In order to be precise, the financial planning process needs to be more investigative. Generic solutions are easy to offer and implement but do not serve the purpose of long-term planning
Financial planning is gradually emerging as one of the most important and talked about professions in the Indian finance space. Financial planners are mushrooming left, right and centre and with them different concepts of financial planning are also emerging. Some extremely innovating, some very stale and most of them looking like “cut, copy, paste”, which makes you surprised at the homogeneity of these concepts. Talk to financial planners across India or read their thoughts in various newspapers and magazines, you will come across some standard answers in different types of personal financial planning prepared by the financial planners. Sample of these standard prescriptions in financial planning are as follows: “Equity is a must in the portfolio”, “mutual funds help in sustainable wealth creation”, “keep cash in bank or liquid funds up to three months’ expenditure”, “gold is a good hedge against price rise but the exposure in gold should not exceed 10%”, etc.
Why is it that there is so much homogeneity in the recommendations made by financial planners? Are these indicators of bankruptcy of ideas or these recommendations are the need of hour? A closer investigation of issues in financial planning reveal that some questions are so difficult to answer that most of the financial planners try to avoid the real answer and adopt a rather conservative approach in order to be safe. The lack of ability to offer quality suggestions to their clients comes from two aspects: 1) Some issues are too hot to handle, and 2) Being extremely rational in the approach may reveal chinks in the armour and expose the limitations of the financial planning as an approach.
Read other articles on financial planning.
Let us look at some of the intriguing issues that the financial planning process involves which can be described as follows:
Portfolio return must beat inflation, but which inflation and how? The fact that portfolio return must beat inflation sounds very noble as an idea and logical at the face of it. If portfolio return does not beat inflation, the effective wealth creation does not happen. But this is easier said than done. Is it easy to identify the inflation that you want to beat? Is the inflation number measured by WPI (wholesale price index) or CPI (consumer price index) or is it some other number? Is the inflation having same impact for person having small income vis-à-vis a person having a fat source of income? Just dig deep into this aspect of financial planning. What are the assumptions considered by the financial planner in considering rate of inflation for a long period of twenty years when he recommends retirement planning to you? Also is the financial planner unnecessarily increasing risk exposure of your portfolio to beat inflation? Last but not the least, if the financial planning fails to beat inflation, what happens? What are the exigencies built into the process of financial planning to handle inflation?
Generally financial planners assume a rate of inflation and blindly apply it in the process of financial planning. But the complex question of inflation needs deeper analysis of the economy and economy-related events. Since very few financial planners have adequate knowledge about it, they try to be an escapist.
Read Financial planning: Choose carefully
Equities give return in long run which is better than all asset classes, but how long is long run? There is no doubt that one should invest in equities. Also, there is no doubt on the fact that equities generally outperform many asset classes by providing better returns. But some of the questions that remain unanswered are—what is long run in equity investment and what happens when equity fails to provide returns even during long run that we have seen post 2008 global recession? Since mutual funds are a recommended route of investment in equity for a retail investors, the obvious question that an individual needs to know is how to handle failed investments in mutual funds. Is blind reliance on mutual funds for investment requirements fine or there is a need for periodic review of the investments? The basic question that remains unanswered is how will an investor handle a mutual fund scheme which has failed to perform? Also what is long run in the investment indicating as to how long one should wait for mutual funds to perform? If JM Keynes is to be believed, we are all dead in the long run.
The experience of the last five years in the Indian equity market has shattered what was assumed during the 2003-2007 period. Debt has outperformed equity substantially barring some good mutual fund schemes and selected stocks. What should an investor do in such a scenario if it again happens in future? This again shows that blind reliance on equities in all scenarios can be fatal for sustainable wealth creation. Portfolio churning should be designed in such a way so that it is able to handle the dynamics of market. Also, there should be due consideration given to the co-relation factor before investment decisions are made and executed.
Read Financial Planning: Simplicity works best
Exposure to an asset classes depends on risk appetite or age: How much exposure an investor should take in an asset class? Should a 25-year old person with a low savings go for equity exposure or a person, in his early fifties, with a substantial income have more equity exposure? The question that remains unanswered is what decides my exposure—my risk appetite or my age? Ideally for a person who has lower income levels, exposure to equity should be restricted because he has not yet built a foundation for long-term wealth creation. While a person in his fifties with a healthy disposable income has a higher risk appetite and can go for equities in spite of the disadvantage of time on his side.
This shows that while deciding on exposure to any asset class, risk appetite of an investor cannot be ignored in spite of his age. So a generic prescription cannot be given for all categories of investors. Also, whether an investor should invest 10% of total corpus in gold or more cannot be standardized and will be decided based on ability to take risks.
In order to be precise in character the financial planning process needs to be more investigative. Generic solutions are easy to offer and implement but do not serve the purpose of long-term planning. In order to build a robust financial planning process, detailed homework is needed to be done these riddles.
(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)
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This means access to other articles (outside the subscription period) are not included.
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Meticulous Financial Planning cannot guarantee end results, nothing can - because we simply do not know what the future holds. Investment results (whether from debt or equity) vary way too much from the estimates / expectations at the time of undertaking investments.
Allocating money to gold has caught fancy currently because of the way gold prices have been appreciating in the past decade. 10% allocation to gold may sound intelligent; whether it is wise to allocate 10% to gold only time will tell, especially given the prevailing high prices. An average investor has no business to dabble (speculate) in gold
Returns from equity: It is a mistake to believe that ‘under all conditions‘, equities give better returns in the longer term.
Irrespective of the investor’s risk appetite, it is recommended to have reduced exposure to equities (not more than 25%).
a) in the higher ranges (peak) of the bull market. (There can never be case for zero exposure to equity as the markets could keep on rising till the euphoria lasts.)
b) And when low risk debt instruments offer 10% per annum or more.
Even the world’s best and most successful investors do not know how their investments will behave in the future. Successful investing is about controlling the controllable. You can't control what the market does, but you can control what you do in response. In the long run, your returns depend less on whether you pick good investments than on whether you are a good investor.
Thus, when it comes to financial planning, even specific solutions may not work well or may work only as well as generic solutions.
A generic solution of investing only for the long term (5 years or more), asset allocation and periodic re-balancing may work as well or better than a specific financial planning solution.