Financial Planning & Securities Market - Chapter 5

Financial Planning & Securities Market - Chapter 5

Understanding The Concept Of Financial Planning

In economics we all learn about far ends and scarce means. Now apply the same concept to your long term family goals. How do you achieve goals like retirement plan, nest egg, children’s education, children’s marriage, trust funds etc with your limited income? The idea is to save more out of your current income, invest in the right assets and then make the assets work hard for you. Financial planning ensures that the household has adequate income or resources to meet current and future expenses and needs.

Income or inflows will come from two sources; Income from profession / business / employment and income earned on investments like equity / debt etc. Here are some basic premises of financial planning.

  • Income has to be utilized to meet current expenses and also to create assets that can generate income to meet future expenses
  • Savings don’t happen by chance. Expenses must be controlled to fit into available income and to be able to generate target savings
  • These savings must be invested in productive assets that can grow over time so that they generate income streams in the long run with minimal risk.
  • Resources gaps can be bridged by borrowings or loans to acquire high value assets like home, property, car etc.
  • Financial plan has to combine the four essential aspects of risk minimization, return maximization, liquidity management and tax efficiency.

Steps In Financial Planning

Financial planning is the process calibrating your resources towards your goals. Here are the six steps entailed.

  1. Financial planning process begins when the client engages a financial planner and describes the scope of work with timelines
  2. Next step is to collect client data including goals. All goals must be defined in monetary terms so that they can be effectively planned for
  3. Do an objective analysis of your current financial status. That includes your income, expenses, assets and liabilities. That determines risk and saving capacity.
  4. Based on the assessment and your inputs the financial plan is prepared. This includes augmenting income, controlling expenses, reallocating assets, managing liabilities etc.
  5. Implement the asset allocation recommendations and complete the necessary paper work to execute and implement the plan.
  6. Finally, the plan must be continually monitored vis-à-vis the goals and wherever required, the necessary rebalancing must be done periodically.

 How To Effectively Leverage The Power Of Sips In Financial Planning

Having made the plan, the next question is how to action the plan. Long term financial planning is best done through SIPs. Firstly, SIPs synchronize with your income flows and the pressure is not felt. Secondly, SIPs offer the benefit of rupee cost averaging so you don’t worry about timing the market. Check this out.

Target Goal

After (X) years

Investment Asset

Annual Yield

Monthly SIP

Car Margin (Rs.75K needed)

2 Years

Liquid Funds



Home Margin (Rs.12 lakh needed)

4 Years

Bond Funds



Child’s Education (Rs.1.50 crore)

16 Years

Equity Funds



Retirement (Rs.3.50 crore needed)

30 Years

Equity Funds





Total Monthly SIP allocation



The first two items in the above table are short term allocations while the last two are long term allocations. Asset classes are pegged in the plan accordingly; debt for short term and equity for long term. Once you know how much is needed to be saved each month, just work your household budget backward. That is where SIPs come in handy!


Important Role Of Goals In Your Financial Plan

Often investors tend to use words like dreams, objectives, targets and goals interchangeably. What matters to financial planning are your goals. Goals are structured and have monetary implications. Here is what you need to understand about the role of goals in financial planning.

Goals must be clearly set out

Goals can be articulated, which means they can be put down on a piece of paper. They are very specific in nature. For example, saying that you want retire rich and lead a worry-free retired life is too ambiguous. You need to fill in the blanks. What are your specific goals? Do you want to take a foreign holiday? Do you propose to spend for your grandchildren? Do you plan to create an emergency fund? When needs and dreams are articulated; that is when they become goals.

Goal is that which has a financial implication

This is one of the most important aspects of goals in financial planning. To plan for your child’s future, you must understand how much the education costs today. Then you must inflate and estimate how much it will cost after 15 years. Based on the time frame decide upon the risk that you can take and your return expectations. You can work towards a goal but you cannot realistically work towards a dream. Goals help to estimate the financial implication of your dreams.

Goals are about goalposts and checkpoints

These are two different things. Goalposts are the timelines for your goals but checkpoints are equally important. What do we understand by checkpoints? Any long term goal has to be broken into a series of intermediate goals. Even a 25 year retirement goal must have intermediate checkpoints. If you plan to grow your wealth by 14% annualized over 20 years, you need to review at checkpoints of 3 years and 5 years if you are on target and take corrective action.

Goals are what can be prioritized

All goals have priorities. Planning for child’s education is a priority but it is a long term goal. Your exotic vacation does not carry the same priority. The next step is to prioritize. If you have two short term goals competing for resources like a foreign vacation and your home loan margin, you will obviously prioritize home loan margin. In the longer term, given a choice between your retirement corpus and buying a second home, you will obviously choose building the retirement corpus. Prioritizing goals makes them actionable.

Goals must be measurable to be monitored

Goals that cannot be measured are just statements of intent. How do you measure goals? Is your current financial plan on track to achieve your goals? Is your investment mix right for your goals? Are you under-insured or over-insured? Are you taking too much risk or are you taking on inadequate risk. Your goals must be constantly reviewed and monitored based on return parameters, risk parameters, liquidity parameters and tax implications. Goals that are measurable must be monitored at least once a year.

Striking the right equity / debt balance in your financial plan


The thumb rule is that higher risk means equity and lower risk means debt. But that can be misleading. For example, the biggest risk you run in long term financial planning is not taking on enough risk. Equity offers tax efficiency and long term wealth creation. On the other hand, debt offers you stability and regular income. Here is how to balance your plan.

Risk appetite matters but more importantly it is your risk capacity

When you are in your mid-twenties to your mid-thirties, your risk appetite is much higher compared to a 50 year old person. As your age progresses, at regular intervals you should be reducing your equity exposure and increasing your debt exposure. The thumb rule for equity exposure is (100-age); that is just intuitive and not reasoned out. That means if you are 25 years of age, then 75% of your portfolio should be in equities. Risk appetite is the risk you are willing to take but what matters is the risk capacity; which is the risk you can afford.

Allocation depends on the nature of goals

Ideally, for planning your retirement, children’s education, children’s marriage etc, you must have a bigger allocation to equities. Equities are risky in the short run, not so much in the long run. In fact, empirical evidence is that over the longer term diversified equity funds have vastly outperformed other asset classes.

Asset mix also depends on liquidity needs

Why does liquidity determine your debt / equity mix? If you need the funds in 10 years then equity can be a good option. If you need the funds after 3 years then equity may be too risky and debt funds may be a better option. If you need the funds after 1 year, even income funds may not be advisable. You are better off investing in liquid funds.

Tax considerations influence debt equity mix

In any financial plan, it is post-tax returns matter more than the pre-tax returns. If you already paying high taxes on your income, your key priority will be to make your financial plan as tax-efficient as possible. Relatively equity is more tax efficient than debt. When it comes to equity funds, the dividends are entirely tax free in your hands as are long term capital gains (up to Rs.1 lakh). Even short term capital gains are taxed at a concessional rate of 15%. And of you want to add the Section 80C benefit, opt for ELSS. In case of debt dividend are tax free but there is DDT to the extent of 29.12% on debt fund dividends. Additionally, short term capital gains are taxed at your peak rate while LTCG is taxed at 20% after indexation. Equities are more tax smart.


Ten Mistakes to Avoid In Your Financial Plan

Quite often people tend to get their financial planning conceptually wrong. Here are 10 such mistakes to avoid.

  1. Not having well defined goals is the first mistake. When you set your goals don’t be too ad hoc in the process. It is your plan for the next 30 years so let it be comprehensive. You surely don’t want to create a financial plan and then realize that some critical goals have been missed out. It is important not only to define your goals thoroughly but also to ensure that you have SIPs that are tagged to each goal. Tagging ensures that you don’t stop SIPs along the way. That is only possible if you have well defined goals.
  2. Starting late on your financial planning process is a cardinal blunder. The earlier you start the more the power of compounding works in your favour. Frankly, there is no right age to start, but the thumb rule is that, the earlier the better. The moment you start earning income, you need to start the process of financial planning. Time plays an important role in financial planning. The sooner you start, the longer you invest for achieving your goals. The longer you have at your disposal, the longer you have to create and nurture income-earning assets and investments. The longer you create assets, the longer the income on your assets creates further assets. This is how the power of compounding works in your favour. It makes money work hard for you.
  3. Not focusing on reducing your debt is a key mistake. Once you create your financial plan the first step must be to reduce debt, especially high cost debt. We are referring to high cost debt like rolled over credit card debt, personal loans, hand loans etc. If you are giving away too much of your income by way of EMIs then you are never going to generate anything worthwhile to invest. As a starting point, use any surplus money to first reduce your high cost debt like credit cards and personal loans. High debt levels can mess up the best of financial plans.
  4. Not focusing adequately on insurance is another planning sin. You need protection at various levels. For example, you need life insurance against life risk. You also need to ensure that your assets are insured adequately. Additionally, liabilities should also be covered with term policies so that you don’t disrupt your plan in an exigency. Adequate protection also improves your risk appetite.
  5. Tax saving is important but that can be the driving force of your financial plan. Don’t load your portfolio with endowments and ULIPs for the sake of 80C benefits. Keep your insurance and investments separate. Tax saving is essential but that cannot be the theme of your financial plan. When you focus purely on reducing your tax burden, you tend to make sub-optimal financial planning decisions. Even if you manage to save tax you miss out on other more relevant investment opportunities.
  6. Don’t underestimate the destructive power of inflation. When we calculate the future cost of payables, don’t be too conservative on inflation. Inflation is not just the government announced rate of inflation but what you experience. For example, inflation in India may be currently around 4% as per RBI but it has been around 7% at the consumer level and that is what matters to you. Certain expenses like higher education have gone up manifold in a short span of time.
  7. Don’t make the mistake of overestimating returns on investment. Just because equities generated 22% last year does not mean that it will generate 22% in the next five years too. Debt funds outperform equities in certain years due to falling interest rates. When you overestimate investment returns, you tend to under-invest and you will end up with lower corpus creation. Apart from interest rates, also remember that as the overall markets become more matured, the returns will automatically come down. Be conservative in estimating returns on your investments.
  8. Budgeting and cost cutting are the building blocks, so don’t ignore them. One of the best ways to save is to reduce the frivolous expenses that you can dispense with. One of the key Financial Planning errors investors commit is to expect that investments will take care of their financial needs even if they continue to live an extravagant life. It does not really work that way, as you will find out.
  9. Keep a tab on costs, fees and taxes. Yes you have to act like Scottish penny pincher. There are quite a few aspects to this argument. You need to ensure that you don’t end up paying too much in the form of churning costs or TER. Also ensure that fees paid to your financial advisor are proportionate to the benefits delivered. Quite often, short term returns may look salivating but ensure that you make money net of taxes too.
  10. Preparing and executing the financial plan is not enough; it also needs to be monitored. Creating and executing the plan is not the end of the process. You need to constantly monitor it. Set triggers on a regular basis. Review your plan broadly at least every quarter and thoroughly once a year. If the situation demands, then be prepared to rebalance your financial plan at least once in 3-4 years. This will ensure that your plan is in sync with your goals.


Financial planning is now the default approach for investors to plan their investments in a bid towards their goals.