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Financial Planning

Mutual funds and their importance in financial planning

  • Mutual funds – what & how?Money pooled from investors with common financial objectiveInvestment of the pooled money in financial assets – stocks, bonds, government securities etc – with the aim of booking income and capital growth Issue of ‘units’ to investors Sharing of gains/losses with unit holders
  • The Technique Pre-declared investment objective Pursuit of specific investment strategy Considers relative merit of each security/class of security Constantly examines portfolio’s strengths in the context of financial indicators, government policy, economic climate Mutual Funds and their importance in Financial Planning

 

  • Mutual Fund The Aim Ensure satisfaction of investors by meeting these prime goals:  Safety, protection and growth of capital Generation and provision of income  Each investor can use a combination of funds to create a customised portfolio to reach his/her goals Mutual Funds and their importance in Financial Planning
  • Mutual Fund Advantages Professional management of pooled investments, backed by research Instant diversification, even with a small amount of capital Convenience – ease of entry and exit Low cost investment vehicles Multiple investor-friendly choices – growth, dividend payout, dividend reinvestment Strict regulation by SEBI Transparency in reporting and compliance Mutual Funds and their importance in Financial Planning

 

  • Mutual Fund NAV Profitable investment activity leads to increase in worth of each unit, reflected in net asset value (NAV) Similarly unprofitable investments lead to a fall in worth of each unit NAV is net assets divided by number of units, expressed as a number Mutual Funds and their importance in Financial Planning
  • Mutual Fund Importance of NAV NAV rises when prices of investment held in a fund’s portfolio increase; it declines when prices fall For normal usage, NAV relates to per-unit price, applicable for a given day NAV is a common point of reference in investment circles Mutual Funds and their importance in Financial Planning

 

  • Mutual Fund A General Myth A fund with higher NAV is not necessarily worse than another with lower NAVComparing funds simply on the basis of NAV is not a prudent idea There are more scientific ways of comparing funds in the same category Mutual Funds and their importance in Financial Planning

 

  • Mutual Fund Suitable for Investors Money pooled from investors with common financial objective Investment of the pooled money in financial assets – stocks, bonds, government securities etc – with the aim of booking income and capital growth Issue of ‘units’ to investors Sharing of gains/losses with unit holders Mutual Funds and their importance in Financial Planning
  • Mutual Fund SIP as a Tool for Disciplined Growth of Capital Rupee Cost Averaging Even small investors can protect their investments from the vagaries of the market SIPs are an organised, regulated way of meeting the challenges of investing It is advisable to carry on SIPs over long term for maximising returns Mutual Funds and their importance in Financial Planning

 

  • Financial Planning – The Basics A process of meeting financial goals, backed by suitable investments Planning considers many factors to guide an individual towards realisation of objectives Requires complete and accurate risk profiling by a qualified financial plannerEach individual is unique. So each financial plan is unique as well Mutual Funds and their importance in Financial Planning

 

  • Financial Planning Assessment of Risk-taking CapabilityA detailed examination of specific risks is needed; even large macro risks must be analysed Exact considerations include the following: the individual’s age, investment horizon, present financial status, commitments, liabilities, income- generation capabilities, projected changes in income Mutual Funds and their importance in Financial Planning

 

  • Financial Planning Asset Allocation Asset allocation: how investments should be spread over various asset classesA reliable plan leads to accurate asset allocation A planner will recommend modifications in a client’s allocations when his life stage changes New commitments, liabilities, windfall profits, inheritances, medical crises will generally imply fresh allocation strategy Mutual Funds and their importance in Financial Planning

 

  • Financial Planning Asset Allocation through Mutual Funds Key questions: How much in debt funds? How much in equity funds? Younger investors can generally focus more on equity; this is more volatile. Debt is recommended for older investors; this is more predictable. However, there is no hard and fast rule!• Even within the same asset class, allocations must be done sensibly. Examples: How much in diversified growth funds? How much in sectoral funds? How much in international feeder funds? Mutual Funds and their importance in Financial Planning

 

  • Financial Planning Use of Mutual Funds for Retirement Planning Funds are suitable for those who wish to build a corpus for their years in retirement Apt for those who are planning to meet long term goals, keeping specific needs in mind SIPs done for long periods can withstand the impact of a fluctuating market Mutual Funds and their importance in Financial Planning

 

  • Financial Planning Use of Funds for meeting Short- and Long-term GoalsFunds can help an individual realise aspirations like:  Purchase of property Children’s education Marriage Commencement of a business enterprise• Travel• Repayment of loans Mutual Funds and their importance in Financial Planning

 

  • Financial Planning Two Critical Issues for Fund Investors The importance of understanding one’s time horizon The significance of backing each goal with the required financial commitment Mutual Funds and their importance in Financial Planning

 

  • Financial Planning A few tips from a Planner’s Desk Put money aside in liquid funds and fixed income funds with near-term maturity to meet exigencies like an imminent loan repayment Invest in conventional income funds and monthly income plans (MIPs) to derive regular income for meeting household expenses Invest in diversified multi-cap funds in order to build a corpus for acquiring real estate or spend on a world tour, perhaps a few years later Choose diversified growth funds to start SIPs for five, ten, fifteen years. This will be a disciplined, bit-by-bit investment programme aimed at retirement. Such an exercise may be started with low-cost, passively- managed index funds Mutual Funds and their importance in Financial Planning

 

  • Financial Planning Enabling Clients to Realise their GoalsA financial planner writes a plan and makesrecommendations. He also re-evaluates the plan from timeto time. He does the following: Sits with his client to gather data Take into account all factors, including life expectancy, inflation, tax laws, economic trends Assesses client’s risk profile Performs tasks related to goal setting, budgeting, asset allocation, investment planning, tax planning, retirement planning Mutual Funds and their importance in Financial Planning

 

  • Financial Planning Recommendations with regard to FundsWhen a planner has to recommend funds, he must knowtheir scope, nature and purpose. A particular fund may bechosen for the following reasons: Investment objective – whether this suits the client’s precise requirement Quality of the portfolio Past performance – this is the commonest yardstick. No guarantees for the future Promoters’ track record and standing Service standards Mutual Funds and their importance in Financial Planning

 

  • Financial Planning The Finest Funds will Make a Difference! Suitability of the products is the planner’s principal consideration Along with conventional products, there is a variety of ‘new’ funds available Exchange traded funds, gold exchange traded funds, international feeder funds, thematic funds and the like have further embellished the world of funds Mutual Funds and their importance in Financial Planning

 

  • Can Mutual Funds help in Tax Planning? Planners often recommend Equity Linked Savings Schemes (ELSS). These offer two advantages: tax savings and the potential to generate returns over their lock-in period of three years. Funds are generally said to be tax-efficient. The government has over the years taken a benign view of capital gains recorded by long-term investors as well as of dividends paid by funds*DTC proposes changes in tax laws

 

  • Enter Early, Invest RegularlyTwo mantras repeated constantly by all planners whorecommend funds:• The earlier the better – chances of optimising returns are stronger• Regularity of investment has no substituteThe moral: Short-term volatility is here to stay; so remain infunds for long periods

 

  • A Study of RisksMany risks threaten the modern-day investor. These frequently stemfrom: changes in government policy harsh economic and political swings decline in corporate profitability unfriendly interest rate high inflation high tax rates volatile market conditionsAlso, an investor may have to bear the impact of job-loss,divorce, ailment etc. A plan will fail if these risks are notconsidered as part of the big picture
  • Investors’ Risk-taking AbilityInvestors may be: Traditional (unadventurous) Restrained (reserved)• Hard-hitting (daring)An individual’s risk-taking ability will determine what sort offunds will suit himThe higher the risk, the greater is the chance of beingrewarded. Yet nothing is assured or guaranteed

 

  • An Eye on CostsA planner keeps a vigil on costs when it comes to recommendingmutual funds Certain costs are unavoidable, others are not. In some cases, operational inefficiencies add to a fund’s costs. This is reflected in expenses run up by the fund in question Frequent churning of fund holdings is best avoided as this adds to transaction costs Funds can be compared on the basis of their costs too A financial planner often looks at ‘net returns’ when comparing performances. He is concerned with an investments real return after all costs are deducted

 

  • Risks in the World of Mutual FundsNo investment is without some risk or other. Some fundsare riskier, others are relatively low-risk in nature. There arerisks even for an early starter and regular investor.Generally. Equity funds: High risk, high potential returns Debt funds: Low risk, stable returnsThe chances of risks impairing a mutual fund portfolio(leading to under-performance) will reduce if the rightstrategies are followed

 

  • Risks in the World of Mutual Ffunds Inflation Risk – the possibility that price increases will adversely impact a funds real inflation-adjusted returns Interest Rate Risk – the possibility that returns will decline as a result of changing interest rates Credit Risk – the possibility that a bond issuer will fail to repay interest and principal Exchange Rate Risk - the possibility that returns will be affected because of fluctuations in the value of the currency vis-à-vis another currency

 

  • Financial Planning Some Caveats for Mutual Fund Users A plan that recommends mutual funds is likely to fail if there is... Inadequate diversification Over- or under-allocation to a particular asset class• Poor portfolio quality because of wrong choices A common pitfall: Over-stated rewards, under- emphasised risks Mutual Funds and their importance in Financial Planning
  • Financial Planning The Rewards are WaitingA good financial plan, which guides the client towardsinvestment in the right mutual funds, will be able to: Spread his investments over the chosen funds in the most desired manner Derive the most optimum returns, leading to superior stability, protection, income generation or capital appreciation Meet the investor’s expectations, leading to fulfilment of aspirationsThus, a good plan strengthens the investor’s fortunes: hecan now meet his financial objectives according to thetimelines that are envisaged in the plan Mutual Funds and their importance in Financial Planning