Financial Planning
Concept:
Everyone has needs and aspirations. Most needs and aspirations call for a
financial commitment. Providing for this commitment becomes a financial goal.
Fulfilling the financial goal sets people on the path towards realizing their
needs and aspirations. People experience happiness, when their needs and
aspirations are realized within an identified time frame. For example, a father
wants his son, who has just passed his 10th standard Board examinations, to
become a doctor. This is an aspiration. In order to realize this, formal
education expenses, coaching class expenses, hostel expenses and various other
expenses need to be incurred over a number of years. Then estimated financial
commitments towards these expenses become financial goals. These financial goals
need to be met, so that the son can become a doctor. Financial planning is a
planned and systematic approach to provide for the financial goals that will
help people realise their needs and aspirations, and be happy.
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Investment Horizon:
The year-wise financial goals statement throws up the investment horizon. It
would be risky to expect the first three years expenses to be met out of equity
investments being made today. But equity is a viable investment option for
expenses starting from Year 4. In most cases, the investor would have some
regular income out of which part of the expenses can be met. So the investments
being considered now need to fund only the balance of the financial goals.
Back to top Objectives and Benefits:
The objective of financial planning is to ensure that the right amount of money is available at the right time to meet the various financial goals of the investor. This would help the investor realize his aspirations and experience happiness. An objective of financial planning is also to let the investor know in advance, if some financial goal is not likely to be fulfilled.
Thanks to advance information available through financial planning, timely corrective actions can be taken, such as:
• Reviewing what is a “need” and what is a “desire” that can be postponed for the more desirable objective of realizing the aspiration.
• Moving to a smaller house, or a house in a less expensive locality, to release more capital.
• Improving the future annual savings by economizing on expense, or taking up an extra part-time job, or influencing the spouse to take up employment for some time.
The financial planner may also suggest a loan to meet the heavy expenses.
Financial planning thus helps investors realize their aspirations and feel happy. It also helps the financial planner, because the process of financial planning helps in understanding the investor better, and cementing the relationship with the investor’s family. This becomes the basis for a long term relationship between the investor and the financial planner.
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Need for Financial Planners:
Most investors are either not organized, or lack the ability to make the calculations described above. A financial planner’s service is therefore invaluable in helping people realize their needs and aspirations.
Even if the investor knows the calculations, the knowledge of how and where to invest may be lacking. The financial planner thus steps in to help the investor select appropriate financial products and invest in them.
Transactions such as purchase of house or car, or even education, necessitate a borrowing. The financial planner can help the investor decide on the optimal source of borrowing and structure the loan arrangement with the lender.
Taxation is another area that most investors are unclear about. Financial planners who are comfortable with the tax laws can therefore help the investor with tax planning, so as to optimize the tax outflows.
Financial planners can also help investors in planning for contingencies. This could be through advice on insurance products, inheritance issues etc.
The financial planner thus is in a position to advise investors on all the financial aspects of their life.
Back to top Alternate Financial Planning Approaches:
The financial plan detailed above is a “goal-oriented financial plan” – a financial plan for a specific goal related to the particular aspiration.
An alternate approach is a “comprehensive financial plan” where all the financial goals of a person are taken together, and the investment strategies worked out on that basis. The steps in creating a comprehensive financial plan, as proposed by the Certified Financial Planner – Board of Standards (USA) are as follows:
• Establish and Define the Client-Planner Relationship
• Gather Client Data, Define Client Goals
• Analyse and Evaluate Client’s Financial Status
• Develop and Present Financial Planning Recommendations and / or Options
• Implement the Financial Planning Recommendations
• Monitor the Financial Planning Recommendations
The comprehensive financial plan captures the estimated inflows from various sources, and estimated outflows for various financial goals, including post-retirement living expenses. The plan can go several decades into the future.
A comprehensive financial plan calls for significantly more time commitment on the part of both the investor and the financial planner. However, the time commitment needs to be viewed as an investment in a long term relationship.
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Life Cycle and Wealth Cycle in Financial Planning:
While working on a comprehensive financial plan, it is useful to have a perspective on the Life Cycle and Wealth Cycle of the investor.
Life Cycle
These are the normal stages that people go through, viz.:
Childhood
During this stage, focus is on education in most cases. Children are dependents, rather than earning members. Pocket money, cash gifts and scholarships are potential sources of income during this phase. Parents and seniors need to groom children to imbibe the virtues of savings, balance and prudence. Values imbibed during this phase set the foundation of their life in future.
Young Unmarried
The earning years start here. A few get on to high-paying salaries early in their career. Others toil their way upwards. Either way, the person needs to get into the habit of saving. The fortunate few who start off well have to avoid falling into the trap of unsustainable life styles.
Equity SIPs and Whole-life insurance plans are great ways to force the young unmarried into the habit of regular savings, rather than lavish the money away.
This is the right age to start investing in equity. Personal plans on marriage, transportation and residence determine the liquidity needs. People for whom marriage is on the anvil, and those who wish to buy a car / two-wheeler or house may prefer to invest more in relatively liquid investment avenues. Others have the luxury of not having to provide much for liquidity needs. Accordingly, the size of the equity portfolio is determined.
Young Married
A cushion of assets created during the early earning years can be a huge confidence booster while taking up the responsibilities associated with marriage.
Where both spouses have decent jobs, life can be financially comfortable. They can plan where to stay in / buy a house, based on job imperatives, life style aspirations and personal comfort. Insurance is required, but not so critical.
Where only one spouse is working, life insurance to provide for contingencies associated with the earning spouse are absolutely critical. In case the earning spouse is not so well placed, ability to pay insurance premium can be an issue, competing with other basic needs of food, clothing and shelter. Term insurance (where premium is lower) possibilities have to be seriously explored and locked into.
Depending on the medical coverage provided by the employer/s, health insurance policy cover too should be planned. Even where the employer provides medical coverage, it would be useful to start a low value health insurance policy, to provide for situations when an earning member may quit a job and take up another after a break. Further, starting a health insurance policy earlier and not having to make a claim against it for a few years, is the best antidote to the possibility of insurance companies rejecting future insurance claims / coverage on account of what they call “preexisting illness”.
While buying an insurance policy, there has to be clarity on whether it is a cashless policy i.e. a policy where the insurance company directly pays for any hospitalization expenses. In other policies, the policy-holder has to bear the expense first and then claim re-imbursement from the insurer. This increases the liquidity provisions that need to be made for contingencies.
All family members need to know what is covered and what is not covered in the policy, any approved or black listed health services provider, and the documentation and processes that need to be followed to recover money from the insurer. Many insurance companies have outsourced the claim settlement process. In such cases, the outsourced service provider, and not the insurer, would be the touch point for processing claims.
Married with Young Children
Insurance needs – both life and health - increase with every child. The financial planner is well placed to advise on a level of insurance cover, and mix of policies that would help the family maintain their life style in the event of any contingency.
Expenses for education right from pre-school to normal schooling to higher education is growing much faster than regular inflation. Adequate investments are required to cover this.
Married with Older Children
The costs associated with helping the children settle i.e. cost of housing, marriage etc are shooting up. If investments in growth assets like shares and real estate, are started early in life, and maintained, it would help ensure that the children enjoy the same life style, when they set up their independent families.
Pre-Retirement
By this stage, the children should have started earning and contributing to the family expenses. Further, any loans taken for purchase of house or car, or education of children should have been extinguished. The family ought to plan for their retirement – what kind of lifestyle to lead, and how those regular expenses will be met.
Retirement
At this stage, the family should have adequate corpus, the interest on which should help meet regular expenses. The need to dip into
capital should come up only for contingencies – not to meet regular expenses.
The availability of any pension income and its coverage (only for the pensioner or extension to family in the event of death of pensioner) will determine the corpus requirement.
Besides the corpus of debt assets to cover regular expenses, there should also be some growth assets like shares, to protect the family from inflation during the retirement years.
Wealth Cycle
This is an alternate approach to profile the investor. The stages in the Wealth Cycle are:
Accumulation
This is the stage when the investor gets to build his wealth. It covers the earning years of the investor i.e. the phases of the life cycle from Young Unmarried to Pre-Retirement.
Transition
Transition is a phase when financial goals are in the horizon. E.g. house to be purchased, children’s higher education / marriage approaching etc. Given the impending requirement of funds, investors tend to increase the proportion of their portfolio in liquid assets viz. money in bank, liquid schemes etc.
Inter-Generational Transfer
During this phase, the investor starts thinking about orderly transfer of wealth to the next generation, in the event of death. The financial planner can help the investor understand various inheritance and tax issues, and help in preparing Will and validating various documents and structures related to assets and liabilities of the investor.
It is never too early to plan for all this. Given the consequences of stress faced by most investors, it should ideally not be postponed beyond the age of 50.
Reaping / Distribution
This is the stage when the investor needs regular money. It is the parallel of retirement phase in the Life Cycle.
Sudden Wealth
Winning lotteries, unexpected inheritance of wealth, unusually high capital gains earned – all these are occasions of sudden wealth, that need to be celebrated. However, given the human nature of frittering away such sudden wealth, the financial planner can channelize the wealth into investments, for the long term benefit of the investor’s family.
In such situations, it is advisable to initially block the money by investing in a liquid scheme. An STP from the liquid schemes into equity schemes will help the long term wealth creation process, if advisable, considering the unique situation of the investor. Given the change of context, and likely enhancement of life style expectations, a review of the comprehensive financial plan is also advisable in such situations.
Understanding of both life cycle and wealth cycle is helpful for a financial planner. However, one must keep in mind that each investor may have different needs and unique situations; the recommendations may be different for different investors even within the same life cycle or wealth cycle stages.
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Financial Planning Tools:
The financial plan preparation becomes simpler with the aid of packaged software. These help not only in estimating the cash flow requirements and preparing the financial plan, but also ongoing monitoring of the portfolio. A few mutual funds and securities companies provide limited financial planning tools in their websites. A serious financial planner might like to invest in off-the-shelf software that will enable storing of relevant client information confidentially, and offer ongoing support to the clients.
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