Perspectives on Financial Planning

This post was triggered by a conversation I had with two people last week, both close to retirement.  The specific topic of our discussion was the management of finances after retirement.  My points were on the lines that I have mentioned in an earlier post but somewhere, I dropped the phrase, ‘financial planning.’  To this, one of them responded by saying something to the effect that he’d been doing fine without having to indulge in “Western concepts” such as financial planning.  When I tried to correct that impression, the other gentleman chipped in by saying that even if it wasn’t a “Western concept,” it was certainly a “new age concept,” most likely a “fad.”

Financial Planning is widely defined as “the process of meeting one’s life goals through the proper management of one’s finances.”  The term, ‘life goals,’ refers to events such as retirement, buying or building a house, the higher education of one’s children, or the marriage of one’s children.  Financial Planning requires us to ascertain how much money should be kept aside for these events.  It then involves aligning existing investments and investing future savings in a manner that maximizes the chances of having the required amount of  money when we need it.

Clearly, this description of Financial Planning would sound logical to anyone, anywhere across the globe.  Furthermore, in India, we have, for generations, been conscious of the need for financial security and have accepted it as our responsibility, to plan for our children’s future.  So what would explain the reaction of those gentlemen?

Their reaction was on account of their inability to link the phrase, ‘Financial Planning,’ to the concept of financial planning.  Even though the concept has been in practice in India for generations, we never gave it a name.  On the other hand, the phrase came to our wider attention only at the start of this century, but without any  linkage to the concept that we had already been practising.  To add confusion, there have emerged a set of advisors who, armed with a certification in financial planning, use the media to give the impression that good financial planning needs a sophisticated understanding, which investors (or even advisors without any certification) are incapable of possessing.

Financial planning is rooted in a recognition that investing is about more than just seeking high returns or the safety of our money.  The best investment decisions are those that are made in the context of our life goals.  The money that we save and invest, is best targeted at transforming our financial needs and aspirations into reality.  Whether we describe this as Financial Planning, or give it any other name, is immaterial. 

Many years ago, as I remember, the typical modus operandi for financial planning in a household would be to start by crudely estimating how much money would be needed for a future goal (such as a child’s marriage) and then figure out how much was needed to be saved based upon how long it would take for an amount to double in a bank deposit or a Post Office scheme.  All the families then had to do was to find the means and the discipline to invest that amount.  Distilled to its essence, success in financial planning has had a lot to do with the application of commonsense and financial discipline.

Yes, there are aspects related to the times that we live in,  that make the case for engaging a financial advisor.  In today’s times, most working people do not have the comfort of having an assured pension after retirement.  Furthermore, with progress in medical science enabling us to live longer, those of us retiring today are likely to spend more years in retirement than those who retired, say, twenty years ago.  In addition, there are many more things, small and big, that we would like to spend our money on.  The net result of all of this is that to achieve all our goals, a number of us will need to earn a return on our investments that is higher than what bank deposits offer.  In other words, a number of us would need to invest in complex options such as shares and mutual funds.  It is in respect to these investment options that a good financial advisor can add the most value by helping make choices that maximize the chances of us meeting our goals.  And to do that, in my opinion, a certification in financial planning is not a pre-requisite.

Life and Investing

Beyond the often-cited need for returns or safety of our money, there is a bigger purpose to investing in our lives.  The clarity to see investing in the context of life can help us make better investment decisions.  This post offers a perspective on this for those of us who are working and haven’t yet retired.

Most of us start our working lives with no wealth, dependent on the earnings from our profession.  As we move through life, most of us build wealth through what we save from the earnings from our profession, and invest.  Years later, when we retire from our profession or choose to take things easy, the wealth that we have built by then, will likely be the primary source of our income. 

Even so, some of us will retire out of necessity (brought about by age or an inability to earn income from our profession), while some of us will do so out of choice, on our own terms.  Whether we will, indeed, be able to be live life on our own terms, will depend on the amount of wealth we are able to acquire, relative to our need for passively generating income from it. If asked to choose between retiring out of necessity and retiring on our own terms, each one of us would prefer the latter. Logically, therefore, the acquisition of the wealth to be able to do so, should be an important (if not the most important) purpose for investing.

Equally logically, we need to understand what it would take to accomplish this goal.  No doubt, the quality of the investment choices that we make throughout our life will contribute to the wealth we build.  In addition, I’d like to submit two factors, related to investing, that will also play a crucial role: one, the amount that we save and invest, and the other, the timeliness of our investments (i.e. our ability to not delay investing).

In my experience, far too many of us focus our attention on the quality of investment choices, losing sight of these two factors.  While all three work best together, and not in isolation of each other, I believe there is a case to say that these two factors are individually more important than quality of our investment choices.  I hope to touch upon this in more detail in a future post.  For now, I’d like to offer the following thoughts:

For a number of people, savings are regarded as what is left over from one’s income, after factoring expenses.  In other words, for such people, paying for today’s expenses is more important than planning for future expenses.  I recommend flipping this around.  I believe that the wealth that we need to meet our future aspirations should determine our investment choices and the amount that we save, and not vice versa.  So long as our aspirations are reasonable, and we start investing early in life, it shouldn’t be difficult to find the right balance between our savings and our expenses.  Thrift and regular investing can also reduce the need for riskier investments, so to say.

While deciding our investment choices, we should diversify against the risk of our profession.  This risk is highest for employees having significant holdings of shares of the company they work for, or entrepreneurs keeping most of their wealth as capital in their business.  What if, something were to happen to the company one works for?  What if, something were to happen to one's business?  Limiting one’s exposure to one's business or the shares of the company that one works for, helps protect against this risk.

Looking at investing in the context of life is a key part of what is known as, ‘financial planning.’  Financial planners understand their client’s financial aspirations and then draw up a roadmap to translate these into reality.  Most even handhold the client on the way towards achieving these aspirations.  Chances are that your trusted financial advisor would be adept in the art and arithmetic of financial planning.  If not, you might like to ask around or check out the website of the Financial Planning Standards Board India.  They have the option to search through the list of financial planners registered with them.