Chapter 12. Recommending Model Portfolios and Financial Plans

Learning Objective

This concluding Unit discusses three key aspects of financial planning – how to understand the risk profile of investors, how to decide on an asset allocation mix for the investor, and an approach to deciding on model portfolios.

There are differences between investors with respect to the levels of risk they are comfortable with (risk appetite).

Risk profiling is an approach to understand the risk appetite of investors - an essential pre-requisite to advice investors on their investments. Risk profilers have their limitations.

Risk profile is influenced by personal information, family information and financial information.

Spreading one’s exposure across different asset classes (equity, debt, gold, real estate etc.) balances the risk.

Some international researches suggest that asset allocation and investment policy can better explain portfolio performance, as compared to being exposed to the right asset classes (asset allocation) is a more critical driver of portfolio profitability than selection of securities within an asset class (stock selection) and investment timing.

Strategic Asset Allocation is the ideal that comes out of the risk profile of the individual. Tactical Asset Allocation is the decision that comes out of calls on the likely behaviour of the market.

Financial planners often work with model portfolios – the asset allocation mix that is most appropriate for different risk appetite levels. The financial planner would have a model portfolio for every distinct client profile.

Asset Types: There are two types of Assets, 1. Physical Asset and 2. Financial Asset

Physical Asset:

  • Real Estate and Gold are examples of physical assets
  • Recently, the union Finance Minister has announced Gold Linked Unit Scheme launched by MF scheme.
  • Real Estate has also been a preferred investment alternative with the Indian investor.
  • However the capital required is often beyond the means of the small individual investor.
  • Quick liquidity is also one of the restrictions to enter into real estate.
  • Good is news is that the investors who wants to invest in real estate but having less amount and also wants liquidity can invest through Real Estate MF scheme.
  • Government has given green signal for Real Estate MF scheme which is going to be launched AMCs

Financial Asset:

  • In the financial asset category, Indian category have generally had guaranteed or fixed return products.
  • Such as Bank Deposits, Company Deposits and Government savings instruments such as public provident fund, Indira Vikas Patra, National Saving Certificate etc
  • Financial assets include capital market securities such as equity shares, bonds/debenture (issued by companies or FI), money market instruments such as commercial paper or certificates of deposits.
  • Individual investor can buy capital market instruments but do not have any direct access to money markets instruments.

Major type of Financial Assets:


  • Bank Deposit have been a favored investment option with the Indian investor, mainly because of the liquidity and safety benefits, they think which is not so in most of cases.
  • In fact the real reason of investment in banks FD by most of the common people is the unawareness about the other debt products and unawareness cause of very few MF advisors in the market.
  • Yield on bank deposit is negligible after accounting for inflation and tax.
  • While the return on the capital is guaranteed by the bank, deposit is not a secured investment, its perceived safety coming from the soundness of the bank management or ownership
  • Investors should be advised to park only a part of their savings in bank deposits.


  • The corporate borrowers – companies also issue debentures paying fixed rates of interest.
  • Companies pays different rates of interest depending upon how strong their rating
  • Credit Rating given by Credit rating agencies such as CRISIL, ICRA, CARE etc decides the secured ness of the companies debentures and hence its effect on interest rate given to the investor.
  • Less the rating more the interest rate will given to investor and hence high would be the risk for investor and vice versa.

Financial Institutions (FI):

  • FI such as ICICI, IDBI issues bonds on a regular basis.
  • These bonds issued with the intent of financing infrastructure development in the country.
  • These bonds qualify for a tax deduction under section 80C. Because of its government utility purpose they are been treated much secured one.


  • Public Provident Fund (PPF): PPF is a government obligation, hence virtually risk free. PPF carries tax free interest of 8% PA and eligible for tax rebate under section 80C
  • Indira & Kisan Vikas Patra (IVP/KVP): The current yield is 8% over the 6 years but fully taxable hence less attractive.
  • RBI Relief Bond: These issued by the RBI pay interest at 8% which is taxable and have maturity period of 5 years.
  • Other National Saving Scheme: Other National scheme such as Post Office accounts, Recurring Deposits etc. Now a days it not so popular.
  • Government Securities: This is Government paper normally issued on a long term basis. The amount required for direct investments can be large. Hence, for large investors, they are best accessible through MF.

Life Insurance:

  • Premium paid on life insurance qualifies for deduction under sec 80C and maturity is also tax free under sec 10(10)D
  • Hence investors prefer life insurance because it also acts as forced saving apart from tax saving and life insurance
  • But careful evaluation proved that investor should buy insurance, not just as an investment but mainly to provide for his dependents in as of his untimely death.
  • ULIP: A recently developed phenomenon between MF and insurance companies has been the development of Unit Linked Insurance Plans offered both life insurance as well as investment in MF by life insurance organization. ULIP combines the benefits of MF investing with the added benefit of life insurance.

Features of PPF:

  • 15 year deposit product made available through banks
  • Risk-free government obligation
  • Open to individuals and HUFs
  • Only one account permitted per entity
  • Offers tax-free interest of 8% P.A. and contribution up to Rs.70,000 (min Rs.500) are eligible for deduction under sec 80C
  • Option to withdraw 50% of 4th year balance in the 7 year
  • Restriction on withdrawal reduces liquidity
  • Interest receipt and withdrawal of principal exempt from tax.
  • Only individuals and HUFs are eligible to invest

Features of RBI Relief Bonds:

  • Issued by RBI on behalf of the Government of India
  • A 5-year investment product with 8% interest offering
  • Interest is currently taxable (used to be tax free earlier) and payable semi-annually
  • Free of risk of default

Government Securities:

  • Long term government paper
  • Risk-free government obligation
  • Low-return and define the benchmark rate of return on the yield curve
  • Specially appointed Primary dealers deal in G-Secs
  • Generally high ticket investments
  • Best accessible to small investors through mutual funds

Features of other Government Schemes

  • Indira Vikas Patra and KVP issued by central government and sold by post offices
  • Current yield on IVP is 8%
  • Interest is taxable
  • Investor identity is protected and investment in cash is possible

Direct Equity Investment (Share Trading) vs Investment through Mutual Funds

  • Investment through mutual funds is more secured, easy, convenient and profitable than direct equity investment because
    • In direct investment investor need to identify good return stock by themselves which is very critical and need specialization with time and infrastructure.
    • Whereas MF specialize in this area which carry out the research and analysis by team of fund managers whom are dedicated for that job only.
    • MF gives investor a broad diversification and hence risk reduction even by investing small amount which is not possible in direct investment
    • MF provides much professional management advice which is not in direct investment
    • Tax saving along with market linked investment return is only in MF
    • Low level of transaction cost in MF because of economies of scale.
    • MF gives investors a complete satisfaction, complete peace of mind with convenience.

Bank Deposit vs. Debt Funds

  • Bank deposit is guaranteed by the bank for repayment of principal and interest
  • Any risk associated with investment of the investor’s funds have to be borne by the bank
  • The depositor has a contractual commitment from the bank to pay
  • A mutual fund, on the other hand, invests at the risk of the investor
  • Hence, there is no contractual guarantee for repayment of principal or interest to the investor
  • The investor need to assess the risk in terms of the credit rating of the bank, which provides an indication of the financial soundness of the bank.
  • In case of investments in debt funds, investor needs to know whether the fund invests in high quality assets or lower rated debt.
  • It can be seen that the bank deposits are not totally free from risk
  • A conservative debt fund can give higher returns than a bank deposit.

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