IC33 English Chapter 4 Notes

Chapter 4: Financial Planning

Financial planning is:

  • a process of identifying one’s life’s goals, translating these identified goals into financial goals and managing one’s finances in ways that will help one to achieve those goals.
  • It involves assessing one’s net worth, estimating future financial needs, and working towards meeting those needs through proper management of finances.
  • Financial planning takes into account one’s current and future needs, one’s individual risk profile and one’s income to chart out a road map to meet these anticipated needs.
  • Individual’s goals may be: Short term: (Buying an LCD TV) or medium term (Buying a house) pr long term (Education or marriage of one’s child or post retirement provision).

Life Stages

Savings may be considered as a composite of two decisions.

  1. Postponement of consumption: an allocation of resources between present and future consumption.
  2. Parting with liquidity (or ready purchasing power) in exchange for less liquid assets.
  • If we look at the above life cycle, we would see that three types of needs can arise. These give rise to three types of financial products.
  • Enabling Future Transactions: For meeting a range of anticipated expenditures.
  • Specific Transaction Needs: These needs are related to specific life events, which require a commitment of resources. Example: Making provision for higher education / marriage of dependents. General transaction needs: Amounts set aside from current consumption without being earmarked for any specific purposes – these are popularly termed as ‘future provisions’
  • Meeting Contingencies: Contingencies are unforeseen life events that may call for a large commitment of funds. These are not met from the current income and hence need to be pre-funded. Examples: Death, disability or unemployment leading to loss of income
  • Wealth Accumulation: These needs arise from the desire to accumulate wealth by way of prudent investments in favorably market conditions.

Three types of products in the financial market:


IC33 chapter notes 4


The longer the time period of our investments, the more they will multiply.

When is the best time to start financial planning?

Elements of financial planning include:

Investing – allocating assets based on one’s risk taking appetite,

Risk management,

Retirement planning,

Tax and estate planning, and

Financing one’s needs

  • Financial planning should ideally start the moment you earn your first salary.
  • Purpose of Cash Planning: 1. Manage income and expending flow, establish a reserve of liquid assets, meet emergency needs. 2. Create and maintain systematically a surplus of cash for capital investment.

Steps for cash planning:

Step 1: Set your goals and Prepare a budget.

Step 2: Analyse the expenses and income flows over the last six months; Categories expenses into fixed and variable expenses ; Try to reduce variable expenses, as you may not have control on fixed expenses.

Step 3: Predict future monthly income and expenses over the whole year; Design a plan for managing cash flows

  • Insurance Planning: This involves constructing a plan of action to provide adequate insurance against such risks. The task here is to estimate how much insurance is needed and determining what type of policy is best suited.


Investment Parameters:

  • Risk Tolerance: It is a measure of how much risk someone is willing to take in purchasing an investment. Risk tolerance varies with age and time.
  • Time Horizon: It is the amount of time available to attain a financial objective.
  • Longer the time horizon, the less concern is there about short-term liability.
  • Liquidity: Ability to convert the investment into liquid cash.
  • Marketability: It is the ease with which an asset can be bought or sold.
  • Diversification: It is the ease with which an asset can be bought or sold.
  • Tax Considerations: Many investments confer certain income tax benefits. One may like to consider the post-tax returns of various investments.

Selection of appropriate investment vehicles based on the above parameters:

  • Fixed deposits of banks / corporate,
  • Small savings schemes of post office,
  • Public issues of shares,
  • Debentures or other securities,
  • Mutual funds
  • Unit linked policies that are issued by life insurance companies etc.

Retirement Planning: Retirement planning involves three phases

  • Accumulation: Accumulation of funds is done through various kinds of strategies to set aside money for investment with this purpose.
  • Conservation: Conservation refers to the efforts made to ensure that one’s investments are put to hard work and that the principal gets maximised during the individual’s working years.
  • Distribution: Distribution refers to the optimal method of converting principal (which we may also call the corpus or a nest egg) into withdrawals / annuity payments for meeting income needs after retirement.
  • Tax planning is done to determine how to gain maximum tax benefit from existing tax laws.
  • Inflation is a rise in the general level of prices of goods and services in an economy over a period of time.
  • Shares can be categorised under wealth accumulation products.
  • Life insurance can be categorized under contingency product.
  • Bank deposits can be categorised under transnational products.
  • Individual with an aggressive risk profile is likely to follow wealth accumulation investment style.