Process of Financial Planning

Process of FP in Practice..1
• Step I: Establish a trust relationship with
the client
• Step 2: Define the client’s goals
• Step 3: Analyze and evaluate client’s
financial status
• Step IV: Determine client’s risk
tolerance level
 Process of FP in Practice..2
• Step V : Ascertain client’s tax situation
• Step VI: Recommend the appropriate asset
allocation and specific investments
• Step VII: Executing the plan
• Step VIII: Periodic Review
What is Asset Allocation ?
 Asset Allocation
• Product allocation – cash, debt, equity
• Country allocation
• Industry allocation
• Fund house allocation
• Time allocation – long and short term
 Sample Allocation
Illustrative Allocations Conservative Moderate Aggressive

Cash 25% 10% 5%

Bonds 55% 45% 25%
Large Cap Equity 15% 25% 40%
Small Cap Equity 5% 15% 20%
Derivatives 0% 5% 10%
What Should be the Basis for Allocation ?
8
Risk Profiling of Client
Risk Appetite vs. Risk Tolerance
 Risk Appetite Vs. Risk Tolerance
• Risk Appetite is the total exposed
amount that an
individual/organization wishes to
undertake on the basis of risk-
return trade-offs for one or more
desired and expected outcomes

• Risk Tolerance is the amount of

uncertainty an
indiduals/organization is prepared
to accept in total or more narrowly
within a certain business unit, a
particular risk category or for a
specific initiative
 Examples
• The individual/organization has a higher risk
appetite related to GOALS and is willing to
accept higher losses in the pursuit of higher
returns (Risk Appetite)

• While we expect a return of 18% on this

investment, we are not willing to take more than a
25% chance that the investment leads to a loss of
more than 50% of our existing capital (Risk
Tolerance)
 Typical Investor Profiles
• Conservative – Investor with no experience in
stocks, risk averse, retired

• Moderate – Some experience in stocks, willing to

take risks, high risk investor but retiring soon

• Aggressive – Young investor, long time horizon,

experienced in stocks, retired but high net worth with
sufficient stable income from bonds
 Risk Profiling of an Individual

• http://www.moneycontrol.com/personal-financ
e/tools/risk-assessment-tools.html#res
Measuring the Financial Health
 As a Financial Advisor..You Should
• Organizing your client’s financial data.
• Assisting your client in goal setting.
• Financial Analysis for the client.
• Developing appropriate strategies.
• Evaluating and choosing the best option
amongst the various strategies.
• Coordinating and implementation of the
planned decisions.
Assessing Current Wealth
 The process consists of 3 steps
1. List the items of value that you own. These are your assets
• Values of assets should not be understated or overstated

2. List the amounts that you owe to others. These form your
liabilities

3. Subtract your liabilities from your assets; the difference is

your net worth

Assets (Items of value) - Liabilities (Amount owed) = Net Worth

 Your Assets: What You Own
• Monetary Assets
• Investment Assets
• Retirement plans
• Real estate
• Automobiles and other vehicles
• Personal property
• Other tangible and intangible assets
 Monetary Assets
• Cash or other assets that can be easily
converted into cash (Assets for present)

• These assets provide necessary liquidity in

case of an emergency

• Examples -- cash, saving accounts, liquid fund

investments
 Investment Assets
• Assets that are invested for the future

• These assets are used to accumulate wealth to

satisfy a goal

• Examples -- stocks, bonds, mutual funds, cash

value life insurance (Endowment/ULIP), FD,
etc.
 Retirement Plans
• Investments by you or your employer to save
for retirement

• Long-term investments that often carry a

penalty if used before a certain age

• Examples : GPF, PPF, EPF, NPS, Other

Pension Plans
 Real Estate
• Tangible asset such as land, independent
house, flat reported as fair market value

• Represents most of your savings, and

normally appreciates in value

• Examples -- primary residence, vacation

home, and rental property
Automobiles and Other Vehicles
• Tangible assets that
normally must be
inspected

• Reported as fair market

value, but normally
depreciate in value

• Examples -- cars, trucks,

motorcycles etc.
 Personal Property
• Tangible assets that
represent your lifestyle

• Reported as fair market

value, but normally
depreciate in value

• Examples -- boats,
furniture, electronics,
clothing, jewelry
 Other Assets
• Any other tangible or intangible asset that may
or may not be of value

• Examples -- business ownership, copyright,

patent, collections, paintings etc.
 Your Liabilities: What You Owe
• Current liabilities are liabilities that must be
paid-off within the next year.
– examples -- credit cards and utility bills

• Long-term liabilities are liabilities that extend

beyond one year.
– examples -- home mortgage, auto loans, personal
loans etc.
Your Net Worth: A Measure of Your Wealth

• Insolvency: Do you owe more than you

own?

• How age affects net worth guidelines ?

 Why Is Determining Net Worth Important?

• It helps in comparing change in financial

position

• Helps in tracking asset appreciated in value

and depreciating in value

• Helps in assessing the increasing and

decreasing liabilities
 Exercise
Mukesh bought a flat for 12 Lakhs, worth 20 Lakhs today. He has
no loan repayments i.e. EMIs due on his flat. He has FDs worth Rs.
2 Lakhs and cash of 30,000 in his account, jointly held with his
wife. He has mutual funds worth 1.5 Lakhs and stocks worth 1.5
Lakhs. Ritesh, an old colleague of his, has taken a loan from him for
Rs. 50,000, for which he pays him 10,000 every month. His wife,
Geeta is fond of diamond jewellery and owns up to 3 Lakhs of
diamond jewels.
Mukesh bought a car for 4 Lakhs, 3 years ago. He has a tax liability
of Rs. 35k per year. He has no other outstanding bills pending,
except for telephone and electricity bills to the tune of Rs. 5,000 .
A] What is his net worth?
B] Can you think of ways of increasing his net worth?
The Income and Expense Statement and
the Cash flow Statement
 There are three steps to create an income statement,

1. List all income received during the time period.

• List all sources of income for the period of the income
statement. Income from salary is generally received
after deducting tax at source (TDS).
• The main source of income for most people comes in
the form of salaries, wages, self-employment income,
and commissions. Other sources of income include
bonuses, interest, dividends, rent, gain on the sale of
assets, and gifts and inheritances. All sources of income
should be included in order to make the income
statement complete and accurate.
2.Determine the surplus/deficit of income over
expenditures.
2. List all expenditures made during the time period.

• Major categories of expenditures should be

listed. It is not necessary to account for every
penny spent.
• By reviewing cheque-book records and credit card
statements and recording the cash payments, you can easily
develop categories of expenditures. By adding the payments
made in each category, you will have a fairly accurate
account of where your money has gone.
• Fixed Expenditure
• they remain the same each month or year. Examples of such
expenses are rent, mortgage payments, life insurance
premiums, and equated monthly instalments of loans. These
are called Fixed expenditures.
• Variable expenditures
– Certain expenses change from month to month, such as food, clothing, medical
expenses; telephone and utility payments; household operating expenses;
contributions; and recreational expenses.

• Both Fixed and Variable expenses can be either

Discretionary or Non-Discretionary Expenses

• Discretionary Expenses: Eating outside, Excess

shopping, Changing models of mobile every 3 months etc.

• Non-Discretionary Expenses: House Maintenance

Charges, Grocery Expenses, Medical Expenses, Electricity
Charges where you cannot really do any curtailments.
Using an Income Statement to Trace Your Money

• Personal income statement -- the financial

motion picture

• Cash basis: statement based entirely on actual

cash flows
 Income: Where Your Money Comes From

• Sources of income:
wages, tips, royalties,
salary, and commissions

• Income is amount earned,

not necessarily amount
received.
 Expenditures: Where Your Money Goes

• The two major expenditure categories: taxes

and living expenses

• Fixed expenses: Expenses you don’t directly

control -- e.g., mortgage, rent, cable TV

• Variable expense: Expenses you can control

-- e.g., food, entertainment, clothing
 Where Does It Go, On Average?
• Taxes, Food, Housing,
Medical Care

• The more earned, the

more spent on education
and entertainment.
 Critical Questions
• Question 1: Do you have adequate liquidity to meet
emergencies?

• Question 2: Do you have the ability to meet your debt

obligations?

• Question 3: Are you saving as much as you think you

are?

Using Ratios: A Financial Thermometer

Question 1: Do You Have Adequate Liquidity

• Ratios to determine whether or not you have

enough monetary assets:

(1) to pay for an unexpected large expense or

(2) to tide you over during periods of reduced
or eliminated earnings

– Current ratio
– Month’s living expenses covered ratio
 Current Ratio
• monetary assets
current liabilities

• This ratio shows you whether you have

enough liquid assets to cover expenses
currently due.
 Interpretation
• Ratio greater than 2
recommended

• Track the trend and if

going down --make
changes
 Month’s Living Expenses Covered Ratio

• monetary assets
month’s living expenses

• This ratio tells you how many months living

expenses you can cover with your present
level of monetary assets.
Interpretation
• The rule of thumb: 3 to 6
months of expenses

• Factors that affect the rule of

thumb:
– Available credit cards or home
equity loans
– Potential for higher earnings on
less liquid accounts
– Stability of income

• Track the trend and if going

down--make changes
Question 2: Can You Meet Your Debt Obligations?

• Ratios to determine whether or not you can

meet current or long-term debt obligations:
– Debt ratio
– Long-term debt coverage ratio
 Debt Ratio
• total liabilities
total assets

• This ratio tells you whether you could payoff

all your liabilities if you liquidated all your
assets.
Interpretation
• Represents percentage
of assets financed with
borrowing

• Track the trend; ratio

should go down with
age
 Long-term Debt Coverage Ratio
• total income available for living expenses
total long-term debt payment (EMI)

• This ratio tells you how many times you

could make your debt payments with your
current income.
 Interpretation
• Ratio of 2.5 or greater
recommended

• Track the trend and if going

down -- make changes

• Consider the inverse --the

percentage of take-home pay
needed to repay debt
 Question 3: Are You Saving As Much As
You Think?

• Ratio to determine whether you are saving as

much of your income as you think.
– Savings ratio
 Savings Ratio
• income available for savings
income available for living expenses

• This ratio tells you what proportion of your

after-tax income is being saved.
 Interpretation
• Typically range between
40% to 65% including
savings for retirement,
children education,
insurance, EMI etc.

• Varies with stage of the

financial life cycle and
goals
Budgeting & Financial Planning
 What is Budgeting ?
• Budgeting is a process for tracking, planning,
and controlling the inflow and outflow of
income.
 How does the budgeting process work?

• The budgeting process begins with gathering the data that

makes up your financial history

• Next, you use this information to do a cash flow analysis. You

will calculate your net cash flow, which tells you whether cash
is coming in faster than it’s going out, or vice versa.

• Then you will determine your net worth. Having a snapshot of

your present financial situation, you’ll then define your financial
objectives and create a spending plan to achieve them. Finally,
you will periodically check your progress against the plan and
make adjustments as needed.
A budget can assist you in determining whether

• You are living within your income limits

• Your current spending patterns are
satisfactory
• You are saving and investing sufficient
amounts to satisfy your financial goals
• You need to make changes in order to satisfy
your financial goals
 Monthly Budget
• Monthly budget planner excel
.

A Budget Can be Drawn Up in

Six steps
 Step 1: Estimate Your Future Income

• Bonuses • Inheritance
• Business • Interest rate changes
upturn/downturn • Investment gains/losses
• Commissions and • Job promotion
royalties • Personal property sale
• Cost-of-living • Salary
adjustments increase/decrease
• Dividends • Change in tax bracket
• Gifts • Tax refunds
Step 2: Determine Your Expected Expenditures

• Review prior period expenses and determine

which will recur in the forthcoming period
• Determine what new expense items are
anticipated
• Estimate the amount of each expense for the
period
• Add individual estimated expenses to obtain
total estimated expenses
 Step 3: Determine Your Financial Goals

• Saving for an emergency fund

• Increasing savings and investments
• Buying a new car
• Paying off a loan
• Buying a house
• Saving to fund children’s education
• Providing retirement income
Prioritizing of Goals
 Step 4: Determine whether there is a
Surplus or a Deficit
• When projected income exceeds projected expenditures,
there will be additional amounts of cash, which can then be
added to savings/investment plans or used to pay down
liabilities

• When projected expenditures exceed projected income,

there is a deficit. This means additional amounts will have
to be withdrawn from savings/investment plans to pay for
these additional expenditures. In such a case, it may be
necessary to review projected expenditures and reduce
some of them, or look for ways to increase projected
income.
 Step 5: Record Actual Income and
Expenditures for the Period Budgeted

• Actual amounts earned and spent are not always the same as
those projected. By recording the actual amounts and
comparing them with the budgeted amounts, you can
immediately see the differences, called variances. Spending
more than a budgeted amount for one item can be offset by
spending less than the budgeted amount for another item

• Similarly, if actual income exceeds actual expenditures, there

is a surplus, which means additional cash. The opposite is a
deficit, which means that cash will have to be withdrawn
from cash savings or other assets in order to pay for the
deficit spending.
 Step 6: Evaluate Whether Changes in the
Budget Are Necessary

• If there are large variances, or your surplus/deficit is not what

you would like, you need to analyze your budget. Examine
the variances and study where the amounts spent are greater
than the budgeted amounts

• For example, if your actual phone bills are consistently

greater than the amounts budgeted, then you need to either
reduce your phone usage, if possible, or increase the amount
budgeted for this item.

• Remember Discretionary and non-discretionary expenses

 Exercise

1. Priti is a 30-year-old young professional. Her net salary is Rs.

50,000 pm. She is expecting a bonus of Rs. 30,000 in the next
6 months. Her car loan outflow is Rs. 6,000 pm. The rent is
Rs.15,000 pm. She spends on food and clothing Rs. 9,000 pm.
She invests all her surplus funds in retirement schemes, so far.
She invests Rs.10,000 pm on pension annuity fund. She wants
to save money to enjoy a holiday with her parents and take
them on a world tour. She will have to have Rs. 6 Lakhs for
this trip. She has monthly medical and miscellaneous
expenses for her parents to the tune of Rs. 5,000 pm. Her
salary is expected to go up by Rs. 5,000 net of tax, in 2
months time.
Prepare a budget for Priti.
Should she invest in any other instruments as well? What
could they be? Discuss.
 Exercise
Nitish is a 40year old, working with Elder Pharma Ltd. He lives with his wife,
child and elderly parent. In the year 2007-2008, he expects interest from his Fixed
Deposits to amount to Rs. 20,000. He has invested in mutual funds to the tune of
Rs. 2 Lakhs, the value of which all together is Rs. 2.5 Lakhs. He has received tax-
free dividends of Rs. 10,000, in the year. His agricultural income comes from the
land in his village. He received Rs. 1 Lakh this year as agricultural income. He is
quite generous with the people who look after his farm, and they are faithful
farmers who have been associated with his family for more than 40 years, now.
He lives in a self-occupied house, where the EMIs are Rs. 15,000 pm. His salary
is Rs. 8 Lakh pa. His monthly expenses to look after the house inclusive of
groceries, utility bills, car maintenance, and children’s education comes to Rs.
30,000 pm. Medicines and miscellaneous purchases come to approximately Rs.
10,000 pm. His insurance payment is Rs. 5,000 pm. He wants to set up an
emergency corpus of Rs. 2 Lakhs and set aside Rs. 10,000 pm as retirement funds.
There is an anticipated expense to cover the leakage in the house to the tune of Rs.
50,000. This leak has to be fixed before the monsoon begins, which is in another 2
months time.
Prepare a worksheet and analyze his expenditure pattern to determine if his
future goals can be achieved.
 Exercise
Naik, who is living in Mumbai decided to look into his finances one saturday
afternoon. He had not had a look at them in a long time for now. It was decided
that it was high time that he took out some time for stocktaking regularly. He
and his wife Renu, sat down to discuss and enumerate all their respective
responsibilities and priorities. Renu said that she had a family wedding coming
up and there were some gifts to be purchased on an immediate basis. Her
brother’s wedding was fixed up and she wanted to buy a gift worth Rs. 8,000 for
him.
Their son would require tuition fees to be paid to Aggrawal classes. Aggrawal
Classes charged Rs.20,000, a year which was due to be paid in 2 months time.
Mr. Naik had a commitment to pay EMIs for his home loan for which the
monthly outflow was to the tune of Rs. 12,000 pm. Looking at their long-term
plan, they wanted to save Rs. 5 Lakhs for their child’s education, Rs.8 Lakhs for
his wedding and Rs. 50 Lakhs as a corpus for their retirement. Mr. Naik is due
to retire in 5 years time. He earns Rs. 60,000 pm, after taxes.

Identify the short term and the long-term goals, their priority and the time
needed to fulfill the goals and their monthly cost. Determine if there is a surplus
Record Keeping and Financial Planning
 Record Keeping
• The three reasons for accurate record keeping
– Preparing taxes
– Tracking expenses
– Providing information for others to use in the
event of an emergency
 Record Keeping (cont’d)
• The two steps of record keeping
– Tracking your personal financial dealings
– Storing your financial records in an accessible
manner
 Ways to Track Expenditures
• Using checks and credit cards: Those expenditures
leave a paper trail

• Using cash: Record expenditures in a notebook or ledger

• Generating a monthly income and expense statement

• Using computer programs to track all financial

transactions

• Learning what and where to keep records

 Taxes
• Keep all tax-related receipts and records for 6
years.

• Always keep accurate tax records in the event

of an audit or tax department query.
Revisit: Time Value of Money

Time for Exercise on Estimating

your retirement needs and
savings for retirement
 Exercise-1
• If Mr. Ahuja who is 30 years old, is planning to invest for his post
retirement life. He is expecting his retirement at the age of 65
years and his life expectancy is 80 years. He requires Rs.
24,00,000 per years to meet his all expenses after retirement and
this amount is expected to go up due to average inflation rate of
5% p.a.. He can earn 7% p.a. on investments after retirement:

– How much he should invest every year from now till he retires?

– Expected rate of return is minimum12 % p.a. (SIP in HDFC Top 200

Fund)

– If he has savings potential of Rs 10,000 p.m. (Rs 120,000 p.a.), than

how much money p.a. he will get after retirement under same conditions
for meeting his expenses.
 Exercise-2
• Suresh is planning for funding higher education
of her daughter. His daughter is 7 years old and
she is expected to join higher education at the
age of 20 years. Present cost of higher education
is Rs. 20,00,000 and average inflation is 5% in
cost of higher education.

• How much he should invest every year so that he

can fund her education. On an average a equity
growth fund is expected to generate 12% p.a.
 Exercise-3
• Naina is 22 years old. She has recently started her work. Naina is
working with an educational institute and she has been trained to counsel
students. Day in and day out, she talks to young people about the careers
and goals and where they want to be in life. This set her thinking in terms
of her future. Her aspiration levels increased and she herself wanted to
study further. She knew her potential and she was getting educated on the
job market and her areas of interest. After doing the initial research, she
concluded that she wanted to study abroad. However, as is well known, a
22 year old doesn’t have a lot of money in her kitty. Also she knew that
her parents could not take the burden of such a loan. She decided that she
would need to plan for fulfilling this dream of hers. She calculated the
amount to be Rs. 15 Lakhs. She wanted to have saved up Rs. 15 Lakhs in
8 years time. The average market return is about 10%pa. How much
would she need to invest to get Rs. 15 Lakhs in 8 years? Also, if Naina
invests in yearly instalments rather than a one time proposition, how
much will she have to invest each year, so that she will have Rs. 15
Lakhs corpus at the end of 8 years at a 10% rate of return.