• Insights

Financial planning is all about managing the long-term financial goals of your clients through investments in various asset classes in a prudently defined asset allocation. The risk profile of an individual principally determines an appropriate asset allocation. Equity is one of the main asset classes, others being debt, liquid and real estate.
Equities are known to have the highest risk amongst asset classes; the risk in the simplest terms here is the volatility of expected returns.
Financial planning does not aim at obtaining the highest return available in a given time frame from the representative asset classes.
Though, the optimization of returns and their protection in a financial planning portfolio in order to achieve a chosen financial goal is an objective sacrosanct to financial planning.

Check for inflation
Inflation is an important consideration while planning for a financial goal and constructing an investment portfolio, especially for goals to be achieved in the distant future. It is imperative that the returns to be targeted should beat inflation hands down.
No wealth to be created shall have a competitive value unless it satisfies the purchasing power of the specified time in the future.
The average inflation, as measured by the Consumer Price Index for industrial workers, has been in the region of 8 percent in the independent India. The latest inflation numbers are touching 9 percent.
An asset class which is unable to generate post-tax long-term returns enough to beat such numbers will, therefore, erode the investment value of its representative portfolio when seen from the perspective of servicing a chosen financial goal such as retirement or children’s higher education. The table (on the facing page) gives average inflation numbers along with returns from equities as measured by Sensex returns over different time periods.

Equity
It can be observed that for long-term financial goals, tenure exceeding 10 years, a higher exposure to equities shall give sumptuous and inflation beating returns with low volatility.
However, for medium-term goals, to be achieved in 5 years to 10 years, a measured asset allocation approach helps with equities still in prominence. The band of the annualized returns, therefore, expands with a higher volatility of returns.

Short-term goals
Here, the protection of value generated in the Financial Planning portfolio gains higher priority. For short-term goals, 1-3 years, equity returns are attainable with a much higher volatility with risks of erosion of capital being a chief concern. Nonetheless, a small monitored exposure to equities is required with higher emphasis on protecting the capital and hedging the returns.

Benefits of equity
It may, however, be of importance to note at this point that the income generation in the portfolio should be enough to edge out the effects of inflation for the period of the financial goal.
The equities currently are the best tax-efficient vehicles in which you can generate and sustain long-term wealth. The dividends from equities and equity-oriented mutual fund products are tax free in the hands of investors.

Revised dtc
The same is true for Long Term Capital Gains (the holding period exceeds one year in this case) for such instruments. In the revised Direct Taxes Code (DTC), however, which may come into effect from April 1, 2012, the long term capital gains shall be applicable from the end of the financial year in which the equity asset is acquired and, after allowing for a specified deduction, balance gains shall be taxed at the rates applicable to the tax payer.

The indian mindset
The Indian scenario of equity investment is not too exciting with just about 5 percent of household financial savings per annum being routed to equity and equity-oriented investments.
The financial behavior of Indian masses is ridden with a ‘safety conscious’ syndrome. This behavior asymmetry, however, transforms in times of market euphoria to a ‘greed and fear’ psychosis.

Why opt for financial planning
The financial planning way of investing moderates to a large extent these twin traits as the objective is to achieve medium-to-long-term goals through systematic investments in various asset classes including equity without worrying about everyday market movements except when nearing a goal. This augurs well for your financial planning.
The optimally arrived at asset allocation pursuant to a carefully analyzed financial situation and risk profile of an individual by a financial planner, preferably a certified financial planner or CFPCM professional, actually sets the rule for equity exposure in a financial planning portfolio for achieving the defined financial goals.

Plan well
The equity investment in a planned manner is desirable in every financial planning portfolio, even in a portfolio post-retirement, for wealth building as well as for combating inflation over the desired period.
It is good as well for the economy at large as the industry gets easy access to long-term funds.
The ruthless nature of market retribution for non-performance imposes a self regulated accountability and better corporate governance in the system.

The views expressed here are personal and do not necessarily represent those of the organization.

RANJEET S. MUDHOLKAR is working with Financial Planning Standards Board India (FPSB India) in the capacity of Vice Chairman and CEO. The views expressed here are personal, and do not necessarily represent that of the organization. FPSB India is the sole marks licensing authority for the CFP marks in India, through agreement with U.S.-based FPSB Ltd.

©Entrepreneur August 2011

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equities, Financial Planning, gain, Goal, inflation, portfolio, wealth