Financial Planning & Goals - Chapter 7

Financial Planning & Goals - Chapter 7

Every individual has long term goals like a secure retirement, quality education for their children, a nest egg for emergencies etc. You will normally find a huge gap between your goals of the future and your current resources. That is where asset allocation and investing comes in handy to make money work much harder for you. Money cannot be made to work hard by random efforts. What it requires is a carefully calibrated financial plan. Let us first understand what financial planning is all about?

What Do We Understand By Financial Planning?

Financial planning is a planned and systematic approach to provide for the financial goals that will help people realise their needs and aspirations. Obviously, it is a lot more complex than what the definition suggests and to understand financial planning in the right perspective, let us look at the various steps that go into financial planning. It is the combination of all these steps that actually culminates into a financial plan.

Step 1: Make an assessment of your Financial Goals

Educating your daughter in Oxford can be a dream but to realize that dream after 15 years requires a solid corpus as well as the ability to meet her regular annual expenses during the stay abroad. But there is a problem here. These goals pertain to a period 15 years later. You have no clue how much the course will cost at that point of time. That is where a scientific estimation can be really handy.

You can estimate future expenses (what the goal requires) with some key inputs. You can start with the current cost as the base or the starting point. This cost must be inflated and you can use the rate of inflation as well as the recent fee hikes as the rate for escalating costs. Also try and factor in the currency related costs. Indian rupee has normally weakened against hard currencies like the dollar, Euro and the Pound. Make a provision for that also as a weak rupee means that you need to save more.

Step 2: Work out the investment horizon

This is an important part of the assessment because when you have a goal that is 15 years down the line, you can take a long term view and ride the power of equities. On the other hand if the goal is maturing in 3 years then you need to use debt for stability. That is what investment horizon is all about. It shows how to structure your asset allocation and your investment plan to meet these goals.  This is important in identifying the suitable investment option to create the corpus.

There is another aspect to investment horizon. It requires that you plan the cash flow from investments in such a view that market risk is reduced to the bare minimum. For example, if first instalment for college is payable in 17 years, then you don’t hold equity funds for 17 years. That would be too risky. Ensure that around the 15th year or so the funds are converted into liquid funds to avoid any negative surprises in the last minute.

Step 3: Assess your detailed fund requirements

This is an important step as it is an attempt to leverage your existing and future resources to the hilt to achieve your long term goals. Detailed fund requirements are a function of your corpus requirement and also the rate at which you will invest your existing resources to meet the long term target.

While the estimation of the goal value calls for an assumption regarding inflation, the amount required for investment also must consider the expected rate of return from the chosen investment. Remember, when you are planning for your goals some 15 years down the line, you are not going to be using lump sum investments. The best way would be to use SIPs. Any online calculator would tell you how much you need to save at what rate of return to reach your target corpus.

Once the above 3 steps are completed, your financial plan is done. The next steps are to execute the plan through a financial planning professional and then review the plan on an annual basis and make adequate changes when required. For mutual fund advisors, financial planning is the most scientific method to help customers reach their goals in a systematic and organized manner.

What Are The Major Objectives And Benefits Of Financial Planning

The principle 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. It gives direction to the investor’s spending and saving habits. It not only channelizes savings into investments and investments into goals; but also inculcates the saving and investing habit early in people. That is the big advantage that financial planning brings to the table.

Financial planning is the key to achieving goals more credibly. Consider the following instances.

  • Financial planning allows you to draw a line between what is a need and what is a desire so that goals can be prioritized clearly. Desires can be postponed but genuine needs have to be prioritized.
  • Financial planning gives you triggers to save cost if needed. Based on the plan you may decide to settle for a smaller car or a smaller home or even put off unnecessary expenditure for the time being.
  • Highlights cases where income may be insufficient to meet needs. Accordingly you can plan for both partners working or taking up some additional consultancy projects to bridge the gap.
  • It highlights where the saving may be insufficient and you may have to rely on a loan funding to bridge the gap. You need to plan your documentation accordingly well in advance.

Financial planning, apart from helping the individual, also helps the financial planner to understand the investor better. This becomes the basis for a long term relationship between the investor and the financial planner.


Why do you actually require a financial planner?

The analogy is quite simple. When we are unwell, we go to a doctor and when you want to build a home, you consult a structural engineer. But, when it comes to future wealth, we try to do it on our own. Here is what a professional financial planner can add to your palate.

  • Investors are not organized or lack the ability to make the calculations. A financial planner’s service is therefore invaluable.
  • Knowledge of how and where to invest may be lacking. The financial planner helps the investor select appropriate financial products and facilitates investment.
  • Financial planners also help the individual make the right choice with respect to the best loan, the best investment product and the best scheme suited to their needs.
  • Tax planning is another key area and investments have to be tax efficient. After all, it is post tax returns that really matter to you. Here again, Financial planners can chip in.
  • More importantly, Financial planners can help investors plan for contingencies and uncertainties so that the financial plan is more secure and predictable

Understanding Financial Planning With Respect To Life Cycle

Financial planning is largely contingent on the life cycle of the individual because the financial plan needs to be attuned to that. Here is how you need to go about it.

First stage - Childhood

Here, the focus is on education in most cases. Children are dependents, rather than earning members. Investments made from such sources are typically for the long-term, which makes equity investments viable. Parents and seniors must imbibe virtues of frugality.

Second stage - Young Unmarried

This is an important stage because the earnings commence but responsibilities are not too many. This gives enough leeway to plan from an independent perspective. At this stage income is likely to be limited while expenses could be high. This is when the actual saving habit must be inculcated and controlling expenses must be developed so that it stands in good stead in the long term. This is the right age to start investing in equity for the long term goals. At this stage, the immediate plans include making a reserve for marriage, buying a car, acquiring an apartment etc.

Third stage - Young Married

If you have created the safety net of assets in the previous stage, it can be a confidence booster while taking up the responsibilities associated with marriage. Where both partners have well-paying jobs, life can be financially comfortable. Insurance becomes paramount at this stage as you have income and time in your favour. Expenses are likely to mount rapidly at this stage. Medical coverage is important at this stage as you cannot let medical emergencies play with your financial plan.

Your responsibilities increase when children are born because that is when the serious financial planning has to start; including securing the future of your children; both professionally and financially. If you have not yet created a financial plan, this is the stage to embark on the same. This is a difficult stage but with careful planning it is possible.

Fourth stage - Married with grown up children

Here there could be a lot of lumped up expenses. These include the cost of higher education, costs of marriage, helping your kids to settle down etc. This is when you actually realize the importance of having started off on equity investing early in your career. At this stage, as goals for which the person has been accumulating comes closer, funds will be moved from volatile assets such as equity to more stable debt investments.

Fifth stage - Pre-Retirement

By now, children would have started earning and contributing to family expenses. Also, any loans taken for purchase of house, car or education of children would be largely repaid. The time is ripe to plan what you will do post your retirement. Hopefully, your resources should have grown enough to see you through the retirement years.

Last stage – Post 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. Of course, if you have pension income, it is icing on the cake but you really cannot count on that. It is time to become a lot more conservative in your investments.


Understanding The Wealth Cycle

Understanding the stages of the wealth cycle gives us an idea of how we spend the initial years contributing and how the later years you reap the benefits of making money working hard for you. Here are the key stages.

  1. Accumulation: This is the early stage when the investor gets to build his wealth. It covers the earning years of the investor
  2. Transition: This is the phase financial goals are in the horizon. These include house to be purchased, children’s higher education / marriage approaching etc. The portfolio shift must be more in favour of safety and security to avoid late surprises.
  3. Inter-Generational Transfer: In this stage, investors start thinking about orderly transfer of wealth to the next generation. This can be normally done through a will that is professionally drafted and also legally registered.
  4. Living out the benefits: This is the stage when the investor needs the funds that have been accumulated over time. Hence, investors in this stage would move the funds to asset classes that provide easy access to funds via regular periodic income.


Understanding All About Risk Profiling

There are differences between investors with respect to the levels of risk they are comfortable with (risk appetite). At times there are differences between the levels of risk the investors are comfortable with. These factors go into your risk profile and that forms the basis of financial planning since returns and risk are two sides of the same coin. Let us now look at what impacts risk profile of an individual.


Major Factors That Influence Risk Profile (Risk Appetite)

There are a number of factors that go into determining your risk profile. Some of these are captured hereunder.

Family Information

  • Risk appetite of an individual increases as the number of earning members in the family increases as they have more people to fall back upon
  • Risk appetite decreases as the number of dependent members increases as one source of income has multiple expectations
  • Risk appetite is higher when life expectancy is higher because you have more time on hand. Also, the risks can be insured at a low cost.

Personal Information

  • Lower the age, higher the risk that can be taken, as your risk appetite is much higher and also risk capacity is much higher when you are young.
  • Professional qualifications improve your employability and especially multi-skilled professionals can afford to take more risk
  • Those with steady or permanent jobs are better positioned to take risk as they have a stable source of income to fall back upon
  • It is also a mind game. Adventurous people are better positioned psychologically to accept the downsides that come with risk

Financial capacity

  • Higher your existing capital base, better the ability to financially take the downsides that come with risk. Wealth is always is big advantage to begin with.
  • People earning regular income can take more risk than those with unpredictable income streams or people in unstable businesses.

There are risk profiling tools at your disposal which cover most of the above factors. Some AMCs and brokers also provide risk profiling tools in their website. These tools will typically revolve around investors answering a few questions, based on which the risk appetite score gets generated. Such tools collect factual information and test the psyche of the individual so that appropriate profile can be mapped.

Finally, when it comes to risk profiling, you have to distinguish between risk appetite, risk capacity and risk tolerance. Risk appetite is the willingness of an investor to take risks to achieve their strategic investment objectives. Risk capacity is the ability to take risk. The capacity to take risk will depend upon personal factors like the age of the investor, income levels and stability of income, the wealth of the investor etc. Risk tolerance of an investor defines the limits or boundaries of the risk that an investor is willing to take.

Understanding The Role Of Asset Allocation

Asset allocation is a delicate balance between risk and returns. Remember the old adage; “Don’t put all your eggs in one basket” is extremely relevant to asset allocation. But, what exactly is asset allocation? The distribution of an investor’s portfolio between different asset classes is called asset allocation. This is determined by a number of factors like the tenure of goals, risk appetite, risk capacity, expected returns on various asset classes, economic conditions, correlation among asset classes etc.

Broadly, asset allocation can be strategic or tactical

At an individual level, the choice has to be made between Strategic asset allocation and Tactical asset allocation. Let us understand what exactly these are.

Strategic Asset Allocation is the ideal allocation that emanates from the risk profile of the individual, the return requirement to meet the goals and the investment horizon. Risk profiling is the key to deciding on the strategic asset allocation. As the person grows older, the debt component of the portfolio keeps increasing. This is an example of strategic asset allocation. It is more rule-based. As part of the financial planning process, it is essential to decide on the strategic asset allocation advisable for the investor. The asset allocation will change if there is a change in the risk and return preferences of the investor.

Tactical Asset Allocation is a lot more dynamic and the decision comes out of calls on the likely behaviour of the market.  An investor, who decides to take higher exposure to equities because of expectations of buoyancy in industry and share markets, is taking a tactical asset allocation call. Similarly, a bond investor who shifts to long duration bond funds to make the best of falling interest rates is also making a tactical call. A person increasing share of gold in the portfolio is also into tactical asset allocation.  The thumb rule is that tactical asset allocation is suitable only for seasoned investors.


Model Portfolios And How To Customize Them

Remember that model portfolios are indicative and not decisive. It needs to be customized to unique needs. Here are some model portfolios for different life stages.

Young upwardly mobile with no dependents

50% in diversified equity schemes (via SIP)

20% in sector funds

10% in gold ETFs

10% in diversified debt funds

10% in liquid schemes

Young, married, single income with kids


35% in diversified equity schemes (via SIP)

10% in sector funds

15% in gold ETFs

30% in diversified debt funds

10% in liquid schemes


Single income with adult children


35% in diversified equity schemes (via SIP)

10% in index funds

15% in gold ETFs

30% in diversified debt funds

10% in liquid schemes


Aging couple in their seventies


15% in index funds

10% in gold ETFs

30% in diversified debt funds

30% in MIPs

15% in liquid schemes


These are indicative and need to be adjusted to the unique needs of the person. But they are all about an approach to strategic asset allocation.