Archive for Financial Planning Process

You must ask questions

December 12, 2009 at 5:46 pm · Filed under Financial Planning Process, certified financial planner, financial planning

Dear Reader

At Procyon Financial Planners, of late, we are seeing a distinct and welcome change in the attitude of the investors. It appears, all of a sudden, that there is a surge of interest amongst the investors about financial planning.  Invariably, investors are keen to know about qualification and experience of financial planners, number of clients they serve and so on.

Since the time we began our financial planning practice in Bengaluru (then Bangalore) in 2006, we are providing information to our clients and investors about the need for financial planning. So much so that some of our clients started complaining that we were much focused on financial planning! This change of questioning attitude augurs well for investors in general and young earners in particular.

Some times, we receive funny queries that are actually very long winding and seem to have been directly influenced by the literature available on the net in developed countries. I do not see anything wrong in this and in fact welcome this information seeking process before hiring your financial planner. At the same time, may I remind the general investor that India is almost three decades behind in adopting financial planning principles in the area of personal finance and very much at the lower end of the learning curve? You will find that a Certified Financial Planner in India can boast of only 4 year’s experience because it is only in 2005 the first batch of CFPs obtained their certification.  It is only now in circa 2009 that one of regulator has fleetingly mentioned that advisors should adopt financial planning process. Funnily, the same regulator has forgotten to define what he means by ‘financial planning’.  Investor seems to be ahead of both the financial planning profession and finacial regulation.  No wonder this is happening because we live in the age of seemless flow of information.

Investors must also keep it in mind that in India there are regulations pertaining to selling financial products but not enough about financial planning services. One regulator, with a recent regulatory intervention has in one stroke converted a class of product sellers to financial advisors. Does it serve any one’s interest that a product seller has to work as financial advisor with rudimentary regulatory frame work, without any specialised training and such necessities?  Dé·jà vu all over again? 

That aside, I urge investors in India to exercise the same diligence and questioning attitude when buying financial products as well. I am raising this particular issue here because I see a huge gap between the way an investor,

(a) queries a financial planner about the costs, services, past experience and so on, and

(b) goes through the process of buying a financial product.

Is it because the questions one should ask when it comes to hiring a financial planner are well documented in the World Wide Web and questions one should ask when buying a financial product are not so well documented?

If you apply the same principle of ‘question your financial planners thoroughly before hiring’ when you buy a financial product as well, you may probably not end up facing the huge gap between what is said and what is delivered.

This issue is particularly relevant if the reader understands the fact that there are millions of financial product sellers in India where as the number of financial planners are a miniscule part of that number.

It would be interesting to know how you as investor failed by not asking right questions or benefitted by asking the right questions when buying a financial product.

Regards,

Narendra

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A primer on tax planning (for salaried employees) and financial planning

November 8, 2009 at 3:27 pm · Filed under Financial Planning Process, Tax Planning, financial planning

Dear Reader from India,

Have recently uploaded a A primer on tax planning (for salaried employees) and financial planning (pdf format).  You can download the same at http://www.procyonfp.com/knowledge_base_articles.

Hope you will find the contents useful.  You are welcome to send your comments.

Regards,

Narendra

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Bundling & Unbundling or bungling?

July 4, 2008 at 6:25 am · Filed under Financial Planning Process, General Insurance, Insurance, Life Insurance, financial planning, investment planning

Why does a company try to hard-sell a product?

It’s simple logic that the company is trying to maximize it’s (in turn it’s agent’s) profits by selling a product which brings in high profit.  In a business environment, this logic is never going to change.  And if we extend this logic further, the product which brings in the higher profit need not necessarily be a good product for the buyer.  In the same way, just because a product is highly profitable, it need not necessarily be a bad product for the buyer.  The entire reasoning of good or bad is quite relative.

For example, all things being same, a combination of term insurance and any other asset classes (a process of unbundling the need of insurance and investment) would be a good fit for a young healthy person. Cost of insurance is low and he will have the flexibility to choose that asset(s) which suits his needs most.

Now look at another situation wherein term insurance is not available to a particular person for whatever reason but he still needs insurance.  In this scenario, he has to look at that option which provides him insurance cover and he may have limited option of choosing the asset class for investments and may have to bundle part of his investment with insurance.

Now, how does a financial planner handle such a situation?

It’s quite simple.  He analyses a client’s unique needs and recommends suitable strategy/products.  That is because he has the option to choose the way he is remunerated ie., either fee for advise or commission or a combination of both.  In any case, the product selection is at the end and not at the beginning of financial planning process.

A product vendor is handicapped in this situation either because of inadequate knowledge base (about his own products and the ability to analyse the needs of his/her clients) or because of the way he is remunerated or a combination of both.

World over criticism against life insurance is that it’s often mis-sold to gullible people.  First page of Google search for the word “mis-sell” generates 4 entries (out of 10) about mis-selling life insurance!  That’s 40%!! (and rest of entries are about someone having  the word “missell” in his/her name!!)

While on this topic, do you ever wonder why only life insurance companies sell products with investments and not general insurance companies?  It’s easy to brush this situation aside by arguing that general insurance products are up for annual renewal.  In which case why single premium life insurance (investment) products are available in the market? And why some companies pride themselves in selling such policies in very high number?

Regards,

Narendra

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Inflation & Oil Crisis – few thoughts

June 8, 2008 at 1:37 pm · Filed under Financial Planning Process, financial planning, mutual funds ·Tagged ,

It’s one of those times the investors as well as advisors dread.  Markets are choppy; analysts are sending out diametrically opposite views and investors are confused.  Being on the horns of dilemma, choices are not pleasant.  Runaway inflation makes return after taking in to account the effect inflation and taxation (real return) negative and investors dread the roller coaster ride of stock market.

First reaction would be to run for the cover.  Let us juxtapose the situation and imagine that investor holds real assets (property, gold etc.) as investments and prices of real assets tumble.  Would he sell them under loss?  Most unlikely! Because of illiquidity and loss of capital, he will still hold on to them for things to turn around.  Then why is that an investor in equity assets thinks differently than an investor in real assets or the same investor thinks differently between two asset classes?  Availability of liquidity (i.e., buyers at lower market levels) coupled with fear appears to be the main reason.  Fear arises due to lack of understanding of equity as an asset class.

There is no doubt that equity is the prime asset class that would provide an investor positive real return in the long run.  Here, the word “long run” is very important because in the chaotic world of equity investment, it takes some time for the market to move towards economic fundamentals.

We did a brief analysis how Indian stock market behaved in the past.  NSE’s Nifty is 50 stocks index representing fairly adequately performance of the Indian stock market.  The base period selected for Nifty index is the close of prices on November 3, 1995 and the base value of the index has been set at 1000.

Between 3-11-1995 (Nifty level 1000) and 06-06-2008 (when this analysis was done; nifty level 4627.8), there were 3152 trading sessions.  Out of them, 1686 sessions (53.5%) yielded positive returns.  Of them, 94 (3%) sessions yielded more than 3% return and only 21 (0.67%) sessions yielded more than 5% return.  Here the return is calculated as percentage change over the previous closing.

Those 21 sessions were spread across the years as under:

1996 – 3 sessions

1997 – 3 Sessions

1998 – 1 session

1999 – 2 sessions

2000 – 3 Sessions

2001 – 1 Session

2004 – 1 Session

2006 – 2 Sessions

2007 – 1 Session

2008 – 4 Sessions

 

Above data clearly shows that very few trading sessions result in high positive returns and the investor would have lost the market return if he had not stayed invested on those days.  Due to this, it would be futile to time the market; on the other hand investor should give time to the market to get the return.

If we cannot time the market, is then investment a passive process.  Definitely not!  Investment needs active management but active trading cannot be construed as investment.  This is where financial planning process helps the investor to choose the right asset allocation depending on his goals and time horizon.  In the past 13 years (almost), Nifty has given a return of 13%.  Many of the financial goals would have a longer investment horizon than this.  Wherever investor has the advantage of time, he can consider equity as a prime option to create wealth.  Choosing the right asset allocation and rebalancing them periodically is the key to create wealth in the long term through investments.

How then – not being an active investor and not happy with market return – to better the performance?  This is where mutual funds score over other financial instruments and investment avenues.  Options like systematic investment plan (SIP) and systematic transfer plan (STP) help the investor to control the cost of acquisition.  The skills of fund manager may help the investor to achieve a return which is better than average market return.  Today, mutual funds are available for many types of asset classes, real and financial, which otherwise retail investor cannot invest directly due to ticket size and/or lack of firsthand knowledge.

As far as the present investment scenario is concerned, valuations are bound to suffer due to uncontrollable inflation fuelled by rising energy cost and subsidies that governments provide.  Energy importing countries like India and China would suffer most.  Oil shock of seventies did not hurt India much because then India was an agrarian economy with agriculture contributing majorly towards GDP.  Services sector did not exist then.  Today, services sector is major contributor and agriculture has slipped to third position.  Changes in the technology and lifestyle have made all sectors energy dependent.  Detrimental effect of rising cost of energy would be felt in all sectors and more so in Industry sector. 

Should this make us think of getting out of equity as an asset class?  Answer would be an emphatic no.  Being realistic in our returns expectation would be a first step.  Being realistic about negative real returns of fixed income instruments would also help.  Many clients would ask us during the planning process why we considered a very conservative long term expected rate of return.  We think we were being realistic about the long term expected rate of return.

Seventies oil crisis resulted in more efficient Japanese car makers taking over western markets and Japan developing electronics industry as the economic force.  Who knows which innovation would help us to overcome the current crisis?

And if you thought oil crisis would blow over, think again!  Watch this video!

http://www.abc.net.au/science/broadband/catalyst/asx/oilcrisis_hi.asx

Regards,

Narendra

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Planning for a financially secure retirement – why?

May 8, 2008 at 10:29 am · Filed under Financial Planning Process, financial planning, retirement planning

The moment we join employment force, be it on hire or self employment, the retirement clock starts ticking.  We are certain that we retire from employment after several years.  Also, those of us who are employed know the year in which we retire by default.  Some may choose to retire early and some may be willing to accept extension of retirement age through contracts. This implies that we have ample time to plan for this important event in our life.

 

While it is important to know how to plan for retirement, it’s equally important to understand why to plan for retirement.

 

Once up on a time, Government job was much sought after for retirement benefits it entailed.  How times have changed!  Under the current dispensation, a government employee has to contribute her money for retirement fund, similar to a private sector employee.  Job related social security benefits like provident fund, family pension and gratuity will never be able to fund substantially the retirement corpus.

 

Modern health care and increased financial resources have contributed to increase our longevity.  We not only live longer than any time in our history and lead an active life too – so much so that our retirement life would be longer than our period of employment.  So we have to fund a longer retirement period through shorter earning period!

 

Then there are unforeseen medical and long term care expenses.  Old age typically brings medical problems and increased healthcare expenses. We may also would like to pass on inheritance to our children.  Without a well planned retirement corpus, we may be forced to sell off the assets to generate the required cash; even worse we may become financial burden to our children during old age.  Many families have adopted single child policy and this makes us even more vulnerable during old age.

 

Last but not least, inflation has a killer effect on our standard of living.  If not taken in to account while planning retirement needs, inflation will punch holes to our best plans.

 

Who does not want retire comfortably?  But we need to find out what is “comfortable retirement”?

The goal of Retirement Planning is to allocate the financial resources available so that we can plan for a financially secure retirement.

 

After understanding ‘why’ of retirement planning, let us look at ‘how’ of it.  When we start planning our retirement, we have to answer the following questions:

 

Ø  How Much Will I Need?

Ø  Where Will My Money Come From?

Ø  How To Investment For Building A Nest Egg?

Ø  What Are The Tax Implications And Effect Of Compounding

Ø  What’s Importance Of Asset Allocation And Diversification

Ø  How To Review And Perform Course Correction

A Certified Financial Planner is specially trained to look in to our financial future and plan for such eventualities.  He has the wherewithal to peek in to the likely future based on our risk appetite, time horizon, existing asset base and such several variables.

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Life-Cycle Investing

June 3, 2007 at 4:05 pm · Filed under Financial Planning Process, financial planning

Raj & Rakshita, aged 37 and 35 are today’s working couple with a daughter and son.  After taking into account all their expenses between them they have a surplus income of roughly Rs.1.5 Lakhs annually.  They have invested this surplus mostly in several insurance policies.  Endowment, money back, return of premium plans and recently unit linked plans also.  The couple’s insurance advisor has sold them these plans over several years.  Two major events in the future, children education and marriage and their own retirement need is being met through the proceeds of these insurance plans. 

Meet Gopal and  Krithika,  aged 36 and 32 with daughter.  Gopal works for a leading retail chain and Krithika is the home maker.  This family also has almost Rs.1.5 Lakhs annual investible surplus.  Gopal does not believe in investing in insurance or such ‘less-risk’ avenues.  He is an aggressive investor in shares and stocks and also into ‘trading’ in stocks.  He firmly believes that in the long term only equity investment would give him the kind of returns he needs to build the corpus for his daughter’s education and marriage expenses and their own retirement needs. 

Between these two families, what’s common and what’s not?  Life cycle needs like children education and marriage expenses and planning for retirement is a common thread.  However, choice of financial instruments to meets these goals is vastly different.  Raj & Rakshita has chosen the ‘less-risk’ option of investing in insurance (this is not fully true in case of unit linked plans) whereas Gopal & Krithika have choose the other option at the other end of the spectrum viz., investing directly in to stocks and shares. 

Before a financial planner can say whether these two approaches help the respective families to meet their goals, it would be better to understand what’s meant by life-cycle investing. Depending on the earning capability, age and the current level of accumulated wealth, investors are broadly classified in one of the four stages of the life cycle: accumulation, consolidation, spending (withdrawal), or gifting.  

According to the theory of Lifecycle investing, each individual will go through various lifecycle stages, in which the investment needs are different.  

Accumulation phase (Age Twenties and Thirties) 

When younger, the individuals are able to invest in higher risk assets and follow an aggressive investment strategy, designed to provide maximum long term growth. Some examples of such assets are equities and mutual funds. 

Consolidation Phase (Age Forties and Fifties) 

In mid-life the individual has accumulated assets to cover the important needs like housing, children education and marriage expenses and is now looking for opportunities to increase wealth generation. In this phase, the individual would have more resources to devote to investment, but might want to take a less risky approach. There is a need to rebalance the asset allocation now and move towards less-risk options like Hybrid Funds or Debt Funds.  Some portion of exposure to equity investment may still be needed to take care of effect of inflation. 

Spending Phase (Age Sixties and Seventies) 

The third phase is the ‘spending’ or ‘decumulation phase’ during which the individual is no longer working and is living on the income and capital accumulated in the first two phases. Loss of capital owing to investment in higher risk assets is not acceptable to the investor in this phase.  Asset allocation will mainly be skewed towards Govt. Bonds and securities yielding regular income. 

Gifting Phase (Age Eighties and Nineties) 

Finally, there is the ‘gifting’ phase, in which individuals who have accumulated far more wealth than they will need for their own lifetimes, decide to pass some of their assets on to others.  The ‘life cycle’ theory suggests that, as individuals move through these phases, their investment needs and objectives change significantly and, while being able to hold mostly risk bearing assets when young the individual needs to eliminate most investment risk as they grow old. 

The Ages mentioned against each phase may vary depending on the financial status and attitude of the individual towards work.  It’s not very uncommon to see people who now retire in their forties or early fifties.  This will only increase the length of spending phase which is longer than accumulation and consolidation. Also, health condition and lifestyle are important factors in deciding the longevity of the individual.  Improved healthcare facilities and comfortable lifestyle lead to increased longevity. 

Having known investment life-cycle, now we can analyse the decisions made by the couples Raj & Rakshita and Gopal and Krithika. Each phase of life have their own imperatives and asset allocation strategies.  One-size-fits-all may not work in all phases of life.  Raj & Rakshita, with their reliance on insurance policies to meet their life cycle needs may woefully fall short of their needs.  Gopal and Krithika with their aggressive attitude towards investment may face the scenario or loss of capital. 

Financial markets and products have developed significantly, since the Lifecycle theories first gained popularity. It is now important for investors of all ages to consider their investment options in a more balanced manner. Sophisticated risk-management strategies are commonly employed by large corporations, however such modern techniques are yet to find wider usage by individual investors to plan their investment portfolios over the four life-cycles mentioned above.

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Inflation – The Silent Killer

December 30, 2006 at 3:30 pm · Filed under Financial Planning Process, certified financial planner, financial planning, retirement planning

If you have watched Amitabh-Hema starrer “Bhaghban”, you would have sympathised with the retired couple and their travails. In one of the early scenes in the movie, when the character played by Amitabh is to avail a loan from his provident fund account, when he is asked about the appropriateness of his action, he quips that his children would take care of him! Personally, I think “Bhaghban” is an ideal guide for planning your retirement or rather how not to approach your retirement planning with such a casual attitude. And in the movie Amitabh plays the role of a banker!!

More than retirement planning per se, I want to highlight how the deadly silent killer called inflation would play a spoilsport with your retirement plan.

Inflation is variously defined by economists but for our discussion, it could be defined as a situation wherein there is an increase in the overall level of prices over an extended period of time.

As an individual you will have no control over inflation; however you will be greatly affected by it, more often adversely.

During your earning period, there are several ways you will be able to mitigate the effect of inflation, rising wages being one of them. However, it’s during retirement period, the effect of inflation would be magnified because your income is not automatically adjustable for inflation; you need to plan for this event.

Let’s suppose that during the first year of your retirement, you will need Rs.2.5 Lakhs to meet your needs. If there is an inflation of 5% in the economy, the general level of prices would increase by 5% in the next year. However, this will not happen abruptly let’s say on the first day of the New Year but very gradually. That’s why inflation is a silent killer. In the next year you will need Rs.2.62 Lakhs to maintain the same standard of living because all prices have gone up 5%. But returns from your investment (typically you would have invested in those investments which give a fixed and/or assured return) will not increase by 5% to offset the effect of increase in price level. This means, you will need to dip into your corpus (capital invested) or reduce your standard of living or a combination of both. You will not be happy with lower standard of living and if you dip in to your capital, you may end up with a situation with no corpus left out. It’s scary to be in this catch-22 situation. It’s even scarier because you have absolutely no control over the unfolding economic situation because you are neither the finance minister nor the governor.

How one would break this catch-22? Financial planner knows that inflation is a fact and it can not be wished away. One can not live with the situation also. So it’s to be managed carefully. Like an orchestra, many things have to happen simultaneously.

There are several strategies a retiree has to adopt in such a situation. Estimating impending inflation is easier said than done, that too when the plan is to be put in place several decades earlier to actual retirement. Other option would be to attempt to create a big corpus wherein the returns would be always more than the needs. Question is can this be achieved by all? What if the resources are limited? It is here the attitude of the investor plays a major role. With the help of financial planner, she must chose the type of assets she will own during her retirement period carefully so that overall income generated by the assets is always ahead of inflation. There are several such assets that are likely to generate a return adjusted for inflation – equity, growing annuity etc.

There is no substitute to the awareness of the fact known as “inflation” and being prepared to face it squarely with the help of your financial planner. Investor must also know the importance of ‘inflation-beater’ assets and should make them part of the overall portfolio both during the wealth accumulation/growth phase as well as wealth erosion/depletion phase.

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Where to find a Certified Financial Planner

September 29, 2006 at 1:22 am · Filed under Financial Planning Process

CFPs are small in number in India.  New CFPs are passing out every quarter and you can find the directory of CFPs in India at www.fpsbindia.org

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Basics of financial planning process

September 29, 2006 at 1:11 am · Filed under Financial Planning Process

Financial Planning Defined

Financial Planning is the process of :

Examining a client’s personal situation, financial resources, financial objectives and financial problems in a comprehensive manner,

Developing an impartial, integrated plan to utilize the resources to meet objectives and solve problems,

Taking the steps to implement that plan once approved by the client, and

Monitoring the plan performance to take corrective action as necessary to assure that results match the plan projections

Financial Planning Defined

“Financial Planning is planning for and managing life’s financial outcomes”

Financial Planning Process

A formal, six-step process, formulated by the College of Financial Planning (US) in 1972, designed to address, in whole or in part, life’s financial issues and opportunities.

Financial Planning Process Step One: Establish the Client/Planner Engagement

You and Your Planner Should

Discuss your objectives & expectations
Discuss the services available
Clarify responsibilities and time frame
Finalize the scope of the engagement
Determine the fee/compensation arrangement

Financial Planning Process Step Two: Gather Data & Determine Goals

Your Planner Should

Obtain information & documents
Help you “refine” or crystallize goals
Develop an understanding of your values & attitudes

Financial Planning Process Step Three: Examine Current Financial Condition, Problems & Opportunities

Your Planner Should

Analyze information, Identify problems & opportunities across each major financial planning discipline

Finance – Asset & Liability Structure, Cash Flows
Investment Taxation – Ordinary and Income
Risk Management – Insurances & Asset Protection
Law – Estate, Charitable & Legacy Planning

Financial Planning Process Step Four: Develop & Present Financial Plan

Your Planner Should

Prepare & present a personalized financial plan
Establish a review cycle

Financial Planning Process Step Five: Implement Your Plan

Your Planner Should

Assist the Client or manage the process as defined in the Engagement Agreement
Financial Planning Process

Step Six: Monitor the Financial Plan;

You and your Planner Should

Review changes in personal circumstances
Review and evaluate impact of changing tax laws
Review and Discuss changing life circumstances
Make periodic adjustments or recommendations as necessary

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