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\nIn this long write-up, I discuss an\u00a0\u00a0engineering (methodical) approach to personal finance. I introduce the concept as\u00a0growing wealthy using an engineering approach. I then describe the parts of the approach in some detail. A full presentation that follows this approach can be found\u00a0below.<\/p>\nThis article previously appeared as: https:\/\/freefincal.com\/growing-wealth-engineering-approach\/<\/p>\n
<\/h1>\nIntroduction<\/h1>\n
I use the title \u2018Growing Wealth \u2013 An Engineering Approach\u2019 to describe this approach. In simple terms, it is \u00a0my personalized approach to financial planning. I have had the opportunity to consult with many financial advisors. I have also read quite a few\u00a0articles and\u00a0books on investing and building financial wealth. \u00a0I am usually at ease with the terms used by financial planners and can understand them. \u00a0Yet, when I talk to others about financial planning, I\u00a0\u00a0yearn for something that I can relate to. (And yes, I do talk, invited or uninvited, with all and sundry when it comes to financial planning.)\u00a0As a software professional, it was natural for me to adapt\u00a0the principles that I use in my professional life. Hence the \u2018Engineering Approach\u2019.<\/p>\n
<\/div>\nBefore we talk about the approach, \u00a0note the use of the word Wealth here. In most situations, we use the words\u00a0\u2018rich\u2019 and \u2018wealthy\u2019 in the same way. \u00a0I use the word in a specific way. \u00a0Rich is having \u2018money\u2019 now; it may not last long.\u00a0Wealthy is having \u2018resources\u2019 to meet all your requirements and wants. Seen this way, the ultimate aim of any financial plan would be to become \u2018wealthy enough\u2019.<\/p>\n
Constituents of the approach<\/h1>\n
I work for a large company that has a large number of managers. For a few years, I used to teach a course called \u2018Project Management Fundamentals\u2019 to new and aspiring managers. Combining project management and engineering, I came up with the following\u00a0constituents of the approach:<\/p>\n
<\/div>\n\n- Clear objectives statement \u2013 Scope, Schedule, Resources<\/li>\n
- Requirements<\/li>\n
- Design that is consistent with assumptions and constraints<\/li>\n
- Clear approach to risk<\/li>\n
- Sensible implementation<\/li>\n
- Validation, Maintenance<\/li>\n<\/ul>\n
Let us look a bit more into each of them.<\/p>\n
<\/div>\n![\"growing-wealth\"](\"https:\/\/freefincal.com\/wp-content\/uploads\/2016\/09\/Growing-Wealth.jpg\" "\\"growing-wealth\\"")
<\/a><\/p>\nProject Objective Statement<\/h2>\n
Any\u00a0engineering project has a clear objective statement that clearly spells out these parameters:<\/p>\n
<\/div>\n\n- Scope \u2013 What we want to do<\/li>\n
- Schedule \u2013 When we want to finish it<\/li>\n
- Resources \u2013 What would we use<\/li>\n<\/ul>\n
Scope is the most important parameter in a financial plan. If we conceptualize this well, the goals write themselves. The way I see it, scope is the visualization of \u2018Being Wealthy\u2019 \u2013 the kind of life I like to lead. It includes all aspects \u2013 family size, lifestyle, support to children, legacy for children, etc.\u00a0One can want to live like the Ambanis, Warren Buffet, etc. Yet, it is more useful to look around our personal life and spot people who live happy and contended lives. \u00a0 Schedule is the amount of time that you want to work to achieve the scope. Resources is the means that you would use \u2013 for most people it would be their personal earnings.<\/p>\n
Requirements<\/h2>\n
This is just another word for \u2018financial goals\u2019. \u00a0It is quite easy to take the scope statement and to break it into many types of requirements:<\/p>\n
<\/div>\n\n- Life events \u00a0\u2013 Marriage, Kids education, Parents, Siblings, etc. \u00a0These events create requirements that we have to address, one way or another.<\/li>\n
- Quality of life \u2013 Kind of home, kind of vehicle, all the variable lifestyle aspects. These have a lot of variation. My personal take is that we often get misled by how wealthy people live. We look at them after they have become wealthy; but we fail to realize that they led simpler lives before that. And we often don\u2019t spot the difference between the rich and wealthy.<\/li>\n
- Dreams and desires \u2013 We should realize the importance of these. We can\u2019t limit our lives to just the discharge of responsibilities. We should have desires and dreams that are just that \u2013 with no constraint of necessity or need.<\/li>\n<\/ul>\n
Of course, the first and unsaid item in the list\u00a0\u00a0is post-retirement.<\/p>\n
If we write the requirements in a SMART way, they become financial goals. I give a few examples: a)\u00a03 lakhs by end of 2017 for trip to Bali \u00a0 b)\u00a010 lakhs by end of 2019 for downpayment for home \u00a0 c)\u00a0\u2018Enough\u2019 money to fund child\u2019s education in a private engineering college<\/p>\n
Assumptions and Constraints<\/h2>\n
In this approach, this is a catch-all for lots of variables. A good engineering plan would be mindful of the constraints. The constraints can be systemic and\/or personal. \u00a0Often the plan addresses them by making valid assumptions. In wealth creation, these would be:<\/p>\n
<\/div>\n\n- Money available every month, every year, to create the corpus for the goal<\/li>\n
- The inflation associated with the goal<\/li>\n
- The investment options suitable for the timeframe, and their returns<\/li>\n
- \u00a0The time to manage all this, and<\/li>\n
- The discipline<\/li>\n<\/ul>\n
In other words, these are the \u2018personal\u2019 part of personal finance!\u00a0If you spend some time thinking about these, you would have a much improved plan. But you don\u2019t need to spend too much time. Make as set of assumptions \u00a0and get started.\u00a0The financial plans have a long life. So,\u00a0you get enough time to test the assumptions that you have made and change them as required.<\/p>\n
Here is an example. Your goal may need an investment of 10,000 per month over 3 years. It is easy to reduce the investment amount by making an unreasonable assumption on the rate of return. But the testing would soon reveal the bad quality of the assumption. Another example. You could assume a good amount of discipline from you to make investments tied to the market. But if your testing reveals that you did not do any investments in a year, you have to change the assumption.<\/p>\n
Design<\/h2>\n
This is always the fun part. But this is also the part that needs skills and expertise. It is possible to do the design (and implementation) yourselves. The site freefincal.com has loads of material and calculators that you can choose for almost any design question that you would face. \u00a0You can also take the help of an advisor. Just ensure that they are indeed independent and don\u2019t have conflicts of interest.<\/p>\n
<\/div>\nIn the approach, design comes down to the following steps:<\/p>\n
\n- Take each requirement\/goal<\/li>\n
- Based on the time frame, choose an asset class\/avenue\n
\n- 1-3 years \u2013 Fixed income or debt instruments, few \u2018low risk\u2019 equities\n
\n- View this as \u2018savings\u2019, rather than \u2018investing\u2019; don\u2019t chase returns<\/li>\n<\/ul>\n<\/li>\n
- 5 years \u2013 More equity than debt<\/li>\n
- 10 years \u2013 Predominantly equity<\/li>\n
- Your mileage may vary!<\/li>\n<\/ul>\n<\/li>\n
- Estimate the expected return, and then calculate the monthly investment needed<\/li>\n
- The\u00a0 expected return would be a blended return based on the debt:equity mix that you choose<\/li>\n
- Be sure to factor in inflation for the requirements<\/li>\n<\/ul>\n
Yes, these are the same steps that any book or manual would list!<\/p>\n
<\/div>\nAddressing the risks \u2013 Insurance<\/h2>\n
Any real life plan would have to account\/plan for risks.\u00a0And it has to be an effective plan and focus on mitigation and contingency.\u00a0\u00a0For financial plans, the risk stems from the resource \u2013\u00a0which in this case is the individual who is building the wealth. A simple term plan will address the life risk. You can address other risks like health, temporary or permanent loss of income, etc. by appropriate insurances.<\/p>\n
![\"\"](\"https:\/\/srinivesh.in\/blog\/wp-content\/uploads\/sites\/4\/2018\/07\/Picture2.jpg\")
<\/p>\n
Implementation<\/h2>\n
A good piece of engineering spends more mindshare on design and less on implementation. Still, implementation is a crucial step. \u00a0In the approach, implementation is the actual act of making the investments. The following can be a list of steps:<\/p>\n
\n- Choose the right\u00a0asset class\/product family<\/li>\n
- Wherever possible, choose the type that saves tax \u2013 NSC instead of FD, ELSS instead of mutual fund, PPF instead of long-term debt, etc. etc.<\/li>\n
- For each asset class\/product family you have chosen, shortlist the \u201cbest-in-class\u201d products<\/li>\n
- Talk to the advisor, talk to the seller of the product, talk to previous buyers, and go buy it!\u00a0 Just choose 1 or more from your shortlist, and don\u2019t try to chase the \u2018best\u2019<\/li>\n
- It helps if the product can be tracked online<\/li>\n
- If the product requires periodic purchase (most would) set up an auto mechanism, or put it in your calendar<\/li>\n<\/ul>\n
In my view tax planning then becomes an implementation detail. It is not a main requirement, but just a by-product of implementation.<\/p>\n
<\/div>\nValidation<\/h2>\n
In any engineering, and definitely in electronics and software, the product is only as good as the testing. In financial plan, validation is another term for periodic reviews. During the review you need to compare the performance with expectations and market. You also need to test that your assumptions are holding true, and change them if they are not. And obviously, you need to make the necessary corrections in the implementation for the next period. This implement-validate cycle then repeats for the length of your wealth building timeframe. This part looks simple but has to be practiced with rigour.<\/p>\n
A lot of the usual questions that come up regularly can be addressed in validation. An example is the question of \u00a0pre-paying home loan vs investing additional amounts. This is just a case of testing your assumptions on compounded positive growth and compounded negative growth. For some years, you can go with the assumption that making extra payments towards your home loan is good. You can later change the assumption\u00a0based on additional factors that come up.<\/p>\n
And that is it. I created my financial plan before formalizing the approach. I find it much easier to describe financial planning to others when I use this approach. I have given informal and semi-formal presentations on this to audiences within my company. (They would primarily be software engineers.) There has been some positive feedback. I welcome your comments\/critiques on the approach.<\/p>\n
An area that I have not described is on the realization of the wealth \u2013 redemption. The typical approach is to shift the corpus to debt 2-3 years before the goal. The goal would then be met by redeeming the debt portfolio. I am more in favour of having a single portfolio for all goals. Of course if you have followed the methodical approach to creating wealth, you would have enough at hand to follow the redemption process that you are comfortable with.\u00a0 It finally comes down to this statement made by the monk-like person who runs the facebook group Asan Ideas For Wealth: \u00a0RIPFPI \u2013 Remember, It is your Personal Finance, so Personalize It!<\/p>\n
![\"\"](\"https:\/\/srinivesh.in\/blog\/wp-content\/uploads\/sites\/4\/2018\/07\/Picture3.jpg\")
<\/p>\n
Here is the slideset that describes the approach in detail<\/a>.<\/p>\n <\/p>\n
Thank you for the time to read this post. Please leave your comments.<\/p>\n","protected":false},"excerpt":{"rendered":"
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