Financial Planning and Mathematics

8/7/2019 Financial Planning and Mathematics

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Financial Planning and Mutual Funds1

Financial Planning


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FinancialPlanning

Definition

Plan to Financethe Needs=


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What are those needs?

Birth & Education Earning Years Retirement

38 yrs22 yrs Over 25 - 30 yrs

Housing

Childs Education

Childs Marriage

Phase I Phase IIIPhase II

Age

Marriage

Children

22 yrs 60 yrsAge


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MoreModern Needs

-- Longer Retirement Life

- Higher Medical Costs

- Improved Standard of Living

- Vacations Abroad

- Visit Abroad to meet the studying child

- Club Membership

- Second Car

And more.


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One needs to estimate time horizon

and amount required for these needsand then adjust for inflation


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INFLATION ROBSYOUR PURCHASING POWER

10 yrs 20 yrs 30 yrs 40 yrs

(Assuming inflation @ 8% p.a.)

Rs. 25,000 today

53,973

116,525

251,568

543,113


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COSTOF LIVING

Item 1987(Rs.)

1997(Rs.)

2017(Rs.)

Colgate Toothpaste(100 gms. Tube)

8.05 18.90(8.91%)

104.00

Ham am Soap 3.05 7.85

(9.92%)

52.00

M asala Do sa 3.50 14.00(14.87%)

224.00

Petrol 7.99 25.48(12.30%)

259.12

LPG Cylinder 56.15 137.85(9.40%) 830.85

Zodiac M ens' Shirt 225.00 510.00(8.53%)

2620.27


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Estimating Future Needs

Rs.3 lakhs today:Rs.3 lakhs today:--

Rs. 20 lakhs today:Rs. 20 lakhs today:--

Rs. 100 lakhs today:Rs. 100 lakhs today:--


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Estimating Future Needs

The jobbecomes moredifficultbecauseofchanging

needs and aspiration levels. Theincome levels ofpeople

arechanging rapidly.

Thereis a needtoreviewthe needs and amount

required.


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Estimating and paying for future

needs covers the cash outflowsaspect


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But Financial Planning is aboutfinancing the needs


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Hence the need for savings to

accumulate money to finance those

needs

It covers the cash inflows aspect


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Can We then say

Financial Planning is

Cash Flow Management with clear estimation

about cash inflows and cash outflows after

adjusting for increase in income and savings,

inflation and taxation


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Amount requiredto be savedmonthly:-

ForRs.25 lakhs :ForRs.25 lakhs :--

Rs. 100 lakhs :Rs. 100 lakhs :--

Rs. 250 lakhs :Rs. 250 lakhs :--


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How to accumulate wealth to financethe needs?


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Important Lessons

Start Early

Invest Regularly

Think Long Term

Manage Risk

Save andInvest


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1.StartEarly

You

Age : 25 years

Start : Today Invest : 5 years

Amount : Rs 10,000p.a.

Redemption on

retirement (age 60)

YourTwin

Age : 25 years

Start : at age 30

Invest : 30 years

Amount : Rs 10,000

p.a. Redemption on

retirement (age 60)


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Who has more ?

3

13

51

2

12

50

0.780.1 0.10

25 30 40 50 60

Age (in yrs)

ValueofInvestm

ents

(Rs.inLacs)

You Your win

You Start

Investing

You Stop Investing,

Your twin starts


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2.Invest Regularly

Small investments

No substantial outflow at any point of time

Rupee Cost Averaging Continuous buying at different prices reduces the average

cost.


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Rupee cost Averaging

When you invest a fixed sum every month, you buy

more units when the price is down while you buy lesser

units when it is up.

You will observe that by investing regularly your returns

are always better than average returns as you can

avail of the advantages of rupee cost averaging.


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Arithmetic ofRupee Cost Averaging

M o n t o u n t I n v s t( s . )

S l P r ic( s . )

N o . o f U n i t sP u r c s

1 1 1 .

1 1 6 6 . 6 6 7

1 9 1 1 1 . 1 1 1

4 1 1 .

T T L 4 4 4 4 . 4 4 4

Average Sales Price of Units : Rs. 12 ( i.e. Rs. 48/4 months)

Average Purchase Cost of Units : Rs 11.61 ( i.e. Rs. 4000/344.444 units)


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Arithmetic ofValue Averaging

1 12 1000 83.33 83.33 1000

2 15 2000 133.33 50.00 7503 9 3000 333.33 200.00 1800

4 12 4000 333.33 0.00 0

TOTAL 48 3550

Month Amount Invested

(Rs.)

SalePrice

(Rs.)

TotalValue

Units to own Units tobuy

Average Sales Price of Units : Rs. 12 ( i.e. Rs. 48/4 months)

Average Purchase Cost of Units : Rs 10.65 ( i.e. Rs. 3550/333.33 units)


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3. Think Long Term

Power of Compounding

Invest in instruments with matchingtenure


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THEEIGHTWONDEROF THEWORLD...

The Power ofCompounding

350,000

2,533,529

330,000

2,099,636

300,000

1,572,834

Savings Returns *

Saves from age

25 to 60

Saves from age

27 to 60

Saves from age

30 to 60Assuming an annual savings of Rs. 10,000 in an instrument providing return of 9.5%

p.a.


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STARTEARLY; SAVEREGULARLY

Every % difference in return counts

Peri

(in rs.)

Your

sa ings

Rs.

Grows @

4. % .a.

to Rs.

Grows @

6. % .a.

to Rs.

Grows @

. % .a.

to Rs.

5 60,000 67, 70,706 76, 6

0 120,000 151,028 167,579 196,198

15 180,000 255, 7 00, 05 85,080

20 240,000 85,572 482,150 682,424

25 300,000 547,730 731,293 1,150,514

30 360

,000

749

,809

1

,072

,641

1

,887

,401

* Assuming an investment of Rs. 1,000/- per month

In the short run, a 1% differential in the rate of return may not

matter as much - but in the long run, it can be significant!!!!!!!


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4.Manage Risk

Diversify

Keep focused on your goals

Seek professional advice


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What is the relation between risk andreturn

When an investment carries higher risks it should give

higher returns.

The importance of asset allocation lies in the fact that bymixing assets having different risk characteristics it

attempts to reduce risks and increase returns or It attempts to generate a higher return for a given levelof risk

Or it attempts to reduce the risk for a given level ofreturn


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FV = PV(1 + r)n

Applications aside, what do you think this

equation really signifies?

Theessenceofhowtocreatewealth!


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Enhancing FutureValue

Wealth creation is nothing butenhancementoffuturevalue

FV = PV (1 + r)n

The moreThe more

you save,you save,

makes amakes a

differencedifference

PV

The moreThe more

you earn,you earn,

makes amakes a


r

The soonerThe sooner

you start,you start,

makes amakes a


n


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The more you save, makes a difference

Growth rate of 7% p.a.

Amount saved per month

5,000 1,500,000 4,073,986

3,000 900,000 2,444,391

1,500 450,000 1,222,196

1,000 300,000 814,797

Total Amount

Saved

Value after

25 years


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The sooner you start, makes a difference

Rs. 1000 invested p.m. @7% p.a. till the age of 60

Starting Age

25 420,000 1,811,561

30 360,000 1,227,087

35 300,000 814,797

40 240,000 523,965

Total Amount

Saved

Value at the

age of 60


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The more youearn, makes a difference

Rs. 1000 invested p.m.

Growth Rate

6% 164,699 696,459

8% 184,166 957,367

10% 206,552 1,337,890

12% 232,339 1,897,635

Value after 10

years

Value after

25 years


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Mathematics of Investing


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The Future Value Equation


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FV = PV(1 + r)n

FV = Future Value

PV = Present Value

r = Rate of Return/ Coupon Rate

n = No. of compounding periods


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Illustration

Mr A Bachchan plans to buy a house after 5 years.

The current cost of such a house is estimated to be Rs.

35 lakhs.

Assuming property prices rise 3% p.a., how

much will the housebeexpectedtocost 5 yearsdown the line?

FV = PV (1 + r)n

FV = 35 (1 + 3%)5

FV = 40.57 lakhs


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Illustration

Ms M Dixit invested Rs. 10 lakh in a no-load mutualfund scheme in their IPO, four years ago.

According to the latest fact sheet, the scheme has

shown a CAGR since inception of 10% p.a.

Howmuch is Ms Dixit's investmentworth today?

FV = PV (1 + r)n

FV = 10 (1 + 10%)4

FV = 14.64 lakhs


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Illustration

Mr A Devgan has a dream to take his wife on a luxury

cruise in the Caribbean, after 4 years.

The cruise is expected to cost Rs.3 lakhs at that time.

Assuming therisk freerateofreturn tobe 7% p.a.,

howmuch should heinvesttoday, torealisethis

dream, withouttaking any risk?

FV = PV (1 + r)n

PV = FV/ (1 + r)n

PV = 3/ (1 + 7%)4

PV = 2.29 lakhs


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Illustration

Mr J Shroff dreams of sending his daughter to Harvardafter 4 years, for which he is ready to invest 35 lakhs

today.

The education is expected to cost Rs.50 lakhs at that time.

Howmuch should his money earn forhimtorealise his dream?

FV = PV (1 + r)n

r = (FV/ PV) 1/n -1

r = (50/ 35) 1/4 -1

r = 9.33% p.a.


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Financial Planning Process

Need Analysis

Evaluate Person Specific Situation

Define Objectives

Analyse Earnings

Determine Time Frame

Risk Profiling

Portfolio Construction

Asset Allocation

Choice of Products

Profit Booking

Taxation Issues

Regular Review


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INVESTORs RISKPROFILING

Profile the customer on following parameters :-

- Goals

- Background Information

- Risk Tolerance

- Past Experience


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Examples ofGoalSetting

- Ask for the Time Horizon of the investments

- What percentage of the investments does he plan to

redeem within the next 3 years

- What is his primary investment goal viz. income

generation with cash flows; income generation without

cash flows; growth of money with little money in incomegenerating instruments; for long term growth only.


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Examples ofBackgroundInformation

- Age of the investor

- How many more years before he retires ?

How stable or secure is his employment situation

currently?

if not an employee, will he rely on this investment for

current income?

Understand his current financial situation. Consider

regular expenses and ability to repay outstanding loans

as well as savings for emergencies and retirement.

Understand his current investment situation


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Examples ofRisk Tolerance

Can he tolerate a temporary decline in the value of hisinvestments ? If yes, upto what percentage is ok with him

?

Does he have an existing investment philosophy viz. Notcomfortable with taking risks; aggressive investment

approach, willing to take risk with 50% of his investments

etc.

Is he comfortable with volatility ?


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INVESTOR PROFILE

Mona, Joydeep ( Age 28 years )Financial oalsFinancial oals

Planning to purchase a

house in the next 5 - 8 years

Planning for family in 2

years time.

Creating long-term wealth

for retirement

Investment StrategyInvestment Strategy

Stocks

75%

Short-term

10%

Aggressive Growth Portfolio

Bonds

15%


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INVESTOR PROFILE

Sheela, Shekhar ( Age 37 years ) and two kids

Financial oalsFinancial oals

Has a housing loan

Providing for children

education (7-10 years)

Planning for childs wedding(15 - 20 years)

Take care of old parents

Planning for retirement

Investment StrategyInvestment StrategyBalanced Portfolio

Stocks

60%

Short-term

15%

Bonds

25%

INVESTOR PROFILE


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INVESTOR PROFILE

Meera & Akash Chaudary

Financial oalsFinancial oals

RetiredRegular Income

Medical Costs

Investment StrategyInvestment StrategyConservative Portfolio

Stocks

15%

Bank

Deposits

40%

Bonds

45%


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Mutual Funds


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Theflow chart belowdescribes broadly the working ofa mutualfund

O i ti Of M t l F d


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Organisation Ofa Mutual Fund

Ad t Of M t l F d


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Advantages OfMutual Funds

Professional Management

Diversification Convenient Administration

Return Potential

Low Costs

Liquidity Transparency

Flexibility

Choice of schemes

Tax benefits

Well regulated


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DEBT FUNDS


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DEBT FUNDS

Objective:

Income generation through investment in a

variety of debt and money market instrumentsacross maturities with a view to maintain a

balance of safety, returns and liquidity.

F t d B fit


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Features andBenefits

Ideal for investors looking to earn steady returns with arelatively low risk appetite and a medium to long terminvestment horizon.

Invests in debt and money market securities like Call, T-bills, CDs, CPs, Corporate Debt, PSU Bonds andGovernment Securities across a range of maturities andrisk profiles.

A t P fil


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Asset Profile

Instruments issued by Government of India, Banks,

FIs, corporates, PSUs, PFIs etc. with medium to long-term maturities.

AAA rating denotes highest level of safety.

Gilts are instruments issued by the GOI and the StateGovts., also known as G-secs.

Sovereign holding component balances out theinherent credit risk and liquidity risk inherent in a DebtFund.

Q lit ti P t


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Qualitative Parameters

Selecting the right investment plan based oninvestment profiles, a basket of securities acrosscredit profiles across tenures.

Active duration management.

Track record of the fund manager.

Expectations of interest rate movements.

Change in Economic

Outlook Shift in StrategyIn tune with Market

Reality

Credit Quality


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CreditQuality

Credit Quality of a Debt Funds portfolio is veryimportant. It also enhances liquidity and enablesappropriate valuation.

Hence, most funds rate corporate paper in-house,

apart from the accepted market rating by agencieslike CRISIL, CARE, ICRA etc.

Credit quality is directly proportional to the risk-returnratio of a debt fund.

Quantitative Parameters


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Quantitative Parameters

Asset Class (Gilts, Corporate, Bank Bonds)

Liquidity

Volatility

Assets under Management of the scheme as well as

the Fund House

Average portfolio maturity

Entry/Exit Load

Minimum Investment

Expense Ratios

EQUITY FUNDS


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EQUITY FUNDS

Objective:

Capital appreciation through investment in a

diversified/focused portfolio of carefully

researched and selected equity shares.

EQUITY FUNDS


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EQUITY FUNDS

TypeofEquity Funds

Diversified:Invests in diversified portfolio of stocks.

Sectoral: Invests in stocks of specific industry/sector

of the economy

Index: Invests in the stocks in a benchmark index like

NIFTY or SENSEX in the same proportion as the

individual stocks appear on the index

EQUITY FUNDS


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EQUITY FUNDS

Equity Fund Management Styles

Active Management:The fund manager tries to

outperform a benchmark index by investing in stocks

that are likely to outperform the broad market indexes.These portfolios are characterized by very high

portfolio turnover.

Passive Management: The fund managers strategy is

to track a broad market index like NSE-50 or

SENSEX. These portfolios are characterized by very

low portfolio turnover

EQUITY FUNDS


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EQUITY FUNDS

TypeofEquity Stocks

Value Stocks:These stocks are of fundamentallystrong companies, but may be undervalued due to

economic, political or market related conditions.T

hefund manager attempts to buy them cheap and sellthem in a market uptrend.

Growth Stocks: These stocks are of companieswhich are in rapidly growing industries and are

increasing their sales, profits and market sharesrapidly. The fund manager invests in these stocks,rides the up-trend and offloads it before the growthrates come down.


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Thank You

Financial Planning and Mathematics

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