PFM Chapter-6 (Global)

Chapter 6: Financial Management Strategies You will learn about how to make financial strategies for your clients, various pros & cons of financial strategies and how to help you client implement these strategies We all know that most people do not have enough money to take care of all financial goals at the same time. This means the financial planner and the client need to work together to prioritize goals and financial recommendations required to achieve the specified goals. The financial planner needs to optimize financial management strategies to make suitable and attainable recommendations? If you fail to plan, you plan to fail. This may sound like an old saying, but it explains an essential aspect of personal finance: a financial plan is critical. Regardless of age, marital status, or income, it is essential that you have a personal financial plan. Creating a strategy for financial success is easier than it sounds; you just need to know where to start. Below mentioned eight strategies can serve as a roadmap for straightening out your finances and building a better financial future. 1. Prepare a household budget A budget builds the foundation for all other financial actions. It allows you to identify problem areas and these can be corrected. You will learn to differentiate between your needs and your wants. Having a financial plan to meet monthly expenses and investing for various goals will give you peace of mind. Once the budget is prepared, you should stick to it. 2. Build an Emergency Fund As part of the budget, one needs to plan for an emergency fund. We cannot expect the unforeseen. We just know that the need for an emergency fund will come sooner or later. To cover yourself in case of an emergency (i.e., unemployment, injury, car repair, etc.), you need an emergency fund to cover four to six months of household expenses. 3. Spends on needs first, then wants You have learned to understand the difference between your need and want, be resourceful and be strategic when you spend on what you want. For instance, re-evaluate your Cafe Coffee Day and dining out habit, if you have one. Can it be once in 15 days instead of weekly? If you eat out for lunch every day, could you pack lunch some days? 4. Understand and differentiate between Good Debt and Bad Debt All debts are not equal. There is a noteworthy difference between good debt and bad debt. Good debt, such as a home loan, typically comes with a low-interest rate, tax benefits, and supports an CFP Level 1 - Module 1 - Personal Financial Management - Global Page 1

investment that grows in value. Bad debt, such as credit card debt, will burden you with high- interest rates, no tax benefits, and no hope for appreciation. Bad debt will actually reduce your standard of living. When making your financial plan, you need to make sure that you are keeping bad debts to a minimum. 5. Repay your outstanding loans One of the most important steps to a successful financial plan is paying back your bad debts. You have to keep your debt repayment period low in case of bad debts like credit card, vehicle loan etc. You should include a significant amount of money for debt repayment in your budget. 6. Understand your credit score A high credit score will make it easier to get loans at a Prime lending Rate (PLR) where the interest rate charged by banks is lower. This will mean less money spent on interest payments and more money in your pocket. 7. Pay yourself first Pay yourself first is a popular phrase in personal finance and retirement-planning literature. It means automatically routing a specified amount from each salary at the time it is received. The savings contributions are automatically routed from each salary to your savings or investment account that is you are paying yourself first. In other words, paying you before paying the monthly expenses and making discretionary purchases. 8. Review your Insurance coverage Lastly, review your insurance coverage. Meet with your Certified Financial Planner professional and make sure that your policies match the goals in your financial plan. Insurance is a form of emergency fund planning. At times, you will have events that a regular emergency fund won’t be able to cover. Then you will be happy to have property or health or disability or even life insurance. Developing and Optimizing Financial Management Strategies Financial management, especially cash flow, is about making safety net. After having safety net, we can go ahead with improving the client’s financial position. We all know how significant unanticipated expenses or even a relatively short break in a client’s flow of income can create financial difficulties. Saving is for short term needs like emergency funding, and investing for meeting financial goals is another valuable function of financial management. For example, if a client wants to purchase a house in a few years, he or she will almost certainly need to save for a down payment. In most cases, the best place to hold those savings is in cash or cash equivalents. With those two areas in mind – security and investing for a future need – let’s consider potential financial management strategies. CFP Level 1 - Module 1 - Personal Financial Management - Global Page 2

The first step to developing an effective financial management strategy is to analyse the client’s current situation. The tools discussed earlier – cash flow statement, budget and, to some extent, the statement of financial position – can be put to good use in this exercise. Once the financial planner has a clear idea of a client’s current financial situation, the financial planner can begin formulating a financial management strategy. To develop a strategy, we will consider four areas:  Cash flow (budget)  Cash on hand, including emergency funds  Anticipated needs for cash  Desired levels of cash accumulation Cash Flow Cash Flow management may seem the simplest things but is the most important. You can evaluate a person’s cash flow situation by considering the answers to two questions: 1. Does the person’s monthly cash inflow is more than the outflow? 2. If the answer to question 1 is “no”, can we make efforts to find a remedy to the situation? These two questions can help us understand his cash flow position. If enough inflow exists, then we can proceed to a second step to determine whether there is enough cash on hand. If not, building cash reserve becomes the focal point. However, if there is enough cash on hand, the next step is to determine future cash needs, such as saving for a down payment on a home or another major purchase. After the financial planner knows the goal, he can help the client develop an accumulation plan that will help him in achieving his goals. Understanding current cash flow position means evaluating inflows and outflows. A good starting point is to look at a cash flow statement, and a budget. The cash flow statement is the more important of the two. The cash flow statement shows actual inflows and outflows. A budget sometimes represents the desired state more than the actual. A financial planner should look at financial statements with the objective of properly understanding cash inflow and cash outflow. Financial planner also need to understand future cash inflow and expected outflow in coming years. Sometimes the client have more money flowing into their income accounts than is flowing out and sometimes it may be the reverse Excess outflows can be the result of several things. Some could include:  Significant additional expenses, such as an illness or major home repairs  Job loss or other income reduction  Variable interest-rate increase on a mortgage or other loan  Unanticipated increases in insurance costs or taxes etc.  Excessive spending patterns  Purchases on credit leading to EMIs and affecting cash outflows.  Divorce, separation or death of a spouse or partner  Increase in Inflation so affecting return in real sense on a fixed income  Other issues such as a gambling addiction or alcohol or substance abuse CFP Level 1 - Module 1 - Personal Financial Management - Global Page 3

Strategies to address these types of imbalances will largely depend on the cause of excess outflows. However, in almost all cases, these are temporary outflows and reduction will happen or will be required. One way of reducing excessive cash outflows is as simple as putting away the credit cards and placing a freeze on new purchases. However, other situations can require a bit more prudence. In few cases, especially those involving excessive debt, some form of debt restructuring or asset realization may be necessary. Not all countries have bankruptcy (or insolvency) laws, but when a client’s financial situation is bad enough, bankruptcy may be a last resort. Prior to bankruptcy, some banks will work with the client to create a less formal debt restructuring that allows for lower monthly payments. In some places, community or government-related agencies can provide help to restructure debt (again, without resorting to bankruptcy). Before moving on, let’s briefly review bankruptcy, its benefits and the problems it can cause. Bankruptcy As mentioned, not all countries have bankruptcy laws. Where they exist, bankruptcy laws generally allow for one of two methods to address severe debt situations. The most significant form of bankruptcy is debt forgiveness. That is, after the bankruptcy petition is approved, debts are eliminated or liquidated. In some jurisdictions, not all debt qualifies for liquidation. For example, in the United States, child support payments cannot be eliminated through bankruptcy, nor can college student loans. Additionally, if the client wants to continue living in his or her home (or maintain a car, etc.), he or she will need to continue making payments or the lender may repossess the asset. Where debt liquidation is allowed, the process and time required for the case to advance through the legal system can vary significantly, from several months to several years. Perhaps the biggest downside with this form of bankruptcy is a loss of assets for the person filing; loss of access to credit for a specified period (a number of years in some cases), inability to run a business or be a company director and even harm to future employment prospects (if prospective employers require a credit check to be completed).. In almost all cases, at least some assets must be liquidated or given back to the lender. Provisions can sometimes be made to retain the family home or keep a car along with a few other assets, but usually, assets go away. However, there is not a single standard; sometimes assets, such as retirement accounts, may be kept out of bankruptcy proceedings. In other cases, all assets can be seized. Many creditors prefer debt restructuring to bankruptcy. Rather than eliminate debts, creditors agree to accept lower payments, either by extending the repayment term, forgiving part of the debt, or by lowering interest rates. These may also be used in combination. The big upside for debt restructuring is that it does not normally require giving up assets. In return for the promise to repay the debt, the client gets to keep all, or most, assets. Businesses also periodically use this form of restructuring. CFP Level 1 - Module 1 - Personal Financial Management - Global Page 4

In all cases, bankruptcy appears on a person’s credit report and can continue to adversely affect a client’s credit rating even beyond the period of the bankruptcy if the bankruptcy stays on the record. Bankruptcy can keep an individual from acquiring a new loan or credit card for a period, depending on laws in the territory and creditor policies. Bankruptcy should never be considered as the first, best option. However, after a client has explored all reasonable alternatives, bankruptcy, if an option, can improve a client’s financial situation. Other Forms of Eliminating Debt or Reducing Payments As we know bankruptcy against the borrower is seen as the last resort. There can be lot of discussion with the client to restructure his debt so that financial situation can improve and debt is taken care of. For example your client has purchased a house worth 2 crores and a loan was taken for 1 crore for which EMI works out to be Rs.90000 p.m. When he purchased the house, his monthly income was able to afford this, but of late he changed job for better but had to lose his job. New job is paying him less amount. It is becoming difficult for him to pay EMIs. He has two options: 1. Sell the house, pay outstanding loan and stay in rented accommodation for few years till his financial position improves 2. He may shift to a smaller house and repay some part of outstanding loan and thus reduced EMIs and his own house. He may have 2 cars, may sell one car and repay car loan. He may also work on reducing his lifestyle expenses. It would do little good to restructure debt payments or sell assets to raise funds if the client continues to overspend and assume more debt. Actually, this would create a more difficult situation, because two available tools would have been eliminated. As a result, lifestyle changes should often be a required part of the debt management process. Mortgage or Other Long-Term Debt We should discuss a simple question; does it always make sense to pay off a loan or other long- term debt? It is not necessarily. If the client is making all payments on a timely basis, has some level of discretionary income and savings, and is generally in reasonably good financial condition, there is no need to pay off all his debt? Many people feel that owning a debt free house gives them a sense of security. They want to know that, in almost all circumstances, they will have a place to live. For them, paying off their mortgage is a primary financial goal. Think about what it would take to lose your home if you had an outstanding mortgage. Depending on the level of your cash reserves and other liquid assets, missing a few payments could cause the lender to begin foreclosure proceedings. In fact, during the 2008 (and later) global recession, many homeowners faced this exact situation. Not having to worry about losing a home provides a powerful sense of security. CFP Level 1 - Module 1 - Personal Financial Management - Global Page 5

Does it always make sense to pay off a home mortgage as quickly as possible? Not necessarily. 1. Pre-paying mortgage principal may put too much of a dent in available cash flow, thereby negatively impacting a client’s overall financial situation. 2. Using funds that are otherwise invested to pay down a mortgage may not be financially wise. Home loan interest rate is 8% p.a. and the investment you withdraw to pay off loan is generating 12% p.a. Does it make sense to pay loans by selling investments generating higher return than interest on loan In the example above, good financial advice would ensure that if the debt had been repaid, the cash outflow previously used to service that debt should be invested to meet future goals. Some believe that paying off a long-term loan (such as a mortgage) early can result in significant savings. While this may be true, one must bear in mind the Time Value of Money principles of amortization. Amortization tells us that the initial payments of a mortgage (for more than half the term) consist mostly of interest payments; thus it may only make sense to repay a mortgage in its early life span. The principle of equivalence tells us that we cannot add up nominal amounts from different time periods; in other words, one rupee of interest in 10 years is not equivalent to one dollar of interest today. Home loans offer tax benefits under Sec 80C and Sec 24 B (As per old tax brackets- can be opted for) One should always keep client goals and desires in mind. As a result, even though it might make better financial sense to keep a mortgage in place, if the client’s need for security is great enough, that becomes the best use for available funds. Client first is the cornerstone of financial advice ethics, and this sometimes means the financial professional’s idea of the best path must give way to the client’s desires. We have looked at reducing debt as one step toward improving a client’s financial condition. Let’s shift our focus to increasing income. Increasing Income Many a times paying off debt is not the viable solution looking at the tax benefits it offer. An alternative, and additional option, is increasing income. While this may be difficult, it is sometimes possible to find additional income sources. Here are a few possibilities for increasing income:  Ask for a raise at work, or ask for more responsibility that might provide a higher salary.  If doing shift work, ask to work an additional shift.  Find a second job, possibly part-time, to supplement income.  Get a new job with a higher salary.  Shift investments from a growth focus to an income focus. This must be done with care, as it may negatively impact other long-term goal achievement and generate unwanted tax consequences.  Income-producing investments include real estate, bonds and dividend-paying equities.  Complete an education program to qualify for a better paying job, or a higher salary from the current job. (Note: An issue with this option is that education usually costs money, and that doesn’t help solve the problem of not enough net inflow. However, there may be low CFP Level 1 - Module 1 - Personal Financial Management - Global Page 6

or no-cost options that could be helpful, such as on-the-job training and some government- sponsored programs).  Rent out a room in the home.  Start a new or part-time business (i.e., become an entrepreneur).  Other possibilities exist, and the preceding list certainly will not be applicable in all situations. However, options clearly exist to increase income, and depending on the need, some of those options may need to be considered. Structure When a Certified Financial Planner meets a new client and interaction starts, very often, we find that the client is not able to explain about his exact financial status. Few clients have very vague idea of their true cash flow situation. They perhaps know roughly how much money is coming into their accounts. Most likely they know whether they have enough money each month to cover expenses. When asked for exact or close amounts, though, many clients cannot answer the question. For getting appropriate advice from financial professionals, clients need to have a good idea of their cash flow situation. Gathering the data about his current financial position is most important. Once compiled, the financial professional and client can use the information to build a more accurate budget. By pursuing cash inflows and outflows, we can identify changes in either category. Perhaps a large insurance premium payment came due, which in turn, created a temporary negative cash-flow situation. People sometimes forget such payments, and so are surprised each time they must make one. Had this insurance premium budgeted in monthly expenses, it would not have affected the cash flow. By keeping good records of cash flows, clients will find less opportunity for negative surprises. In the same way yearly bonus may help cover expenses or provide extra money, but it should not be counted on as a regular inflow. Identifying special inflows is as important as tracking outflows. Saving People in India are known for saving money, while people at some areas are known for spending more and saving less. Local culture, along with the economic environment is the deciding factor for savers and spenders. People often want to know how much of their net income they should save. The answer, of course, depends on the individual, but we can identify a reasonable rule of thumb. For decades, people have been encouraged to save and invest 10 -15% of their income. Starting investing this much percentage every month can take care of most of the goals but as income increases, people should invest a higher percentage than this, The amount of investments will also depend on various financial goals to be achieved by the client. Let us understand this with the help of one example. Suppose a person who is 35 years old wishes to accumulate Rs.75,00,000 in 20 years’ time. Rate of return is 12% p.a. How much he needs to invest per month to enable him to achieve the goal? CFP Level 1 - Module 1 - Personal Financial Management - Global Page 7

Solution: with the help of CASIO FC200V Set- Begin N = 240 (20*12) I% = 12 PV =0 PMT =? (SOLVE) = 8153.43 FV = 7500000 P/Y =12, C/Y =1 Solution with the help of Excel: Why we changed rate of return to 11.3865% from 12% p.a. CFP Level 1 - Module 1 - Personal Financial Management - Global Page 8

Because investment is per month and rate of return is 12% p.a., so we will assume 12% to be effective rate and will find out nominal rate in this way. In FC 200 V, we change P/Y and C/Y depending on investment per month (P/Y=12) and compounding per annum (C/Y=1) Let us understand the effect of inflation on cost. Let us take an example that present cost of higher education of child is Rs.75, 00,000 and amount is required after 20 years (child is new born). If we want to know the future cost of education after 20 years, it will be done like this: (Inflation rate=5%, Rate of return=12%) -7500000 PV 5 I (Inflation rate) 20 N P/Y =1 C/Y =1 Solve FV =19899732 Amount to be invested per month will be: Set- Begin N = 240 (20*12) I% = 12 PV =0 PMT =? (SOLVE) = 21633.49 FV = 19899732.79 P/Y =12, C/Y =1 Instead of doing this in two steps, we can do it in one step by using real rate of return. Let us understand how to compute Real rate of return which is the rate adjusted for inflation. Real rate in our example= (1.12/1.05)-1*100 =6.667% Let us understand use of real rate in calculating amount to be invested. Present cost of education is Rs.20,00,000 and amount is required after 15 years. Inflation rate is 6% and rate of return is 14%. Mr. Mehta wishes to invest some amount today for education goal of his son. How much should he invest today? Set- Begin/End (Does not affect in case of PV, It affects in case of PMT) -2000000 PV 6I 15 N P/Y =1, C/Y =1 Solve FV = 4793116 (Future cost of education) CFP Level 1 - Module 1 - Personal Financial Management - Global Page 9

How much amount to be invested today: Set Begin/End 4793116 FV 15 N 14 I P/Y =1, C/Y =1 Solve PV=-671499 (Amount to be invested today) If he invests Rs.671499 at 14% p.a. for 15 years, he will be able to meet education goal of his son. Let us do same question with the help of using real rate: Real rate= (1.14/1.06)-1 *100= 7.5472% Solution: 2000000 FV C/Y =1 15 N 7.5472 I P/Y =1, Solve PV = 671499 The Impact of Changes: We know by now that changes to inflows or outflows affect overall cash flow management. Sometimes these changes are small. Other times, the changes can be significant. Assuming overall financial wellbeing, small changes are unlikely to make much of a difference. A little bit more or less money each month may not even be felt. However, large changes can have a significant impact on a client’s financial wellbeing and require advance preparation. Income Loss: We all know the impact a job loss could have on a client’s financial plan. Assume one of the partners suffered a job loss because of losses in the company she was working. They have taken huge debt as both husband and wife were getting decent salary and were able to pay their EMIs and were able to have a very comfortable life. Income loss can be the result of work cutbacks (e.g., job elimination, or a decrease in hours or salary), disability, or perhaps the individual’s desire to work less or in a less stressful job. In case of some clients, income can fluctuate on month to month basis. A robust emergency fund is the best solution to protect against income loss. If income loss is due to disability, insurance coverage in addition to available government benefits can also help. Income Increase: If there is increase in income of client, it should be spent and invested judiciously. In fact, increasing the amount of money flowing into a client’s accounts is a very good way to improve financial position. However, an income increase can be problematic when it is applied inappropriately. Sometimes clients who start making more money do not save or invest the increase; they spend it. Spending often leads to more spending, and it’s possible that the entire income increase will be spent, resulting in no real long-term benefit to the client. It can also be true CFP Level 1 - Module 1 - Personal Financial Management - Global Page 10

that if a client sees him or herself as needing to maintain a higher standard of living because of an income increase, he or she may wind up in a worse situation than before the increase. This situation will usually be the result of moving up the ladder, i.e., getting a promotion to a higher position, and wanting to maintain a certain image. In these situations, clients often combine greater levels of spending with increased debt, to their disadvantage. Medical Expenses Depending on the level of employer provided medical benefits, healthcare expenses can cause great harm to a client’s financial wellbeing. Even when the employer provides good medical benefits, a client needs to buy separate health insurance policy. Ehen client changes job, his existing group health insurance policy from employer will lapse. There is need to buy a family floater policy in which full family is covered. Looking at very high cost of healthcare, one needs to keep additional provision for medical emergencies. Existing healthcare benefits may also require out-of-pocket expenses. Family Emergencies Family emergencies can also have substantial drain on financial resources. Imagine getting a call from a family member saying a serious accident has taken place or one of the children has lost job due to recession, or something similar. A parent’s natural response would be to try to help, perhaps with a financial contribution. Significant contributions could negatively affect a family’s budget, especially if the need for assistance is frequent. While the parent may not necessarily want to provide the funds, he or she may feel compelled to do so. The need for extra money is not limited to children. Parents, or other close relatives, could also need additional funds. While it’s impossible to anticipate every need, the financial planner and client should consider the potential for family emergencies when setting up an emergency fund. Property-Related Loss Property related loss can cause lot of financial harm to the client. A seriously damaged car, a house that requires substantial repairs, major appliances that need to be replaced – all can put a dip on a client’s financial wellbeing. In most cases, the best approach is to recognize that such things may happen, and set aside funds to cover the events as they arise. When an expense is too high to pay all at once, borrowing some of the money may make sense. However, the less a client uses credit, the better off financially the client will be. Positive Changes Some financial changes are positive such as an income increase from job, bonus, and incentives. Increasing discretionary cash flow could allow a client to speed up goal achievement. As an example, let’s look at a situation where a client wants to eliminate Rs.10, 00,000 of debt, with a nine per cent annualized interest rate (compounded monthly). The loan is taken for 5 years and he is paying his EMIs every month. When there is increase in salary say by Rs.10, 000 p.m., he can use CFP Level 1 - Module 1 - Personal Financial Management - Global Page 11

part increase towards payment of higher EMI and retire his debt early and pay less interest as a result. A client may want to know the most suitable application for increased cash flow. The best way to answer would be to evaluate the situation in the context of the client’s goals. Financial professionals learn there is seldom one right or best solution that fits every situation. Using the example of paying off a home mortgage, the financial professional might decide that it’s always appropriate to pay down a mortgage as quickly as possible — or never appropriate to do so. Neither option is always right or always wrong. In fact, few, if any, financial options are always either right or wrong. As a result, financial professionals should evaluate each situation in light of the client’s goals and financial condition. Recommendations should be based on the client’s situation. Every plan should be customised as per client’s needs and goals. Implementing Financial Management Strategies with a Client What should be the primary goal of client to meet various financial goals?  Increasing Assets  Decreasing Debt For many clients, increasing assets is a priority goal. Sometimes, decreasing debt may be more beneficial and be a better effort for initial goal achievement. In this section, we will look at some specific examples of developing and implementing action plans to achieve financial management goals. Getting from Here to There Goals may be complex sometimes, and the client’s resources may be limited. Even in a simple situation, the client may need some direction about how to implement the plan of action to achieve a goal. To illustrate, think about the process of preparing for a long drive. Planning your long drive  Think about when you want to travel. Certain days or times can be busier than others, especially around public or school holidays.  Look at your route before you set out, so you know the basics of which roads and turns you need to take.  Look for places along the route where you can stop and take a break. It's good to have a break at least every two hours.  Check the weather forecast and road conditions (road works and closures) for the route you want to take.  Make sure that your car is roadworthy, the windows are clean and that you have plenty of petrol to get there.  Give yourself plenty of time to get to where you want to go.  Avoid travelling at times of the day when you would normally be sleeping. Get a good night’s sleep before you set out. CFP Level 1 - Module 1 - Personal Financial Management - Global Page 12

Avoid distractions while you're driving. Set a playlist before you set out and don't drink or eat until you're having a break. Turn your mobile phone on silent or turn it off. If your passengers are being distracting, ask them to stop. Driver fatigue Driver fatigue is when a driver becomes tired, weary or exhausted and is the cause of many fatal crashes on our roads. To help you avoid feeling over-tired when you're driving: Stop at least every 2 hours for a rest. Get out of the car and walk around. If possible, share the driving with another licensed, experienced driver. Snack on light, fresh foods. Avoid fatty, sugary or carbohydrate-filled foods as these can make you tired. Don’t drink any alcohol, even small amounts, beforehand as it'll make fatigue much worse. The signs that you're getting fatigued and should stop driving immediately include:  Trouble focusing, keeping your eyes open or holding your head up  Daydreaming  Forgetting things or missing signs or exits  Yawning or rubbing your eyes  Drifting out of your lane or tailgating  Feeling restless and grumpy.  If you do experience any signs of fatigue: Don’t keep driving. Find a safe place to stop and have a rest immediately. Once you've stopped, move to the passenger seat and take a ‘power nap’ for about 15-20 minutes. Try not to sleep for longer than 40 minutes. If you do, you might feel groggy and confused when you wake up rather than refreshed. Keep in mind that a power nap just lets you carry on safely for a bit longer. It doesn’t cure fatigue. Make sure that you’re completely awake before you start driving again. If you still feel sleepy after a short nap, don’t continue your journey. The only cure is to have a proper sleep for 7-8 hours. We could continue the process, but from the list above, you can see that even a relatively simple task such as preparing for a long drive can require many action steps. Financial advice is no different. To accomplish a goal requires mapping out options and making decisions as to which options represent the best plan of action. Let’s learn how to plan to have sum of money required for the holiday we want to take. The two big questions are when and how much? Are we planning the trip this year, or later? What will be the cost to make a trip say abroad, where we want to go and do what we want to do? Once we know the amount and timeframe, we can begin building a plan of action to accumulate the required corpus within the desired amount of time. CFP Level 1 - Module 1 - Personal Financial Management - Global Page 13

 How much do we need, and when do we need it?  Let’s assume Rs.3, 00,000 in two years  Do we have any excess inflow that we can apply to this goal?  Let’s assume we have enough discretionary income  Where will we save the money – Bank FD or Liquid Funds of Mutual Funds, or somewhere else?  Since it is short-term goals, money should be held in cash or a cash equivalent. We should not use equities or long-term bonds.  We have decided to open a recurring deposit account in a bank in which a certain amount will be debited from savings account and will be transferred to RD account which provides 6% return p.a. and compounding is quarterly. How much do we need to save each month? If we save Rs.11745 (rounded off) , we will achieve our goal in 24 months. Set - Begin 24 N 6I 3, 00,000 FV P/Y =12 (Monthly investment) C/Y =4 (Quarterly compounding) Solve PMT = 11741.18  Can we afford to do this without negatively impacting our overall financial situation?  Yes, let’s go! Some clients will subconsciously know what to do and how to do it. Others will need step-by-step guidance from the financial professional. Along the way, the financial professional and client would need to monitor how things are going to determine whether any changes are required. It may be that developing a plan of action is as simple and straightforward as the preceding example. However, many times, this is not the case. To help us consider how to prioritize action steps when multiple goals and limited resources exist, let’s look at a couple that has asked for guidance with their financial management situation. Case Study- Mrs. and Mr. R.P. Singh Mr. Sharma, a Certified Financial Planner has been approached by Mrs. and Mr. R.P. Singh. They want to establish an emergency fund, pay down debt, and build a fund to save a down payment for a new house. The couple has a comfortable income, but they have increased their lifestyle expenses. As a result, they have accumulated Rs.2, 00,000 in credit card debt, carrying annualized interest charges of 14 per cent. The couple are making minimum debt payments of Rs.2400 each month and if they keep on paying minimum payment every month, it may take many months to repay this debt. After doing the appropriate calculations, Mr. Sharma the financial planner has determined that the couple should fund an emergency fund of Rs.2,50,000 over the next 24 months. Additionally, they want to purchase a house in five years and they want to save an additional Rs.30,00,000 for that purpose. Annualized interest paid on highly liquid savings is 6%, compounded annually. They will be saving for all these goals at the end of the month. Their goals, in order of importance, are: CFP Level 1 - Module 1 - Personal Financial Management - Global Page 14

1. Pay down debt 2. Establish and fund their emergency fund 3. Accumulate the new home down payment Here are the calculated amounts for each goal (all amounts rounded). 1. Pay off RS.2, 00,000 credit card debt in five years. Set End 60 N (5 years x 12 months) 14 I (14 per cent annualized annual interest charged on debt) -200,000 PV P/Y =12, C/Y =12 PMT = 4653.65 2. Fund Rs.2, 50,000 emergency fund over the next 24 months. 24 N 6I 2,50,000 FV P/Y =12, C/Y =1 PMT =9845.36 3. Accumulate Rs.300, 000 down payments in 60 months 60 N 12 I (Long term, investment in Equity MF) 300,000 FV P/Y =12, C/Y =1 (Payments per year 12, Compounding per year 1) Solve PMT =3734 Total monthly payments to achieve all goals = Rs 4655+9845+3735 (rounded off) Rs.18234 p.m. When the financial planner suggested this monthly investment to meet their 3 goals which are indeed crucial to achieve, they found it difficult to invest this month amount per month looking at their spending habits. What is the suggestion?  Paying off credit card debt is very important as the interest rate is very high. They will be at peace when this debt is paid off  Saving money for emergencies is also very important, this goal also has to be achieved  The financial professional, Mr. Sharma needs to explain them the importance of making household budget and to cut down on discretionary expenses  If possibility of curtailing expenses seems difficult, we have no option except to postpone buying the house for few years. The financial professional’s job is to find and understand these options, then present them to the client, and provide whatever guidance needed to help the client choose an optimal solution. Then, the financial professional and client can work together to develop a set of implementation steps leading to goal achievement. CFP Level 1 - Module 1 - Personal Financial Management - Global Page 15

The entire preceding scenario involved time value of money (TVM) calculations. Compound interest on savings is what makes it possible to achieve long-term financial goals. In the next chapter we will explore TVM calculations and their application to achieving financial goals. CFP Level 1 - Module 1 - Personal Financial Management - Global Page 16