Personal Financial Planning ebook
Transcript of Personal Financial Planning ebook
Personal Financial Planning
Foundation Course on Insurance & Takaful Based Personal Financial Planning
By Azmy SalihBA (Cey), M.HRM (Colombo), AII (India), AITD (SL), MCPM (CPM), Dip. Islamic Studies (Islamic Online University), Dip. Modern HRM, Dip. Translation Studies (CPA),Certified HR Auditor, Certified NLP Practitioner, Certified Life Coach
Personal Financial Planning
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Personal Financial Planning
Normally, people always think it is not really
possible to fulfill all their goals or dreams without
having a High Salary or belonging to a rich family.
But it is not the truth. With the help of Financial
Planning you can achieve all your life goals or
dreams.
DO YOU WANT TO KNOW HOW?
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There are only 3 major components in the Financial Planning process:
Current Resources (CR)
Investment Options (IO)
Financial Goals (FG)
The Financial Planner first makes a note of your financial goals
and its priorities. Then the planner analyses your current financial
situation, recommends the right plan with proper asset allocation,
monitoring it regularly, rebalance your portfolio from time to time
based on your changing life style and investment opportunities.
Let us first know - what is Financial Planning?
Financial Planning: CR + IO = FG
What does a Financial Planner do?
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Ideal Foundation
Wealth Creation
Emergency & Debt
Planning
Protection/Risk Management
Foundation of
Planning
Investment
Debt Reduction
Emergency Fund
Insurance (protection)
Net worth, Cash Flow, Risk Tolerance
Goal
Insurance (Savings + Protection)
Investment
Risky Foundation
The following process is important in
Financial Planning:
• Protection Planning ( Insurance )
• Emergency Cash Flow Planning
( Emergency Fund )
• Debt Reduction Planning ( Loan )
• Investment Planning
( Achieving Goal )
The Financial Pyramid
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Steps for setting
Financial Goals:
1. Write your goals and be specific:
2. Identify your time-specific goals:
Short -Term Goals: The goals which you want to achieve within
1 year. For example: your child’s play school admission.
Medium–Term Goals: You want to achieve these goals within 5
years. For example: your child’s school admission.Long–Term Goals: Goals that you want to achieve after 5 years. For example:
Retirement, Child’s Education and Marriage.
3. Priority
.
When you write your financial goals it will help you to visualize
them. It should be specific and realistic.
After listing your Financial Goals, it’s time to number them
according to your priority.
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Personal Financial Planning4. Analysis of your Current Financial Situation
It will give you the full information of your income and expenditure.
Net Worth is an overall statement of your assets and liabilities.
Net Worth = Asset – Liabilities
Cash Flow Statement
Net Worth
Both the Cash Flow and Net worth Statements will give you a real picture of your present situation and help you make
realistic financial goals. Update it regularly. These two vital documents do not replace each other; but they are supportive
documents to each other.
In financial planning, budgeting plays a very vital and important part. Budgeting
will give you the exact picture of your expenses and spending habits. This will help
you to plan your expenses and spending habits more efficiently. If you do not know
where you are spending your money just keep a track on your spending habits on a
monthly basis. This sounds ridiculous, but believe us, this will definitely help you to
reduce your unnecessary spending.
Budgeting
Importance of Cash Flow Statement and Net Worth in Financial Planning
Proper usage of credit card:
It’s an unique tool for cash free purchase payment for interest-free grace period with
redemption points.
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Personal Financial Planning
Time Value of Money
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Time Value of Money (TVOM)
• What will Rs.500 placed in a savingsaccount earning 3% return be worth in 5 or 10 years?
5 years
Rs.579.64
10 Years
Rs.671.96
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Why so much more?• Because our return will earn return
Rs. today
x(1+ Growth rate %)5
=
Rs. tomorrow
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Okay: This can work backwards too
Think of a goal:
• Say I want to have Rs.1000 in five years and Ican earn 5%, how much do I have to put intoday?
Rs.783.53How did we get this?
1000/(1.05)^5(fv)/(1+%)(years)
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Two Key Concepts
(Discounting)
Present
Value
(Compounding)Future
Value
Increases in an amount of money as a
result of interest earned
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Two Key Concepts• Compounding
– When something earns interest the interestthen earns interest
– This increases the value exponentially
• Discounting– The fact that the interest earned interest needs
to be factored into determining the past valueof an item
– Assume we know something is compounded– Exponential function must also be considered
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Personal Financial Planning
Three Types of Amounts• Lump Sum
– One time payment– Put something in, get something out
• Annuity– Fixed, recurring payment– Adding Rs regularly, receive regularly– Payment is always same
• Series of Cash Flows– Recurring, but not fixed
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Timeline: FV/PV of Lump Sum
FV
N I/Yr
PV
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How do we do this?
The relationship can beshown algebraically:
FV(LS) = PV(1+r)n PV (LS) = FV/(1+r)n
n=number of periods
r =Profit rate
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Timeline: FV of Annuity
FVN I/YR
PMT
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Timeline: PV of Annuity
PMT
N I/Yr
PV
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How do we do this?• The relationship can be shown
algebraically:
n=number of periods
r = Profit rate
FV (Pmt) =PMT[(1+r)n-1]/r PV (Pmt) =PMT[1-1/(1+r)n]/r
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However, we can use afinancial calculator
• N= the number of periods
• I/Y = interest rate per year
• PV = present value or value in thepast (investment amount)
• Pmt=payment, recurring investment orannuity amount
• FV=future value
www.zenwealth.comTVM Calculator
I am going to usethe TI BA II +
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Others to check out
www.ultimatecalculators.com
Compound Interest Calculator
www.investopedia.com
Calculator
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Tips on TVOM Problems
• Draw a cash flow chart
• Break the problem into one of four types orinto variations of them
• Figure out what information you have
• Determine what you are solving for
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Rule of 72
• Can be used to determine the length oftime it will take for an investment todouble
– Given the rate of return
– An approximation
• Formula
Years to double = 72 / interest rate
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Rule of 69• Can be used to determine the length of
time it will take for an investment todouble
– Given the rate of return
– An approximation
• Formula
Years to double = 0.35+69/r
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Example
• If Sufyan can earn 6.5% annually, how longwould it take for his Rs.10,000 investmentto double?
Could do10000 +/- PVN= 11
6.5 I/Yr 20000 FV
OR72/6.5 = 11
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Ratios of financial stability
1. Basic Liquidity RatioIndicates the ability to cover monthly expenses in an emergency. Eg. Job LossCash & Near Cash/Monthly ExpensesRecommended Value – 3 - 6
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Ratios of financial stability
2. Liquid Assets to Net Worth RatioIndicates the ability to cover emergency funding like hospitalization.Cash & Near Cash/Net WorthRecommended Value – 15%
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Ratios of financial stability
3. Savings RatioIndicates the ability to fund for future capital and retirement goals.Savings/Gross Income (annual)Recommended Value – 15% - 20%
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Ratios of financial stability
4. Debt to Asset RatioIndicates the ability to meet the liabilities.Total Liabilities/Total AssetsRecommended Value – 50% (Max)
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Ratios of financial stability
5. Solvency RatioIndicates the ability to meet the liabilities and indicates whether the person has borrowed excessively.Total Net worth/Total AssetsRecommended Value – 50% (Min)
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Ratios of financial stability
6. Debt Service RatioIndicates the ability to service debt repayments.Total Annual Debt Repayment/Annual Take Home IncomeRecommended Value – 35% (Max)
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Ratios of financial stability
7. Debt Service Ratio - 2Indicates the ability to service lifestyle related debt repayments.Total Annual Non Mortgage Debt Repayment/Annual Take Home IncomeRecommended Value – 15% (Max)
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Ratios of financial stability
8. Net Investment to Net Worth RatioIndicates how well investment assets have been accumulated for retirement and other needs.Total Invested Assets/Net WorthRecommended Value – 50% (Min)
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Ratios of financial stability
9. Net Worth RatioStarting point to set up a financial plan and help determine how much insurance coverage is required to protect ones assets.Total Assets-Total LiabilitiesThe Net Worth Thumb Rule = Age X Gross Annual Income/10
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Retirement Planning – Case StudyClient : Mr.MubarakAge : 47Requirement : 70% of the salary as pensionExpected Salary Growth : 5%Current Monthly Salary : Rs.65,000/-
How much does he need as pension for a year at the age of 60?How much he has to invest from now onwards?
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Retirement Planning – Case Study CalculationFuture Value = Present Value (1+r)nX70%
Future Value = Present Value (1+r)nX70%Future Value = (65,000X12)(1+0.05)13X0.7Future Value = (65,000X12)(1+0.05)13X0.7Future Value = (780,000)(1.05)13X0.7Future Value = (780,000)X(1.885)X0.7Future Value = 1,029,564.43 (Pension Per Annum)
What is the monthly pension ?1,029,564.43 / 12 = 85,797.00
How much he has to invest from now onwards?
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Insurance Needs Assessment – Human Life Value
Client : Mr.FaizerAge : 40Planning to retire at the age : 60Expected Salary Growth : 5%Earning Per Annum : Rs.2,000,000/-Expected Return from Investment : 8%Existing Life Cover : Rs. 500,000/-
How much additional Cover He Needs?
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Insurance Needs Assessment – Human Life Value
PV = C X {1 – (1+g)n }( r – g ) { (1+r)n }
PV = 2,000,000 X {1 – (1+0.05)20 }( 0.08 – 0.05 ) { (1+0.08)20 }
PV = 2,000,000 X {1 – (1.05)20 }( 0.03 ) { (1.08)20 }
PV = 2,000,000 X {1 – (1.05)20 }( 0.03 ) { (1.08)20 }
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Insurance Needs Assessment – Human Life ValuePV = 2,000,000 X {1 – (1.05)20 }
( 0.03 ) { (1.08)20 }
PV = 66,666,666 X {1 – (2.653)(4.660)
PV = 66,666,666 X {1 – (2.653)(4.660)
PV = 66,666,666 X {1 – (2.653)(4.660)
PV = 28, 712, 446.06
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Insurance Needs Assessment – Human Life ValuePV = 28, 712, 446.06
Human Life Value = PV of All Future Net Income + Liabilities + Funeral Expenses –Current Assets
Human Life Value = 28, 712, 446.06 – 500,00028, 212, 446.06
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Insurance Needs Assessment – Multiple Approach
Client : Mr.CaderAge : 40Planning to retire in : 20 yearsEarning Per Annum : Rs.2,000,000/-Expected Return from Investment : 8%
What is the amount of Life Cover he needs at present?
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Insurance Needs Assessment – Multiple Approach
Life Insurance Required by him will be = 2,000,000 / 8%= 2,000,000 / 0.08= 25,000,000
If you invest = 25,000,000For return rate of = 8%Amount of return = 25,000,000 x 0.08
= 2,000,000
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