Chapter 10. Selecting the Right Investment Products for Investors

Learning Objectives

Investors tend to block their money in physical assets. This unit compares physical assets with financial assets. Distributors and financial advisors perform an invaluable role in helping investors decide on investment products. Mutual fund schemes are just one of the various alternatives that investors consider for investment. This unit discusses some of these alternatives in the context of mutual fund schemes.

Physical assets like land, building and gold have value and can be touched, felt and used. Financial assets have value, but cannot be touched, felt or used as part of their core value. Shares, debentures, fixed deposits, bank accounts and mutual fund schemes are all examples of financial assets that investors normally invest in.

The difference in comfort is perhaps a reason why nearly half the wealth of Indians is locked in physical assets.

There are four financial asset alternatives to holding gold in physical form – ETF Gold, Gold Sector Fund, Gold Futures & Gold Deposits.

Wealth Tax is applicable on gold holding (beyond the jewellery meant for personal use). However, mutual fund schemes (gold linked or otherwise) and gold deposit schemes are exempted from Wealth Tax.

Real estate in physical form has several disadvantages. Therefore, investors worldwide prefer financial assets as a form of real estate investment.

Bank deposits and mutual fund debt schemes have their respective merits and demerits.

Pension Funds Regulatory and Development Authority (PFRDA) is the regulator for the New Pension Scheme. Two kinds of pension accounts are envisaged: Tier I (Pension account), is non withdrawable. Tier II (Savings account) is withdrawable to meet financial contingencies. An active Tier I account is a pre-requisite for opening a Tier II account.

The NPS offers fewer portfolio choices than mutual funds. However, NPS offers the convenience of a single Personal Retirement Account Number (PRAN), which is applicable across all the PFMs where the investor’s money is invested. Further, the POPs offer services related to moneys invested with any of the PFMs.

Financial Planning

• Financial Planning is the overall process of advising clients on how to achieve their financial goals.

• The objective of financial planning is to ensure that the right amount of money is available in the right hands at the right point in the future to achieve an individual’s financial goal.

• Financial planning is the process that helps a person work out where he/she is now, what he/she may need in the future and what he/she must do to reach the defined goals.

• The role of financial planner is one of the most respected professions in the developed countries. It is for the same reason the profession for financial planning is emerging.

• Financial health is as important as physical and spiritual health and people should approach a financial planner who can advise them on achieving financial fitness.

• The Financial Planner is someone who uses the financial planning process to help another person determine how to meet his or her life goals.

• The planner can look at all of clients needs including budgeting and saving, taxes, investments, insurance and retirement planning.

• Risk tolerance of an investor is not dependent on the market, but his own situations.

Characteristics of Good Financial Planner:

• Capacity to build trust with the client
• Good knowledge of financial products
• Familiarity with taxation
• Knowledge of life and wealth cycle
• Regular in touch with clients
• Client need focus rather than own benefit focus

Financial Plan:

• It is the document that details clearly in writing the financial goals, available resources, time frame for investment, asset allocation and implementing the financial planner’s recommendations.

• The life cycle stages of an investor can be classified as follows:

• Childhood stage
• Young unmarried stage
• Young marriage with children stage
• Married with older children stage
• Pre-retirement stage
• Retirement stage

• The income level of investors, the saving potential, the time horizon and the risk appetite of an investor depend on his life cycle.

• Younger investors have higher income and saving potential, take longer-term view and may be willing to take risks.

• Older investors may have limited income and saving, shorter time horizon, and unwilling to risk their savings.

• There are 3 wealth cycle stages for investors:

• Accumulation Stage is when investors are earning and have limited need for investment income. They focus on saving and accumulating wealth for long term. Equity investments are preferred in this stage.

• Transition Stage is when financial goals are approaching investors still earn incomes, but have also draw on their earnings. Investors choose balanced portfolios that have both debt and equity.

• Reaping Stage or Distribution Stage: In this stage, investors need the income from their investment, and cannot save further. They reap the benefits of their savings. They prefer debt investments and preserving of capital at this stage.

• Inter-generational fund transfer refers to transfer of wealth to an investor. Such sudden wealth surge refers to winning in games and lotteries investors should be advised to temporarily park their funds in money market investments and create a long-term plan after thinking through the plan. They must also take into account the impact of tax.

Affluent investors are of two types:

1. Wealth preserving investors who are risk-averse and like to invest in debt
2. Wealth creating investors who prefer growth and are willing to take the risk of equity investments

Steps of Financial Planning & Closing:

• Establishing and defining the client relationship
• Gathering client data, defining client goals
• Gather and Analyze data, assess the current resources and future income potential of the client
• Determine and shape the risk tolerance level of the client
• Analyzing and evaluating a clients financial status
• Determine the client’s tax situation
• Developing and presenting financial planning recommendations and options
• Recommend the appropriate asset allocation, and specific investments
• Executing the plan and making the client invest
• Implementing the financial planning recommendations
• Reviewing progress and portfolio rebalancing