BBA III

Semester V
Subject: Personal Financial Planning
Unit 4: Investment Planning
4.1 Meaning, Need & Importance of Investment Planning
4.2 Mutual Fund
4.3 Capital Market
4.4 Asset Allocation
4.5 Investment strategies and Portfolio construction and portfolio management
Notes Compiled By : Raghunandan Shrivas ( MBA Finance )
Takshashila Mahavidhyalaya Amravati
Personal Financial Planning
4.1 Meaning, Need & Importance of Investment Planning

Investment Planning

Investment planning is the process of identifying financial goals and converting them
through building a plan. Investment planning is the main component of financial planning. The
investment planning begins with identification of goals and objectives. Then we need to match
those goals with our available financial resources. Nowadays there are many investment vehicles
to invest in, most common being cash, equities, bonds and property. So according to the funds
available we can invest in these vehicles to obtain our goals and objectives.

A financial plan ensures that you are well equipped to deal with dynamically changing
circumstances at a personal level as well as a macro level. In the absence of a financial plan, you
might not be empowered to accomplish what you have dreamt of achieving and might also be
under-prepared to deal with contingencies.

Below are 10 reasons why an investment planning is much needed.

1. Managing Cash Flows or Budgeting

If you don't realise where and how your income is spent every month, then you definitely
need to plan your finances better. Many people fail to understand how their monthly salaries get
extinguished, leaving them with very little or absolutely nothing to save. Impulsive buying and
lack of budgeting for expenses leads to many problems in the long run. Thus maintaining a
budget is crucial to stay on track towards your long term financial goals, while you may achieve
all the fancies of life in the short run.

2. Efficiently Managing Debt

Taking a loan does offer instant gratification. However, when the liabilities turn in to a debt
trap, it’s time you put your personal finances in order with a financial plan. Many often land up
increasing our loans and borrowings through credit cards, overdraft facilities or personal loans.
In most cases, these easy finance options result in damaging their financial health, leading them
into a financial mess. A financial plan will not only help you to come out of this mess, but will
also enable you to manage your cash flows better in order to achieve your other financial goals.

3. Streamlining Your Investments

If your investments are scattered and you are yourself unsure about where you have
invested, then it’s high time for you to put your portfolio in order. Many often indulge in
investing in a haphazard manner without conducting a proper need based analysis or undertaking
sufficient research on financial products. In most of the cases, tips from friends and families go
about forming a portfolio, which may eventually leave an unsuitable portfolio for you. Also
investing in an ad-hoc manner results in scattered investments which get difficult to manage /
track. The investment portfolios of such investors are extremely strewn with duplicating schemes
and investments that do not provide any advantage of diversification. Such investment portfolios
need to be consolidated and re-aligned so as to meet your financial needs.

4. Invest In The Right Financial Products

Many people invest in the equity asset class through shares or mutual funds. However more
often than not, as mentioned earlier, such investments are done on recommendations from
friends and relatives and without taking into consideration one's financial goals and risk appetite.
In most of the cases these unplanned and non-researched investments result in loss of the
investors' money. Hence, it is extremely important that you invest only after considerable
research has been undertaken on any investment proposition. Constructing a financial plan will
enable you or your financial planner to review your portfolio (both equity and debt) and strike
the right asset allocation to provide you with the best possible outcomes.

5. Set The Right Asset Allocation

Most people consider equity as the best investment option especially during a stock market
rally. However, it is never wise to put all eggs in the same basket. It is vital for you to understand
that not all assets move in the same direction at the same time. If equities are witnessing a bear
market, it is unlikely that other asset classes such as gold, debt instruments and real estate will
also be witnessing a down-turn at the same time or vice-versa. Hence, it is best to invest in more
than one type of instrument to improve your chances of achieving your long-term goals with
minimal turbulence. Hence, a suitable asset allocation for you can be devised through a financial
plan that acts as a shield to protect your wealth during uncertain economic conditions and market
volatility.

6. Weeding Out Inefficient Financial Products

Sometimes people land up taking multiple insurance policies such as Endowment, Money
Back, ULIPs, Pension Plans etc. due to the incomplete knowledge or mis-selling of products
through agents. Many a times, these policies do not solve the purpose of the insured and only
result in filling the pockets of the agent who sold you that policy. Some policies which promise
you a life cover plus returns (market linked) may fail to do both. More often than not, these
policies provide a very low cover and also low returns due to the number of charges involved. A
financial planner can help you understand which insurance policy suits you the best and which
ones are best avoided.

7. Calculating The Right Insurance Cover

In case of unfortunate circumstances, the right amount of insurance can be a financial boon to
you or your family members. While life insurance will ensure that your family members are able
to maintain the same standard of living even in your absence, the right amount of health
insurance cover can avoid burning a huge hole in your savings that mishaps or unforeseen tragic
events could have created. However, many people do not understand how much life and medical
cover they should take. A holistic financial plan will take into account your income, expenses
and goals amongst host of other aspects to determine the optimal amount of cover both - your
life and health insurance needs.

8. Set SMART Financial Goals

If you want to plan for financial goals such as buying your dream home, a car, a vacation
abroad, child's education and their marriage needs and your retirement amongst host of others;
prudent financial planning can come to your recourse. Through experience we can say that many
vie for all the aforementioned goals, but lack of prudent financial planning and / or
procrastination on executing the financial plan drawn, which in turn hinders accomplishment of
financial goals set. So, it is imperative that a prudent financial plan is made, and is vigilantly and
religiously followed so as to make your dreams come true.

9. Inculcating A Regular Savings Habit

To create wealth in the long-term, investing with discipline and determination is the key.
Even a child needs discipline and regular monitoring to achieve his goal of being a good student.
Hence, you too, need to invest regularly and wisely to meet your financial goals. Investing small
amounts regularly will also prove to be light on your wallet and reduce the burden of defraying a
huge amount from your bank account. With a financial plan in place, you can determine the
amount that you would need to invest regularly to meet all your goals. You can establish the
requisite corpus for meeting your financial goals through planned investments in the right
investment avenues.

10. A Blueprint To Your Long Term Goals

If you don't have road map of how to achieve your dreams, a prudently drawn financial plan
can be your blue print to meet all your financial goals while empowering you to deal with
contingencies as well. Hence financial planning is for those who have unclear ideas or plans of
how they would achieve their dreams and wishes in life.

Here are ten powerful reasons why Investment planning is important -

1. Income: It's possible to manage income more effectively through planning. Managing
income helps you understand how much money you'll need for tax payments, other
monthly expenditures and savings.

2. Cash Flow: Increase cash flows by carefully monitoring your spending patterns and
expenses. Tax planning, prudent spending and careful budgeting will help you keep more
of your hard earned cash.

3. Capital: An increase in cash flow, can lead to an increase in capital. Allowing you to
consider investments to improve your overall financial well-being.

4. Family Security: Providing for your family's financial security is an important part of the
financial planning process. Having the proper insurance coverage and policies in place
can provide peace of mind for you and your loved ones.

5. Investment: A proper financial plan considers your personal circumstances, objectives

and risk tolerance. It acts as a guide in helping choose the right types of investments to fit
your needs, personality, and goals.

6. Standard of Living: The savings created from good planning can prove beneficial in
difficult times. For example, you can make sure there is enough insurance coverage to
replace any lost income should a family bread winner become unable to work.

7. Financial Understanding: Better financial understanding can be achieved when

measurable financial goals are set, the effects of decisions understood, and results
reviewed. Giving you a whole new approach to your budget and improving control over
your financial lifestyle.

8. Assets: A nice 'cushion' in the form of assets is desirable. But many assets come with
liabilities attached. So, it becomes important to determine the real value of an asset. The
 knowledge of settling or canceling the liabilities, comes with the understanding of your
finances. The overall process helps build assets that don't become a burden in the future.

9. Savings: It used to be called saving for a rainy day. But sudden financial changes can still
throw you off track. It is good to have some investments with high liquidity. These
investments can be utilized in times of emergency or for educational purposes.

10. Ongoing Advice: Establishing a relationship with a financial advisor you can trust is
critical to achieving your goals. Your financial advisor will meet with you to assess your current
financial circumstances and develop a comprehensive plan customized for you.

4.2 Mutual Fund

Mutual Funds

Before launching a mutual fund scheme, the Mutual Fund Company or Asset
Management Company (AMCs) needs to register with the market regulator - the Securities and
Exchange Board of India (SEBI). On approval from the authority, they can launch mutual fund
schemes that are eligible to collect money from the public.

When you buy a mutual fund, you pool your money along with other investors. You put money
into a mutual fund by buying units or shares of the fund. As more people invest, the fund issues
new units or shares.

Investors share the profits or losses of the fund in proportion to their investments. Mutual funds
normally come out with a number of schemes, which are launched from time to time with
different investment objectives.

Mutual Funds Definition

A mutual fund scheme, as the name suggests, is a shared fund that pools money from
multiple investors and invests the collected corpus in shares of listed companies, government
bonds, corporate bonds, short-term money-market instruments, other securities or assets, or a
combination of these investments.

The investments are in accordance with the investment objectives as disclosed in offer document.
Therefore, an equity mutual fund scheme will invest predominantly in a portfolio of stocks,
while a debt fund will invest a significant portion of its assets in bonds.

A fund manager manages the investments in a mutual fund. There can be more than one fund
manager, based on the discretion of the AMC. The fund manager/s manages the fund on a day-
to-day basis, deciding when to buy and sell investments according to the investment objectives
of the fund.
How Mutual Funds Work?

The mutual fund collects money from you and other investors and allots units. This is similar to
buying shares of a company. Here, the price of each mutual fund unit is known as the Net Asset
Value. The assets are invested in a set of stocks or bonds that form the portfolio of the fund. The
fund manager, depending on the investment objective of the scheme, decides the portfolio
allocation.

Types of mutual funds according to Maturity Period

Open-ended Mutual Funds

Open-ended funds are available for subscription throughout the year. These funds do not have a
fixed maturity. Investors have the flexibility to buy or sell any part of their investment at any
time at a price linked to the fund's Net Asset Value (NAV). Several other facilities are available
to open-ended funds such as Systematic Investment Plan (SIP), Systematic Transfer Plan (STP),
Systematic Withdrawal Plan (SWP) etc.

Close-ended Mutual Funds

Close-ended funds offer a stipulated maturity period e.g. 3 years, 5 years etc. at the time of
launch. These funds are open for subscription only during a specified period. Investors can invest
in the scheme at the time of the new fund offer and thereafter they can buy or sell the units of the
scheme on the stock exchanges where the units are listed. When the maturity period terminates,
the redemption proceeds are transferred in to the account of the investors.

Types of mutual funds according to underlying asset allocation

A scheme can also be classified according to its investment objective. Some scheme may broadly
have an objective to invest predominantly in equity, or debt or a mix of different asset classes.
Such schemes may be open-ended or close-ended schemes as described earlier.

Equity Mutual Funds

Equity fund have an objective to generate capital appreciation over the long term. Such mutual
funds normally invest a major part of their corpus in equities. Naturally, equity funds have
comparatively high risks. These are suitable for high-risk profile investors who have an
investment horizon of 5 years or more. Equity mutual funds are most suitable for long-term goals
such as retirement.

Debt Mutual Funds

Debt funds have an investment objective to provide regular and steady income to investors. Such
schemes invest in fixed income securities such as bonds, corporate debentures, Government
securities, and money market instruments. Though debt funds are less risky compared to equity
schemes, the return potential too, is lower.

4.3 Capital Market

Capital Market and Its Types

Capital market is referred to as a place where saving and investments are done between
capital suppliers and those who are in need of capital. It is, therefore, a place where various
entities trade different financial instruments.

There are two types of capital market:

Primary Market

Secondary Market

Capital market is where both equity and debt instrument like equity shares, preference shares,
debentures, bonds, etc. are bought and sold.

Functions of Capital Market:

 It acts in linking investors and savers

 Facilitates the movement of capital to be used more profitability and productively to

boost the national income

 Boosts economic growth

 Mobilization of savings to finance long term investment

 Facilitates trading of securities

 Minimization of transaction and information cost

 Encourages a massive range of ownership of productive assets

 Quick valuations of financial instruments

 Through derivative trading, it offers insurance against market or price threats

 Facilitates transaction settlement

 Improvement in the effectiveness of capital allocation

 Continuous availability of funds

The capital market is the best source of finance for companies. It offers a spectrum of investment
avenues to all investors which encourage capital creation.

Types of Capital Market

Primary Market:

The primary market is a new issue market; it solely deals with the issues of new securities. A
place where trading of securities is done for the first time. The main objective is capital
formation for government, institutions, companies, etc. also known as Initial Public Offer (IPO).
Now, let us have a look at the functions of primary market:

Origination: Origination is referred to as examine, evaluate, and process new project proposals in
the primary market. It begins prior to an issue is present in the market. It is done with the help of
commercial bankers.

Underwriting: For ensuring the success of new issue there is a need for underwriting firms.
These are the ones who guarantee minimum subscription. In case, the issue remains unsold the
underwriters have to buy. But if the issues are completely subscribed then there will be no
liability left for them.

Distribution: For the success of issue, brokers and dealers are given job distribution who directly
contact with investors.

Secondary Market:

The secondary market is a place where trading takes place for existing securities. It is known as
stock exchange or stock market. Here the securities are bought and sold by the investors. Now,
let us have a look at the functions of secondary market:

Regular information about the value of security

Offers liquidity to the investors for their assets

Continuous and active trading

Provide a Market Place

4.4 Asset Allocation

Asset allocation refers to an investment strategy in which individuals divide their

investment portfolios between different diverse asset classes to minimize investment risks. The
asset classes fall into three broad categories: equities, fixed-income, and cash and equivalents.
Anything outside these three categories (e.g., real estate, commodities, art) is often referred to as
alternative assets.
Factors to consider for Asset Allocation

1. Age: If you are in the age of 20-30, you can afford to take high risk and may consider
allocating a major portion of your portfolio into equities. If you are in the mid age i.e. between
30-55, you should have a diversified portfolio with moderate risk i.e. along with equity you
should also invest in some other asset classes such as debt or fixed income instruments. However,
if you are approaching your retirement, it’s advisable to have a conservative portfolio comprising
of debt or fixed income instruments to safeguard the principle amount.

2. Income: The amount you invest is a function of the income you generate. An increase in your
income will result in the increase of your investible surplus. The frequency and growth potential
of your income also play a role in choosing the assets .

3. Time Horizon: Depending on how soon you want to meet your financial goals, you can decide
on choosing various asset classes. For instance, for a long term goal like retirement which could
be 20 years away, consider investing more in equities and less in debt or fixed income
instruments. On the other hand, if you are looking to invest for shorter time horizon i.e. up to 3
years, you could choose to invest in debt or fixed income instruments.

4. Risk Tolerance: Your willingness as well as the ability to take risk is a function of the points
mentioned above and plays a crucial role in designing your portfolio. If you are willing to take
high risk, you can choose to keep a larger chunk of your portfolio in riskier assets. However, if
you want to minimise the risk, you can opt to put larger chunk of your money in debt or fixed
income instruments.

Benefits of Asset Allocation

• Lower risk: By diversifying your portfolio, you lower the risk by distributing it to multiple
asset classes.

• Enhanced opportunity for market gains: Through multiple asset classes, you may lessen the
impact of nonperforming asset categories, and improve your chances of participating in market
gains.

• Increased goal orientation: A well allocated portfolio helps in reducing the need for constant
monitoring of investment positions, thereby further reducing the need of buying or selling in
response to the market’s short-term ups and downs.
4.5 Investment strategies and Portfolio construction and portfolio management

Investment Strategies

When an investor decides to invest in stocks or investment funds, he/she can choose the shares of
a lot of listed companies. Those investments usually have different levels of risks and varying
levels of returns. Since there are several and different choices of investments, the chances are
higher for the investor to succeed if he/she had a specific strategy to choose between these
investments. The investor can have an even better chance if he/she adopted several strategies so
each one can fit a specific economic situation.

The investor can specify which of the investment strategies fits his/her personality,
circumstances and investment goals. One of these strategies might, for example, include a
method that focuses on acquiring growth stocks (shares with growing capital). He/she might also
adopt another strategy that aims to preserve the capital by focusing on low risk investments. No
matter what strategy the investor chooses, it should be consistent with his/her investment
objectives such as retirement, buying a house, paying tuition, etc… a good example is if the
investor is twenty years old and invests for retirement, he/ she would prefer a more open strategy
with higher risks compared to an investor in his/her fifties investing for retirement where his/her
strategy would be more conservative.

 Giving the strategy time

Once the investor specifies his asset allocation strategy, he/she should give it time
to work. It is important for the investor to commit to the plans for them to work. It might
be even better to commit to his/her asset allocation strategy for a full economic cycle
keeping in mind to try to be flexible to change when other good investment opportunities
arise.

 Asset Diversification

Diversification, as asset allocation, is an important component in managing an

investment portfolio. Asset allocation and diversification have similar goals and
strategies which are allocating the money on different sectors and lower investment risks.
Asset allocation is applied in allocating the capital in different investment assets such as
stocks or liquid cash whereas diversification means buying a number of investments
within one category of assets. For example if your investments had stocks in it, you
should diversify your shares or investment.

 Rebalancing the Portfolio

An investor should maintain the asset allocation he/she chose in his/ her
investment strategy to manage the portfolio until he/she thinks that the time has come to
change it based on age or financial position. One of the requirements to sustain the
 current asset allocation strategy is to rebalance it or redo its allocation every now and
then. Rebalancing a portfolio is very important because the market performance increases
or decreases the assets’ value in some investments with time. When the investor decides
it’s the right time to rebalance the portfolio, there are several ways to do so but the
investor can prefer one on another. To rebalance the portfolio, the investor can:

a. Sell a part of the invested asset with increased value and then reinvest the profits in
another asset that is not high yet.

b. Change how new invested money is added to the portfolio by placing it in other impaired
assets until the investor finds the best allocation.

c. Increase the capital of the investment portfolio and place the increase to be fully invested
in impaired assets.

 Risk Causes

There are a lot of factors that could cause investment risk. The most popular is
volatility where investment prices volatile to high and low levels without warning. This
means that the price might go to less than the price the buyer paid to get it. The problem
with volatility is that it cannot be predicted nor its effects on investment.

 Investment Portfolio Performance Follow-up

Follow-up on investment portfolios is considered important because it helps in

making the necessary changes on the portfolio. For example, if some specific shares
affected the performance of the portfolio and lowered it or increased the risk on it with
more than what the investor is willing to take; he can dump them and invest in other.

Portfolio construction

Managing risk and getting the investment mix right

Portfolio Construction is all about investing in a range of funds that work together to create an
investment solution for investors. Building a portfolio involves understanding the way various
types of investments work, and combining them to address your personal investment objectives
and factors such as attitude to risk the investment and the expected life of the investment.

When building an investment portfolio there are two very important considerations.

 The first is asset allocation, which is concerned with how an investment is spread across
different asset types and regions.

 The second is fund selection, which is concerned with the choice of fund managers and
funds to represent each of the chosen asset classes and sectors.
Both of these considerations are important, although academic studies have consistently shown
that in the medium to long term, asset allocation usually has a much larger impact on the
variability of a portfolio’s return.

The 4 steps to creating a portfolio

1. Create your risk profile – Measure your perceived level of risk for an investment (scale of
1 to 10)

2. Asset Allocation – Determining the right combination of assets – the most important part
of the portfolio construction process.

3. Fine tune your portfolio – Choose to invest in and/or review your existing portfolio to fit
in with the asset allocation most suitable to you, potentially reducing your risk and
increasing your returns.

4. Review your portfolio regularly – Once you have constructed your portfolio, it is
important to continue to review your asset allocation on a regular basis. Investors failing
to do this, may find they become overweight in a particular asset class, potentially
increasing the overall risk of their portfolio.

Portfolio Management

Portfolio management can be defined as- The process of selecting a bunch of securities
that provides the investing agency a maximum return for a given level of risk or alternatively
ensures minimum risk for a given level of return.

Investment portfolio composing securities that yield a maximum return for given levels of risk or
minimum risk for given levels of returns are termed as “efficient portfolio”.The investors,
through portfolio management, attempt to maximize their expected return consistent with
individually acceptable portfolio risk.Portfolio management thus refers to investment of funds in
such combination of different securities in which the total risk of portfolio is minimized while
expecting maximum return from it.

As returns and prices of all securities do not move exactly together, variability in one security
will be offset by the reverse variability in some other security. Ultimately, the overall risk of the
investor will be less affected.
Steps involved in Portfolio management process

Portfolio management involves complex process which the following steps to be followed
carefully.

Identification of objectives and constraints.

Selection of the asset mix.

Formulation of portfolio strategy

Security analysis

Portfolio execution

Portfolio revision

Portfolio evaluation.

Now each of these steps can be discussed in detail.

1. Identification of objectives and constraints

The primary step in the portfolio management process is to identify the limitations and
objectives. The portfolio management should focus on the objectives and constraints of an
investor in first place. The objective of an Investor may be income with minimum amount of risk,
capital appreciation or for future provisions. The relative importance of these objectives should
be clearly defined.

2. Selection of the asset mix

The next major step in portfolio management process is identifying different assets that
can be included in portfolio in order to spread risk and minimize loss.In this step, the relationship
between securities has to be clearly specified. Portfolio may contain the mix of Preference shares,
equity shares, bonds etc. The percentage of the mix depends upon the risk tolerance and
investment limit of the investor.
3. Formulation of portfolio strategy

After certain asset mix is chosen, the next step in the portfolio management process is
formulation of an appropriate portfolio strategy. There are two choices for the formulation of
portfolio strategy, namely

 an active portfolio strategy; and

 a passive portfolio strategy.

An active portfolio strategy attempts to earn a superior risk adjusted return by adopting to market
timing, switching from one sector to another sector according to market condition, security
selection or an combination of all of these.

A passive portfolio strategy on the other hand has a pre-determined level of exposure to risk. The
portfolio is broadly diversified and maintained strictly.

4. Security analysis

In this step, an investor actively involves himself in selecting securities. Security analysis
requires the sources of information on the basis of which analysis is made. Securities for the
portfolio are analyzed taking into account of their price, possible return, risks associated with it
etc. As the return on investment is linked to the risk associated with the security, security
analysis helps to understand the nature and extent of risk of a particular security in the market.

5. Portfolio execution

When selection of securities for investment is complete the execution of portfolio plan
takes the next stage in a portfolio management process. Portfolio execution is related to buying
and selling of specified securities in given amounts. As portfolio execution has a bearing on
investment results, it is considered one of the important step in portfolio management.

6. Portfolio revision

Portfolio revision is one of the most important step in portfolio management. A portfolio
manager has to constantly monitor and review scripts according to the market condition.
Revision of portfolio includes adding or removing scripts, shifting from one stock to another or
from stocks to bonds and vice versa.

7. Performance evaluation

Evaluating the performance of portfolio is another important step in portfolio

management. Portfolio manager has to assess the performance of portfolio over a selected period
of time. Performance evaluation includes assessing the relative merits and demerits of portfolio,
risk and return criteria, adherence of the portfolio management to publicly stated investment
objectives or some combination of these factors.

Performance evaluation gives a useful feedback to improve the quality of the portfolio
management process on a continuing basis.