11.1 Goal Oriented Financial Planning

11.1.1  What is financial planning?

Needs and Aspirations – A father wants his son to become a doctor. This is the need and aspiration of the man.

Financial Goal – Financial goal specifies the amount of money required to meet the needs and aspirations and the time horizon by which the money is needed.

Example – The man needs to spend and invest the following to finance his son’s education –

YearCurrent Cost of EducationInflation per yearFuture CostRegular SavingsShortfallInvestment to be made (Present value at 6%)
17,00,0008% p.a.7,56,0001,00,0006,56,0006,18,868
25,00,0006% p.a.5,72,4001,00,0004,72,4004,20,434
36,00,0006% p.a.7,28,0931,00,0006,28,0935,27,359
48,00,0005% p.a.1,019,3301,00,0009,19,3307,28,195

Column 2 – Cost of the yearly education expense in today’s terms.

Column 3 – Future Cost – Current cost multiplied by inflation per year.

Column 4 – The man estimates that he can save Rs. 1 Lakhs every year out of his income. This would help him meet part of the expenditure.

Column 5 – Shortfall is the amount of expense which he will not be able to meet with his regular savings.

Column 6 – How much he needs to invest to meet the shortfall. This is the present value calculated assuming investment is made with annual return of 6%.

Comparing the money required and the money available will give the shortfall, if any. A person could take loan to finance the extra money needed.

Financial Planning – A systematic approach to provide for financial goals so that people can realise their needs and aspirations

11.1.2  Measuring the Financial Goals

The questions that need to be asked while calculating financial goals –

  1. What will the value of expense if it was done today?
  2. When will the expense be incurred?
  3. How much will be the inflation?
  4. If the expense has to be made in foreign currency, what will be the impact of foreign exchange?

How to calculate Future Value in MS Excel?

Future Value = FV(rate, nper, pmt, [pv], [type])

rate = rate of inflation

nper = No. of years

pmt = expense per month

pv = cost in today’s terms

type = It represents the timing of payment i.e. at the beginning (denoted by 1) or at the end (denoted by 0). This may be omitted altogether.

11.1.3  Investment Horizon

Total length of time for which the investor needs to invest to meet his financial goal.

11.1.4  Assessing the funds required

The investor normally will be able to meet a part of the funds required from his regular savings each. An effort has to be made to find out how much more is required which should be invested today. To calculate how much money will be needed in the future factoring in inflation, use the following formula –

P = A × (1 + r)n

                P = Principal – Cost in present value terms

                A = Amount – Cost in future

                r = Rate of Inflation

                n = Time Period (in years)

11.1.5  Financial planning objectives and benefits


  • Financial planning ensures that the right amount of money is available at the right time to meet the financial goals.
  • Financial planning also tells the investor in advance if some financial goal is unlikely to be met because his earnings or savings might not be enough

Financial planning ensures that the investor takes the corrective action in a timely manner –

  1. Reviewing what is need and what is desire and if some desires can be postponed so that the most important needs are met first.
  2. Release capital by moving from a larger house to a smaller house or selling family jewellery.
  3. Increasing savings by reducing expense or taking up part time job
  4. Consider a loan to make up the shortfall.

11.1.6   Need for financial planners

Financial planners are needed because –

  1. Calculate Financial Goals – Most investors may not be organized to assess their needs in financial terms and may not be able to calculate how much money is needed to meet their financial goals.
  2. When and where to invest – Investors may not have the knowledge about all the financial products available and which is the most suitable for them.
  3. Loan – Financial planners can arrange the loan and have it structured, if a shortfall is detected.
  4. Taxation – Most investors are not experts in taxation and need guidance of financial planners.
  5. Contingencies – Financial planners can help investors plan for contingencies through insurance policies, inheritance mechanisms, etc.

11.2  Alternate Financial Planning approach - Comprehensive Financial Planning

So far the financial plan that was discussed was goal oriented financial plan. Another plan that can be developed is a “comprehensive financial plan”.

In this plan all the financial goals of a person are assessed together and then the investment strategies are developed.

In a “comprehensive financial plan”, all possible inflows and outflows are estimated including post-retirement living expenses.

Note: Important - 

Steps to create a comprehensive financial plan, as per Certified Financial Planner – Board of Standards (USA) are –

  1. Establishing and defining the client-planner relationship
  2. Gathering client data, including goals
  3. Analyzing and evaluating client’s financial status
  4. Developing and presenting financial planning recommendations and/or alternatives
  5. Implementing the financial planning recommendations
  6. Monitoring the financial planning recommendations

11.3  Life Cycle and Wealth Cycle approaches of Financial Planning

There are two ways to conduct financial planning – life cycle approach and wealth cycle approach.

In the life cycle approach, various stages of a person’s life cycle are discussed and what his expenses and income in each stage will be and accordingly make a financial plan.

In the wealth cycle approach, a person’s life is divided into stages on the basis of his earning potential and accordingly his investments are planned.

A.  Life cycle approach

  1. Childhood
  • Income is through pocket money, cash gifts, scholarship.
  • Children are dependent on parents so the money can be invested for long term in equity   
  1. Young Unmarried
  • Income is limited
  • Most of the goals are for medium and short term. People who want to get married or incur expenses like buying a car or starting a business should keep money in schemes which offer high liquidity.
  1. Young Married
  • If both spouses are earning, financial situation of a family is good. If only one spouse is earning, life insurance policy must be taken to plan for contingencies.
  • Health insurance policy must be taken while a person is healthy, and he is at the stage where he does not have to make a claim for a few years. This will prevent the insurance companies from rejecting future claims on account of pre-existing illness.
  • When health insurance policy is bought, it needs to be checked whether it is a cashless policy where the insurance company directly pays the hospital or the one where the policy holder claims reimbursement from the issuer
  1. Married with Young Children
  • Insurance needs increase on account of children.
  • Expenses are high because of education expenses.
  • Funds allocated to long term goals of college education and retirement should be invested in equity.
  • Funds allocated to medium term goals like house, car or foreign vacation should be invested in debt.
  1. Married with Older Children
  • Expenses related to setting up children increase – higher education, cost of housing, marriage.
  • At this stage the funds that have been accumulating for these specific goals are either spent or moved to more stable investments like debt.
  1. Pre-Retirement
  • Expenses should have reduced because children should have started earning and contributing to the family wealth.
  • Loans taken for education, car etc should have been repaid by this stage.
  1. Retirement
  • At this stage the family should have saved enough that the interest from investments should be sufficient to meet regular expense. The need to withdraw from capital should arise only in case of contingency.
  • Besides investment in debt, some portion of the money should be kept in equity as a safeguard against inflation.

B.  Wealth Cycle

The stages in wealth cycle are –

  1. Accumulation
  • Investor is building his wealth.
  • Covers the years from Young Unmarried to Pre-Retirement.
  1. Transition
  • This is the phase when financial goals have to be met. Payment has to be made to children’s higher education, marriage expenses, purchase of house.
  • Investors increase the proportion of portfolio in liquid assets like bank, liquid schemes.
  1. Inter-Generational Transfer
  • Investors plan for inter-generational transfer of wealth in the event of death.
  • Financial planners can help the investors with taxation, preparation of will and other inheritance mechanisms.
  1. Reaping/ Distribution
  • This stage is equivalent of retirement phase of Life Cycle approach.
  • In this stage, the investor needs money that has been accumulating. Investors start moving money from more volatile investments to safer and more liquid investments.
  1. Sudden Wealth
  • Sudden wealth can arise because of inheritance of wealth, winning a lottery, etc.
  • To prevent it being squandered away, the same should be invested. Where exactly should the funds be invested depends on the investor, but an approach that can be followed is to park the money initially in liquid schemes and then start an STP to equity.
  • Further, all of the money should not be put in equity. Even if the investor is willing to take high exposure to equity, funds should be transferred in tranches.

Quick Revision

[WATU 8]

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Categories: Education