1. Too many expenses and loans

Banking is a booming business in India as more and more people are continuously borrowing. At the same time, recovery agencies are also a booming business as more and more people default on their loans. Although India has traditionally had one of the best savings rates as compared to western nations, the same cannot be said of the next generation. Although most people today have a high and stable income as compared to the earlier generations, their expenses are equally high. One of the key reasons is that they have many expenses and loans. There are too many temptations today and all one needs to do is call a bank or financial institution for a personal loan. In this process of keeping up with the next iPad, gadget or car, many young people end up paying a substantial amount of their income towards EMIs.

Besides EMIs, insurance premiums and personal expenses eat into earnings quite quickly. I am sometimes surprised to see people with a seven-figure monthly salary finding it difficult to save. This is because they have major expenses such as penthouses, bungalows, yachts and so on. Since these are big-ticket items, servicing debt and maintaining these often result in a liquidity crunch even for affluent families with very high incomes.

Some people, especially business owners and professionals, take on loans because their accountants advise them to do so from a tax planning perspective. This is primarily to harness the advantages of depreciation and interest deduction. However, if taken ad-hoc without taking a holistic view of the family’s liquidity, present needs and future requirements, such decisions often put a family in cash flow problems.

2. Over-concentration in real estate

Although it sounds stereotypical, most people hoard real estate like there is no tomorrow. One reason is our love for real estate. Besides, there is an abundance of black money in the system and a lot of income in cash that can be comfortably cushioned in real estate investments. Additionally, people believe that not only is real estate insulated from market vagaries, but that it also gives stellar returns along with tax benefits. As a result, many people even borrow to invest in real estate and are leveraged [which means they take on debt].

Most Indians have completely forgotten the great Indian real estate crash of 1995 and the subsequent lull for several years until 2003 – 2004. This is a very dangerous strategy to adopt as it can prove to be lethal during real estate crashes, especially since real estate is an illiquid investment.

3. Inadequate insurance against death, disability, professional liability and loss of income

Most people buy life insurance as an investment. This is because there is a lot of emphasis on life insurance as a great tax saving tool and many people are enamoured with tax saving instruments. Besides most people are so busy with day-to-day activities, they often wake up between January and March every year to do something to save tax. Due to such ad-hoc purchases, they end up with a plethora of irrelevant policies.

What’s worse is that many pay high premiums for a very low cover. Despite paying high premiums, most people are under-insured when it comes to life insurance. There is no assessment of the actual financial risk their family will face, in case of their premature death, and most liabilities are not covered. At the same time, they have negligible or no critical illness cover, negligible disability cover, no income protection and no social security benefits. This area must be adequately addressed to ensure lifestyle maintenance, wealth creation and wealth protection.

4. Investments done in an ad-hoc fashion, due to time constraints

The portfolio of most people would probably look like this: more than 50 – 60 per cent in real estate investments, 30 – 40 per cent in debt [PPF, insurance policies, fixed deposits, bonds and post office], 5 – 10 per cent in cash [savings account, short term fixed deposits and cash], gold [primarily bought as jewellery] and very negligible equity.

Most people have just these investments: Real Estate, PPF, EPF [for employed people], gold and insurance policies.

Considering that people are getting busier by the day, financial planning takes a backseat. This is when people end up taking decisions based on advice of different sets of people [chartered accountant, colleagues, banks, real estate agents, family members, insurance agents and financial advisors]. There is no co-ordination between all the advice sought from these different sets of people and hence their actions are extremely haphazard in nature. Hence if you take a look at the finances of most people [even the most sophisticated], you will clearly see that it is a hodgepodge of products accumulated over time.

5. Lack of goal-setting and planning

“I take life as it comes. I don’t plan for it,” said a leading Bollywood actress. It’s very easy to say this but nothing meaningful can be achieved in life without setting goals and planning. Yes, life will happen as you plan and sometimes you will need to course-correct, but there are certainties in life that will happen. For e.g. death, retirement [everyone will grow old and will stop working or slow down at some point of time], paying taxes and so on.

I am appalled when people spend several months planning for their vacations or discuss as a family on the next car to be bought, but when it comes to financial planning and goal setting they say, “I will do it after a few months” or “I don’t have time right now.”

6. No written financial plan

Since there is no formal education in personal finance, most people do not understand the concepts of financial goal setting, cash-flow and debt management, insurance planning, asset allocation, maximisation of post-tax income, retirement and estate planning .

Their realisation of the importance of a financial plan is reactive rather than proactive, in that it is only when an event happens that they realise the need for a financial plan or the need to take a holistic view of their financial situation.

7. Myopic view of tax planning

Most people generally believe that the objective of tax planning is to minimise taxes and often do things that are not in their best interest. They take several loans, buy real estate and life insurance in an unplanned fashion and indulge in tricks to fool the taxmen such as showing limited income or a weak balance sheet with the only objective of not paying tax. However, the right goal of tax planning is to maximise post tax-income.

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When you combine these two factors, it means that women must save more of their take-home salary than men. So for men if the rule of thumb is that they must save at least 30 per cent of their take-home salary, for women this figure should be 50 per cent.

Women [by and large, according to experienced financial planners] also tend to be conservative in their investment approach. However, if they are to meet their retirement savings goal, then they must eschew the conservative approach and invest a large portion of their retirement corpus in equities [which are known to give higher returns over the long term]. In view of their longer life span, even after retirement women should not shift their entire corpus to debt. Some portion of their corpus must remain in equities so that it is able to fight inflation over 25 years or more of their retired lives.

If you anticipate an investment horizon of seven years, you could invest in balanced funds that invest 65 – 80 per cent of their corpus in equities

Before you begin investing

Prior to any savings to meet your long-term financial goals, you must pay off all your high-cost debts, such as personal loans and credit card debts. Having paid off your debts, get into the habit of paying credit card bills at the end of each month, instead of paying interest on revolving credit.

Establish a contingency fund. This should equal 3 – 6 months of your living expenses, including child’s education fee and cost of insurance premium. This fund is meant to take care of temporary layoffs, prolonged illness or an accident that leads to temporary disability. Keep the contingency money in a savings account or a liquid fund [from a mutual fund house] where it is easily accessible. Next, let us discuss how you can go about meeting some of your most important financial goals:

Starting a family

Now suppose that from the day a woman starts working, she starts saving for the time when she will take a break from her job to start a family. She believes that she has an investment horizon of five years. A risk-averse individual should put her savings for this goal in fixed deposits while a non-conservative investor might consider putting her money in debt mutual funds.

A woman who anticipates that she has an investment horizon of seven years could invest in balanced funds that invest 65 – 80 per cent of their corpus in equities. It has been seen that the probability of negative returns from equity declines dramatically if the investment horizon is at least seven years.

Avoid branded children’s products either from insurance companies or mutual funds

Investing for child’s education

Working women, especially single parents, should begin planning for their child’s future by buying term insurance. This will ensure that even in case of the parent’s untimely demise, the child’s education doesn’t suffer. Women, as mentioned earlier, at times tend to be over-cautious in their investments. Many of them invest 100 per cent in debt even for long-term goals such as child’s education [where the typical investment horizon is 18 – 21 years]. Remember that the cost of education in India has historically grown at a faster pace than a broad measure of inflation such as the Wholesale Price Index [WPI]. The only hope you have of meeting this goal is if you have a considerable portion of the education corpus invested in equities [75 – 80 per cent].

Conservative investors may opt for balanced funds with 65 per cent equity allocation. Remember that liquidity becomes a very important factor at the time your child starts college education: you will need money at the time of admission and then continuously for the next few years. It will not help if your money is locked up in illiquid instruments that will mature at a later date. Do keep this very important factor in mind when saving for your child’s education.

Avoid branded children’s products either from insurance companies or mutual funds. Instead invest in high-quality diversified equity funds from mutual fund houses [these typically get more attention from the fund manager than child plans because they have a larger corpus and hence earn the fund house more money].

Three years before you approach your goal, start shifting your savings from equities to debt, so that a sudden downturn in the markets does not affect your child’s prospects.

Investing for retirement

Investing for retirement is also a long-term goal where the investment horizon is of 25 years or more. Only by investing in equities will your portfolio be able to counter the ravages of inflation. Women who have an appetite for risk may opt for a 100 per cent equity portfolio. Those who are risk averse may opt for a mix of 75 per cent equities, 20 per cent debt and 5 per cent gold.

Active or passive funds

Those who use the services of a financial planner or know how to choose the right mutual funds may opt for active funds in their retirement portfolio. If you invest in them, monitor their performance. If a fund’s performance falters, switch to another with a sound long-term track record. If you don’t want the hassle of monitoring the performance of active funds, opt for an index fund which will give you returns in line with that of the benchmark index upon which it is based.

Allocation by market cap

Of the total equity portion of your retirement portfolio, allocate 70 – 75 per cent to large-cap or large- and mid-cap funds. 25 – 30 per cent may be allocated to mid- and small-cap funds.

Allocation to debt

In a long-term portfolio, such as for retirement, meet your debt allocation by investing in Employee Provident Fund [if you are employed] or Public Provident Fund [PPF, if you are self-employed] or both.

Allocation to gold

In a retirement portfolio 5 – 8 per cent may be allocated to gold. This will give greater stability to your portfolio and also enable it to fight inflation.

As your retirement approaches, shift your corpus from equity to debt, especially if the corpus is small-sized and a decline in the market will affect retirement income. Very large corpuses can weather market volatility [in the sense that if the corpus size declines from 80 crore to 60 crore, it will not affect the retiree’s lifestyle]. Even after retirement have at least 20 – 25 per cent of your retirement corpus in equities so that it can continue to fight inflation over the quarter century of your retired life.

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Most people today end up taking advice from several different people and hence end up with so many unnecessary and irrelevant products. Some people are completely fascinated or fixated by the gold or platinum tag their private bank allocates them. They believe that just because they are gold clients, they get the best and customised advice that is possible, and more importantly that their advice is free. I recently came across an intelligent person who said, “I am a Gold client of this bank. They have allocated a relationship manager specifically for my account. I am being taken care of on a regular basis. Besides, they don’t charge a fee and have given me a financial plan”.

When I saw the financial plan this gentleman had received, it was just a canned copy printed directly from a software. All the relationship manager had to do was sit for an hour with the person, tick off boxes spread over 6 – 8 pages and the financial plan was done. This gentleman was given a printout of this after 3 – 4 days to show some additional work was done and that was it.

There was no detailed analysis, no thought given to the overall financial goals and strategy, and no effort that was put in by the relationship manager to create a sound financial plan. There was nothing mentioned about what to do with existing insurance, investment and loans. There was no debt strategy, no estate planning exercise, and no real estate strategy. The ultimate objective was to sell some irrelevant unit-linked insurance plans and proprietary investments that were not required at all. I told him, “This is not a financial plan and this is not how you should be taking advice.”

What is then the correct way to get advice?

The correct approach is to create a comprehensive written strategy that would cover every aspect of personal finance for you. In short, there is a pressing need to take a holistic view of your overall situation. There should be one person or a team who takes stock of your cashflows, assets, liabilities, liquidity needs and helps you firm up your financial goals. What is the point of having several lakh earning 4 per cent when you are paying a loan with an interest cost of 16 per cent? What is the point of having several properties, if there are no inflows from them or there are severe negative cashflows for the properties? What is the point of having life insurance if you are severely under-insured despite paying huge premiums?

Just as an infection to your liver can spread across other key organs, similarly a decision in one area of finance impacts another and your overall financial situation. It is very important that people understand this and make prudent decisions.

The first and key decision that you must make is to select a good financial advisor. If you think you are capable enough of making money decisions on your own, great. Even then, a good financial advisor can prove effective and efficient in managing your overall finances. But, if you do strongly believe that you do not need any, then you should be able to spend enough time to understand several areas of personal finance, changing economic trends, products and options suitable for you. Finally, you should implement the strategies that you have devised for debt management, risk management and insurance, asset allocation and investments, tax planning, retirement planning and estate planning in a timely manner. For others who believe that they could benefit from sound financial advice, you must at least understand the basic parameters on how you would choose a financial advisor/planner.

How should you choose a Financial Advisor/Planner?

A lot of agents, financial distributors and banks try to call themselves financial advisors or planners. They generously also use the term financial planning/wealth management as and when it pleases them. Consumers are naturally confused about the various terminologies used and hence do not actually question what a particular designation means. If you ask a person whom he would go to advice for [of these two titles] given a choice, Certified Financial Advisor or Certified Senior Financial & Investment Specialist [CSFIS], 95 per cent of the time, he will opt for CSFIS. Incidentally, both these certifications are fake.

I was talking to a journalist friend the other day and he asked me what questions a person should ask a financial planner. I told him that more than the person asking the financial planner, what is far more important is the questions the financial planner asks you.

First: How detailed and comprehensive was the data-gathering interview?

This is one of the most important steps in the financial planning process and will drive all the advice to be given. Was the data gathering comprehensive enough? Did the financial planner make notes of the information that you did not have and ask you to get back with this information? Did he take in information about you, your family, your aspirations, dreams, goals, income, expenses, cashflows, assets, liabilities, insurance, investments, tax situation, wills, powers of attorneys and information that might be relevant? Did he ask about your behaviour towards risks and how you react in bullish and bearish situations? Did he understand the mistakes that you have committed in the past and how were they committed?

A good financial planner should take anywhere between 3 – 5 hours including a social chat over 1 or 2 sessions to complete this data gathering process. He will then review the data collected and revert to the client for more clarifications to make sure he has understood the overall scenario well.

This first step itself is the single biggest clue. I find that most people genuinely interested in financial planning are keen to understand how their financial decisions will affect their life, much more than how certain products work or how to get the highest returns. In fact, the biggest value-add of a good advisor is how he utilises his skills to better understand the client’s overall situation and emotional issues and how best he handles the overall picture.

A salesman on the other hand will ignore most of the issues like estate planning, debt and cashflow management and be only interested in how much money you have to invest and how much insurance can be sold. Another category of sales people will just focus on how their scheme will make you rich, save tax for you and give you the highest returns. This is the most dangerous category and should be avoided completely.

Second: Look closely at how the planner discusses risks and returns with you.

Does he promise you the moon and tells you how good he is and that he has provided the highest returns? No good financial planner in his sane mind will ever do so and this is the kind of person you should look at working with. Does he take you through a proper risk profiling exercise, and tell you that the long-term return of the stock market is around 12 –15 per cent and therefore one should not believe theories of 30 per cent returns?

Third: Don’t look at the bank brand and opt blindly for advice, as the bank is not going to advise, it is the advisor that does. Most relationship managers in banks are primarily sales people always on the lookout for selling more products to clients. They frequently change employers so a relationship manager at Bank A can tomorrow be at Bank B and then at Bank C.

Fourth: Does the financial planner take you through estate planning matters, retirement planning, different offerings, as might be suitable to you, and any other issues? He might not deal directly in any of those things but most good planners will at least give you an overview of what you need and refer you to someone competent. Finally, the composition and presentation of financial plans can vary immensely. The groups most notorious for doing rudimentary financial planning or misusing financial planning are banks and big distributor of financial products. I told a person, “If you ever want to insult a good financial planner tell him that his plan was as good as the one you got from your bank’s financial planner!”

Most of the private banks and distributors have a well-deserved reputation for first selling life insurance as investments and churning portfolios under the garb of financial planning.

As a popular business anchor says on television, “Would you go to a chef for a haircut, or a barber for food advice? Then why go to the wrong person for advice?” The problem today in the financial services industry is that you don’t know who the barber or chef is because everyone uses the same title or name. Make sure you understand the terms financial planner, financial planning, wealth management and wealth manager, and that you are not just getting a lemon in the name of financial planning.

Who should be on your team?

Several key members should be a part of your team.

Chartered Accountant [CA]: Having a good CA on your team is absolutely necessary. CAs today provide help on several areas such as bookkeeping [day-to-day accounting], preparing and filing returns; tax audit, tax planning advice, project finance and so on. Understand that they are professionals and expect to be compensated in a fair manner. Do not cut corners by just thinking about costs. In fact, most times the advice that you will receive will be a function of the fees that you pay.

Banker: People are likely to have a high amount of loans. Having a good relationship with a banker could mean preferential treatment and rates on loans and other deposit products. This is also a function of your account size with the bank. If you are unhappy with your bank or if your bank has not acted in your best interests, move on to some other bank.

Public Sector Banks are likely to give you loans at a much lower cost than private sector banks. Although the infrastructure might not be so great and documentation could take time, the savings that you will make over a period of 10 – 20 years is likely to compensate for the initial inconvenience.

Financial Advisor/Financial planner: We’ve already discussed this in detail above. This is again one of the key decisions a person should make. The key requirements here are someone acting in your best interests, his integrity and his skill in creating customised solutions for you.

Real Estate Agent: Considering that you are likely to own several pieces of real estate, make sure you have an ethical broker with you who does not just show you some properties but also objectively tells you appropriate prices and gets you the best deals. He should be conversant with the paperwork required, do appropriate due diligence and constantly keep abreast of real estate happenings in the area. You might also want to consider real estate consulting firms, if the ticket size of your real estate is sizeable [above ` 5 – 10 crore].

Insurance Agent: Most people think of life insurance as an investment and as a means to save tax. At the same time, they think of general insurance as a pure cost. Hence, most people are inadequately insured [low covers], have the wrong set of policies with them and are paying a huge premium. You must get the risk transfer piece of your financial planning process right. Your Financial Planner can help you arrive at the quantum of cover you must take for every financial risk that you are exposed to. A good insurance agent will help you implement action items as detailed out by the Financial planner and regularly service you with updates, premium collection, submission and receipts.

Lawyer: There are several areas, where most people, require legal help. Considering a person’s real estate exposure, it is very important that a real estate lawyer vets all your property-related documents right from title of the property to preparing the legal buy or sell document. Additionally, lawyers can create the leave and license document for you and other paperwork that could be needed. Many people bypass lawyers by letting the real estate agent handle the real estate paperwork. It would always be beneficial that you double-check all pieces of paperwork with a lawyer specialising in real estate. Another area where a lawyer will be of immense value will be is estate planning. A competent lawyer can handle creation of wills, power of attorney and trusts.

Excerpted with permission from The only Financial Planning Book that you will ever need, by Amar Pandit, Network 18 Publication Pvt. Ltd. INR 499

This was first published in the April 2013 issue of Complete Wellbeing.

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