Financial planning aims at ensuring that a household or individual has adequate income or resources to meet current and future expenses and needs. The regular income for a household or individual may come from sources such as profession, salary, business or even investments. The normal activities of a household or individual and the routine expenses are woven around the regular income and the time when this is received. However, there are other expenses that may also have to be met out of the available income.
The current income that is received must also provide for a time when there will be no or low income being generated, such as in the retirement period. There may be unexpected expenses which are not budgeted, such as a large medical expense, or there may be needs in the future that require a large sum of money, such as education of children or buying a home, all of which require adequate funds to be made available at the right time. A portion of the current income is therefore saved and applied to creating assets that will meet these requirements. Financial planning refers to the process of streamlining the income, expenses, assets and liabilities of the household or individual to take care of both current and future need for funds.
Example
Vikas is 40 years old and earns Rs.2 lakhs a month. He is able to save about Rs.40,000 a month after meeting all the routine expenses of his family, paying the loans for his house, car and other needs. His investments include those for tax savings, bank deposits, bonds and some mutual funds. He pays premiums on life insurance for himself and his wife. Vinod is the sole earning member of his family and he believes he takes care of his finances adequately to take care of his current and future needs. How would financial planning help him?
The following are a set of indicative issues that financial planning will help Vinod resolve:
As the sole earning member has he made provisions for taking care of his expenses by creating an emergency fund if his current income is interrupted for any reason?
Does he have adequate insurance cover which will take care of his family’s requirements in the event of his untimely demise?
Does the family have adequate health insurance cover so that any medical emergency does not use up all the accumulated savings?
What are his specific future expenses and how will he fund them?
If Vikas has to create a corpus to fund large expenses in the future, what is the size of the investment corpus he should build?
Given his current income and expenses is he saving enough to create the corpus required?
Will he have to cut back on his current expense or can he increase his current income so that his expenses in the present and the savings for the future are met?
What is the wealth Vikas has so far built from his savings and how can he best use it to meet his needs?
How should his saving be deployed? What kinds of investments are suitable for Vinod to build the required corpus?
How much of risk is Vikas willing and able to take with his investments? How would those risks be managed?
How should Vikas ensure that his savings and investments are aligned to changes in his income, expenses, future needs?
A formal treatment of the issues that Vinod faces will require a financial planning process to assess the current situation; identify the current and future needs; determine the savings required to meet those needs and put the savings to work so that the required funds are available to meet each need as planned.
Financial planning is thus a process that enables better management of the personal financial situation of a household or individual. It works primarily through the identification of key goals and putting in place an action plan to realign the finances to meet those goals. It is a holistic approach that considers the existing financial position, evaluates the future needs, puts a process to fund the needs and reviews the progress.
Understand the need for financial planning
There is a large range of financial products and services that are available for investors today and these need to be linked to the specific needs and situations of the client. Not every product may be suitable to every client; nor would a client be able to identify how to choose and use products and services from the choices that are available in the market. Financial planning bridges this gap as the Investment Adviser possesses the expertise to understand the dynamics of the products on the one hand and the needs of the client on the other. This makes them best suited to use such products and services in the interest of the client.
Role of the Financial Planner
The Financial Planner has a significant role to play when it comes to advising clients because the needs of each person is different front that of the other. The financial planner has to recognise the exact needs and goals of an individual and a household or family and then make efforts to ensure that these needs or goals are achieved. Personal financial management requires time and attention to recognize income and expense patterns, estimates of future goals, management of assets and liabilities, and review of the finances. Individuals do not have time to undertake all these detailed financial activities in a busy world and they need someone like a financial planner to focus on this area and help them in their efforts. It is not easy to set financial goals and this requires specific expertise and skill which may not be present with most individuals. Every financial goals requires finding a suitable product and a proper asset allocation to different asset classes so that this can be achieved, which is where the financial planner steps in. Selecting the right investment products, choosing the right service providers and managers, selecting insurance products, evaluating borrowing options and such other financial decisions may require extensive research. A financial planner has capabilities to compare, evaluate and analyse various products which enables making efficient choices from competing products. Asset allocation is a technical approach to managing money that requires evaluating asset classes and products for their risk and return features, aligning them to the investor’s financial goals, monitoring the current and expected performance of asset classes and modifying the weights to each asset in the investor’s portfolio periodically to reflect this. Financial planners with technical expertise enable professional management of assets. Financial planning is a dynamic process that requires attention to the constantly changing market and product performances and matching these with the dynamic changes in the needs and status of the client. This kind of attention can be provided by a financial planner.
How is financial planning different from a typical financial advisory service?
Financial planning requires following of a specific process wherein the client along with their overall needs and goals are at the core of everything being done. Other financial advisory services would normally look at meeting just a specific need like advising on stocks or debt but the relation with other aspects might be missing.
The financial planning effort is a comprehensive process as it covers all aspects of a client’s personal financial requirements including retirement, insurance, investment, estate and others. A typical financial advisory service is more likely to look at just a small part of the total financial requirements.
Goal setting becomes the central part of the financial planning process, and all efforts are then directed towards meeting the goals. Overall goals might not be given too much importance in a normal financial advisory activity, where some specific target is sought to be achieved.
Financial planning looks to ensure that all the financial activities are not at cross purposes with each other. As against this, a typical financial advisory service might not even realise that some steps suggested would be working against some other goal or requirement. For example, financial planning would ensure that the asset allocation for an older individual meets their risk-taking ability and that their equity exposure across asset classes is kept in check. This might not happen when normal advice is taken just for say equity mutual funds investment without knowing the equity exposure elsewhere.
Monitoring the situation and then taking action to ensure that things remain on track is a key part of the financial planning process. It is inbuilt to the entire effort, so this becomes a natural part of the activity. This might not happen with respect to a normal financial advisory where the individual might have to take the initiative themselves and see that things are going according to plan.
Financial planning looks to select what is right for an individual and this would differ from person to person. This takes into account both the returns as well as the risk which is vital. This might not happen for a normal financial advice, where the goal might be completely different like earning higher return and where risk might be ignored.
There has to be continuity in financial planning efforts which sets it apart from other financial advisory wherein this could be a short one-time exercise or even piecemeal efforts at different periods of time.
