How Mutual Funds Can Be Used in Financial Planning

8/6/2019 How Mutual Funds Can Be Used in Financial Planning

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How mutual funds can be used in financial planning

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(14-May-2011 )

How mutual funds can be used in financial planning

"Riches do not respond to wishes. They respond only to definite plans, backed by definitedesires, through constant persistence."- Napoleon Hill

The importance of Financial Planning couldn't have been summed up better than this. To simplyput, financial planning is a tool through which you can chalk out definite plans in order to achieveyour financial goals thus ensuring you peace of mind at various stages of your life cycle.

All of us have financial goals be it buying a house, buying a car, getting children married, theireducation and then our retirement. But, unless we do not assess where we stand in terms of ourincome, expenses, assets, liabilities, age and risk appetite, all the financial goals would justremain "dreams" and would never turn into a reality.

Today there are several investment avenues; but for you to optimally undertake financial planning(to achieve financial freedom), what is required is combination of various financial products in therespective asset classes be it equity, debt or gold. However, your asset allocation also needs tobe optimally structured for work for you (in the financial plan); or else it would not help youattaining financial freedom.

Strategic Asset AllocationBarring "most conservative portfolios" which do not hold equities at all, every portfolio should be

optimally structure and diversified to hold all asset classes:

Cash - for security and liquidity, so that one can take advantage of opportunities as theyarise
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Bonds - to help preserve capital and provide a steady income

Stocks - for growing wealth and to help you beat inflation and counter the impact of taxes

Real estate - because of their low correlation with stocks and bonds

Gold - for its ability to be a hedge against the inflation bug and other economic andpolitical uncertainties

Once your asset allocation is optimally structured, the next important action point should behaving the right investment avenues / products under each asset class, in order to achieve thefinancial goals (within the time frame) with comfort.

Among the various investment avenues available today, mutual funds (amongst other investment

avenues) are a wealth creating avenue, aiding you achieve your financial goals. Moreover theypower your portfolio with diversification benefit. And mind you diversification immensely helpsduring the turbulence of the capital markets as the jerks (of turbulence) are felt far lesser. Theother benefits which you enjoy while investing in mutual funds are:

Professional management Your money is managed by a professional fund manager,hence ascertaining the prospect of the companies is not your headache and portfoliochurning (if required) too is taken care by him.

Economies of scale Even though if a mutual fund does engage in high portfolio

churning in the race to deliver luring returns, the voluminous trade carried out by it helps toenjoy the economies of large scale and have lower impact on their profitability. But on theother hand if you were to do this by yourself, you may get negatively impacted on theprofitability front due to small volume of trades carried out.

Lower entry level With the minimum investment amount in mutual funds being as lowas ` 5,000, the encouragement to start small and at the same time take exposure to thefund's portfolio of 20-30 stocks (due to diversification) is also present. Now this is unlikestocks because there with 5,000 you can barely buy few quality stocks and this especiallytrue when valuations are expensive.

Innovative plans/services for investors Today for regularinvesting in mutual funds

(which is much needed to achieve financial goals), AMC (Asset Management Companies)offer innovative plans such as SIP (Systematic Investment Plan) / STP (Systematic TransferPlan). Also for facilitating withdrawals too (taking care of your cash flow requirements),SWPs (Systematic Withdrawal Plans) are in place, thus enabling you to manage yourportfolio from a financial planning perspective too.

Liquidity Unlike direct stock investing where you may encounter a situation where astock turns illiquid (due to various reasons); in mutual funds you would not face such asituation if the scheme selected by you follows strong investments systems and process.This because the stock selection process helps in eliminating such illiquid stocks. Moreover
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time to recover from any possible setbacks in the value of the portfolio.

Portfolio rebalancing

Afterbuilding a portfolio having answered the aforementioned questions you cannot afford to sit

tight. What is required is portfolio rebalancing. Rebalancing refers to the action of bringing aportfolio of investments that has deviated away from target asset allocation. The goal ofrebalancing is to move the current asset allocation back in line to the originally planned assetallocation. Rebalancing is primarily warranted under conditions where the returns havesignificantly deviated than expected or to stay in line with market conditions. For example, anequity heavy portfolio needs to be restructured in contraction phases where company profits arehit harder and interest rates move up. It could be done by moving a portion of equity holdings todebt instruments. Mutual funds probably allow the easiest window to rebalancing due to theirdiversity of offerings.

A case would be may help you understand rebalancing better.

Mr X has planned for his son's marriage in 2020, for which the estimated cost in 2020 would be1.7 crores. In 2010 he is advised to invest 70,000 in equity and 30,000 in Debt assuming anaverage return of 12% for equity and 5% for debt. The expected value of investments after theend of 1 year would be 78,400 for equity and 31,500 for debt.

However, at the end of 1 year period, the equity markets performed worse than expected at 8%and the debt markets performed better than expected at 14%. Hence, the portfolio value, insteadof the planned 109,900 ended up as 109,800. Consequently, the ratio of equity to debt

changed from the original 70:30 to 69:31. To rebalance the portfolio, Mr X has to liquidate hisdebt holdings by 1,260 and invest in equity. However, Mr. X's portfolio value would fall short of100 when compared with his expected portfolio value.

Thus, mutual funds given their diverse categories and their inherent advantages enable you andyour financial planner to align the investment goals on the mantra of

DIVERSIFICATION + PATIENCE = SUCCESS
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Independent Financial Adviser

From Wikipedia, the free encyclopedia

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Independent Financial Advisers orIFAs areprofessionals who offer independent

adviceon financialmatters to their clients and recommend suitable financial productsfrom the whole of the market. The term was developed to reflect a UKregulatory position

and has a specific UK meaning, although it has been adopted in other parts of the world,

such as Hong Kong.

The term "Independent Financial Adviser" was coined to describe the advisers working

independently for their clients rather than representing aninsurance company, bank or

bancassurer. At the time (1988) the UKgovernment was introducing the polarisation

regime which forced advisers to either be tied to a single insurer or product provider or tobe an independent practitioner. The term is commonly used in the United Kingdom

where IFAs are regulated by the Financial Services Authority(FSA) and must meet strict

qualification and competence requirements.

In the UK the industry has been de-polarised since 2005. There are now three main

classes of adviser: tied advisers (working for one financial institution), multi-tied advisers(offering products from a selection of the market and usually paid on a commissionbasis)

and independent financial advisers. Independent financial advisers must offer their clientsthe option to pay for advice by fee as an alternative to commission.[1]

Typically an Independent Financial Adviser will conduct a detailed survey of their

clients financial position, preferences and objectives; this is sometimes known as a

factfind. They will then advise appropriate action to meet the client's objectives; and ifnecessary recommend a suitable financial product to match the clients needs.

Individuals and businesses consult IFAs on many matters including investment,

retirement planning,insurance, protection and mortgages(or otherloans). IFAs alsoadvise on some tax and legalmatters.

Contents

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[edit] Paying for advice

Some financial advice is about investments and pensions: and some of these are 'financial

products' packaged and marketed by financial institutions: and most of them paycommission. In the UK it is common for IFAs to limit the advice they give to

commission-paying financial products. Traditionally IFAs have relied upon commissionto pay for their services. In recent years there has been a shift towards fee based advice asthis is perceived as fairer toward the client. However, due to under-capitalisation in the

advice sector and consumer reluctance to pay for advice on which financial product to

buy, the transition to fee based advice by IFAs has been slow and concentrated in the

'high net worth sector'.

The FSA has introduced a new disclosure regime for advisers giving regulated

investment advice on retail financial products. Since July 2005 this regime insists that

advisers who market themselves as independentmust offer the option of paying a fee foradvice on which 'appropriate' financial product to buy. The four main remuneration

options available for financial advisors are as follows:

Commission: Traditionally the most common way to pay for advice on financial

products is for the IFA to receive a commission from the product provider. Theamount of commission must be disclosed, and some IFAs will rebate a portion of

their commission, particularly in Execution-Only cases. The amount of

commission and whether it is deducted from the amount actually invested or is

included in the cost of the investment varies from product to product. The clientpays for commission from product charges. As well as the initial commission, the

adviser is likely to be also paid an annual "trail" commission by the product

provider. Not all products offer the same rate of trail commission and therefore a

potential conflict of interest may arise. The products making the highestmanagement charges usually offer the adviser the highest trail commission.

Financial products paying any trail commission will usually carry higher annualcharges than investments which do not.

Fees: Less common than commission, IFAs must offer the option of giving

advice on financial products by working for a fee. The IFA is not bound by FSA

regulations to include advice on those investments and pensions which do not paycommission. Depending on the size and type of the investment, and the

complexity of the advice, paying an IFA by way of a fee can work out cheaper

than paying commission. Paying a fee for advice can mean that the IFA is not

influenced to recommend one packaged product over another simply because onepays more initial commission than another.

Combination: It is also possible to pay a combination of fees and commission. In

this situation the IFA may rebate a proportion of the commission they would havebeen due, or they may charge fees for advice and commission for transactions.
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Fee-Only: In economies that have developed financial planning (e.g. the USA,

Canada, Holland) the phrasefee-only refers to a method of advice where the

advising firm receives no commission at all and is paid entirely by individual.Unfortunately the Financial Services Authority uses the term in the context where

it is clear the advising firm may also accept commission (referred to above as

'Fees' and 'Combination'). Financial advisory firms in the UK that are fee-only inthe international definition contend that paying for advice from a firm which

accepts commission will cause a conflict of interests.

There are requirements for the type and amount of payments to IFAs to be clearly

disclosed, so it would normally be easy to determine the cheapest option for a particularcommission-paying financial product such as an investment.

Marketing costs such as commission increase the annual charges on financial products by

a significant amount (ref: Sandler Review).

[edit] Qualifications

To offer financial advice an individual must represent or be an appointed representative

of a firm registered with the Financial Services Authority(FSA). The FSA require that

firms ensure that individuals acting for them have appropriate qualifications. The list of

appropriate qualifications is determined by theFinancial Services Skills Councilat thebehest of the FSA.

The qualifications for most firms relate toChartered Insurance Institute (CII) exams past

and present.

The entry level is normally the historic 'Financial Planning Certificate' (FPC), or itssuccessor, the 'Certificate in Financial Planning' (CFP) which includes an additional

examination focusing on investment advice and risk. For the payment of a fee to the

Personal Finance Societymembers with this level of qualification may use the CertPFSdesignation. The exams to achieve this are certificate level as designated by the

Qualifications and Curriculum Authority(QCA) each exam is approximately equivalent

to a GCSE (five for CFP and three for FPC).

The next level is the historical 'Advanced Financial Planning Certificate' (AFPC) andnewer 'Diploma in Financial Planning' (DFP). Again for a fee members of the Personal

Finance Society may use the designation DipPFS.

The next level is 'Advanced Diploma in Financial Planning'.

The highest level is 'Certified Financial Planner' (CFP) issued by the Institute of Financial

Planning orChartered Financial Plannerstatus granted by the CII.

All IFAs also have an obligation to keep up with current developments in the profession,

sometimes referred to as Continuous Professional Development. There are many
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advanced and more specialised qualifications an IFA may take throughout their career,

and it can be worth asking about an advisers specific areas of expertise.

While the CertPFS qualifications are the minimum requirements, it is likely that anadviser will progress to the more advanced qualifications throughout their career. With

the introduction of higher qualifications becoming more important, the level ofqualification can therefore be a useful indicator of an adviser's expertise, although a great

deal of experienced advisers currently offer a greater deal of practical knowledge thanthose obtaining qualifications rapidly in a corporate training ground.

In addition to that, recently a project was managed by the Financial Services Skills

Council (FSSC) - to assess the various types of IFA Qualifications.

All qualifications / designations have been assigned a level based on an analysis whichwas completed by UK NARIC, a national DfES agency which provides guidance on

levels of international qualifications (academic, vocational and professional). A list of

these qualifications was compiled at IFA Promotion and split up into two levels (A & B).

[edit] IFA Network

IFA Network is an association of IFAs. All financial advisers in the UK must either beauthorised or exempt under the Financial Services and Markets Act 2000. Membership of

an IFA Network qualifies an IFA as being exempt from regulation. The IFA Network is

then responsible for the advice and regulatory compliance of its members. [citation needed]

[edit] If things go wrong

Financial servicesare heavily regulated in the United Kingdom. While this may in somecases restrict the market and places a heavy burden on financial services professionals, it

also makes for one of the safest consumer markets in the world.

If a client buys a financial product on the advice of an IFA which turns out to beunsuitable, they have the right to complain and, if the complaint is upheld, may receive

compensation. All regulated financial services companies, including IFAs must have

effective internal complaint handling procedures. If a complaint is not dealt withsatisfactorily internally, the client has the option of going to the Financial Ombudsman

Service, which will conduct an independent investigation and has the power to award

compensation if warranted. In a large majority of cases referred to the Ombudsman, it

finds that the firm had treated the customers complaint fairly.

This does not mean that a client can claim compensation simply because an investment

loses money. With all investments, there is an element of risk, the basis for complaint

would only be whether or not that level of risk was unsuitable for a particular client based

on the information given to the adviser. This is particularly important (and not well-understood in the public consciousness), and especially in relation to the sale of with

profits endowments intended to be used to repay an interest only mortgage. A great many
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people saw strongly reduced investment returns from their endowments due to lower

interest rates (and hence investment returns) and subsequently claimed that they had been

mis-sold. While the poor performance is regrettable, it in no way constitutes mis-sellingin the legal sense unless it can be shown that the endowment was unsuitable for the

client's needs at the time it was advised. It is not possible to use retrospective judgements

to assess decisions made in good faith in the past either.

[edit] Execution-only

In some circumstances an IFA will arrange a financial product to a client without

providing them advice. This is known as an execution-only service, and is often

accompanied by a partial rebate of commission paid by the product provider. This formof sale can be useful when the client does not require advice, as they can often get better

value by going through an IFA than if they went directly to the product provider. It can

have problems however, since no advice is given, the client has no redress if theysubsequently find the product to be unsuitable for them. This has formed the basis of

several mis-selling claims for certain classes of product.

[edit] Depolarisation

On 1 December 2004 the Financial Services Authority (FSA), the UK financial regulator,changed the rules governing financial advisers. Previously (under a system known as

Polarisation) there were only two types of financial adviser, those who would advise

and sell only one companys products - known as a Tied Agent, and those who would

advise and sell the most suitable products from the whole of the market IndependentFinancial Advisers (IFA).

With Depolarisation, the FSA has changed this dramatically. A firm may now offer

advice on products from just one provider (single tied), more than one provider (multi-tied) or from the entire marketplace (whole-of-market). Generally speaking, to be able to

call itself "independent", a firm must offer its clients the option of paying for the advice

by a fee and must be a whole of market adviser.

There are a few complications however :

1. A firm may hold themselves out as being whole of market for one class of productsuch as investments, but be multi-tied on another, for example pensions.

2. An adviser can start a relationship with a client as a single tied adviser, but canthen broaden the scope of advice to multi-tie or whole of market advice (hecannot decrease the scope of advice he offers though). If he does this he must re-

disclose his status to the client.

The regulations that introduced regulation for mortgages and general insurance (GI) were

developed and introduced around the same time as the depolarisation rules
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How Mutual Funds Can Be Used in Financial Planning

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