Introduction to financial Planning

Introduction

Few people in India today really understand the importance of financial planning. While for many, financial planning begins and ends with collecting ULIPs (unit-linked insurance plans) and endowment plans without any rhyme or reason, there are others who simply associate financial planning with tax savings. Financial planning is not just about having good stock-picking skills, or identifying the right mutual fund schemes, or arming you with dozens of ULIPs. It is a holistic approach to managing your overall asset portfolio by taking care of every aspect of your life, including risk management, goal-setting and achievement, asset allocation, and retirement planning. The following are some of the aspects of financial planning:

 

Effective risk management:

A sound financial plan begins by identifying and covering all the potential risks that you are exposed to. These include life insurance, medical insurance, mortgage insurance, home and household insurance, automobile insurance, among others. Once these risks are appropriately covered, you will be emboldened to take on bigger risks in life. Clearly, this is one of the most important aspects in the financial planning process, and every sound financial planner should begin by ensuring appropriate coverage for you. Any failure to take necessary steps in this regard will raise your future risk-taking ability.

 

·         If you are a 25-year-old bachelor with dependent parents, then your life insurance needs will differ from that of a 40-year-old with dependent parents, wife and kids.

·         Similarly, if you fail to cover your dependent parents for medical insurance, then one major surgery is probably enough to blow a big hole in your pocket—something that you can ill-afford if you are serious about accumulating long-term wealth.

·         If you have a 20-year home loan, then taking out a mortgage redemption plan will ensure that the responsibility of paying the EMI does not fall on your dependents in the event of your untimely death. In a nutshell, coverage of one’s risks helps to preserve wealth and is one of the most crucial aspects of financial planning. Not having a financial plan in place could lead to unnecessary stress and hardship when one of life’s nasty surprises come visiting you. The result—you (or your dependents) may end up running from pillar-to-post borrowing money, and in the process, having your financial goals derailed.

 

Goal-setting and achievement:

The importance of financial planning is often underestimated. Planning ahead is about creating realistic financial goals that will facilitate financial independence in your life. A good financial planner should help you to articulate your short-term and long-term financial goals in life. So how does one go about achieving one’s financial goals? Well, to begin with, financial planners analyze your profile thoroughly based on your age, current income, monthly savings, current net-worth, number of dependents, and your short-term and long-term financial goals. Planners then do a post-mortem of your existing monthly savings and investments and tweak it accordingly so that you are on the right path to achieve your financial goals in a timely and convenient manner. Short-term goals like buying a car or taking an international vacation can be planned ahead through investments ranging from conservative fixed deposits that ensure wealth preservation to systematic investment plans in an equity or balanced mutual fund. The shorter the time horizon, the more conservative should be the portfolio mix to ensure capital preservation.

 

Long-term goals like your child’s higher education abroad should be planned ahead carefully for two reasons. One, because the amount involved is huge—an MBA education abroad costs nearly Rs20 lakhs today, but 20 years later, when your child is ready to enrol for an MBA, assuming inflation at 5% per annum, the value of the course will skyrocket to more than Rs50 lakhs. Long-term financial planning helps you to beat inflation and meet your financial goals comfortably. Planning ahead ensures that you pay all your bills on time and maintain your credit rating in good standing

Clearly, goal-based financial planning is the need of the hour in India. Unlike the developed countries, the concept of financial planning and wealth management is still at a nascent stage in the country. Given the lack of a well-defined and committed financial planning, the process of wealth management has been, at best, an ad hoc, haphazard process. Today, you can effectively use asset allocation to build long-term wealth and achieve your financial goals.

 

Appropriate asset allocation:

A sound financial plan should take Into consideration investment across asset classes, including stocks, Bonds, fixed deposits, gold, real estate, among others. As each asset class behaves and moves differently, the right asset allocation mix will help you to benefit from effective portfolio diversification. In fact, even among stocks, there should be meaningful allocation across sub-asset classes, such as large-cap, mid-cap or small-cap stocks or mutual funds, and the risks that each of these entail should be properly understood. Asset allocation is typically pre-defined and Differs for every individual depending on his overall risk profile, age, current income and networth, time horizon, financial goals, number of dependents, among others.

 

• A 30-year-old can have a greater proportion of stocks and equity funds in his portfolio compared to a portfolio of a 50-year-old. A high concentration of equity helps in long-term wealth maximization, especially if age is on your side.
• If you have a low tolerance for risk, then a high equity-based portfolio may not be the right thing even for a 35-year-old. On the other hand, if you are a 55-year-old with a high risk tolerance, you can still take aggressive bets on equity, although you need to ensure that You don’t violate your predefined asset allocation limits.
• Time horizon also plays an important role in the asset allocation process. The greater your time horizon, the more risks you can afford to take, and higher will be the potential return over the long term.

 

Asset allocation should not only be pre-defined, but it also must change from time to time. For instance, you can define an asset allocation for yourself that changes every five years (see Table 1). As and when you cross a particular threshold age, you should change your asset allocation mix accordingly.

 

No pre-defined asset allocation is complete without portfolio rebalancing.

This is a periodic procedure that allows you to rebalance your portfolio to the original pre-determined asset allocation mix. For instance, you are 50 years old with a pre-defi ned asset allocation of 50 : 30 : 20 into equity, debt and gold, respectively. Say, one year later, the stock market rises by 50%, whereas the returns on debt and gold remain stable. Accordingly, your asset allocation changes to 60 : 24 : 16. In such a scenario, you need to sell some of your stocks and buy more debt and gold to bring your investments back to the original mix. In other words, by selling (buying) stocks at higher (lower) levels, portfolio rebalancing helps you to buy low and sell high.

 

Retirement planning: Today, with life expectations going up, people must factor for nearly one-third of their lives to be spent post-retirement. That means you need to build a substantial nest egg to ensure that you can continue living with the same standards that you did just prior to retirement. In other words, by investing for the long term, you can let your money work for you to help you achieve your retirement goals. Today, a financial planner should be able to

guide you through the range of retirement products available in the market, including ULIPs, endowment plans, unit-linked pension plans, including the New Pension System (NPS) recently announced by the Government of India.

 

Importance of financial planning

• Financial planning is important for the following reasons: Through risk management, it ensures appropriate coverage that could vary depending on whether you are single and working (with or without dependents), newly married (with single or both spouses working), married with kids (dependent or financially independent children), or in the post-retirement phase. Risk coverage ensures that your financial goals are not derailed and your wealth is preserved over the long-term.
• Through goal-setting and the right asset allocation mix, you can ensure that your short-term and long-term financial goals are met.
• There are many who believe that financial planning is only for the wealthy and that those with limited income cannot indulge in financial planning because they don’t have anything to plan with. However, the real truth is that those with limited income need financial planning more than those with high disposable incomes.
• You may be earning a high income, but you may end up spending it all and some more. Similarly, you may earn limited income, but while you may be a careful spender, much of your earnings may be consumed towards debt servicing and living expenses. Financial planning ensures that you make the most out of your limited (or abundant) resources.

 

Conclusion

In a nutshell, financial planning helps you to deal with the impact of inflation, thus facilitating long-term goal achievement and retirement planning. Financial planning also allows you to maintain and upgrade your lifestyle, whether it is wealth preservation through appropriate risk coverage or wealth accumulation through the right asset allocation mix or comprehensive wealth management through a holistic approach towards determining the right risk-reward ratio on your overall portfolio.

 

Source: thefinapolis

 

Term Plan is The Best Plan

The primary objective of life insurance is to provide financial protection for your family in case of policy holder’s death. It helps you to ensure that your family and loved ones will have sufficient money to fulfill their needs in your absence also.  

Term plan is the pure form of life insurance or in other words we can tell that it is a pure risk cover plan in which the insured pays a lower premium for a higher sum assured. Term insurance is the cheapest among other forms of life insurance; it helps the policy holder to insure himself for a larger amount at a relatively low premium. As we mentioned earlier insurance is not a place to park your investments, the ultimate objective of insurance is to provide financial assistance to your family in your absence. Term plan helps you to cover your life with a very less premium, so that you can invest the major part of your savings in some other productive investments. If a person is return sensitive investor or he is looking for returns from his investments, term plans are not suitable for them. Most of the term plans doesn’t give any returns if nothing happens to the life insured. There are some plans it return the premiums paid if the individual survives the tenure.

 

Term plans are cheaper than other kinds of insurance because of their lean cost structure. In term plan’s premium only administration expenses and the mortality charges are covered. There is no savings element in the premium charged to the insured. As a result of this, if the insured were to survive the term of the plan, he gets no returns. In fact the premiums paid towards this plan are entirely written off if no eventuality occurs during the tenure of the plan. Only in case of an eventuality your nominee will receive the sum assured. At the same time if you are considering insurance as an investment you have to go with Endowment plans or ULIPs. But here the charges will be very high because these plans will impose allocation charge, fund management charge, etc. apart from the mortality charges and administration charges.

 

In life insurance terminology, endowment plans are referred to as ‘with-profits plans’. They cover the individual’s life in case of an eventuality; if he survives the term he receives the maturity amount. In the happening of the individual’s demise, his nominees receive the sum assured with accumulated profits/bonuses on investments. In case the individual survives the tenure, he receives the sum assured and accumulated profits/bonuses.

 

As a whole life Insurance is a powerful tool to cover your unforeseen risks that can affect your family in your absence. It also works as a saving instrument which can help you in planning for your children’s education, daughter’s marriage, pension, retirement benefits or for any other defined objectives. Factors you should consider before buying term insurance are: 

 

1.    Adequate Sum Assured.

2.    Rider benefits.

3.    Claim History of the company you are purchasing insurance.

4.    Competitive Pricing.

5.    Administrative Costs.

 

Types of Term Insurance policies

Term insurance policies can be classified into different types, some of the major categories of term insurance are listed below;

 

·         Single-premium term policies

·         Regular-premium term policies

·         Term policies with return of premium

·         Loan cover term insurance

 

Single-Premium Term Policies

Single Premium Term policies are those there you have to pay the premium in a lump sum amount. The policy will cover your life for a predefined term. This plan helps you to escape from the burden of paying the premium every year. Pay the premium once and forget, it will give you cover for a predefined term. Compared to regular premium plans the premium will be high in this plan because you are paying money only once where as in regular premium plan you will be paying the premium every year.

 

Regular-Premium Term Plans

Regular-Premium Term Plans offers you the option to pay the premium on a yearly basis. If you don't want to make a huge one-time payment, go for this option. You will have to pay the premium every year till the end of the insurance term.

 

Term Policies with Return of Premium

Normally in Term plans, if the policy holder survives the policy term nothing will be returned to him. You will lose all the money that you have paid. But in this plan you get back all the premiums you paid. It could be with or without interest. Biggest advantage of this plan is if you survive the maturity, no money is lost. But you have to pay a heavy premium every year, it will be much more than the regular premium policies.  

 

Loan cover Term Insurance

This policy is meant for the people those who have taken home loans. The insurance amount will be equivalent to the outstanding loan amount. It gradually decreases, in the same proportion, as the loan amount is paid back. The premium here works just like the Equated Monthly Installment (EMI) of the home loan. It stays constant through the repayment period. This kind of policies assures the insured that, in an eventuality like death, his/her family will not be burdened with the repayment of heavy debt.

 

Advantages of Term Life Insurance over other Insurance

Term Life Insurance has the following advantages

 

·         Helps to Settle Loans

·         Flexible Duration

·         Inexpensive

·         Investment

·         Suitable for Satisfying Particular Requirements

 

Helps to Settle Loans

Loans are generally repayable over a period of years. When an insured takes a loan for car or house or other movable and immovable properties he is under the responsibility to repay it over a period of time. During such circumstances an insured can take a term loan in order to ensure that his dependents have sufficient cash to repay them in the event of his unexpected death in that period.

 

Flexible Duration

This is the only type of life insurance policy whereby an insured can insure his life for a period small duration like one year. This type of lenience will help the insured to properly plan and assign the sum required to make the payments. In the absence of such flexibility the insured will be enforced to oblige with the time limits set by the company for the respective policy.

 

Inexpensive

Even though term insurance premiums increase over a period of time they are still considered inexpensive when compared with other kinds of policy. Cheap term life insurance does not mean that the consumer will lose quality or benefits. This can help the customer even to save money in the initial stages which he/she normally pays in other policies. On the contrary when the premiums are increased the insured will be able to make use of the cash mounted up to pay the remaining premiums. In the meantime the earlier deposits would have earned interest as well. Therefore the customer will be able to obtain cheap life insurance quotes.

 

Investment

Compared to a whole life insurance policy, term life insurance policy costs are very cheaper. It helps you to invest your money in some other productive investments where you are invested.  This means that you can invest your money yourself instead of depending on the insurance company. Insurers are typically very conservative when investing your money, so by taking a term life insurance policy you can enjoy more freedom in choosing the investments.

 

Suitable for Satisfying Particular Requirements

Term insurance is not only useful for settling loans but also for others particular requirements. Suppose a person wants to build a house or fund his child's education in an expensive university he can place targets and invest in a term insurance for that particular period. This will help him to meet critical events which would have otherwise been very difficult.

Drawbacks of Term Life Insurance

Some of the disadvantages of term life insurance are as follows:

 

·         Premiums Increase with Age

·         Temporary Protection

 

Premiums Increase with Age

Term insurance policies require the insured to pay a lower amount in the beginning; as a person gets older he needs to pay a higher amount of premium. This will show to be a difficult task if the person is not able to allocate funds regularly. In addition the insured may have more commitments and some of them might be unexpected. Therefore the concept of cheap term life insurance seems to be a myth when a person is not able to meet the policy demands at this stage.

 

Temporary Protection

In a Term Plan the insured may not be able to enjoy permanent protection like a permanent life insurance policy. The insurance policy covers risks of death only during the specific term. This places the insured in a disadvantage because if he is not able to renew the policy and pay higher premiums he will lose the protection thereafter. The insurance company will not refund the money if the insurer does not die in that particular period.

 

This type of insurance is observed to be the best especially when it is not possible to allocate a huge sum but at the same time the customer is badly in need of insurance. There is no precise time for term insurance; it can be for a period of 1, 5, 10 or 15 and even 30 years. The insured has to choose that particular time which is convenient for him.

 

6 points to remember while choosing a Term Plan

Following are the points that you should keep in mind while selecting a Term Plan.

 

1.    First of all understand the concept of term insurance like what is means, how it works, what are the benefits, etc.  

 

2.    All term life insurance companies are not the same. Try to find out the financial strength of the company you are seeking to buy from.

 

3.    Compared to whole life insurance, term life insurance is very cheap. It is cheaper because it is designed to cover you only for a certain period of time.  If you want to cover your whole life, term life insurance is not suitable for you.

 

4.    Term Life Insurance is good if you want to cover your family and your home in the event of your death. If you have a home loan, you can purchase a term insurance policy for the amount of home loan. This ensures that you family will not lose their home, in case of your premature death.

 

5.    You should always prefer a guaranteed renewable policy, so that your coverage cannot be terminated if you have any kind of health problems in future. If you are purchasing a guaranteed renewable policy company has the responsibility to renew the policy after the predetermined term even if you are suffering from some health problems.

 

6.    Choose only convertible Policy

It is very important to remember that while choosing the term insurance you should make sure that the policies are convertible, so that you can switch to other plans later if needed. If you do not prefer the convertible policy, till the end of the policy term you should have to continue with the same Term plan, you won’t be having the option to switch to another plan.

Posted By - IndianMoney.com Research Team- On-06/08/09

 

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