LITAS Formula – The Five Steps that Control Your Financial Life
Liquidity – Insurance – Target/Goal (financial) – Asset allocation/Portfolio of investments – Scenario planning & review
The LITAS formula
Liquidity: Set aside 6 months of your expenses into a Fixed Deposit with a bank. This is primarily to take care of the needs in case of sudden negative turn of events like loss of job, meeting with an accident, etc. This allows you to focus on the problem at hand (searching for a job, recovering from an accident, etc.) rather than worrying about where to get the money to spend the next day.
Insurance: Once you have your “Liquidity” needs addressed, the most important thing to focus on is getting yourself insured. The right level of insurance depends on the current expenditure levels of your family which is supported by you and their requirements which will come up over the next 5 years. This should be the primarily level of insurance any person should start with. One should only take PURE TERM INSURANCE, which will come very cheap at roughly less than 1/10th of a per cent or 0.1% of the annual cover you are looking at. Assuming you are looking at Rs.1cr insurance are under age of 30, you can get the cover for next 30 years, at a cost of less than Rs.9,000/- per annum. Consider cutting down on your monthly movie or dinner.
The next thing is to get Medical Cover for a relevant amount of say Rs.2 lakh, which will cost about Rs.5000/- per annum, a small measure for sudden medical emergencies.
Target/Goal Setting: Once the above two things are taken care off, a person should focus on meeting various other financial goals in life. Define each one of them carefully, putting a time in future when he would need chunks of money. For e.g. Money is need in chunks for the following events in life:
a) Marriage – Rs.10 lakhs – in 3 years
b) Buying a car – Rs.5 lakhs – in the next 4 years
c) Foreign education for your child – in the next 10 years – Rs.25 lakhs
d) Purchase of a house – Rs.1cr in the next 15 years
e) Retirement needs – Rs.5cr in the next 30 years, etc.
Once goal setting is done, the person can calculate backwards – how much he needs to save and how much he needs to earn on it over the required period of time. (Please refer to the Crorepati Principle) This goal setting also helps him understand whether his current level of saving is enough or not, and how he should optimise his expenses.
Asset allocation/Portfolio Creation: To achieve the goals set in point 3, the person needs to grow the money by investing in relevant investments like fixed deposits, mutual funds, equities, etc. A good balance of investments to create a portfolio based on return expectations along with the risk assessment needs to be carried out.
Scenario Planning/Reviewing: All the above 4 aspects as time passes are critical. Money needs keep changing based on income, age, dependents, health, job & career, etc. Also the underlying expectations of return on your investments can go wrong and must be corrected as early as possible to avoid failure of a financial plan. If you expect to earn 15% p.a. over the next 15 years, but your current portfolio is yielding less than 10% for the last 3 years, a review is a must as the long term plan just fails. You can either correct it by changing asset allocation or by increasing your savings, when you see the deviations. Keep a ready reckoner for reviewing your investments regularly at defined timelines – say every 1 or 2 years.
Always review in which stage you are in the LITAS formula. If it is followed in the same order as 1 to 5 steps, the ELEMENT OF CHANCE in your FINANCIAL LIFE will be dramatically reduced. Most people follow only some of the above steps and in random order and end up having no control over their financial lives.