ET Wealth | Stress test your financial plan | Economic Times

You create a financial plan to achieve goals in a systematic manner. But it can run into unexpected problems that prevent you from reaching your milestones. To ensure that your financial plan is not waylaid, simulate difficult scenarios and check if you are prepared to deal with these. Subject the plan to various stress points and check its readiness to get past them. Here are some variables that can impact your plan and what you can do to keep it on track.IncomeYour goal can be at risk if your income is slashed or ends for a certain period of time. This can happen due to the following reasons:a. Illness or disabilityb. Spouse stops workingc. Loss of jobStress testConsider two simulations, one where your income is slashed midway through the goal permanently, and two, where you lose it for a specific period of time. In the former case, you will have to recalculate the amount you can invest for a goal and may have to reduce your goal value or increase the time horizon to be able to reach the goal. Alternatively, you may have to fi nd a way to increase your income. In the second case, you will have to arrange sufficient funds to continue investing during the period of loss of income, or recalculate the increase in investment when you restart investing.How to minimise itBuy insurance: If you have sufficient health, life and accidental disability insurance plans, these will mitigate the impact of loss of income and you can continue investing without taking a break.Keep an emergency corpus: If the break is for a short or medium term, a contingency corpus will ensure the continuity of investment without impacting your goal.ExpensesIf your outgo suddenly increases, your investment towards the goals will drop, impacting your ability to reach them. This can be due to:a. Birth of a childb. Medical expensesc. Big-ticket purchase like house on loanStress testIn case of childbirth, you will not only have to simulate the cost incurred during hospitalisation, but also the increase in your monthly budget after the child arrives. For terminal or long-term illnesses, consider the monthly expenses on medicines, etc. For a house, include attendant expenses like registration, stamp duty, maintenance, etc, to know the exact amount you will have to spend.How to minimise itBuy insurance: Health insurance can help soften the blow to your expenses in case of hospitalisation by cutting down the out-of-pocket expenses and impacting your investments. Similarly, maternity benefits in an insurance plan can take care of your childbirth-related expenses.Plan child and big purchases: It is best to calculate the expenses incurred during childbirth or purchase of a house. Instead of randomly dipping into your savings or impacting your cash flow, plan ahead to save for these events.Debt-income ratioThe ratio of your total monthly debt to gross monthly income is the debt-income ratio and should ideally be less than 40%. Anything above this is likely to result in stress for your goals, while less than 20% is unlikely to affect your plan. Debt would include all types of loans like that for house or car, personal and credit card loans.Stress testIf your debt-income ratio increases to beyond 40%, calculate by how much your budget will be slashed and if you will be able to continue investing for your goals.How to minimise itPlan purchases: Save for your big-ticket purchases by converting these to short-term goals and making space for these in your monthly budget. Try not to take debt for each big purchase.Prioritise goals: If your budget is unable to accommodate saving for some goals, put them off for later or till your income increases.Repay debt at the earliest: Pay your credit card bills in full or the interest will eat into your income, further reducing your ability to save for goals.InflationA rise in the cost of household essentials, education and health care can increase the expenses significantly. If you do not subject your plan to this stress point, you could run short of the amount you collect for a goal.Stress testSimulate inflation figures not just for consumables, but also for education and health as these are rising at a fast pace of 10-12% and 15-20%, respectively. This means that when you undertake the simulation, calculate the amount you need for your child's higher education or a medical buffer for retirement, with and without factoring in inflation. The difference will tell you how far you are off the mark.How to minimise itCalculate goal value correctly: There’s little you can do to soften the blow of rising inflation other than taking an average inflation figure into consideration while calculating the long term goal values.Investment returnsYou may have started investing for a goal in various assets, but the returns and risks from these can alter over time, impacting the financial plan. While some risks are out of your control, say, global crises or macroeconomic factors, you can minimise some risks by diversifying portfolio and changing instruments over time.Stress testSimulate a market fall to know how you will react in case of short term volatility or the damage your savings will incur in a bearish market. Also, consider the possibility of your assets not giving optimum results. So check how much you will save with, say, 8% return, instead of the 12% you need.How to minimise itAvoid panic reaction: Do not sell at the first sign of market volatility. Continue to invest for the long term if you have goal-linked investments for over 12 years.Review periodically: For long-term equity investments, check if your funds or stocks have fallen for more than four quarters. Move to better performers to ensure optimum returns.Diversify portfolio: Keep a mix of equity and debt depending on the proximity to goal. Invest 70-80% in equity for goals over 12 years away. Shift to debt two years before your goal.