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“Know what you own, and know why you own it.”-Peter Lynch
Why Financial Planning?
It is rightly said in the above quote that we can’t make money by letting it
remain idle or in savings accounts; financial planning and management of the
resources in the most efficient way is what one should do. Financial planning
is a process that uses your financial resource to achieve your financial goals.
In short, it helps you plan the use of your money to meet your needs and
retain something for a rainy day.
Who needs financial planning?
There is no yardstick to decide as to who needs to plan their finances.
It applies to everyone who uses money to survive in this world; the difference
lies only in their scale and level of income, investments and expenses.
Does everyone plan their finances?
Not really, because they hardly know what it means to plan their finances
and, therefore, always have reasons to postpone it. People who have done
financial planning have not just been fair with their money, but have also
generated wealth for themselves and their generations.
Steps in Financial Planning
While Financial Planning is a process of planning your finances, there are
certain things you need to know before you could proceed with the planning
phase. The factors to consider before financial planning have 4 steps. A fair
understanding of these four steps is sure to make the financial planning
process more meaningful:-
Knowing Your Financial Goals
Financial goals of an individual define what he or she would like to achieve in
terms of money over a period of time. Some examples of financial goals are:
● buying a residential property worth 5 crores in July 2016
● Saving Rs. 2 crores for daughter’s marriage expenses in 2030
● Purchasing a resort worth Rs. 10 crores in Rajasthan
● Planning for a retirement income of Rs. 8 lakhs per month starting
2030
● Repaying Housing loan worth Rs. 1 crore in 5 years starting from 2016
● Purchasing Gold worth 50 lakhs in 3 years’ time
These goals can be divided into Short Term, Medium Term and Long Term
Knowing Your Financial Position
Cash Flow Statement
A statement that gives details about how much money you received, how
much you spend and how much you save is called the Cash Flow Statement.
A cash flow statement consists of details pertaining to cash received and
cash paid during the year irrespective of the year to which it belongs. All
payments made by way of cash or through bank are considered and
payments made from all bank accounts are considered. The payments could
be for expenses, repayment, investment and loan everything is considered.
The balancing figure is generally allocated among bank balances and cash in
hand.
This statement is a basic document to be prepared by the individuals/entities
for knowing the liquid position and for preparing detailed analytical report of
inflows and outflows of money. It does not consider the non cash expenses.
Investment Avenues and Investor Awareness
Statement on Networth
A Statement on Net worth provides a quick looks at your financial situation at
a given point of time. It gives details about your assets, liabilities, and the
difference between the two is your net worth. In short it tells you how much
money you will be left with had you paid of all your liabilities with the help of
money from your assets (cash generated by way of interest or by sale of the
asset).
Example:
| A | Assets | Amount |
| Liquid Assets Rs. | ||
| Savings Account | 20,00,000 | |
| Fixed Deposit with Bank | 60,00,000 | |
| Liquid Fund | – | |
| Cash | 5,00,000 | |
| Invested Assets | ||
| Stocks | 1,00,000 | |
| Mutual Funds | 2,00,000 | |
| Bonds | 1,00,000 | |
| PPF | 5,00,000 | |
| Gold | 13,00,000 | |
| Real Estate – Land | 50,00,000 | |
| Other Assets | ||
| House | 2,50,00,000 | |
| Car | 8,50,000 | |
| Total Assets (A) 4,15,50,000 | 4,15,50,000 | |
| B | Liabilities | |
| Home Loan | 80,00,000 | |
| Car Loan | 3,00,000 | |
| Total Liabilities (B) 83,00,000 | 83,00,000 | |
| Total Networth (A-B) 3,32,50,000 | 3,32,50,000 |
Investment Planning
Investment Planning and calculations involve preparing a schedule for saving
target one wishes to reach keeping their long term goals in mind.
While preparing these figures one has to have in mind the Time value of
money concept, for we all know that a rupee earned today is far more
valuable than a rupee earned tomorrow. Also it will be of interest to the
reader to know the magic Compounding Interest can create.
Compounding Effect
People with very limited income have been able to save around 3 to 4 crores
by investing in equities over a period of two to three decades amounts in the
range of 10, 50 and 500.
The idea behind preparing a Cash Flow Statement or a Net worth Statement
is for the investor or the individual to understand his position and what
exactly he does with money he earns or receives. Where an individual has
savings in lakhs of rupees earning an interest of about 6 %, it will be
worthwhile to pay off his loans taken at the rate of 16% from the savings
held, instead of retaining the savings and repaying the loan with interest.
When should one opt for Financial Planning?
The moment one begins earning money or has property to manage, one
should opt for Financial Planning.
Planning your Finances
● Financial Planning is a must
● Know where you stand – Net Worth (Assets – Liabilities), Personal
Budget
● Make your financial goals clear – Goals and Objectives – Major
Purchase, Children’s Education, Retirement, Marriage, Vacation
● Know how to reach your targets and timelines
● Implement your financial plan
● Reap the benefits
What is the Role of a Professional Financial Planner?
The role of a professional Financial Planner is most important because most
of the investors are not as financially educated as one is required to be to
manage investments, risks etc. A reliable professional offers advice that best
suits your financial status and financial needs. Well, in order to ensure that
such professionals are carefully chosen and well regulated, investment
advisors or professional financial planners are regulated with the help of The
(Investment Advisors) Regulation 2013.
Components/Elements of Financial Planning
Income Planning
An individual’s income planning strategy defines his sources of income and
how he plans to meet his short and long term goals.
Sources of Income
● Salary
● Business Income
● Self-Employment
● Investment Income
While the first three sources of income invariably require personal
participation of the individual, investment income does not require his
personal participation but still generates income. Therefore, while dealing
with the sources of income, it is important to have both active and passive
income sources that help the individual in those difficult times when personal
participation becomes difficult.
Income Tax Planning
“The Hardest thing to understand in the world is income tax”- Albert
Einstein
Though it is not the case in general, still there is a lot which is required to be
understood and planned. Tax planning is must do for People falling in the
high income category because they end up paying close to 30% of their
earnings in the form of taxes. Hence investments offering tax benefits should
be the preferred option. Knowledge on simple tax saving investments can
help in planning for their taxes.
Chapter VIA & Other Deductions under the Income Tax Act, 1961
Insurance and Health Planning
“Fun is like insurance; the older you get, the more it costs.” – Frank
McKinney
Insurance Planning is concerned with ensuring adequate coverage against
insurable risks. Calculating the right level of risk cover is a specialized
activity, requiring considerable expertise. Proper Insurance Planning can
help you look at the possibility of getting a wider coverage for the same
amount of premium or the same level of coverage for the same amount of
premium or the same level of coverage for a reduced premium. Hence the
need for proper insurance planning.
Insurance Planning takes into account the risks that surround you and then
provides an adequate coverage against those risks. There is no risk not
worth insuring yourself against. Be it life or non-life. And insurance should
first and foremost be looked as a measure to guard against all risks. Now,
Insurance need differs from person to person, too. It depends on your age,
profile, requirements, level of risks, your income etc. So insurance planning
takes into account all the factors before chalking out a plan customized for
you and gives you the most suitable option.
Life Insurance Planning
Your Life Insurance Needs
Calculating life insurance needs is not a simple exercise. You must evaluate
your current and required cover in 2012 and take corrective action.
Remember that each of us has their own lifestyle, goals, aspirations and
dependents that may be completely different from the life situation for your
friend or colleague. So what works for someone else may not work for you.
There are essentially three ways to calculate your insurance needs:
(a) Expense protection: Calculates the corpus required to take care of
the family’s future expenses and goals. Inflation diminishes the value of
money and hence expenses need to be adjusted to inflation for calculation of
protection required.
(b) Human life value: It is the economic value of an individual- the
present value of all his or her future income. Setting aside the part of income
one spends on oneself, the protection required through human life value
calculates today’s value of one’s income for the years till his or her
retirement.
(c) Needs analysis: In this method you calculate your needs by
considering each of your dependents and what financial milestones you want
to achieve for them. The needs may range from child education, marriage to
repayment of loans. Next you assess your current assets and investments
and shortfall due to possible loss of life. This gap in income can be filled up
by insurance.
Ideally, insurance must be taken to cover the working period in one’s life.
You take insurance to protect your dependents from the loss of your income;
using the same logic, you take insurance for the time that the dependents are
being supported by your income. Hence, it is advisable to take insurance till
one’s retirement. However, when insurance is taken for protecting and saving
towards specific goals, then the tenure of the plan should match the years
left for meeting the goal.
Choosing a product will depend on the specific need and the life stage one is
in. What is the final product you will choose? When there are multiple
choices that match the need, it is the affordability that makes the final choice.
Most importantly, individuals must be aware of the purpose of the insurance
they are buying. They must know that life insurance products for investment
and savings are structured for the long term and meant for someone who is
earning and whose earnings are supporting his/her dependant(s).
In a nutshell:
● Insurance Planning is the first step to cover against risk.
● Opting for adequate life insurance cover is essential. It is very
important that you are adequately covered as inadequate cover is
equal to no cover at all.
● Insurance requirement to be reviewed once in every 2 years
● Insurance secures our
● Future
● Finances
● Loved Ones
● Insurance planning is the first step towards financial planning and
financial planning should be the first step towards purchasing
insurance. To advise an individual on his or her insurance needs, it is
important to get a holistic view of the present and the future.
● Insurance requirement must be reviewed every two years or when
there is a change in the family scenario, for example, the addition of
dependants.
● The insurance requirement changes with every change in your life —
income, expenses, life style, members, liabilities and assets.
Types of Life Insurance Policies
There are a variety of policies available in the market, ranging from Term
Endowment and Whole Life Insurance, to Money Back Policies, ULIPs, and
Pension plans. Let’s see what each of these is about, so that you can
consider the one that best suits you.
● Term insurance policy
● Whole Life Policy
● Endowment Policy
● Money Back Policy
● Annuities and Pension
● Unit linked Insurance Plan (ULIP)
● Riders: Comprehensive coverage
Investment and Wealth Planning
“How many millionaires do you know who have become wealthy by
investing in saving accounts? I rest my case”.-Robert G. Allen
Investment planning/management, also known as portfolio managemernt, is
not a simple activity as it involves many complex steps which is explained as
below
Investment objectives & constraints
The main objectives to be taken into consideration by investors are capital
appreciation, current income and safety of principal. The relative importance
of each of these objectives needs to be determined. The main aspect that
affects the objectives is risk. Some investors are risk takers while others try
to reduce risk to the minimum level possible. Identification of constraints
arising out of liquidity, time horizon, tax and special situations need to be
addressed.
The Asset Mix
An important decision with respect to the asset mix decision has to do with
the proportion of equity shares or shares of equity oriented mutual funds i.e.
stocks and proportion of bonds in the portfolio. The combination on the
number of stocks and bonds depends upon the risk tolerance of the investor.
This step also involves which classes of asset investments will be places and
also determines which securities should be purchased in a particular class.
The Portfolio Strategy
There are two types of portfolio strategies. The first is an active portfolio
strategy which aims to earn greater risk adjusted returns depending on the
market timing, sector rotation, security selection or a mix of these. The
second strategy is the passive strategy which involves holding a well
diversified portfolio and also maintaining a pre-decided level risk.
Securities
Investors usually select stocks after a careful fundamental and technical
analysis of the security they are interested in purchasing. In case of bonds
credit ratings, liquidity, tax shelter, term of maturity and yield to maturity are
factors that are considered.
Implementing Portfolio
This step involves implementing the formulated portfolio strategy by buying
or selling certain securities in specified amounts. This step is the one which
actually affects investment results.
Portfolio Revision
Fluctuation in the prices of stocks and bonds lead to changes in the value of
the portfolio and this calls for a rebalancing of the portfolio from time to time.
This principally involves shifting from bonds to stocks or vice-versa. Sector
rotation and security changes may also be needed.
Performance Evaluation
The assessment of the performance of the portfolio should be done from time
to time. It helps the investor to realize if the portfolio return is in proportion
with its risk exposure. Along with this it is also necessary to have a
benchmark for comparison with other portfolios that have a similar risk
exposure.
Investing Is Not Gambling
An investor should constantly behave like investor, not a speculator.
Investing is NOT gambling. Gambling is putting money at risk by betting on
an uncertain outcome with the hope that you might win money. Part of the
confusion between investing and gambling, however, may come from the
way some people use investment vehicles.
Ideal Investment strategy
Even though all investors are trying to make money, they all come from
diverse backgrounds and have different needs. It follows that specific
Investing vehicles and methods are suitable for certain types of investors.
Although there are many factors that determine which path is optimal for an
investor, we’ll look at three main categories:
(a) Investment objectives,
(b) Timeframe, and
(c) Investing personality
(a) Investment Objectives
Generally speaking, investors have a few primary objectives:
● safety of capital
● current income and
● capital appreciation
These objectives depend on a person’s age, stage/position in life, ,personal
circumstances and income level of the person. A 75-year-old widow living off
her retirement portfolio is far more interested in preserving the value of
investments than a 30-year-old business executive would be. Because the
widow needs income from her investments to survive, she cannot risk losing
her investment. The young executive, on the other hand, has time on his or
her side. The objective and investment pattern of investor from high income
group will be totally different from others. As investment income isn’t
currently paying the bills, the executive can afford to be more aggressive in
his or her investing strategies.
(b) Timeframe
As a general rule, the shorter your time horizon, the more conservative you
should be. For instance, if you are investing primarily for retirement and you
are still in your 20s, you still have plenty of time to make up for any losses
you might incur along the way. At the same time, if you start when you are
young, you don’t have to put huge chunks of your paycheck away every
month because you have the power of compounding on your side.
On the other hand, if you are about to retire, it is very important that you
either safeguard or increase the money you have accumulated. Because you
will soon be accessing your investments, you don’t want to expose all of your
money to volatility you don’t want to risk losing your investment money in a
market slump right before you need to start accessing your assets.
(c) What is your personal characteristic?
The personality trait that will determine your investing path is your desire to
research investments. Thus, in addition to risk taking ability, some personal
characteristics like, a cool temper, balanced outlook and data based
decisions determine the success of an investment.
Forbidden/Unsafe Investments
The following categories of investment are totally forbidden for all categories
of investors (will be discussed in detail in topic all about investor awareness):
● Chit funds, Nidhi’s, Ponzi Schemes, Mutual Benefit societies
● Phoney real estate schemes and plantation schemes.
● Deposits with partnership firms, private limited companies and other
companies who do not enjoy good credit rating.
● Speculative stocks and private placements of equity shares in
companies promoted by unknown –entrepreneurs.
● Volatile scrips which fluctuate rather dangerously.
● Peerless-type savings schemes which use insurance jargon simply to
confuse you.
● New issues of shares by first generation unknown-entrepreneurs.
Some guidelines towards a strong financial future:
The following are important steps towards ensuring a strong financial future:
● Define your goals
● Estimate your current financial position
● Choose the investments according to your life stage
● Diversify your investment to reduce risk
● Do a lot of market research
● Budget for your investment
● Reduce the number of records. Instead of having too many unwanted
bank accounts, demat accounts and unwanted investments, close the
unnecessary ones. Keep one bank account in a branch nearby and
preferably in Joint names.
● Have a cross power of attorney between spouses. This is valid during
one’s lifetime.
● Make nominations in (a)Company’s PF and your PPF accounts (b) LIC
policies and personal accident policies (c) Gratuity (d) Superannuation
schemes (e) Ownership flat (f) bank accounts etc.
● Acquaint your spouse and family members with your financial
arrangements, your advisors and consultants, and familiarise them
with your files and documents.
Risks v/s Rewards
“Never test the depth of the river with both the feet”.-Warren Buffet
You should never invest in anything about which you don’t have knowledge
because it will be considered as foolishness, not that you took a risk for
possible return. Risk is a real life fact for any investor. Stock markets may go
down, companies may go bankrupt, inflation rates may soar or the
government may not have enough funds to pay back. Therefore before
making any investment you have to ask the question “What is the risk
involved?”
One should remember that every investment has risk attached to it. Only the
degree of risk is different. One should analyze the risks to evaluate the
returns that can be expected from an investment.
The key to investment success is ideal diversification of assets.
Diversification means more than just having different types of investments. It
means having a right mix of investments across sectors, time horizons,
markets, instruments and so on. A good portfolio will have stocks, bonds,
mutual funds, money market funds etc. of different companies from different
sectors. When you diversify, you spread your money among many different
securities, thereby avoiding the risk that your portfolio will be badly affected
because a single security or a particular market sector turns sour.
Portfolio and Diversification
A portfolio is a combination of different investment assets mixed and
matched for the purpose of achieving an investor’s goal(s). Items that are
considered a part of your portfolio can include any asset you own–from real
items such as art and real estate, to equities, fixed-income instruments, and
cash and equivalents. For the purpose of this section, we will focus on the
most liquid asset types: equities, fixed-income securities, and cash and
equivalents.
Basic Types of Portfolios:
● Aggressive investment strategies
● Conservative investment strategies
Summary of Investment and Wealth Planning gives the following advantages:
1. Defining return objective
2. Understanding risk tolerance
3. Investment constraints
4. Guidelines to construct a portfolio
5. Basis for portfolio monitoring and review
6. Better control over financial decisions
7. Allows perpetuity and solves disputes between client and advisor.
Retirement Planning
Retirement planning involves planning for the following:
● Allocation of finances for Retirement
● No Government sponsored retirement plan
● Nuclear Families
During the Life Time
Trust
Power of Attorney
Gift
Partition
● Unforeseen Medical expenses
● Estate Planning & systematic investments every month
Steps to be followed in Retirement Planning
● Decide of age for retirement
● Annual income need for retirement years
● Current market value of all the savings and investments
● Determine a realistic annualized rate of return
● Consider company pension plan, if any
Now compute the value required on retirement
Retirement Investment Options
● Public Provident Fund (PPF)
● National Savings Certificate (NSC)
● Employees Provident Fund (EPF)
● Mutual Fund Products
● Insurance Products
● New Pension Schemes
● Reverse Mortgage
Estate Planning
The sum of all the assets of a person, less his liabilities becomes his
ESTATE. For examples all properties, bank accounts investments,
insurances and collectibles, less the liabilities of a person are collectively
called a person’s estate. Estate planning is about
● Accumulating and Disposing of an estate to maximize the goals of the
estate owner.
● Distribute wealth to a certain beneficiary or beneficiaries to
whomsoever the owner wishes.
● Important to take the help of an attorney experienced in estate law
Objectives of Estate Planning
● Asset transfer to beneficiaries
● Tax- effective transfer
● Planning in case of disabilities
● Time of distribution can be pre-decided
● Business succession
● Selection of Trustee or guardian or the exe
Terminologies in Estate Planning
● Will – A document that conveys your wishes about your estate and
helps in following it after your death
● Testator – A person who makes his will
● Executor – A person who executes the will after the death of the
testator
● Legatee/Beneficiary – A person who inherits the estate under a will.
● Inestate – A person who dies without making a valid last will is said to
die inestate
● Probate – A legal process of settling the estate of a deceased person
● Trust – It is a relationship in which a person called the trust transfers
something of value, movable or immovable to another person called a
trustee. The Trustee then manages and controls these assets for the
benefit of a third person called a beneficiary.
● Power of Attorney – A authorization to act on someone else behalf in
a legal or business matter.
Steps and Tools in Estate Planning
Steps
● Listing of assets and liabilities
● Open family discussion on selecting the guardian
● Update the current beneficiaries like life insurance
● Decide upon the distribution of the assets on death
● Funeral arrangements with spouse and family
● Assistance of an estate planning authority
Tools
● Life Insurance
● Will
● Trust
There are various tools that a financial planner can adopt for getting an
estate plan in place. Some tools are effective during the lifetime of an
individual while some after his/her death.
The following figure shows the tools used for estate planning by transferring
the assets to the beneficiary, with or without restrictions, during the lifetime of
an individual.
The following figure shows the tools used for estate planning where the
transfer of assets to the beneficiary becomes effective after the death of an
individual.
Tips in Estate Planning
Following are some points one must check in the “Will”, otherwise it will
create chaos and problems afterwards or it may defeat the very purpose of
the “Will”.
(a) It must be signed by two (2) witnesses who are of the age of majority
and should not be the beneficiaries under that “Will”.
(b) When you appoint a person as an Executor to the “Will”, before
appointment take his consent. Appoint more than one Executor and
handover to each Executor one sealed copy of the “Will”. In case you
wish to have a Registered “Will”, then inform it to the Executor where
you have registered your “Will”.
(c) Prepare the list of all Assets and Liabilities and mention them in the
“Will”. In addition to this, always have a residual clause in the “Will”.
(d) Even though it is not compulsory, it is advisable to have the “Will”
neatly typed and drafted beyond ambiguity.
(e) It must be revised every three (3) years, because in that span of the
period, many changes might take place, for example, assets may
increase/decrease, or beneficiaries may increase or decrease.
(f) Whenever you want to change your “Will”, you can do so by making a
codicil, but it is better if you make a fresh “Will”.
Don’t give the “Will” to the beneficiaries to read because their attitude
towards you may change. Let it be suspense for the beneficiaries.
(g) It is advisable to make “will” for self and spouse separately.
(h) A “Will” may be registered with the Sub-Registrar of ssurances office.
Although it is not necessary to register a “Will”, it adds protection, validity and
secrecy to the “Will”.
The tax Impact
● Transfer of assets under a “Will” isn’t considered a transfer and hence
is a tax-neutral transaction.
● However, when the beneficiaries sell the inherited assets, it will attract
tax based on his taxable income and the classification of the assets as
a business/capital asset.
● Until such time as the assets are transferred to the beneficiaries, the
income from such assets will be assessed in the hands of the executor
as representative taxpayer.
● Through “Will”, trust of new HUF can be created which are separate
taxable entities.
How does Financial Planning help?
● The first benefit will be that you will set realistic financial and personal
goals
● It helps you assess your current financial status by examining your
assets, liabilities, income, insurance, taxes, investments and estate
plan
● You will develop a realistic, comprehensive plan to meet your financial
goals by addressing financial weaknesses and building on financial
strengths
● You will realize the benefits only when you put your plan into action
and monitor its progress
● You will stay on track and be sufficiently informed to meet the
changing goals, personal circumstances, stages of life, products,
markets, and laws