and 22 years respectively to arrive at the corpus needed. Then work backwards to estimate how much you need to save on a monthly basis. By planning to save well ahead in time, you can be comfortable in your financial planning.
  • Purchase adequate insurance: While expenses incurred for wedding or education can be planned for in advance, unexpected big ticket expenses cannot be planned for in advance. A sudden accident or hospitalization means huge cash outflows which can upset your financial planning. Having sufficient insurance is one way of taking care of big ticket unexpected expenses.
  • Use windfalls wisely: Another way of planning big cash flows is to make use of windfalls for such expenses. Annual bonus from your workplace, maturity of a huge investment or part of the corpus which you receive on retirement can be used for this purpose. However, make sure that this windfall was not planned for some other expense. Additional read: How to make best use of your festival bonus!
  • Shift investments prior to goal date: When big ticket cash flow goals are for the long term, investments are usually planned in equity based instruments as equity delivers the best returns over the long term. However, equity investments are risky. Therefore when you near the goal date, you must gradually withdraw your equity investments and move them to safer, more stable debt instruments. This can provide safety as well as stability to your funding plan.

Planning well in advance for a big ticket cash flow can be highly beneficial. As seen above, this will not only reduce the pressure to arrange for funds, but will also help in not disturbing your financial plan.

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