Introduction

To

Financial Planning

(Part of Wealth Management Training- WM Training 101)

Prepared by: Wealth Management Team

INTRODUCTION TO FINANCIAL PLANNING (PART OF WM 101 TRAINING) 1

 Table of Contents

1. Investment requirements...............................................................................................3
The sowing stage..................................................................................................................3
Accumulation stage..............................................................................................................3
Transitional stage.................................................................................................................4
Empty nesters.......................................................................................................................4
Harvesters............................................................................................................................4
Investment Planning Goals - The Key to a Bright Future...................................................5
How to Set Goals.............................................................................................................5
Define Your Time Horizon..............................................................................................5
The Right Amount to Invest............................................................................................6
The planning process...........................................................................................................6
Establishing a relationship with the wealth manager.......................................................7
Set measurable financial goals.........................................................................................7
Gathering client data........................................................................................................8
Produce a lifetime cash flow forecast..............................................................................8
Produce a financial plan...................................................................................................9
Developing financial planning recommendations.........................................................10
Risk tolerance.................................................................................................................11
Monitoring the financial plan.........................................................................................14

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1. Investment requirements

The investment requirements of a family keep changing over time. This is primarily because of
the adjustments that need to be made with different stages of life.

Though investing needs will differ depending on individuals and families, there are certain
investing patterns that are typical of certain ages and stages in one's life cycle.

Let us explore these life stages and what people should ideally be doing with their finances at that
time.

The sowing stage

Yes, you are in your mid-20s and have just received your first salary. To start thinking about
retirement right now does sound like a bit of a drag. But starting early allows you to save that little
bit more and with smaller amounts as well.

The ability to save at this stage is higher as you have little or no responsibilities. So, channelising
a part of your newfound cash flows into a retirement corpus is just ideal. Also, it is a big help at
the latter stages when the responsibilities are more.

Let us illustrate this with some numbers. If you started investing for your retirement at 25, and
plan to retire at 55, with a retirement corpus of Rs 3.5 crore (Rs 35 million), then if you start
saving at 25, you need to save Rs 8,772 per month till age 55 in a balanced portfolio.

This portfolio is expected to give you an average return of 12 per cent annually. If you start five
years later at 30, the monthly outgo for the same retirement corpus would be Rs 16,270.

Ideally use the systematic investment plan route in diversified equity mutual funds or even some
mid-cap funds. Since you are young, aggressive investments are possible.

Also, buy personal medical, accident, critical illness and disability insurance for support, in case
of any unfortunate incidents.

Accumulation stage

Upon marriage, consider adding term life risk cover policies for income protection. Also, start
planning for a house, if you need one. A housing loan at this juncture will be not a burden as
expenses are still not so high. Once you have children, expenses are sure to spiral.

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Also, this stage is initially marked with marriage and then with children. With children, you will
need to start investing towards their education and marriage as well. This is one of the most
financially challenging periods in one's life, since demand for expenses as well as need for
investment for various goals is at the highest point.

But you should take it up as a challenge and make it a point to invest towards all these goals.

With rising responsibilities comes the need to create a contingency fund. Ideally, you should have
6-12 months' expenses in a bank fixed deposit with overdraft facility or a liquid/short-term debt
fund. This helps a lot in meeting expenses in emergencies or while shifting jobs.

The ideal investment avenue for children's goals would again be equity mutual funds. Look even
at children's plans offered by various mutual funds. For marriage purposes, start an SIP in a gold
exchange traded fund, which can be converted to physical format.

Transitional stage

In your forties, it is time to reassess your financial goals as your children are older and you are
also approaching old age. If you have diligently done the above in the earlier years then there is a
lot of breathing space and you should be in a position to review your goals upwards. For instance,
you may want foreign education for your children, a bigger flat at a better location and so on and
so forth.

Empty nesters

As you approach 50, the situation could have taken a dramatic turn. The children might have left
to complete their higher education elsewhere. And to fund this, you would have started drawing
out from their education corpus.

Since investment for children's education goals have ceased, you can use the extra sum to retire
any existing loans. Moreover, this an opportune time to take a final call on your retirement plans
and other goals post-retirement.

Harvesters

You have retired now. And there are three important things that you need to keep in mind; regular
income, capital protection and liquidity.

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Accordingly, put a large part of your retirement corpus into fixed income instruments, like senior
citizens' savings scheme, bank fixed deposits or fixed maturity plans of mutual funds. If you want
an equity exposure, it should be marginal, through monthly income plans or balanced funds.

If these investments are leading to taxation, you may also think of investing in debt schemes or
FMPs (Fixed Maturity Plans) with indexation benefits, to lower your tax burden. Another suitable
avenue to park part of one's retirement corpus would be to purchase property, which will provide
monthly rental income as well as capital appreciation.

As you can see there are different plans that one needs to put at different times in your life cycle.
Start investing now for great results.

Investment Planning Goals - The Key to a Bright Future

So, you have investments. That means you are ready for retirement, or college funding, right?
Wrong! Without proper investment planning, your investments could be doing nothing for your
financial future. Everyone with investments should seek investment planning counsel to help
them set their investment goals.
Here are some things to consider when planning for your financial future.

How to Set Goals

The key to your investment plan is going to be the goals you set. These goals define what you
have planned for the future. The goals should be specific, and detailed. Put in dates as to when
you want to have the money available. Decide how much money you intend to provide towards
your child's college education. Once you have decided on your goals, you need to write them
down. Having a written record of your goals is going to help you prioritize them, and having your
investments' priority plan in hand is essential.

Define Your Time Horizon

A key step in investment planning is defining the time horizon, or the length of time you have to
work on your investment goals. This is particularly crucial to retirement investment planning. You
must decide when you want to open up your investments and use them. This tells you how
aggressive you need to be in your investment portfolio. It helps you define the length of time you
have to work towards your goal.

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The Right Amount to Invest

Many people think that they have to invest a large lump sum in their retirement fund. While this is
not always a bad way to invest, it is not always necessary. You can invest by putting away a
smaller amount in a systematic manner. The key to doing this right is having your goals in sight.

What you are going to do is decide how much you need to invest on either a monthly or annual
basis in order to meet your goal. Be sure that you consider your other bills when doing this, so
that you do not have the temptation to quit your investment plan.

Look for situations where you can invest a little more. Perhaps you receive a large bonus from
your boss at work. Consider investing this, rather than spending it. Consider signing up for
automatic withdrawals into your investment portfolio. This will force you to invest, even when a
new toy or gadget seems to call out to you.

The planning process

Whether the financial planning process is a success or not is as much your responsibility as that
of your wealth manager. The management of your wealth will also not be a success without a
comprehensive planning process. Before beginning the planning process, it is important to
remember you will probably require more than one wealth manager.

The more complex your wealth management needs, the greater the number of practitioners that
you may need to consult. It is recommended that you appoint one practitioner as the lead wealth
manager who can act as a co-coordinator and oversee the process on your behalf. He or she
should ensure other wealth managers are complying with your requirements. It is essential that
the different advisers you consult speak to one another and work together in your best interests.
This will not be effective if they do not co-operate and try to do each other’s work, such as the
accountant trying to manage your investment portfolio or the financial adviser trying to structure
trusts. Most experienced wealth managers will be able to consult other professional advisers on
your behalf.
As part of the financial planning process, there are a number of steps that should be taken.

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Establishing a relationship with the wealth manager

The wealth manager should explain the services he or she will provide and the extent and limits
of his responsibilities. Particularly important is establishing the services that the wealth manager
will not advise on. Wealth managers tend to be better at telling their clients what they can do
rather than what they cannot offer. This should involve agreement on how the wealth manager
will be paid and the way in which fees will be calculated. Part of the discussion should focus on
how long the relationship will last and how decisions about your finances will be made.

Set measurable financial goals

You should set targets of what you want to achieve and when you want to achieve these
objectives. These targets should be measurable so you know when you have achieved them. For
example, instead of saying you want to be comfortable in retirement, set specific targets, such as
an index linked annual income of £50,000.
In drawing up your goals, do not neglect insurance (notably life and critical illness insurance as
well as income protection) and a reserve of money for emergencies. There is little point in saving
for retirement if you have not retained sufficient money to cover unexpected events, such as
medical emergencies or periods without income.
Your objectives will comprise short and long-term goals and you will need to prioritise them
according to their importance.

Objectives can be hard to evaluate and plan for. As an example, you need to decide how much
money you want to set aside for emergencies. Should it be three months’ income, six months’ or
even a year’s income? This decision will be influenced by your level of income, other assets you
own and the amount of risk you want to take with your financial affairs. An objective that is
common to everyone is to achieve sufficient income for retirement.

The other set of objectives you have will fall in between those required to meet unexpected
events and retirement planning. It will be possible to identify these objectives and know you want
to achieve them before retirement, such as saving for your children’s education, weddings and
luxury items including expensive cars. You will need to prioritize these objectives, put a monetary
value on them and a timeframe by when you would like to achieve them.

A challenge, as well as a benefit, is the greater life expectancy people now enjoy. This means
there are generally more generations around to use capital and a greater strain on the use of

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capital by the older generation who may have stopped work. They may suffer ill health and thus
require expensive care and may not pass wealth down to the next generation as before.

Gathering client data

The next step is to accumulate information on your personal and financial affairs.
Personal information will include your age, the age of your wife or husband, how many children
you have, when you want to retire as well as information to help to estimate your life expectancy.
Financial information will include data on your income, existing investment portfolio, savings,
other assets and liabilities, including everyday expenditure and long-term commitments, such as
school fees. Investments should be broken down into asset classes so that projections for future
returns can be made. You should also include insurance in this analysis, notably whether you
have cover for loss of income and critical illness.

Produce a lifetime cash flow forecast

The wealth manager should draw up a cash flow forecast. This will be based, among other things,
on your current position in terms of assets and liabilities that were collected in the previous step,
as well as anticipated income and expenditure in the future.

A cash flow forecast is subject to a number of assumptions, such as future investment returns,
the rate of inflation and the projected increase in national wages. This will help to evaluate exactly
how much income you will need in retirement, for example, by establishing future expenditure
requirements and assets. It will also help you and your wealth manager design an appropriate
asset allocation for your investment portfolio.

For example, you may only require investment returns of 4% a year to ensure you achieve your
stated goals. In reality, however, you may have a portfolio that is taking more risk than you
require as it has been constructed to try to achieve a return of 7% or 8% a year. Without a cash
flow analysis, it is difficult to evaluate how much life cover and income protection is needed to
protect you and your family adequately. Bespoke financial planning tells you what you require and
not the country’s average. A complete picture of your current and future finances will aid tax
planning as well. Cash flow analysis will also produce different scenarios to see how your
finances will be affected. For example, if you are ill for a few months and therefore not receiving
an income, a cash flow analysis will evaluate whether you have sufficient savings and how this
will impact on your lifetime objectives. These scenarios will suggest whether you need to save or
invest larger amounts of money or whether you should lower your expectations.

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Produce a financial plan

Once your objectives have been agreed, personal data gathered and a lifetime cash flow forecast
produced, a financial plan can be constructed to calculate the levels of savings and investment
return you will require to meet your objectives.

It is easier to structure a financial plan to achieve these goals if you set a time scale for attaining
them and a monetary figure so you know when they have been achieved. This may sound
obvious but is not always done. If you say you want to save money so you can afford to send
your children to private school, this is not sufficiently detailed information to help with drawing up
a financial plan. Examples
of the other information required include how many children will attend private school, when your
children will start school, how many years they are likely to spend at private school, the level of
school fees you will have to pay, your income, other expenditure and current savings.
You need to be specific even for retirement planning. How much is sufficient annual income in
retirement? This will vary from one person to another and may change the nearer you get to
retirement. How can you draw up a financial plan if you do not know how much money you are
trying to save and the returns you need to generate from your investment portfolio? In this case,
the first step is to decide how much income you will need in retirement and at what age you would
like to stop work and then work backwards from there. If you want £40,000 a year at today’s
levels of interest rates you will need a savings pot of more than £1 million by the time you retire.
Of course, you will need to take account of inflation eroding the real value of this pot if it grows
faster than the growth in your investments. By establishing that you will require more than £1
million by the time you retire, you can determine how much you will have to save each month
given your existing savings and the degree of investment risk you will be prepared to take to
achieve this objective by the age
at which you wish to retire. The other factor that you will need to consider is life expectancy.

It is hard to know how much money you need to save without knowing how long it will need to
last. Wealth managers have mortality tables that will indicate your age expectancy based on,
among other factors, your age, health, occupation and sex. It is best to expect, and hope, you will
live longer than the projected age.

The above example, however, is a simplified summary of retirement planning. This is

because you need to take account of your other goals as well. Each objective cannot be attained
in isolation. You need also to evaluate likely expenses in retirement, which can be separated into
different types. The first category is living expenses. In evaluating living expenses you need to

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take account of whether they will rise in line with inflation. Some expenses will rise faster than
inflation, some at a slower rate and others in parallel with the consumer price index. These
expenses will be with you for the whole of your life. Examples of expenses that have been rising
at a faster rate than inflation include the council tax, school fees and nursing care costs.

Other expenses have fixed lives and may not be linked to rises in the rate of inflation. Examples
of this include school fees and fixed rate mortgage. Your repayments may come to an end a few
years after you have retired or even before. Such fixed term expenses mean that you cannot
simply assume a rate of inflation of 2.5% a year, for example, to calculate how much income you
will need 10 years after retirement.

The last category of expenses comprises those that will rise with inflation but not last your whole
lifetime. Examples can include holidays, cars and weddings. As was said earlier, you will have
many different objectives in life that will have to be fulfilled over varying periods of time. It is
unlikely that you will be able to fund fully all of
these objectives at the same time. Therefore, you will have to prioritise your goals.
Drawing up your priorities is really your responsibility although your wealth manager should assist
you in explaining the consequences of your decisions. For example, if you decide not to send
your children to private school and insist on them funding their own university education then you
will have more money for a holiday home and retirement, as well as your emergency account.

Developing financial planning recommendations

A wealth manager should now be able to make recommendations of action on how you can
achieve your lifetime financial goals. He should discuss this with you and make revisions based
on any concerns you may have. Although you are paying the wealth manager to advise you, the
relationship should be a partnership so you understand and agree with any recommendations
before they are enacted. You should use the advice, experience and expertise of your wealth
manager but you are not obliged to implement his or her recommendations.

In drawing up recommendations based on the financial plan, much of the information we have
talked about will be considered to create, in effect, a balance sheet. The core aspects of the
implementation of the financial plan will be investment management, insurance, tax planning,
succession and estate planning, wealth protection and banking.

Prior to constructing an investment portfolio, however, two further steps need to be taken –
establishing your risk tolerance and an asset allocation. The asset allocation will be determined
by your objectives, the time frame you have set to achieve them and your risk tolerance.

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Remember that investments can be affected by unexpected events in the short term. These
include changes in investor sentiment and in the economy, such as new growth expectations and
rates of inflation and interest rates. The UK stock market can be impacted by events elsewhere in
the world, particularly in the US. The best recent example is the bear market in equities that
followed the bursting of the technology bubble at the beginning of 2000. This bear market lasted
for three years and led many stock markets to fall as much as 50%.

Risk tolerance

Risk tolerance is a key part of the wealth management process. Risk is hard to quantify as it is a
subjective measure. Ultimately, the level of risk you are prepared to take often comes down to
whether you can sleep at night without worrying about whether your portfolio is losing money.

The wealth manager can use a number of different methods to assess your risk tolerance and
help you to express your own view of risk. These can include personality tests and, more
typically, asking a series of questions. Among the more straightforward questions that may be
asked are what level of income do you need from your investment portfolio over the next five
years and how much capital are you prepared to lose during any 12-month period.

This will provide a guide to how much investment risk you are prepared to take. For
instance, if you are unprepared to lose more than 5% to 10% of your original capital over the next
year, this will limit your exposure to equity markets. This provides a quantitative assessment of
risk rather than simply describing you as low, medium or high risk.
Questions about how much capital you are prepared to lose should also cover different time
periods, such as one, five and 10 years for example.
There is more sophisticated questioning, however, that a wealth manager can undertake to
establish a more accurate risk profile. The wealth manager may ask you to rank statements in the
order of greatest concern to you. Here are four statements as an example and you are supposed
to say which one would worry you the most and rank the others in order.
1. Failing to achieve the investment return I targeted.
2. Achieving a positive investment return but one that is lower than the rate of inflation.
3. A sharp fall in the value of my investments over a one-year period.
4. A sharp fall in the value of my investments over a five-year period.
The wealth manager can drill down even further to try to ascertain your risk profile. One method is
to give you projected portfolio returns that provide an average expected return per year alongside
the range of returns this portfolio may produce every 12 months and the worst possible case
scenario with this portfolio.

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For example, a portfolio with an expected average annualised return of 6.5% may produce a
range of returns of -2% up to 13% every year with the possibility of producing a worse case
scenario of -4%. In comparison, a portfolio with an expected annualised average return of 9%
may produce an annualised range from -7% up to 24% with a worse case scenario of - 20%. The
range of returns possible is a reflection of the greater risk you are taking to produce a higher
expected annual return.

This exercise is trying to verify that for a 9% average return you are prepared to accept a
potential loss of 20% in any one year. You should be aware of the risks you are taking with your
investments. These include not only losses against the stock market but also the real value of
your assets if they do not increase in value as quickly as the rate of inflation. If your assets do not
grow and inflation is at a rate of 2.5%, your investments decline in real terms by more than 25%
over 10 years when the compound effect is included.

The degree of sophistication used during the question and answer session on risk tolerance will
vary from one wealth manager to another. Here is a list of questions that a wealth manager may
ask you before constructing an investment portfolio. This provides a guide to how comprehensive
this part of the wealth management process can be.

1) What is the value of your investment portfolio? What percentage of your total assets does this
represent?

2) Will you need income during the next five years from this portfolio? If yes, when will you need
income?

3) Will significant cash withdrawals be made over the next five years? When are these
withdrawals likely to be made and for how much are they likely to be?

4) For how long will the portfolio be invested? Will it be less than five years, between five and 10
years or more than 10 years?

5) How much of the portfolio can be put in assets that require a minimum investment period of
five years?

6) What annual average return do you hope to achieve from the portfolio? What annual average
real rate of return do you hope to achieve?

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7) Which of the following are the most important considerations to you? Rank them in order of
importance:
• Capital preservation
• Achieving a real rate of return
• Low volatility returns
• Regular income
• Growth
• Aggressive growth

8) Are there any asset classes you do not feel comfortable investing in? The list will include:
• Equity funds
• Shares
• Government fixed interest
• Corporate bonds
• Foreign fixed interest
• Emerging market debt
• Hedge funds
• Property
• Private equity
• Venture capital trusts
• Foreign currencies
• Commodities

9) If your investment portfolio enables you to achieve your long-term objectives over the time
period agreed, then over what length of time are you prepared to accept a substantial loss in
capital?
• Less than 12 months.
• Between one and two years.
• Between two and three years.
• More than three years.

10) As a follow on question to number 9, you may be asked whether you are prepared to alter
your objectives, increase your amount of savings or the length of time you will have to save if you
are only comfortable with market volatility of less than two years.

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The questionnaire should not be an end in itself in assessing your risk tolerance. It is to be used
to spark a discussion not only about risk but also about what you can expect to achieve from
wealth management.

Having ascertained your risk tolerance, your wealth manager can draw up an asset allocation and
select stocks and funds within your portfolio. Remember that wealth management is about more
than investments, retirement and tax planning. Wealth management should cover all your
financial affairs and help you to achieve all your financial objectives. This cannot be achieved just
by buying a portfolio of investment funds. Other issues include pensions, inheritance tax, banking
and planning for school fees.

Monitoring the financial plan

You are now ready to implement your financial plan. But once the financial plan has been
finalized, this is not the end of the process. In many ways, it is just the beginning. The plan needs
to be reviewed regularly to ensure it is still able to meet your expectations and at the right level of
risk.

Furthermore, your own financial and personal circumstances will change over time.
Potentially, this will alter both your objectives and your means of achieving them. For example,
you may receive an inheritance, your business may be acquired or you may be promoted and
thus receive a pay rise.

These developments may mean you upgrade or expand your objectives by deciding to buy
another car or a second holiday home. It may also enable you to retire five years earlier than you
originally planned for, reduce the amount you need to save for retirement or lessen the level of
investment risk you have to take to achieve your goals.

Your objectives may revolve around preserving your existing assets rather than trying to generate
future wealth. A key part of this planning will include structures to ensure wealth is passed on to
your beneficiaries, notably children and grandchildren, in the way you want and in a tax efficient
form.

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