What is Fee only Financial Planning?

Fee-only financial planning in India is yet a very niche and undeveloped market. Most of the investors today prefer to invest through Banks or brokers. The challenge here is the lack of information and understanding amongst the investors.

Before getting into fee-only financial planning let us understand what is financial planning.

What is a financial plan?

One can easily understand a financial plan as an individual’s cash flow and budget. The financial plan comprises understanding one’s current earning, expenses and estimating future earnings and expenses.

It also involves investment whereas one understands the GOALS (both short and long term), estimates the amount required in the future (future value of the goal) and the provisions to be made in the present to account for those goals and make them achievable.

A financial plan is a very customized solution to investor’s varied needs (many a time even generic problems).

The biggest advantage of a comprehensive financial plan is to have clarity (in quantifiable terms) to understand the current situation of an investor and to achieve the financial GOALS, sometimes even helping in deciding a GOAL and prioritizing and having the vision to achieve them.

Various life stages of individuals in a financial plan (income, aggregation, retirement, and preservation) – 

Investor Psyche in various life stages of financial planning
Representation of Investor Psyche

 

 

 

 

 

 

 

 

 

As you can see in the pictorial representation there are various investment psyche that an investor goes through depending upon the market conditions.

So Mr. Smarty is an investor who knows it all and has been investing predominantly in real estate and fixed deposits. He had earlier invested in stocks during the 2005 era and when markets came down crashing in 2008 he suffered a heavy loss.

And being a smart investor as he is he decided to stay away from investments in the stock market or even mutual funds so that in the future he does not lose any money.

This is the classic case for most of the investor once they burn their hands in investments they tend to shy away from it even without understanding the risks and their requirements.

So what went wrong with Mr. Smarty?

The same is wrong with most investors as they fall prey to a typical investor psyche.

An investor psyche has the following phases –

1. Optimism

In this phase markets are moving upwards, sentiments are positive and everyone is gung ho about the markets.

 People are more than willing to participate and there is a feeling of losing out on such an upside movement hence liquidity is also high.

Investors often tend to overlook the risks involved and even tend to buy investments with higher value and costs.

2. Excitement

Things start moving to investors liking and they feel confident about the investments that they have done and are even willing to increase their investments.

3. Thrill

Now the markets tend to touch an all-time high. Everyone in the office in the family is talking about investments.

 The investor is confident about the decision that he has taken and is looking even to increase the investments.

4. Euphoria

This stage is marked by the maximum return to the investor, the investor feels happy and comfortable hence turns complacent and ignores the basic principles of investment and risks.

An investor is looking for making more and more money.

5. Anxiety

This is when the market tends to move southward and corrections start happening but since the investor has tasted returns he remains greedy and the long-term outlook on the market remains positive.

6. Denial

Markets continue to correct and investors now become a bit jittery.

The long-term view now turns to be medium-term but since he has already made the profits and seen the upside he is convinced that this is short-term and the tides will subside.

7. Fear

This is when the investor becomes confused.

He could have book some losses and get out of investments or he can put some additional money and average out the buying cost but investors don’t have any idea and keep on waiting in shock and hope.

8. Desperation and panic

The investor is clueless and feels that he has no control whatsoever and just surrenders to market conditions.

9.   Capitulation

Investors reach the breaking point and exit the market with losses (remember he could have done this earlier) to avoid bigger losses in the future.

10.   Despondency and depression

Now the investor has lost money and he turns negative about markets and doesn’t want to enter the markets again.

This period is the time of maximum opportunity. Few investors though analyze their mistakes and correct and become better and informed investors.

11. Hope

Now the investor understands the risks in the market and also the fact that the market undergoes various cycles.

12. Relief

The markets again move northwards and the earlier investments recover again and we see gains coming in the portfolio. Our faith is restored and the investor is more informed and can bear more risks.

13. Optimism

Markets are again going up, sentiments are positive and the long-term outlook is positive as well.

An informed investor who had experienced the above phase and has learned from the mistakes becomes more empowered and feels positive in this scenario.

Whereas the investor who is unaware and unguarded falls in the prey again.

Biasness in Investments –

Apart from facing these stages an investor often falls into various traps or biases while investing.

We have listed down those biases as follows –

1. Emotional bias

Often in investment one is driven by emotions to an extent that he or she develops a bias.

Like we used to believe that earth is flat until proven otherwise. Emotional biases include loss aversion, overconfidence, self-control, status quo.

2. Anchoring bias

This means an investor is relying too heavily on his bias and is holding to it (hence anchoring).

For example, one might feel a company XYZ is doing pretty well and hence investing in its stock will be a great idea which not necessarily might be true as it might be facing some challenges and unless it is well researched it is not advisable to invest.

But in this case, since the investor is holding on to his belief (anchored) hence is biased towards his viewpoint.

3. Overconfidence bias

Many a time investors are too confident or even overconfident and feel that they know exactly how things work and hence take the wrong decision.

Even when they receive a tip from some random sources they just believe and have a sense of misplaced confidence (read overconfidence) and make a decision without doing any proper research.

4. Loss aversion bias

Investors have more attachment towards loss than gains.

Suppose you invest in fund A and get Rs 20 gain over an investment of 100 whereas portfolio B has given 40 gain and 20 loss making it a net of 20 but still people are sadder in case of portfolio B as they see it as a loss of 20 instead of a gain of 20.

5. Confirmation bias

Investors tend to be attached to information that supports or confirms their existent biases.

For example, if an investor has received a tip from a friend and adviser and while researching for it he is often prone to look around the positives and overlook the negatives to support his bias.

How do I create my financial plan?

There is no hard and fast rule of creating a financial plan. We have enlisted a few simple steps towards creating one’s financial planning.

Steps of Financial Planning – 

1. Calculate net worth

Individual net worth is a summary of all the assets and liabilities one holds.

In simple terms Net worth = total assets – total liabilities.

A higher liability means a bigger burden.

Calculating net worth only on the individual level might not be sufficient. A similar calculation can be done on a household level as well (including all earning members) to understand the complete balance sheet of the household.

2. Determine current and future cash flows

The earning of the household is supposed to grow over some time and so is inflation (inflation will decrease the purchasing power)

Hence accounting for these factors while determining cash flow is very essential. A cash flow statement gives the idea of the expense and savings of the household and helps in understanding if there are any unwarranted spending or any discretionary expenses that can be easily controlled/curtailed.

3. Identify a goal /goals

This is the first and foremost step towards designing a process of constructing a portfolio and following a structured approach.

Not only one has to identify a goal, but also prioritize goals and quantify them

In my previous article, I have mentioned “S.M.A.R.T.” goals one can refer to that process for making a goal that is real, attainable, and quantified. An unknown goal would be like going on a long journey without any purpose.

An example of such a S.M.A.R.T. goal identification would be –

  Name Priority (1 being the highest) Time duration (years) The amount required (in crore)
Goal 1 Retirement 1 25 4.5
Goal 2 Son’s education 2 10 1.1
Goal 3 Daughter’s marriage 3 15 0.77
Goal 4 Leisure trip 4 5 .25

4. Prioritize Goals

The goal has to be prioritized in the order of their necessity for the investors.

In the above case, it is quite clear that for this particular investor Retirement is the biggest priority and has the longest duration as well as biggest in terms of value (4.5cr) whereas Goal 4 i.e. Leisure trip ranks lowest in terms of priority and the duration is less as well

5. Take care of expenses

Because of the above goals and have an investible surplus to deploy towards the goals– just by identifying a goal will not solve the purpose one needs to be disciplined enough to save for these goals and make them realistic and achievable.

For most of us, we have a limited source of income and unlimited expenditure (non-discretionary and discretionary).

As an investor one has to disciplined regarding his expenses, understand and bifurcate mandatory expenses, necessary and important expenses, unnecessary expenses, and expenses that need to be avoided.

6. Risk Profile

Once an investor has identified the goals and has an investible surplus allocated for the specific goals one very important thing is not to get carried away and start investing but rather one should try to understand the risk profile (risk-taking ability) of the investor.

Investing without understanding the risk profile could be detrimental towards the achievement of goals, as markets tend to be volatile, and if one doesn’t have the right understanding of the risk of the investments they might be perturbed by the volatility of their investments.

Just as investors can be risk profiled so can the products and it is very important to match the risk profile of the investors( in alignment with their goals) with the risk profile of the products to optimize one’s portfolio allocation towards specific goals.

For example a short term goal like buying a car in 3 years (conservative approach towards this goal should be ideal) if one invests in equity, it might be subject to high volatility and might even lead towards non-achievement of the goal (due to capital loss), hence one should be very diligent in understanding the risk-taking ability.

7. Mapping of savings to the identified goals

Once we have identified goals and are aware of the savings and risk profile, now is the time to map the savings to goals accordingly.

This mapping can be done keeping the overall risk profile of an investor in the picture or different goals that can demand different risk profiles as well.

For example in the table above if we assume the risk profile of the investor to be moderate the goal such as goal 1 (retirement) can take a slightly aggressive call keeping in mind that the duration to achieve the goal is quite high (25 years) and a small amount of risk will help in achieving the goal easily whereas for the goal 4 i.e. leisure trip he can take a bit conservative approach so as to negate the short term volatility.

8. Asset Allocation

Once the above steps are completed an important stage in the entire process is Asset Allocation.

This pertains to identifying the asset class where the money should be invested. The deployment could be done in Equity, debt, a combination of equity and debt, Real estate, or Gold as an asset class.

  Risk Averse Conservative Moderate Aggressive Very Aggressive
Equity -Large-cap NIL 20% 30% 50% 50%
Equity – Mid and small-cap NIL NIL 10% 15% 25%
Cash and Cash Equivalent 50% 20% 10% NIL NIL
Fixed income –ST 30% 30% 20% NIL NIL
Fixed income – LT 15% 25% 20% 15% NIL
Gold 5% 5% 5% 5% 5%
Alternate investment NIL NIL 5% 15% 20%

The table shows the various Asset allocation strategies depending upon the risk profiling of an investor. For a Risk-Averse investor, the ideal asset allocation should be 50% in cash and cash equivalent, 30% in fixed income (short term), 15%, and 5% in Fixed income (long term) and gold respectively.

Similarly, there are different allocation strategies for different risk profiles be it Conservative, Moderate, Aggressive, or Very Aggressive.

9. Execution

After doing the entire groundwork regarding goal identification and mapping of goals to savings and asset allocation it is important to identify a way to execute the transactions.

The investors have various options to do so, either they can take the help of any intermediary like bank, stockbrokers, independent financial advisors or even the asset management companies or they can go for a direct route and take direct options of mutual funds directly through the fund houses (yes! it saves cost and helps in attaining the goal early with the power of compounding).

Alternatively, investors can also opt for the DIY (Do It Yourself) approach wherein the investor is charged advisory fees and is advised to opt for direct mutual funds and proper financial planning is done.

10. Review

The job is not finished after executing the transactions, it has to be periodically reviewed for any underperformance or change in strategy or if any goal is approaching and they are any asset allocation that is required or even to book some profit depending on the investment strategy.

What is retirement planning?

Simply put the entire process of planning towards/for one’s retirement constitutes what is called retirement planning.

It is not a one-time phenomenon that you just execute and relax rather it’s an ongoing process that requires patience, diligence, and discipline.

Primarily retirement as a goal or retirement planning can be divided into two phases –

1. Pre-retirement

This phase of retirement has two subparts.

The first phase usually is during an individual’s early years of earning (25 to 40) wherein the primary objective of the investor is to understand, identify and prioritize the goals and provisions the savings to meet those goals.

The second stage of this phase is also a very important phase (40 to 60years) wherein the accumulated corpus is put to good use then and at the later stage the primary aim shifts to capital preservation (sometimes booking profits) and subsequently targeting to reach the amount as decided at the start.

2. Post-retirement

There are two important considerations here.

 Firstly, the amount of money that has been targeted earlier should be achieved and

Secondly, the amount that is at the disposal after retirement should be able to last the individual’s life (life expectancy has increased and hence it should be able to provide for the entire lifetime).

For most of the investor’s retirement is considered as a major goal both in terms of corpus required and the effort going towards it.

What separates retirement from other goals is that it does not end after one attains the retirement age but it provisions for the days after retirement till life.

Post-retirement time can be very unpredictable in terms of increased medical expenses, emergency needs, etc hence a prudent retirement plan is very critical.

Retirement planning also depends on various other factors such as if the individual has any loan (home/personal/car or business) and the loan repayment also needs to be taken into consideration.

Factors such as insurance of the household both life and health. What is the taxation of the individual and how to optimize the financial plan around that, if the estate planning is taken into account? A financial planner helps as a guide on the same.

Financial planning in India

How does online financial planning work in India – 

The online financial planning space in India is still evolving and so are investors. With lots of bloggers and websites related to investment and financial planning coming into the picture, information is readily available to investors and hence it apes the way for relevant information being easily available.

An online financial planning flow chart is can be understood in 6 simple steps –

1. Identify online service provider (ideally fee-only based financial planners)

2. Share personal financial data including assets, liabilities, cash flow, goals, etc

3. Have a detailed discussion with the service provider, check the credentials here

4. Finalize the comprehensive plan

5. Execute

6. Review

Free financial planning advice –

There are a few service providers who do free financial planning for a certain income group people (with less than the threshold yearly) but these options are very limited and income proof are required to support the claim.

The services remain the same but these services are aimed towards providing advice to those who cannot afford the fees. There are a few advisors who also do a presentation to a large crowd (ranging from 10 to 50 or 100 people) wherein for most of the crowd they charge upfront fees and for others it is free of cost.

Financial planning software –

There is much financial planning software available across the globe which is primarily used by corporate or financial services providers to be accessed by clients.

These are complex financial planning tools but in India as far as most financial planners are concerned even a complex excel sheet solves the same purpose.

Financial planning software provides a comprehensive solution wherein they guide the investor’s asset allocations, right funds.

Even this software will help in managing credit cards, account balances, home, car, and personal loans.

There are numerous easy-to-use applications (apps) as well which help investors in managing money and investments and help in the execution of the transaction as well.

Financial planning cost –

The industry of financial planning has evolved significantly in the past decade or so. With so much information available online investors are becoming aware day by day.

One thing that one as to be clear about is nothing is free in investment.

Any investment that you do in a mutual fund is charged in the form of expense ratio even though your banker might tell you that they are not charging anything upfront for it (he gets a commission out of all these sales), in fact, regular pans of the mutual fund have a higher cost associated with them and hence the higher expense ratio.

Whereas when one invests through the direct mode of investment (direct plans have a lesser expense ratio) the cost decreases significantly.

A fee-only financial planner (usually they are Certified Financial Planners, CFP) does not have any hidden agenda as they are not being compensated by any fund houses or product manufacturer and hence they are in alignment with the needs of the client.

What is a certified financial planner?

 FPSB (Financial Planning Standard Boards) India has been bestowed upon to conduct CFP (Certified Financial Planner) examination which is a coveted certification as far as financial planning is concerned. CFP certification is recognized in more than 25 countries worldwide.

CFP examination has a comprehensive syllabus covering in detail various aspects of financial planning such as Risk Analysis and Insurance Planning, Retirement Planning and Employee Benefits, Investment Planning, Tax, and Estate Planning, and Advanced Financial Planning covering all the aspects of financial planning.

A CFP certification provides a lot of credibility to the advisor. Most of the “fee-only” advisors in India are CFP certified (though it is not mandatory).

CFP covers the aspects of financial planning concepts in a very detailed manner and enables the advisor to impart those concepts and knowledge to the investors as well. These advisors are adept in using excel and financial planning tools and provide the right advice to investors.

CFP providing fee-only advisor has a fiduciary agreement wherein they have to declare if they have any conflict of interest in case they are promoting any other company products and such agreements prohibit them from doing so.

DIY (Do it yourself) –

These days there are quite a few alternatives available wherein an investor can do a DIY (Do It Yourself) financial planning.

A typical DIY solution providing service will consist of providing tools for your asset-liability, cash flow, goals, risk profiling, and all other such factors that will set you to create your financial planning.

The challenge, however, is that not all people have the interest and understanding to go through the excel sheets and that software to calculate and get to a conclusion.

It can sometimes be intimidating for normal investors who do not have the understanding, time or expertise to get into the nitty-gritty of this stuff.

It is always advisable to consult a financial planner in such a case. A fee-only financial advisor can also help in the same regard.

They provide the right piece of advice without being biased towards any product and advising what is right for an investor. A fee-only advisor will advise an investor to invest in the direct mode of investment wherein the expense ratio is less and hence the cost of investment is less as well.

FAQz 

How much money do I need when I retire? –

Ans – there is no right answer to this question but for a simple viewpoint let us understand how it works.

For a rough estimate there is a thumb rule wherein you should target a minimum of 25 times of annual income, for an investor with an annual income of 10lakh the retirement corpus should be approx 2.5cr and one can aim to increase this corpus as well this is called as 25 rule.

There is also a rule of 4% which suggests how much you can withdraw from your retirement corpus without eating out from the corpus itself. So in the same example, one can withdraw approx 10lakh per annum, and from next year that amount will be adjusted for inflation.

But there are other ways to calculate the retirement corpus needed. So you calculate your annual expense and the growth in salary till retirement and calculate the value of the same at a future date (future value) and provision for the same.

Another way is to estimate what money will be required if you are hypothetically retiring today and calculate the future value of the same and that becomes the retirement corpus.

How would financial planning help me? 

Ans – one of the benefits of financial planning is that it gives clarity about one’s financial condition which is net-worth, cash flow, goals, and the financial path towards achieving those goals.

Financial planning also provides an investor with the discipline and understanding of major life goals and enables them in achieving them.

A good financial planner also educates the investor and provides them with the right set of knowledge that can be used during the life of the investor.

When should I start a financial plan?

Ans – Now.

There is no right time for financial planning, in fact, the later it is done the tougher it becomes to achieve the goals.

Ideally, financial planning should happen as early as possible during an individual earning life.

Early planning helps in achieving the goals well in time and also enables one to place a concrete plan through which it can be achieved.