Q1. I am a 45-year-old working professional. I am the only earning member of my family. My spouse is a homemaker. We have one child, and my parents stay with us. How do I secure their future if something were to happen to me?
Financial planning is the perfect answer to your question. It is the integrated approach to achieving your financial goals with the help of an expert financial advisor. It takes care of important responsibilities like providing for insurance, children’s education, contingencies, etc.
Insurance planning: While helping you with your financial or retirement planning, your financial advisor will assess your life goals vis-à-vis your investments and decide if you have adequate insurance cover. This includes life insurance as well as health insurance. Required insurance coverage is determined by your current income, assets and expected expenses. Considering the rising cost of medical care, it is equally important to have sufficient health insurance cover for yourself, your spouse, your child, and your parents.
Children’s education: There are many plans available in the industry which focus on education and other goals for your children. Your financial planner can help you select and invest in a plan that is most beneficial to you. Some plans offer waiver of premiums should something happen to the insured, while the policy continues and the child will get the benefit, which may be a guaranteed sum or a market-linked yield, depending on the policy. Your advisor will also help with starting certain investments specifically for the benefit of the child—higher education, marriage, etc.
Contingency planning: You are obviously concerned about securing the future of your family, should something happen to you. For example, the family should have sufficient sum available to them while they wait for the insurance claim to be processed. Or, when the parents are old and do not have sufficient health insurance, emergency funds can help you take good care of their health when the need arises.
Estate planning: Few are aware of one important aspect of financial planning—estate planning or preparation of a will. This ensures a smooth handover of your assets to your loved ones, without any hassles, thus ensuring their financial security.
Q2. I am 40-year-old working woman. My husband and I recently got our financial planning done by a certified planner. Considering all aspects, and the fact that there are many investment avenues, how do I choose where to invest?
You are on the right track to secure your future when you get a certified planner to chalk out your financial growth path. With the many investment avenues available today, it can be a daunting task to choose the right options to meet your goals. While deciding, your planner will consider certain important factors.
Financial goals: Every investment is picked with a certain financial goal (or goals) in mind. If your goal is long-term wealth creation, you may prefer to invest a portion of the available funds in growth assets. If the goal is near-term, a stable asset would be a better choice. For medium-term goals, invest in products where funds would be available when you need those.
Time horizon: Now that your financial planning is done, you will have a clearer idea how much can be invested and when you are likely to need funds for various purposes. Depending upon your time horizon, you may choose from short-, medium- or long-term investments.
Essential liquidity: It is essential to maintain some liquidity in your portfolio. This will ensure easy access to funds to in case of an emergency.
Risk and return: Every investment option comes with a certain element of risk even as it offers some returns. Higher the risk, higher the return. Your financial advisor must have assessed your risk profile, or how much risk you are willing to take. This varies from person to person and even with age (or stage in life) in the same person. Your investment must be in accordance with your objectively assessed risk tolerance level.
Prudent diversification: After your risk profiling, your planner will suggest various asset classes so that you are able to generate optimum returns while staying within your risk tolerance level.
Countering inflation: Financial planning will consider expected inflation so that even with a general rise in costs, you are able to meet your life goals. Remember that as inflation increases, your purchasing power will decrease.
Your financial advisor will also suggest that you follow some important rules of prudent financial planning:
- Always invest in well-regulated markets and products.
- Make sure every investment aligns with your goals and risk profile.
- Evaluate your risk profile and your financial plan at regular intervals.
- Review and rebalance your portfolio regularly.
Q3. I am 26 years old and have recently started working with an MNC. My father introduced me to his financial advisor, and she has suggested that before investing, I must first do the exercise of risk profiling. Is it necessary? Why can’t I just start investing in the best performing products?
Risk profiling is the first and most important step in the process of financial planning and investing. Therefore, the Securities and Exchange Board of India (SEBI) has made risk profiling a compulsory regulatory requirement.
It is important to note that each investor has a different tolerance level to market volatility. The quantification of such risk tolerance is known as risk profiling. It is the process of evaluating the ability and the willingness of an individual to take risks. Risk profiling is important to determine the right asset allocation for any portfolio.
Every asset class—debt, equity, commodity, currency, etc.—has a different risk-return ratio. Risk profiling helps the financial advisor to ascertain the suitability of a product or asset class for the investor. It facilitates the right allocation to generate better returns, reduces risk and aligns the investments to meet the financial goals of the investor. Risk profiling also helps in defining the potential threats an investor will face, and in taking corrective measures to avert or minimize losses.
One usually invests in various instruments, keeping in mind a certain financial goal. Risk profiling helps in understand how much risk an investor is willing and able to take. Risk tolerance levels are evaluated through a review of an investor’s assets and liabilities. For example, the risk-bearing capacity of an individual with more assets and less liabilities would be higher than that of an individual with proportionately more liabilities. However, an advisor also needs to consider the willingness of an investor to take risks.
As an investor, knowing your risk profile can help you plan your investments as per your risk-bearing capacity. It helps to ascertain that even in the worst case, you do not end up losing more than what you can afford to. It ensures that you have the right product mix as well as the right balance between risk and rewards in the portfolio.
However, it is very important to note that your risk profile may change over time. Every major event or transition in your life (getting married, having a child, relocating, death of a close friend or family member, and so on) can change your risk profile. That is why it is important to assess your risk bearing capacity at regular intervals.
Q4. I am a working professional and have been investing for the last 15 years. I read in an article that financial planning and risk profiling are very important, and one should review the plan and the profile regularly. At what interval should both be reviewed?
Risk profiling and financial planning together help you determine the best investment avenues. It helps your financial advisor to provide you with a customised solution. It helps in diversifying your portfolio, instead of concentrating your investments in a particular class of investments. It helps in optimizing your overall returns on the portfolio.
Regular reviews are important because your risk profile and your life goals may change over time. You can rebalance your portfolio as and when required in accordance with your latest review. Any misalignment between the plan and the goal can spotted and rectified early. Moreover, reviews will bring in discipline in the way you manage your investments.
Different people have different opinions on when the reviews should be done. Ideally, risk profiling should be done at least once in 3 years, and financial planning review should be done annually. In between, if there is any major event in life, or a transition, the financial plan should be reviewed again.
Always remember to consult a Certified Financial Planner (CFP) to review your planning and risk profile. Similarly, in case of transitions, you can take help of a Certified Financial Transitionist (CeFT).
Note: This story is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.