Financial Planning in Mutual Funds PDF

CHAPTER 4 FINANCIAL PLANNING IN MUTUAL FUND ********************** *****  FINANCIAL PLANNING  MEANING:- Financial planning is a holistic exercise to evaluate your current and future financial standing and thereby enabling you to achieve all your goals in a systematic manner. It cr...

CHAPTER 4 FINANCIAL PLANNING IN MUTUAL FUND ********************** *****  FINANCIAL PLANNING  MEANING:- Financial planning is a holistic exercise to evaluate your current and future financial standing and thereby enabling you to achieve all your goals in a systematic manner. It creates a road-map and equips you to meet all your life's expenses – both the expected and unexpected. Financial planning includes budgeting your expenses, investing in right assets, setting SMART goals, selecting right asset allocation, creating a retirement plan and more.  BENEFITS OR NEEDS OF FINANCIAL PLANNING  Ensuring Adequate Funds  Helps in Ensuring a Reasonable Balance Between Outflow & Inflow of Funds so that Stability is maintained.  Helps in making Growth and Expansion  It Reduces Uncertainties with regards to changing market trends which can be faced easily through enough funds.  Helps in Ensuring Stability and Profitability  STEPS IN FINANCIAL PLANNING 1) Determine Your Current Situation 2) Develop Financial Goals ( for extensive savings and investment programme for your future financial security) 3) Identify Alternative Courses of Action ( continue or expand or change the current situation) 4) Evaluate Alternatives ( Opportunities and Risks)  STEPS IN FINANCIAL PLANNING 5) Create & Implement a Financial Action Plan ( e.g.:- the services of an investment broker to purchase stocks, bonds or mutual funds OR the services of an insurance agent to purchase property insurance) 6) Re-evaluate & Revise your Plan ( its a dynamic process need to regularly assess financial decisions, accordingly adjustments will be there) LIFE CYCLE IN FINANCIAL PLANNING  STAGES 1) Childhood Stage:- Children's are dependents rather than earning members.  Pocket money, cash gifts and scholarships are potential sources of income.  Parents & seniors need to groom children to imbibe the virtue of savings, balance & prudence.  Values imbibed during this phase set the foundation of their life in future. LIFE CYCLE IN FINANCIAL PLANNING 2) Young Unmarried Stage:- The earning years starts here.  Need to get into the habit of savings.  Equity SIP & Whole Life Insurance Plans are great ways to motivate the young unmarried into the habit of regular savings. LIFE CYCLE IN FINANCIAL PLANNING 3) Young Married:- Depending on the jobs placed by both the couples or one should be the factor determining the various Life Insurance Policy or Term Policy & Medical Coverage should be planned.  Start savings regularly & invest in moderate risk, Long term instruments. E.g.:- SIP, Buy term insurance etc. LIFE CYCLE IN FINANCIAL PLANNING 4) Married with Young Children:- Insurance cover with mix of policies (Family Cover) would help the family to maintain their Life style in the event of any contingency.  Young Children Education need to be considered.  For these Adequate Investments are required.  Maintain Savings rate as high & Invest in Moderate Risk.  e.g.:- SIP, Property, Bonds etc. LIFE CYCLE IN FINANCIAL PLANNING 5) Married with older Children Stage:- For Helping the Children settle i.e. Cost of Housing , Marriage etc. investment in growth Assets like shares and Real Estate should be started early in life.  Maintain Savings Rate, Invest in Moderate Risk.  e.g.:- SIP, Property, Bonds etc. LIFE CYCLE IN FINANCIAL PLANNING 6) Pre-retirement Stage:- Children should have started earning and contributing to the Family expenses.  The Family ought to plan for their retirement What kind of Lifestyle to head & How those regular expenses will be met.  Security of Savings a priority, Invest in low risk, moderate return instruments.  e.g.:- Bonds, Fixed maturity period(FMP) plan of mutual fund etc. LIFE CYCLE IN FINANCIAL PLANNING 7) Retirement Stage:- Family should have Adequate Fund balance.  The Interest on the same which should help meet regular expenses.  The Principal Fund balance should be used only for Contingencies.  Availability of pension income will determine the fund requirement.  Security of Savings a priority, Invest in very low risk, low return instruments.  e.g.:- Short term Bond Funds.  WEALTH CYCLE IN FINANCIAL PLANNING STAGES 1) Accumulation stage:- At this stage, when investors are earning & have limited need for investment income.  They focus on saving & Accumulating wealth for the long term.  Equity Investment ( SIP) Preferred.  WEALTH CYCLE IN FINANCIAL PLANNING 2) Transition Stage:- At this stage, when financial goals are approaching, Investors still earn incomes but have also draw on their earnings.  For example:- House to be purchased, Children’s higher education/marriage approaching etc.  Investors increase the proportion of their portfolio in Liquid assets viz. money in Bank, Liquid scheme etc.  Investors choose Balanced portfolios that have both Debt & Equity.  WEALTH CYCLE IN FINANCIAL PLANNING 3) Inter-Generational Transfer:- During this phase , Investor starts thinking about orderly transfer of wealth to the next generation, in the event of death.  The Financial Planner can help the investor to understand various inheritance and Tax Issues, Help in preparing will and validating various documents & Structures related to assets and liabilities of the investor.  WEALTH CYCLE IN FINANCIAL PLANNING 4) Reaping Stage OR Distribution Stage:- When Investors need the income from their investment & can not save further, They Reap the benefits of their savings.  They prefer debt investments and preserving of capital at this stage.  RISK PROFILING MEANING: How much Risk one can tolerate? Which Depends on Risk taking Capacity:-  Income Stability  Wealth Accumulated  No. of Dependents  Goals  Investment Horizon (time to hold security). THEREFORE, Risk Profiling is The Evaluation Process to Find out Individuals willingness to take risk.  This process defines The risk tolerance level of the investor after taking into account the understanding & acceptability of risk in different situations of life.  IMPORTANCE OF RISK PROFILING  Helps in understanding level of risk involved in investments.  Helps in Suitable Asset Allocation:- Once an investor knows how much volatility they can handle, then only they can decide what Equity Allocation one should have & in what funds.  Helps Advisor in Proper Financial Planning:- A Good Advisor will determine a client’s emotional tolerance for risk, their Financial Capacity for risk and a  ASSET ALLOCATION  MEANING:- Asset Allocation refers to Distributing Investors Investible Surplus across asset classes such as Equity, Debt, Gold, Real Estate or even Holding cash for that matter.  Putting your money to work in best possible way is Asset Allocation. Cash  Asset Allocation depends Gol d 5% on Risk Profile Goals Investment Horizon. 5% Equity Real Estat e 40% 20% Debt 30%  BENEFITS OF PROPER ASSET ALLOCATION 1) Optimal Return:- Proper Asset Allocation will help Investor determine how much return they can expect on their investments on the basis of investment risk taking capacity. 2) Risk Minimization:- Learning from past experiences is good, it is significant to follow a proper asset allocation in order to achieve the financial goals. This helps in minimize risk on their investments. 3) Help Investments Align as per time Horizon:- Time Horizon will determine in which asset class to invest a major portion of the investible surplus & correct mix of Equity, Debt, Gold & Real Estate etc.  BENEFITS OF PROPER ASSET ALLOCATION 4) Minimize Taxes:- Proper Asset Allocation will not only help in determining the right asset class, but also the right investment product which will help to minimize taxes. 5) Adequate Liquidity:- Prudent Asset Allocation will make sure that you have sufficient liquidity to pay for the financial goals as & when required.  CONTINGENCY FUNDS An Individual may have a robust financial plan for his future but emergencies of unforeseen nature may come in without any prior warning. Therefore, one of the most important part of financial planning is the maintenance of Contingency Fund / Emergency Fund. IMPORTANCE OF MAINTAINING A CONTINGENCY FUND Emergencies in the form of an Accident , Death, Loss of Job, Loss in Business, Medical Conditions etc. can strike anyone at anytime. THEREFORE, Contingency Fund is very important to be kept aside.  So Returns are secondary and therefore one should make a sensible decision while building a contingency reserve.  In case of any urgency, Money should be Available for use within 24 to 48 Hours.  e.g.:- Cash in Bank, Fixed Deposits, Liquid Funds etc.  FEATURES OF CONTINGENCY FUNDS  Liquidity:- Since emergencies occur suddenly without prior notice, one can never know when one will need the money. Thus, liquidity is the most essential feature of a contingency fund.  Individual’s comfort level:- Contingency fund usually depends on the individual’s comfort level but the general rule is that it should be at least equal to Six months expenses.  Dependents & Earning members in a Family:- Contingency fund usually goes up KIND OF EXPENSES COVERED IN CONTINGENCY PLANNING 1) Household 2) Medical 3) Travel Expenses Expenses Expenses 4) Children Education 5) EMI on Expenses Loans 6) Any other Unavoidable Expenses  EXAMPLES ON CONTINGENCY FUNDS  EXAMPLE 1:- Ms. Riya is a Government Employee and has a very stable career. Her monthly expenses are: Household = ₹ 25000 Lifestyle = ₹ 10000 Medical = ₹ 5000 Children School Fees = ₹ 2500 EMI = ₹ 12500 How many months of contingency reserve should she maintain and what should be the amount of her contingency reserve ?  Answer:- Ms. Riya Should Maintain at least 6 months of contingency reserve amount i.e. Household = ₹ 25000 Lifestyle = ₹ 10000 Medical = ₹ 5000 Children School Fees = ₹ 2500 EMI = ₹ 12500 TOTAL = ₹ 55000 Therefore, for 6 months amount of contingency reserve = ₹ 55000 x 6 months = ₹ 330000. Since Ms. Riya has a very stable career & her job is quite secured being a government employee. 6 months of Contingency reserve should be sufficient to take care of her Emergencies.  EXAMPLE 2:-  EXAMPLE 2 Mr. John is an IT consultant and his career is highly dependent on India’s Economy. In a Booming economy his income doubles while in a weak economy , it is vulnerable. His monthly expenses are:- Households = ₹ 10000 Lifestyle = ₹ 5000 Medical = ₹ 15000 Travel = ₹ 10000 How many months of Contingency reserve should he maintain and what should be the amount of his Contingency reserve? Answer:-  Mr. John should maintain 2 years of Contingency Reserve amount i.e.:- Households = ₹ 10000 Lifestyle = ₹ 5000 Medical = ₹ 15000 Travel = ₹ 10000 TOTAL = ₹ 40000 Therefore, for 2 years i.e. for 24 months amount of Contingency Reserve = ₹ 40000 x 24 months = ₹ 960000. Since Mr. John income is highly uncertain and can also lead to low income in the case of a weak economy. He Requires to maintain 24 months of Contingency Reserve.  INVESTORS GUIDE TOWARDS FINANCIAL PLANNING 1) TOWARDS ELIGIBILITY FOR INVESTMENT 2) KYC ( Know Your IN MUTUAL FUND Customer)  1) TOWARDS ELIGIBILITY FOR INVESTMENT IN MUTUAL FUND  Indian Adult Individual Resident  Minor through Parent/ Guardian  Non- Resident Indian  Religious & Charitable trust  Partnership Firms  Karta of Hindu Undivided Family  Banks & Financial Institutions  Trustees, AMC or Sponsor etc.  2) KYC ( KNOW YOUR CUSTOMER) KNOW YOUR CUSTOMER (KYC) is the Process of a business Identifying & Verifying the identity of its clients. So KYC is for:- A.For Individuals:- An Individuals need to submit Identity of Address proof such as Voter’s ID, PAN CARD, AADHAR CARD etc. B. Micro SIP:- Does not require PAN CARD details because specially designed for weaker section of Society. This initiative helped poor people. C. KYC- Micro SIP:- In October 2011, SEBI Introduced New KYC norms & said that all financial transaction would  FUND CATEGORY GUIDANCE 1) Ultra Short Bond Fund 2) Short Term Bond Fund 3) Long Term Bond Fund  1) ULTRA SHORT BOND FUNDS  Invest only in Fixed Income Instruments  Maturities Around 1 year  Less Price Fluctuations  Greater Protection Against Interest Rate Risk  e.g.:- Franklin India Ultra Short Bond Fund  2) SHORT TERM BOND FUND  Invest exclusively in bonds with maturities of less than a few years  Maturity around above 1 year but less than Long Term Bond Fund Period  Return at Little Risk 3) LONG TERM BOND FUNDS  Invest in Bonds that mature in more than 10 years  e.g.:- UTI Dynamic Bond Fund- Direct, ICICI Prudential Long Term  FINANCIAL ADVISOR Financial Advisor is A Professional Expert in the Field of Finance who imparts Expertise opinion on various aspects of Investment to the Investor.  IMPORTANCE OF FINANCIAL ADVISOR 1) Professional Expertise & Experience 2) Develop a Model Portfolio:- For Short term or Long term Investment 3) Determining Asset Allocation:- He/ She guides the investor on Allocating Funds in various Investment avenues such as Equity, Debt, Bonds, Gold, Silver & Real estate etc. 4) Evaluating Investments:- Periodically evaluating the current investment portfolio. 5) Tax Planning 6) Selecting Appropriate Mutual Fund Scheme 7) Avoids Panic Selling:- His/ Her Expert Market Knowledge  DIFFERENCE BETWEEN ADVISOR & DISTRIBUTOR  Financial Advisor is A SEBI- REGISTERED ADVISOR has to have a Certification of Financial Planning from either NISM( National Institute of Securities Market) or any other recognized Financial Planning Education Body. Whereas, Distributors need to clear a basic exam (conducted by NISM) that test their Knowledge of funds & investments.  Advisor charge a Fee from Investors. Whereas, Distributors get the certain  COLOUR CODING OF MUTUAL FUND PRODUCTS  BLUE COLOUR CODED BOX = LOW RISK  YELLOW COLOUR CODED BOX = MEDIUM RISK  WHITE BROWN COLOUR CODED BOX = HIGH RISK Whereas, SEBI Replaces Colour Codes for Mutual Fund with ‘Riskometer’ SEBI REPLACES COLOUR CODES FOR MUTUAL FUND WITH RISKOMETER RISKOMETER It Contains 5 Levels of Risk from Low to High 1st Low 2nd Moderately Low 3rd Moderate 4th Moderately High 5th High  BANK FIXED DEPOSIT VS MUTUAL FUND  RETURNS:- Bank FD offers fixed rate of returns over a period of time. Whereas, Mutual Fund does not guarantee Fixed Rate of Returns.  RISK:- Investment in Bank FD offers Risk free Return. Whereas, Investment in Mutual Fund are of Medium to High Risk.  BANK FIXED DEPOSIT VS MUTUAL FUND  PREMATURE WITHDRAWAL:- Premature Withdrawal of Bank FD may be allowed with a penalty. Whereas, Redemption of Mutual Funds before one year attracts exit load.  TAX:- Interest on FD is taxed as per Individual Slab Rates. Whereas, In Mutual Fund STCG or LTCG taxed as per Type of Fund & Period of Holding.  BANK FIXED DEPOSIT VS MUTUAL FUND  LIQUIDITY:- Bank FD is comparatively more Liquid. Whereas, Mutual Fund is comparatively Less Liquid.  SUITABILITY:- Bank FD’s are suitable for Investors with Low Risk Appetite. Whereas, Mutual Funds are suitable for investors having relatively Higher Risk Appetite.  MUTUAL FUND OPTIONS A) GROWTH OPTION B) DIVIDEND OPTION a) Dividend Payout b) Dividend Reinvestment Option Option  A) GROWTH OPTION  Growth option is for those investors who are looking for Capital Appreciation.  In Growth Option, The Profits Generated by the Mutual Fund Scheme are Invested back in the Fund. Hence it does not provide any payout.  B) DIVIDEND OPTION a) Dividend Payout Option:- In Dividend Payout Option, The Profits Generated by the Fund are periodically paid to the Investors in the form of Dividends. Investors who need Regular Income from the Investments should opt for Dividend Payout Option. b) Dividend Reinvestment Option:- In case of Dividend Reinvestment Option, The Investors Chooses to Reinvest the Dividend in the scheme.  MODEL PORTFOLIO  MEANING OF MODEL PORTFOLIO:- Model Portfolio is The Optimum Blending of Various Financial Instruments Keeping in mind the Objectives and Preferences of Investor.  Model Portfolio should consider factors such as Age of the Investor, Risk Appetite, time at hand to let the investment grow( Time Horizon), Need for money Immediate or Later and more importantly, The Purpose for making such an Investment.  STEP BY STEP APPROACH OF BUILDING MODEL PORTFOLIO STEP 1:- Define Financial Needs & Goals of Investors STEP 2:- Understanding the Available Investment Products Risk, Return, Liquidity & Maturity Profile. STEP 3:- Asset Allocations Appropriate Mix of Investments such as Equity, Debt, Gold, Real Estate or Cash Holding. STEP 4:- Suggesting Suitable Investments opportunities with each Asset Category. e.g.:- Equity Funds, Debt Funds, Balanced Funds, Tax Saving Funds etc.  PROCESS OF BUILDING MODEL PORTFOLIO 1ST STEP 2ND STEP PROCESS OF ELIMINATION PROCESS OF SELECTION  1ST STEP:- PROCESS OF ELIMINATION a) Define The Filtration Criteria ( Should look for consistent track record in the long run) b) Refrain from Investing in Schemes not suitable c) Limit the number of Funds in Portfolio ( guard against over- diversification) d) Avoid Duplication ( Choose the best in same category funds) e) Eliminate Inconsistent Performers  2ND STEP:- PROCESS OF SELECTION a) Select Across Market Caps ( Investors should have a mix of both Large Cap Funds – Large Capital Investment Company as well as Mid Cap Funds – Medium Capital Investment Company since both have their inherent strengths.) b) Select Across Investment Style ( well managed growth style which shows high growth & Value style Equity Funds which is undervalued temporarily but have the potential to achieve their fair value in the future.) c) Select Across Asset Class ( mix of equity & debt or a hybrid fund to be invested based on risk appetite, prudent approach etc. therefore, selection process must be based on research and Analysis.)