CFP- Level-1-IP (Global) Chapter 7-9

3 Emotional Biases • Endowment • Endowment is placing a higher value on an owned asset over assets that are not owned. • This may be especially true when an individual has inherited an asset. He or she may refuse to sell the asset simply because it was inherited. • Another result is a tendency to demand a higher price to sell an owned asset, along with requiring a lower price to purchase an not owned asset. • In essence, ownership endows an asset with added value. An endowment bias can also result in an investor’s resistance to change his or her ownership in a security. Friday, 15 July 2022 Investment Planning & Asset Management

3 Emotional Biases • Regret Aversion • This is the fear that any decisive action may prove to be less than optimal. The individual attempts to reduce or eliminate the pain of regret associated with poor decision-making. • Regret aversion may also keep an investor from entering the market after it has generated a series of losses, perhaps leading to a tendency to buy high and sell low. Another potential result is the tendency to do nothing, because any action has the potential to create pain, and thereby, regret. • There is a phrase that is relevant: paralysis by analysis. A person may try to avoid making a mistake by engaging in extended periods of research and analysis. The idea is to gather enough information as to make the likelihood of failure almost non-existent. Of course, it is nearly impossible to do enough research and analysis to guarantee a future outcome. Further, the time it takes to do all the analysis effectively guarantees the person will not make a potentially lucrative investment in a timely manner. • You can see how many of the biases can work together, and against the best interest of the investor. Although the preceding biases were presented in an investment context, they can have implications throughout all financial advice. Friday, 15 July 2022 Investment Planning & Asset Management

The Psychology of Money Money often generates strong feelings in people, with the result that not all money- related decisions are rational.  As we saw with behavioral biases, the way people feel about money often influences them to make money decisions that are not necessarily in their best interest. To complicate matters, most people are not aware of their biases or money psychology Hoarders: Enjoy holding on to their money. It may be difficult for them to spend money on luxury or pleasurable items for themselves or loved ones. Spenders: Use money to buy whatever is assumed to bring pleasure. They may have a hard time saving, budgeting and delaying gratification to meet long-term goals Friday, 15 July 2022 Investment Planning & Asset Management

Behavioral Finance The Psychology of Money Bingers: Are a combination of hoarders and spenders. They tend to save, and then spend the money all at once. If binging becomes excessive, it can lead to significant overspending and debt. Money monks: Try to avoid having too much money. They would feel guilty if they received a large amount of money unexpectedly. Friday, 15 July 2022 Investment Planning & Asset Management

Behavioral Finance The Psychology of Money Avoiders: Money avoiders tend to avoid performing various everyday money management tasks. They may feel anxious or incompetent about dealing with money. Risk avoiders often choose safety and security above all else. They don’t like financial surprises and prefer low-risk investments, even if they produce low returns. Friday, 15 July 2022 Investment Planning & Asset Management

Behavioral Finance The Psychology of Money Amassers: Are overly concerned with keeping large amounts of money at their disposal to spend, save and invest. The desire to have more may negatively impact relationships and life enjoyment. Worriers: Tend to worry excessively about money. They typically want to exercise a great amount of control over their money and may invest large amounts of time doing things such as balancing accounts and ensuring enough money is available. Worriers allow money to become a significant preoccupation. They also may feel that, if they only had more money, they could stop worrying (this is seldom true). Money worriers may also be hoarders and amassers. Friday, 15 July 2022 Investment Planning & Asset Management

Behavioral Finance The Psychology of Money Risk takers: Enjoy taking money risks. They like the thrill and adventure of risk-taking. Safety and security, along with much financial advice, feels uncomfortable to many risk takers. Friday, 15 July 2022 Investment Planning & Asset Management

Behavioral Finance Helping Clients to “Behave” Their Way to Success A review of the behavioral biases should lead to the conclusion that the way to help clients behave their way to success is to help them recognize and revise at least some of their core disabling biases. However, before embarking on such an endeavor, you should know that it is, at best, quite difficult to get people to change even one of their behavioral biases. Part of the reason for this is that most people cannot see or recognize the very biases that are holding them back. They simply cannot acknowledge the problem in themselves. What can you do to help? Friday, 15 July 2022 Investment Planning & Asset Management

Behavioral Finance Helping Clients to “Behave” Their Way to Success 1. If you can get someone to agree to a disciplined investing (and overall money) approach, you may be able to provide the behavioral help they need. 2. Help the investor to focus on goals. Help the investor to see the value and desirability of achieving those goals. 3. Create a disciplined approach to asset allocation, investment selection, periodic rebalancing and evaluating progress. 4. If the client will agree to this approach, along with a disciplined process of infusing new capital into the portfolio mix, they may keep their biases from negatively impacting goal-achievement. Friday, 15 July 2022 Investment Planning & Asset Management

Behavioral Finance Helping Clients to “Behave” Their Way to Success 5. Some advisors also suggest that the individual take a small percentage (e.g., 10%) of their money and use it to make the investments they think will be appropriate. If they limit themselves to this small amount, they will do themselves little or no harm. 6. They may even come out ahead if they choose well. If you can keep clients from making wholesale changes based on unsupported behavioral biases, you can do a world of good for them. Making rational money decisions is not always easy, but it’s always necessary. Friday, 15 July 2022 Investment Planning & Asset Management

Behavioral Finance In Theory In Practice Investors have well Defined Goals Investors not sure about their goals Investors carefully weigh the odds of success Investors often act impulsively and failure Investors know how much risk they are The risk tolerance of investors varies with comfortable with market conditions The smarter an investor is, the more money Many smart people commit dumb he will make investment mistakes People who monitor their investments closely People who almost pay no attention to their tend to make more money investments tend to do better Greater effort leads to superior performance On average, professional investors do not outperform amateur investors Friday, 15 July 2022 Investment Planning & Asset Management

• Chapter 8 ends here • Thanks a lot Friday, 15 July 2022 Investment Planning & Asset Management

Chapter 9: Investment Objectives, Constraints and Suitability Friday, 15 July 2022 Investment Planning & Asset Management

Investment Objectives, Constraints and Suitability Ethics in Financial Planning: Eight Principles Principle 1: Client First Place the client’s interests first. Principle 2: Integrity Provide professional services with integrity. Principle 3: Objectivity Provide professional services objectively. Principle 4: Fairness Be fair and reasonable in all professional relationships. Disclose and manage conflicts of interest.

Investment Objectives, Constraints and Suitability Ethics in Financial Planning: Eight Principles Principle 5: Professionalism Act in a manner that demonstrates exemplary professional conduct. Principle 6: Competence Maintain the abilities, skills and knowledge necessary to provide professional services competently. Principle 7: Confidentiality Protect the confidentiality of all client information. Principle 8: Diligence Provide professional services diligently. Friday, 15 July 2022 Investment Planning & Asset Management

Investment Objectives, Constraints and Suitability Engaging Investment Clients For financial professionals, engaging clients isn't about simply acquiring new clients or selling financial products, it’s about taking the time to develop a thorough understanding of a client’s current financial position, hopeful future position, timeline, concerns, behavioral tendencies, risk tolerance, and current level of planning. Investment clients typically do not have the same level of knowledge and comfort or familiarity about finance and investments as financial professionals do, which is why most will seek out and engage the services of an investment advisor. Friday, 15 July 2022 Investment Planning & Asset Management

Investment Objectives, Constraints and Suitability Engaging Investment Clients Some people do not feel comfortable discussing their finances with others, so having an organized, pre-planned approach to each meeting, along with projecting a professional attitude, should help bring a sense of ease to the process. By having an agenda and a list of questions prepared (and possibly printed) ahead of the initial meeting, the time needed to collect factual data is reduced, leaving more time for the discovery process and discussing client objectives, goals, values, needs, etc. Friday, 15 July 2022 Investment Planning & Asset Management

Investment Objectives, Constraints and Suitability Engaging Investment Clients The Initial Client Interview When entering into an initial conversation with a prospective client, it is helpful to think of the process as a two-directional interview. Your prospective clients should be interviewing you as much as you are them, to determine whether there is potential for a good working relationship. Friday, 15 July 2022 Investment Planning & Asset Management

Getting the Client to Talk • If you have not met the client previously, you should spend some time making the client feel welcome and providing them with an opportunity to talk and to feel comfortable with you. • A good ‘ice breaker’ is offering the client a cup of coffee or tea. • Many financial planners fall into the trap of believing that a client has come to hear the planner’s words of wisdom, and the planner will immediately launch into a discussion about markets, performance and other matters. • In fact, the client has come in to tell the financial planner of their problems and wishes to have the planner help solve them. • You might start with ‘small talk’ to help the client open up and feel at ease. Friday, 15 July 2022 Investment Planning & Asset Management

Investment Objectives, Constraints and Suitability • Explain Your Role • Defining the Scope of Engagement • Disclosing Information: A Client’s Right to Know • Address Client Concerns • Disclosure Statements to Prospective Clients • Other Client Concerns Friday, 15 July 2022 Investment Planning & Asset Management

Investor Personalities Individualist investors tend to: • Be confident but act with intent and caution • Make decisions based on information perceived to be factual • Trust their analysis • Stick to decisions once they are made • Be independent (do-it-yourselves) • Be entrepreneurial Adventurer investors tend to: • Be confident, but act with impulsivity or spontaneity (rashly) • Be strong-willed • Be highly risk tolerant/more likely to take risks Friday, 15 July 2022 Investment Planning & Asset Management

Investor Personalities Guardian investors tend to: • Be very cautious and risk averse (anxious) • Seek to protect rather than grow assets • Invest conservatively Celebrity investors tend to: • Be anxious and impetuous or rash at the same time • Follow the crowd or what is “in” now • Follow unfounded “hot tips” • Chase returns Friday, 15 July 2022 Investment Planning & Asset Management

Factors affecting a risk profile of investors • Specific goals: Investors may have lower relative risk tolerance with money they are saving for the down payment on a home, because of a short time horizon, but a higher risk tolerance level for money that is being invested long term for wealth accumulation. • Time frame: A retirement account that has 40 years to accumulate allows for higher risk levels because the investor has more years to earn an income and replenish losses; on the other hand, the shorter the time frame, the less risk an investor would want to take because there would be little, if any, time to recover from a drop in the investment’s value. • Risk attitude: Investors who are risk takers or risk avoiders by nature may have higher or lower levels of investment risk tolerance, respectively. • Current market conditions: A strong bull market may induce even the most conservative investors to assume higher levels of risk, while an extended bear market may have the opposite effect. In strong bull markets individuals tend to think they are more risk tolerant than they truly are, and in bear markets tend to think or act more conservatively than they truly are. • Current financial condition: Net worth can have a significant effect on risk profile. For example, someone who needs returns of 7–8% per year on their investments to fulfil their financial objectives can take much less risk than someone who may need annual returns of 12–13%. Income level could also affect a risk profile; for example, people with little or no discretionary income may be less risk tolerant than those with high savings rates. Friday, 15 July 2022 Investment Planning & Asset Management

Factors affecting a risk profile of investors • Age: As people age, the less tolerant of risk they tend to be • Retired people often are depending (at least partially) on the results of previous investments, including pension and other retirement plans, and they have fewer years to recover any investment losses. • Additionally, since they are retired, they may have no outside income to rely on or to invest and save. • Investment advice: People may adjust their risk tolerance levels based on advice from a respected individual. This can come from investment advisors, newsletter writers, neighbours, friends, and family members. • Past experience: People who have had a poor experience with their investment results often become more conservative with their approach to investing. Likewise, people who have experienced above-average investment results often take more risk than they otherwise would, even though past experience does not indicate future results. Friday, 15 July 2022 Investment Planning & Asset Management

Suitability: Using Risk Tolerance Information Conservative • Low risk tolerance • Primary objectives are to preserve value and receive regular income Moderately Aggressive • Willing to take some amount of risk for moderate returns • Objectives are more balanced—a combination of growth and income Aggressive • Willing and able to take on high levels of risk • Objective is growth (capital appreciation) alone—no income Friday, 15 July 2022 Investment Planning & Asset Management

Investment strategies • Capital Preservation • Income • Income with Moderate Growth • Growth with Moderate Income • Growth • Aggressive Growth Friday, 15 July 2022 Investment Planning & Asset Management

Risk-Return Application • The risk-return trade-off is the principle that links high risk with high reward. • The right risk-return trade-off depends on a variety of factors including an investor’s risk tolerance, the investor’s remaining years to retirement and the likelihood to replace lost funds. • Time also plays an essential role in determining a portfolio with the appropriate levels of risk and reward. • For example, if an investor has the ability to invest in equities over the long term, that provides the investor with the potential to recover from the risks of bear markets and participate in bull markets, while if an investor can only invest in a short time frame, the same equities will have a higher risk involved. • Investors use the risk-return trade-off as one of the essential components of each investment decision, as well as to assess their portfolios as a whole. Friday, 15 July 2022 Investment Planning & Asset Management

Capital Assets: Gains and Losses • Depending on the jurisdiction, capital gains or losses may be categorized in four ways: • Realized • Unrealized • Short-term • Long-term Friday, 15 July 2022 Investment Planning & Asset Management

Calculating Capital Gain or Loss • For each property sold or exchanged, the amount of capital gain or loss typically is determined by subtracting the adjusted basis of the property sold from the amount realized. • The amount realized is the total of all the proceeds received from sale of the property (i.e., fair market value plus any additional cash). If the buyer of the property assumes some or all of a debt on the property, it is treated as if they paid the seller cash. • In simpler terms: • Net proceeds realized – Indexed cost of acquisition = Capital gain/loss • The actual tax determination and calculation will vary by type of property, as well as by jurisdiction. Friday, 15 July 2022 Investment Planning & Asset Management

Keeping good records • Tax-related property records include: • Date of purchase • Amount paid • Length of time the property was held • Adjustments to property basis • Date and amount of sale • Taxpayers who can itemize deductions need to keep the documentation that supports their deductions. Friday, 15 July 2022 Investment Planning & Asset Management

Understanding Life stages (Wealth Cycle) • Accumulation phase (to about age 35) • First job/career • Paying off debt • Begin saving and investing • Consolidation phase (generally age 35 to 60) • Home purchase • Marriage • Children • Children’s education • Peak earning years • More investable income • Retirement phase (generally age 60+) • Income typically ends or is significantly reduced • Portfolios typically reallocated to a more conservative approach • Portfolio distributions • Wealth transfer • Long-term care issues Friday, 15 July 2022 Investment Planning & Asset Management

SMART Goals • Specific • Measurable • Attainable/Achievable • Realistic • Time-bound Friday, 15 July 2022 Investment Planning & Asset Management

SMART GOALS • Specific: The client wants to maintain same lifestyle during his retirement phase as he is enjoying now. He is 40 years old and, even though he really enjoys his work, wants to retire at age 65. His parents and grandparents living/lived a long life. He wants to provide for 35 years after retirement. • Measurable: Current annual living expenses = Rs.450,000; annual inflation is expected to average 4.5%, and her portfolio rate of return should average 8%. The inflated equivalent of Rs.450, 000 in 25 years is Rs. 1352445. That’s the first year’s income requirement. • If we were going to carry out the process, we would need to determine the amount needed to fund the inflation-adjusted annual income throughout the entire retirement period (35 years here). Without going through the calculations here, the client would require a portfolio at the beginning of retirement valued at slightly more that Rs.2.85 crores. • Attainable/ Achievable : The client has already accumulated Rs.100,000, which will grow to just under Rs.685,000 by age 65 (at 8% per annum for 25 years). Assuming no pension benefits, this leaves her with having to accumulate slightly more than Rs.13 Lakh by age 65. The client can easily afford the required annual retirement fund contributions of less than Rs.17,000, so her goal is attainable. • Realistic: Based on her continuing to earn at the same general rate, with no unanticipated large expenses, and assuming she follows through with annual contributions, and that both inflation and her rate of return meet expectations, the goal is realistic. • Time bound: Given that the financial advisor and client know the amount required at age 65 and the periodic payments needed to fund that amount, the goal is time bound. Annual reviews would allow client and advisor to determine the degree to which the plan is on track. Friday, 15 July 2022 Investment Planning & Asset Management

Low Risk to High Risk investments • Term deposits and other bank savings instruments • Short-term, high-quality, sovereign/government debt (e.g., Treasury notes) • Money market funds • Short to medium-term sovereign debt and high-quality state/province/territorial/municipal debt • Longer-term government and high quality corporate bonds • Large-capitalization, dividend-paying stocks (and preferred stock) • Mid-cap stocks • Small-cap stocks • Distressed company stocks and bonds (e.g., high yield bonds) Friday, 15 July 2022 Investment Planning & Asset Management

Portfolio Proposal • A financial planning practitioner shall analyze the information to gain an understanding of the client’s financial situation and then evaluate to what extent the client’s goals, needs and priorities can be met by the client’s resources and current course of action. • Prior to making recommendations to a client, it is necessary for the financial planning practitioner to assess the client’s financial situation and to determine the likelihood of reaching the stated objectives by continuing present activities. • The practitioner will utilize client-specified, mutually agreed upon, and/or other reasonable assumptions. Both personal and economic assumptions must be considered in this step of the process. These assumptions may include, but are not limited to, the following: • Personal assumptions, such as: retirement age(s), life expectancy), income needs, risk factors, time horizon and special needs; and Economic assumptions, such as: inflation rates, tax rates and investment returns. • Analysis and evaluation are critical to the financial planning process. These activities form the foundation for determining strengths and weaknesses of the client’s financial situation and current course of action. These activities may also identify other issues that should be addressed. As a result, it may be appropriate to amend the scope of the engagement and/or to obtain additional information. • A financial advisor generally has one more important task to complete when working with a client to build an investment portfolio. The advisor, using information gained in the process described previously, should create and get approval from the client on an investment policy statement before creating a portfolio. Friday, 15 July 2022 Investment Planning & Asset Management

Investment Policy Statement An investment policy statement lays out the roadmap for a client’s situation, their goals/objectives, and the investment strategy or approach that is being used to achieve those goals. While the IPS describes the investment strategy/strategies to be used, it does not specify individual investment holdings. A well-written investment policy statement would allow another financial advisor to step in and quickly understand the client’s situation and goals, and be able to advise and guide the client. The IPS also helps financial advisors to keep their clients focused on their progress relative to their goals, rather than focusing on investment performance alone. Friday, 15 July 2022 Investment Planning & Asset Management

Investment ManagementInvestment Objectives, Constraints and Suitability Process 1. Discover Investor Risk and Return Profile & Philosophy 2. Determine Investor Objectives And Constraints 3. Establish Geographic Focus 4. Develop An Asset Allocation Mix Strategy 5. Develop an Investment Policy Statement 6. Implement An Asset Mix 7. Monitor the Investment Universe and the Investor 8. Evaluate and Communicate the Portfolio Performance

Investment Objectives, Constraints and Suitability In many cases, an effective IPS can be written in just a few pages. Generally speaking, there is no set, approved format for an investment policy statement; however, a good IPS will contain most of the following items (Morningstar, 2010): 1. Executive summary that provides an overview, including: Current assets Investment plan (i.e., how much will be invested, on what basis) Timeframe Return expectations over inflation and/or the risk-free rate Risk profile (specifically, how much of a loss, or how much variability is acceptable) Target asset allocation Portfolio benchmarks Friday, 15 July 2022 Investment Planning & Asset Management

Investment Objectives, Constraints and Suitability 2. Client description Name Type of account(s) being managed (individual, joint, foundation, etc.) Address Tax ID Friday, 15 July 2022 Investment Planning & Asset Management

Investment Objectives, Constraints and Suitability 3. Investment objectives and client goals 4. Fiduciary responsibility Where fiduciary responsibility is inappropriate (e.g., some territories do not use), substitute “client-first” responsibility 5. Client responsibilities  Disclosing changes in financial situation, goals, assets, or risk tolerance 6. Investment constraints Timeframe Liquidity requirements Tax requirements Legal and regulatory Friday, 15 July 2022 Investment Planning & Asset Management

Investment Objectives, Constraints and Suitability 7. Investment philosophy Risk Diversification Trading and expenses Core and noncore (i.e., satellite) holdings Rebalancing 8. Asset allocation strategy 9. Security selection criteria 10.Implementation, monitoring, and follow-up 11.Review schedule Friday, 15 July 2022 Investment Planning & Asset Management

• Thanks a lot • We end Global course of Investment Planning and Asset Management here Friday, 15 July 2022 Investment Planning & Asset Management