Financial Planning | Know the details of Investment Planning.

 Financial Planning                                      

Financial planning aims at ensuring that a household has adequate income or resources to meet current and future expenses and needs. The regular income for a household may come from sources such as profession, salary or business. The normal activities of a household and the routine expenses are woven around the regular income. However, there are other charges that may also have to be met out of the available income. The current income of the household must also provide for a time when there will be no or low income being generated, such as in the retirement period. There may be unexpected expenses which are not budgeted, such as a large medical expense, or there may be needs in the future that require a large sum of money, such as education of children or buying a home, all of which require adequate funds to be made available at the right time. A portion of the current income is therefore saved and applied to creating assets that will meet these requirements. Financial planning refers to the process of streamlining the income, expenses, assets and liabilities of the household to take care of both current and future need for funds.

Example :

Vinod is 40 years old and earns Rs.2 lakhs a month. He is able to save about Rs.40000 a month after meeting all the routine expenses of his family, paying the loans for his house, car and other needs. His investments include those for tax savings, bank deposits, bonds and some mutual funds. He pays premiums on life insurance for himself and his wife. Vinod is the sole earning member of his family and he believes he takes care of his finances adequately to take care of his current and future needs. How would financial planning help him?

The following are a set of indicative issues that financial planning will help Vinod resolve:

•  a  As the sole earning member has he made provisions for taking care of his expenses if his current income is interrupted for any reason?
•  b  Does he have adequate insurance cover which will take care of his family’s requirements in the event of his untimely demise?
•  c  What are his specific future expenses and how will he fund them?
•  d  If Vinod has to create a corpus to fund large expenses in the future, what is the size of the investment corpus he should build?
•  e  Given his current income and expenses is he saving enough to create the corpus required?
•  f  Will he have to cut back on his current expense or can he increase his current income so that his expenses in the present and the savings for the future are met?
•  g  What is the wealth Vinod has so far build from his savings and how can he best use it to meet his needs?
•  h  How should his saving be deployed? What kinds of investments are suitable for Vinod to build the required corpus?
•  i  How much of risk is Vinod willing and able to take with his investments? How would those risks be managed?
•  j  How should Vinod ensure that his savings and investments are aligned to changes in his income, expenses, future needs?

A formal treatment of the issues that Vinod’s faces will require a financial planning process to assess the current situation; identify the current and future needs; determine the savings required to meet those needs and put the savings to work so that the required funds are available to meet each need as planned.

Financial planning is thus a process that enables better management of the personal financial situation of a household. It works primarily through the identification of key goals and putting in place an action plan to realign the finances to meet those goals. It is a holistic approach that considers the existing financial position, evaluates the future needs, puts a process to fund the needs and reviews the progress.

 Need for Financial Advisory Services    

The primary task of the financial adviser is to link the large range of financial products and services to the specific needs and situations of the client. Not every product may be suitable to every client; nor would a client be able to identify how to choose and use products and services from a very large range. A financial advisor, who possesses the expertise to understand the dynamics of the products on the one hand and the needs of the client on the other, is best suited to enable using such products and services in the interest of the client.

The following are the primary reasons why financial advisers are needed:

• Personal financial management requires time and attention to recognize income and expense patterns, estimates of future goals, management of assets and liabilities, and review of the finances of the household. Many clients may not find time from their professional tasks to focus on these key issues.
• Estimating financial goals, finding suitable products and arriving at suitable allocations to various assets require specific expertise and skills which may not be available in most households.
• Selecting the right investment products, choosing the right service providers and managers, selecting insurance products, evaluating borrowing options and such other financial decisions may require extensive research. A professional adviser with capabilities to compare, evaluate and analyse various products enables making efficient choices from competing products.
• Asset allocation is a technical approach to managing money that requires evaluating asset classes and products for their risk and return features, aligning them to the investor’s financial goals, monitoring the current and expected performance of asset classes and modifying the weights to each asset in the investor’s portfolio periodically to reflect this. Advisers with technical expertise enable professional management of assets.
• Financial planning is a dynamic process that requires consistent attention to changing market and product performances, dynamic changes in the needs and status of the client and the ability to tune the process to these changes. It needs full-time professional attention and the efficiencies of a disciplined and systematic process. 

To choose a financial advisor is to engage a professional to devote time and provide expertise to a process-driven and result-oriented approach in managing personal finances.

 Scope of Financial Planning Services      

Financial advisors enable a household to manage its personal finances efficiently in line with their short and long-term objectives. The following are elements of financial advisory and planning services:

 a. Personal financial analysis : An adviser assesses the financial position of a household by bringing together its income, expenses, assets and liabilities. The sources of income, its stability and growth determine how a household may be able to finance its current expenses and future goals. For example, a sportsman’s income accrues over a short span of time, depending on his success in his chosen sport. The income has to be allocated to his current goals of excelling in his chosen sport, which may need significant investment, and the future goals of securing his living when his income from his sport falls or stops altogether.

Current income is apportioned to current expenses and to saving for the future. The decision to allocate between the two would determine if the household is able to secure its lifestyle, fund its aspirations, and live comfortably. If current income is saved, assets can be built with such savings, these assets generate income in the future when needed, or can be sold to fund a future goal. An employed individual contributing to his provident fund is setting aside a portion of his current salary to create a corpus that will be deployed to generate income after his retirement.

If current expenses are higher than the income, a household borrows and spends its future income today. Borrowings represent an easy option to fund a large scale current expense, such as buying a car or a house. The repayment of the borrowing over a period in the future reduces a part of the future income and apportions it to funding the asset that has been bought with a loan. This will also directly impact the cash flows in the household to meet other requirements. If a young earner invests too early in a residential property with a loan, he may be allocating a large proportion of his earnings to repaying the loan. This may leave him with lesser cash on a regular basis to meet any unexpected expense. The asset, in which he has invested, is a house, which cannot be liquidated in parts to meet sudden needs for funds. So a decision to acquire an asset with a loan, which looked like a compulsory saving in a good asset, may deteriorate into a poor financial decision that impacts his routine life.

A household has to evaluate what assets it needs when and how it can be funded and what the future implications will be on their financial situation. Personal financial analysis provides a holistic view of how these choices will impact the finances of a household. Financial advisers collect information about the household’s finances, and analyse them in various ways to draw various inferences about their financial position.

 b. Debt counselling : Financial advisers help households plan their liabilities efficiently. It is common for households to borrow in order to fund their homes, cars and durables. Several households also use credit cards extensively. To borrow is to use tomorrow’s income today. A portion of the future income has to be apportioned to repay the borrowings. This impacts the ability to save in future and in extreme cases can stress the ability to spend on essentials too. The asset being funded by borrowing may be an appreciating asset such as property, which is also capable of generating rental income. Or the loan could be funding a depreciating asset such as a car, which may require additional expenses on fuel and maintenance, but provide better lifestyle and

commuting conveniences.

Evaluating which assets or expenses can be funded by borrowings is a function advisers can perform. They can advice households about how to finance their assets, how much to borrow, how to provide for repayment, how to ensure that credit scores are not unfavourably impacted. Sometimes, excessive borrowings may lead a household into a debt trap. Such borrowers need counselling and handholding to be able to get out of debt. Sometimes assets may have to be liquidated to pay off debts. Advisers help households to deal with their borrowings taking into account their need and ability to repay debt.

 c. Insurance Planning : Several unexpected expenses that can cause an imbalance in the income and expenses of a household can be managed with insurance. Insurance is a risk transfer mechanism where a small premium payment can result in payments from the insurance company to tide over risks from unexpected events. The temporary loss of income from disabilities and permanent loss of income from death can be covered with life insurance products. Health and accident insurance covers help in dealing with unexpected events that can impair the income of a household, while increasing its expenses on health care and recuperation. General insurance can provide covers for loss and damage to property and other valuables from fire, theft and such events. Insurance planning involves estimating the losses to the household from unexpected events and choosing the right products and amounts to cover such losses.

 d. Investment Planning and Asset Allocation : A crucial component in financial planning and advisory is the funding of financial goals of a household. Investment planning involves estimating the ability of the household to save, and choosing the right assets in which such saving should be invested. Investment planning considers the purpose, or financial goals for which money is being put aside. These goals can be short-term such as buying a car, taking a holiday, buying a gift, or funding a family ceremony or can be long term such as education for the children, retirement for the income earners, or high expense goals such as marriage of children. An adviser helps with a plan to save for these goals, and suggests an appropriate asset allocation to pursue. The adviser does not focus on the selection of stocks or bonds, but instead takes a top down approach of asset allocation. The focus is on how much money is invested in which particular asset class in order to deliver the expected return within the risk preference of the investor. The adviser’s job is to construct a portfolio of asset classes, taking into account the goals, the savings, the required return, and the risk taking ability of the investor. This is one of the core functions of the adviser and many specialise in asset allocation and investment planning.

 e. Tax Planning : Income is subject to tax and the amount a household can save, the return they earn on their investment and therefore the corpus they are able to build for their future goals, are all impacted by the tax regime they fall under. A financial adviser should be able to assess the impact of taxes on the finances of the household and advice appropriate saving and investment options. The post-tax return of financial products will have to be considered while choosing products and estimating holding periods. The taxability of various heads of income such as dividends, rents and interest differ. The treatment of return if accumulated, rather than paid out periodically, varies. The taxability of gains differs based on the holding period. A financial adviser should bring in these aspects while constructing a plan for the household.

 f. Retirement Planning : Providing for retirement is one of the primary financial goals that all people have to plan for. Given its complexity and nature of well-being in the future, many people tend to ignore it until it may be too late thereby compromising the quality of their retirement. To be able to plan for retirement it is important to understand the concept of time value of money and inflation and how it would impact the cost of meeting expenses in the future. Saving and investing for retirement requires understanding of how compounding benefits investors saving for long-term goals. It is important to select the right financial products that are best suited to the long-term nature of the retirement goal as well as to the ability of the individual to take risks. In the pre-retirement stage, rebalancing the portfolio to less volatile assets is an important activity. As retirement approaches, the process of planning should shift focus to the expenses in retirement, the adequacy of the income from investments and pension benefits to meet these expenses and strategies to meet the shortfall, if any. While investing the retirement corpus for income, the taxability of different sources should be considered. The retirement portfolio has to be monitored and rebalanced through the term of retirement too since the needs do not remain the same. Financial advisers bring the skills required to design and execute a retirement plan.

 g. Estate Planning : Wealth is passed on across generations. This process of intergenerational transfer not only involves legal aspects with respect to entitlements under personal law, but also documentation and processes that will enable a smooth transition of wealth in a tax-efficient way. Estate planning refers to all those activities that are focussed on transfer of wealth to heirs, charity, and other identified beneficiaries. There are several tools and structures to choose from, in estate planning. Some choices such as gifts can be exercised during one’s lifetime, while choices such as wills come into play after death. Financial advisors help households make these choices after considering all the implications, and help them complete the legal and documentation processes efficiently.

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