Many people look at financial advisors and stock markets, be it at Wall Street or Dalal Street, with apprehension if not outright suspicion. After all, events like 2008 financial crisis, Harshad Mehta scam, Ketan Parekh scam have adversely affected so many lives, and our regulators RBI, SEBI and IRDA keep coming up with rules to curb one financial malpractice or other.
I have seen some financial advisors making sale pitch: we will make a financial plan for your life events and execute it, you don’t need to know about investing, you just give us your money and enjoy your life. Well, guess what, if I know or learn investing, how will Mr. Advisor make living? Anybody suggesting me not to learn it, I see them as someone perpetuating financial illiteracy, and evidently self-serving in this case. I run away from such advisors. Financial literacy helps me in asking right questions, not be drowned in jargon, distinguish good advisors from bad, and evaluate their performance.
I also noticed some financial advisors focus solely on investing and returns. Sadly, most of the time, I hear people talk about investments: do it to save tax, or only fixed deposits because market is like gambling, or life insurance policies are best investments, or at another extreme, obsession with stock tips and day trading while working on a fulltime job. This is madness! Investing is just one aspect of personal finance. I suggest methodically spinning Artha Chakra, or Wheel of Personal Finance.
Evaluate Finances: Evaluate your current financial state, know your net worth and cash flow, because assets are created by wisely investing saving surplus. Review results of your existing financial plan and progress so far, check if it has been working as per expectations.
Cover Risks: This is often ignored, but is very important. Set aside contingency funds in a low risk instrument (e.g. fixed deposit) to cover 6-12 months of monthly expenses including loan EMI payments. Insure your assets – life, health, house, car etc.
Identify Goals: Find out what are your short (up to one year), medium (1-2 years), and long term financial needs. Needs will be different at various stages of life. For example, one might seek growing and accumulating the investment corpus during working life, but regular income during retired life. Goal identification will help in deciding suitable investments and their durations.
Revise Plan: Devise a plan if you have none, or revise your existing plan if required. Money you need in short term should be kept in low risk instruments such as fixed deposits. For medium term needs, start systematic withdrawal, say 12 installments spread over 12-18 months, from existing investments to low risk instruments. For long term needs, understand your risk profile to compare and pick suitable investment instruments; and exploit power of compounding and use time value of money calculations to figure out the amount you need to save and invest.
If you can’t meet some of your needs through savings and investments (typically for buying big ticket items like a house), you might want to evaluate the loan amount you need to borrow and whether you can afford it. If you decide to borrow, you will need to calculate EMI payment amount and incorporate it in your saving cash flow computations.
Execute the Plan: Unless you act on your plan, exercise so far would be utter waste. So execute your plan with discipline. Periodically (say every 6 or 12 months), go back to first step to review results and progress.
What is your take? Do you follow a method, or there is method in your madness? Let me know through comments.
Bonus: Dilbert's take on financial advisor :-)