The art of good financial planning

You must plan for your financial goals', 'We conduct a complete needs analysis and then give you solutions', 'Our method is superior' so on and so forth.

These lines are used as punch-lines by most financial product sellers while talking to you and posing as financial planning advisors. Goal planning is a far more complex exercise than you can possibly imagine.

In fact, it is the heart of financial planning. A good goal planning structure could give you a lot of control with your cash-flows and also an adequate bandwidth whereby you do not have to compromise now or in later years of your life.

Considering that you have many goals, lets talk about three goals that need to planned viz., down payment for purchasing a vehicle in two years, providing interior decoration to your house in say five years and planning for wedding of your child, in say 12 years.

In order to do good goal planning, the amounts for these goals would need to be defined now and a projection must be made (based on timeframe) for the future value of these goals by taking into consideration the inflation rate or rate of inflation pertinent to that goal in question.

For example, if you propose that you child should study in Australia perhaps you should look at the Australian rate of inflation rather than the Indian rate of inflation.

Now, as you can see that the time frame for each goal is different and planning would depend on your existing assets, i.e. monthly cash-flow available and the time that you have for achieving your goals. The time frame would be your starting point and that coupled with your cash-flow would dictate the rate of return that you need to earn on the goal in question.

Further, the rate of return would dictate the asset allocation i.e. how much money into risk instruments and how much into non-risk instruments and this then culminates to your risk profile for a goal in question.

Yes risk profile is different for each goal. Against this backdrop, how could you possibly have a single risk tolerance framework - the one that is determined by some questionnaire or very crudely put, you being asked by your advisor the level of risk you wish to take? It is the advisor who should advice on the level of risk needed for achieving each goal rather than you choosing it yourself. The purpose of planning is defeated if you choose a generic level of risk.

Once the goal planning is done and if you then feel that the level of risk is higher - you have three choices.

To take lower risk, you will have to have an increase in your cash-flow and that may not be possible as you suddenly cannot increase your income or change your job.

The next is to extend the time frame - but then that is again not necessarily possible with all goals, for example, you cannot say that your child will go to college about five years later when you have more cash.

The third is you will have to compromise on the quantum of the goal - but if you had to do that why would you do financial planning in the first case?

Now, from the goals mentioned above, if the goal was two years away perhaps the strategy for goal fulfilment would be biased toward low risk instruments typically generating lesser rate of return but then the contribution from your end would be much larger here.

Against this, the goal that is 12 years away perhaps the strategy for goal fulfilment would be biased toward high to very high risk instruments typically generating a much higher rate of return and then the contribution from your end would be much larger lower. That is how you can balance your cash-flows so that from what you have you are able to achieve all of your goals.

Remember different goals have a different rate of return and hence they would earn different rates of return. A generic risk level and thereby buying some products viz., unit linked insurance plan or mutual fund or life insurance would just not help.

It would do more harm in the long run and at that time there is a chance that you have to do fire-fighting to provide for the money, there is stress, assets have to be liquidated, some assets just cannot be liquidated as the maturity date is still away and in general the financial situation becomes a complete mess.

Like I said, a goal planning gives you adequate control of your finances and provides a lifetime of peace. If you are not at ease with your finances be sure you don't have goal planning or that the goal planning you have is just not effective.

The author, Kartik Jhaveri, is a Certified Financial Planner and a Chartered Wealth Manager. He may be reached at kartik@transcend-india.com.

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