23 May, 2011

Strategic & tactical considerations in financial planning

Financial Planners are misunderstood to be investment consultants, by many… not their mistake either – for many of them just call themselves Financial Planners, when all they do is offer investment advice. A proper financial plan would be a blueprint to achieve goals in one’s life, after a thorough assessment of one’s current financial position and future cash-flows. Analysing the income/ expenses, past investments, insurance, drawing up cash-flows etc., are a part of financial planning. While arriving at the optimum amount to invest and in which options, there are several strategic & tactical considerations before Financial Planners.

Asset allocation strategy – There are rules of thumb that are used to arrive at the appropriate asset allocation. That may not turn out right always, though it may be broadly right. A better alternative would be to come to an asset allocation that is suitable to the client concerned. Even, if the age and the station in life are the same, asset allocation being recommended can be significantly different based on the goals and when they are coming up, risk bearing capacity, years to retirement and other parameters.

Once the asset allocation is done broadly, we need to get into the allocations in each class. For instance, if Mutual Fund schemes & Equity has been recommended, it needs to be decided as to how much will be allocated to equity directly and how much through MF schemes. Equity shares have to be chosen so that they do not duplicate the holdings, done through Mutual Funds. The direct equity holdings should be in specific companies in which deep exposures are recommended. In others, exposures can be had based on their future potential. These may be small cap companies which are in promising industries and have the potential to become a multi-baggers, overtime.
As regards Mutual Funds, the allocation to Large, mid & small cap, sectoral, balanced, thematic funds etc. needs to be considered and fixed. After this is done, the candidates from each of these classifications can be chosen based on their long-term track record, their performance over the up and down cycles of the market, the portfolio churn , expense ratio, fund management style, fund manager credentials etc. Similarly, debt products also needs to be chosen based on the tenure, liquidity considerations, tax implications, net returns, risk profile of the product etc.

Liquidity management – This again is a very important aspect, which a financial planner would be concerned about. Generally, three months expenses are kept aside as a liquidity margin. Higher liquidity margin is suggested in case of irregular incomes. The expenses will certainly include any loan EMIs they are paying. It needs to be decided now as to where to keep this liquidity margin amount. Part of it will be in the Bank Account. How much we keep there, depends on whether there is a loan or otherwise – a higher amount is kept there if there is an EMI as we would not want any cheques to be dishonoured due to insufficient balance. Another option would be a sweep-in FD in the same bank, which would automatically be liquidated and come into the SB account, when a cheque is presented.

In other cases, we may also maintain a portion of the liquidity in Money manager funds. These funds give a higher return as compared to SB accounts. They are more tax efficient too if invested in dividend option. The other alternative is to set up an overdraft account, wherever possible. In this case, one could borrow to the extent of overdraft sanctioned and need to pay interest only for the period, for which the money is being borrowed.

Contingency Funds – Contingency funds may be required to be kept to tide over unknown situations. It may be required, for instance, if there were an elderly person who may require medical attention. Especially, if this person does not have medical cover, it becomes even more essential to have a contingency fund. In other cases, it is simply kept aside to tide over unknown situations – like medical requirements, unknown expenses which could pop up suddenly or other imponderables.

The place to keep aside contingency funds is in Fixed deposits of banks, Medium term debt funds or Hybrid Funds. A portion can also be in large cap MF schemes & balanced funds. A portion can also be in Flexi-deposits with banks. The prime consideration here is liquidity and the ability to access the funds at short notice.

For that reason, we would not suggest FMPs, NSCs etc., which are not really liquid.
Optimising longterm returns – When allocating funds, one of the considerations is to invest in instruments that give good post-tax returns. From that perspective, one needs to choose options which offer complete tax relief like equity shares or equity oriented MF schemes & PPF or choose other options where tax incidence is low. The long-term capital gains ( after 12 months ) in debt mutual funds is 10% without indexation or 20% with indexation. In case the investment is for a duration below 12 months, dividend option is beneficial as the dividend distribution tax is 14.16%. This is where these will score over the traditionally favoured investment destinations like FDs, Bonds, NSC etc.

Also, while putting money in insurance-based products, one needs to pay attention to taxation aspects. While it is true that while maturity proceeds of most insurance products in general are tax free, it is applicable for pension products. Only upto one-third of the corpus accumulated can be taken out tax free; the rest is taxable. Also, the annuities are taxable as income. Hence, care needs to be taken about which kinds of products one invests in.

It would be evident from the aforementioned points that one should take a 360 view while choosing between the various options, while deciding on the strategic and tactical options regarding one’s finances.

Article by Suresh Sadagopan; Published in Business Standard on 20/2/2011

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