Chapter 11

Helping Investors with Financial Planning

 Financial Needs and Financial Goals
• Financial Needs
– Financial needs occur at various stages in one’s life to meet ’life
goals’
– Financial needs can be classified as investment needs and
protection needs
• Wanting to protect a family’s income from any unforeseen risk is a
protection need. This is met by insurance
• Need for funds to meet the expense on the college education a child is
an investment need. This is met through saving and investment.

– Financial Goals
 Financial need can be described in terms of the amount of money
that may be required to fulfil the need and the time when the money
would be required
 Assessment of financial goals begins with the estimate of future
expenses for every milestone event
 Estimating Financial Goals
• Future value of goals can be estimated based on current cost, time to
goal and the expected rate of inflation
– The formula can be simplified as: [FV=current cost*{1+rate of inflation}^time]
– Use the FV function in MS Excel
– Example: It costs Rs.8 lakh to put a child through formal college education
today. If a family likes to estimate what this cost will be when their child, who
is now 6 years old, is ready for college education at 16 years of age?
• = 8 x (1.07)^ 10 = 15.7 lakh

• Calculating the target rate of return

– Investor has defined the amount to invest as well as the value of future goal
– Example: Suppose the investor indicates that an amount of Rs.5 lakh has been
saved already for this goal, and he likes to know what is the rate at which it
should be invested to meet the goal:
– ((Estimated future value/invested amount)^investment horizon ) – 1
• = ((15.7/5)^(1/10)) -1 = 12.12%
• Use the RATE function in MS Excel
 Estimating the Investment Amount
• Calculating the amount to be invested today
– Example: For an estimated expense of Rs.15.7 lakh after 10 years,
the investor chooses to invest in a diversified equity portfolio,
expected to earn an average return of 14% p.a. The amount to be
invested today can be computed as:
– Future value of goal/(1+expected return)^investment horizon
• =15.7/((1+14%)^10) = 4.23 lakh
– Use the PV function in MS Excel

• Estimating the amount of periodic investment

• Instead of investing Rs.15.7 lakh in a lumpsum, the investor may
choose SIP
• Use the PMT function in MS Excel
• The amount to be invested today in SIP:
• PMT(rate of return, number of periods, PV (blank), FV)
• = PMT(14/12, 10*12, , 15.7 lakh)=Rs.6060
 Financial Planning and its Objectives
• Financial Planning
– Reviewing the portfolio and revising the asset allocation, if required
– Define and implement the action plan for meeting financial goals
– Proposed asset allocation has to match the investor’s risk profile
– Creating an investment plan and asset allocation strategy to meet
financial goals
– Considers the overall situation of the investor

• Objectives of Financial Planning

– Creates a road map in terms what has to be done to achieve the goals
– Ensure that the financial goals of the investor are met by the right
combination of savings and investment
– The current and expected income and expenses and the ability to save
and invest is reviewed
– Forces them to see which goals are realistic and what may have to be
postponed, modified or even given up
 Need for Financial Planners
• Financial planners advise investors on managing their finances such that
goals are achieved.
– Identify the needs and financial situation of an investor
– Translate the needs into measurable financial goals
– Analyse risk profile of the investor
– Plan investments so that these goals can be achieved
– Suggest appropriate asset allocation
– Have a good understanding of investment options available and their
suitability
– Work with clients on their overall financial situation and not just one or
two aspects
– Reviewed periodically so that it continues to be relevant to the
investor’s needs and situation
 Steps in Financial Planning
• Establish the client relationship.
• Ascertain the clients’ needs and define with them, their
financial goals
• Gather data about the clients’ financial status. Analyse the
data to prepare a current financial position statement.
• Understand how much of loss clients can withstand and for
what period
– Adjust choice of products to their risk preferences
• Understand and explain the tax situation to the clients.
– Try to optimise post-tax return on investments.
• Suggest allocation to asset classes and specific schemes
• Execute the plan by making the specified investments
• Review and suggest changes in asset allocation
 Life Cycle Approach in Financial Planning - 1

• Younger investors do not seek income from investments, can take a long-
term view and are willing to take risks.

• Older investors may be unwilling to take risks, given their limited

investing horizon and dependence on investment income.

• Childhood Stage
– Dependence on parents to meet expenses
– Gifts received may be invested for the future
• Young Adult Stage
– start of the earning phase
– Investing in equity must begin in this stage preferably
through Equity SIPs
– Life insurance may be necessary to protect income from
disability or illness
– Individual is partially dependent.

• Young married stage

– Need to provide for emergencies and protect income from
death, injuries or loss is high
– Couple has joint responsibility to create and adhere to
budgets and to control expenses
– Need for term insurance is high
Life Cycle Approach in Financial Planning-2

• Married with Children Stage

– Higher expenses and less money is available for
investment
– Health and life insurance is important as protection
needs are more important than investment needs at
this stage
– Saving for children’s education.

• Married with Older Children Stage

– Higher ability to save and invest because income levels
are higher
• Pre-retirement Stage
– Start setting aside increased amounts to protect their
life style, post-retirement
– Pension products and health insurance are preferred
choices for investors.

• Retirement Stage
– Investors have to pre-dominantly live off their
investments
– Require at least 2/3rd of their last income
– Focus on income generation and protect wealth from
 Wealth Cycle Approach to Financial Planning

• Accumulation Phase
– Accumulate and save for the long-term
– Choose growth-oriented investments
– Have a long-term investing horizon and can allocate savings to equity
• e.g. saving for child’s education.
• Transition Phase
 Withdrawal of funds for some financial goals while accumulating
for retirement
 Middle-aged investors
 Have both equity and debt in their portfolio, as they have a
medium-term horizon
e.g. withdraw from savings to meet the immediate education expenses
of a child while at the same time saving for retirement
• Distribution Phase
 Reaping stage
 Depend on investment income
 Retired investors
 Income-oriented, preferring debt to equity
 Inter-generational Wealth Transfer and
Sudden Wealth Surge
• Inter-generational Wealth Transfer
– Stage at which clients plan to pass on their wealth
to the next generation or to organisations and
trusts
– Focus on the goals of the beneficiaries
• e.g. if the wealth is being transferred to grown-up
children, the assets could be invested in a balanced
combination of equity and debt funds
• If the recipients are young, the wealth could be invested
in long-term growth funds
– Advice on creating trusts and wills and planning
for their estate
• Sudden Wealth Surge
– Investor experiences a sudden surge in wealth
from unexpected flow of funds
• e.g. lottery, sudden appreciation in shares, inheritance
of wealth
– Evaluate tax implications
– Funds should be invested in low-risk products like a
liquid fund till such time a proper financial plan is
drawn
– Money received unexpectedly should be invested
based on financial goals and risk preference
 Financial Planning for Wealthy Investors
• High net-worth investors
– Have adequate wealth to take care of typical financial goals such as education, house
etc
– Do not need goal based financial planning but need planning to manage their wealth

• Wealth-creating investors
– Willing to take risks, investing in equity and risky assets
– Comfort of accumulated wealth
– Any short-term loss will not seriously impair their financial position

• Wealth-preserving investors
– Wealthy investors may not always be risk-taking equity investors
– Cautious about the wealth they have accumulated and focus on preserving its
value
– Choose conservative investments, such debt and government securities
– Focus on regular income from accumulated wealth