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### Instruction: ('What is Financial Planning?',) ### Response:Financial planning aims at ensuring that a household or individual has adequate income or resources to meet current and future expenses and needs. The regular income for a household or individual may come from sources such as profession, salary, business or even investments. The normal activities of a household or individual and the routine expenses are woven around the regular income and the time when this is received. However, there are other expenses that may also have to be met out of the available income. The current income that is received must also provide for a time when there will be no or low income being generated, such as in the retirement period. There may be unexpected expenses which are not budgeted, such as a large medical expense, or there may be needs in the future that require a large sum of money, such as education of children or buying a home, all of which require adequate funds to be made available at the right time. A portion of the current income is therefore saved and applied to creating assets that will meet these requirements. Financial planning refers to the process of streamlining the income, expenses, assets and liabilities of the household or individual to take care of both current and future need for funds.

### Instruction: ('Example of Financial Planning',) ### Response:Example Vinod is 40 years old and earns Rs.2 lakhs a month. He is able to save about Rs.40,000 a month after meeting all the routine expenses of his family, paying the loans for his house, car and other needs. His investments include those for tax savings, bank deposits, bonds and some mutual funds. He pays premiums on life insurance for himself and his wife. Vinod is the sole earning member of his family and he believes he takes care of his finances adequately to take care of his current and future needs. How would financial planning help him? The following are a set of indicative issues that financial planning will help Vinod resolve: LEARNING OBJECTIVES a) As the sole earning member has he made provisions for taking care of his expenses by creating an emergency fund if his current income is interrupted for any reason? b) Does he have adequate insurance cover which will take care of his family’s requirements in the event of his untimely demise? c) Does the family have adequate health insurance cover so that any medical emergency does not use up all the accumulated savings? d) What are his specific future expenses and how will he fund them? e) If Vinod has to create a corpus to fund large expenses in the future, what is the size of the investment corpus he should build? f) Given his current income and expenses is he saving enough to create the corpus required? g) Will he have to cut back on his current expense or can he increase his current income so that his expenses in the present and the savings for the future are met? h) What is the wealth Vinod has so far built from his savings and how can he best use it to meet his needs? i) How should his saving be deployed? What kinds of investments are suitable for Vinod to build the required corpus? j) How much of risk is Vinod willing and able to take with his investments? How would those risks be managed? k) How should Vinod ensure that his savings and investments are aligned to changes in his income, expenses, future needs? A formal treatment of the issues that Vinod faces will require a financial planning process to assess the current situation; identify the current and future needs; determine the savings required to meet those needs and put the savings to work so that the required funds are available to meet each need as planned.

### Instruction: ('Understand the need for financial planning',) ### Response:There is a large range of financial products and services that are available for investors today and these need to be linked to the specific needs and situations of the client. Not every product may be suitable to every client; nor would a client be able to identify how to choose and use products and services from the choices that are available in the market. Financial planning bridges this gap as the Investment Adviser possesses the expertise to understand the dynamics of the products on the one hand and the needs of the client on the other. This makes them best suited to use such products and services in the interest of the client.

### Instruction: ('Role of the Financial Planner',) ### Response:The Financial Planner has a significant role to play when it comes to advising clients because the needs of each person is different front that of the other. a) The financial planner has to recognise the exact needs and goals of an individual and a household or family and then make efforts to ensure that these needs or goals are achieved. b) Personal financial management requires time and attention to recognize income and expense patterns, estimates of future goals, management of assets and liabilities, and review of the finances. c) Individuals do not have time to undertake all these detailed financial activities in a busy world and they need someone like a financial planner to focus on this area and help them in their efforts. d) It is not easy to set financial goals and this requires specific expertise and skill which may not be present with most individuals. e) Every financial goals requires finding a suitable product and a proper asset allocation to different asset classes so that this can be achieved, which is where the financial planner steps in. f) Selecting the right investment products, choosing the right service providers and managers, selecting insurance products, evaluating borrowing options and such other financial decisions may require extensive research. A financial planner has capabilities to compare, evaluate and analyse various products which enables making efficient choices from competing products. g) Asset allocation is a technical approach to managing money that requires evaluating asset classes and products for their risk and return features, aligning them to the investor’s financial goals, monitoring the current and expected performance of asset classes and modifying the weights to each asset in the investor’s portfolio periodically to reflect this. Financial planners with technical expertise enable professional management of assets. h) Financial planning is a dynamic process that requires attention to the constantly changing market and product performances and matching these with the dynamic changes in the needs and status of the client. This kind of attention can be provided by a financial planner.

### Instruction: ('How is financial planning different from a typical financial advisory services?',) ### Response:Financial planning requires following of a specific process wherein the client along with their overall needs and goals are at the core of everything being done. Other financial advisory services would normally look at meeting just a specific need like advising on stocks or debt but the relation with other aspects might be missing.The financial planning effort is a comprehensive process as it covers all aspects of a client’s personal financial requirements including retirement, insurance, investment, estate and others. A typical financial advisory service is more likely to look at just a small part of the total financial requirements. Goal setting becomes the central part of the financial planning process and all efforts are then directed towards meeting the goals. Overall goals might not be given too much importance in a normal financial advisory activity, where some specific target is sought to be achieved. Financial planning looks to ensure that all the financial activities are not at cross purposes with each other. As against this, a typical financial advisory service might not even realise that some steps suggested would be working against some other goal or requirement. For example, financial planning would ensure that the asset allocation for an older individual meets their risk taking ability and that their equity exposure across asset classes is kept in check. This might not happen when normal advise is taken just for say equity mutual funds investment without knowing the equity exposure elsewhere. Monitoring the situation and then taking action to ensure that things remain on track is a key part of the financial planning process. It is inbuilt to the entire effort, so this becomes a natural part of the activity. This might not happen with respect to a normal financial advisory where the individual might have to take the initiative themselves and see that things are going according to plan. Financial planning looks to select what is right for an individual and this would differ from person to person. This takes into account both the returns as well as the risk which is vital. This might not happen for a normal financial advise, where the goal might be completely different like earning higher return and where risk might be ignored. There has to be continuity in financial planning efforts which sets it apart from other financial advisory wherein this could be a short one time exercise or even piecemeal efforts at different periods of time.

### Instruction: ('Personal financial analysis:',) ### Response:• Goal setting with prioritizing of goals The financial planning process starts with the goal setting process. Goals refer to what has to be achieved. This gives a clear target that has to be reached. There are several features that are important when the goals are set. There should be some specific detail with respect to the goal. For example, saying that I want to be rich is a vague term because it can mean different things to different people. Saying that I want to earn an income of Rs. 50 lakh a year is specific. The goals have to be measurable, so that a person knows the exact amount that will help them reach the goal. At the same time the goals have to be realistic. If an individual is able to save around Rs 20,000 a month, then a goal which requires an investment of Rs 50,000 a month is not realistic. Finally, goals also have to be time bound so the individual has a clear idea of when they need to be reached. A goal of wanting to retire in 20 years with Rs 5 crore as corpus is clear because there is a time period attached to it which will help in planning to reach the goal. Once all these features are considered in the goal setting process there will be a list of goals that will be available. However, every individual has restrictions in terms of the income earned and amount saved. This will require that the goals be ranked in order of priority. Important goals need to be put first. So, things like children’s education and retirement should come in front of something like spending on a luxury car or other expense that does not create an asset. It is easy to look at short term needs but this can come at the cost of long term disruption of the goals. This is why there has to be priority to goals that improve the financial health of the individual. For example, there might be a large credit card outstanding and some extra income is earned by the individual. In such a situation, instead of spending the amount, it should be used to pay off the credit card debt. This might not add to an asset but it still improves the financial condition of the individual. • Focus on important goals Goals such as retirement and education of children are important financial goals for which adequate provision of funds have to be made. Long-term goals such as retirement often get lower priority for allocation of savings because it has time on its side. The urgent, shorter- term goals often get higher claim on the available savings. While this may be acceptable for shorter-term goals that are also important, such as accumulating funds for down payment on a home, it may not be right to prioritize consumption goals, such as holidays and large purchases, over long-term important goals. The delay in saving for such goals will affect the final corpus, since it loses the longer saving and earning benefits including that of Clients often believe that the provident fund, superannuation and gratuity corpus they will receive on retirement will be adequate to ensure a comfortable living during the retirement years. In many cases, it turns out to be inadequate. Therefore, every client needs a retirement plan. The Investment Adviser needs to go through the numbers and demonstrate the inadequacy. The objective is to ensure that the client saves enough during the earning years for a comfortable retired life. • Staggering the timing of certain goals The financial situation of an individual may not allow all the financial goals to be provided for. Some financial goals may have to be deferred to ensure that the critical financial goals are not compromised. There are situations when it is not possible to achieve a financial goal in a specific time period. An example could be a person wanting to buy a house within the next year, which would require a down payment of Rs 20 lakh plus an Equated Monthly Instalment (EMI) of Rs 30,000 a month. It could be that the current income situation is not able to support such a situation. Instead of cancelling the goal there is another route available. This is to push back the goal by some time, which will enable the individual to get the required finances in order. Instead of 1 year, if the goal is sought to be achieved after 3 years, then there is a good chance that the desired financial position will be achieved by then. For instance, around the time that the family proposes to buy a house, the annual holiday may need to be reviewed. The holiday may be shorter or planned at a less expensive location. Some financial goals need to be fulfilled within a specified time frame. For instance, education of the child has to happen as per the normal age and progression. Prudent use of debt in the form of loans can be used to tide over any shortage of funds.

### Instruction: ('Cash flow management and budgeting',) ### Response:There is a certain income that is earned by an individual along with the expenses made. Having a plan to ensure that there are savings and these are invested is one part of the process. It is also vital that there is a cash flow match so that the household or the individual does not run into any cash flow problems. This happens when the inflows and outflows of cash do not match. There can be a situation wherein a person spends less than what they earn but still run into cash flow problems. For example, if there is a large expense made at the start of a month it can lead to a cash crunch if there is a delay in the receipt of income unless there is a reserve present. In fact, it could lead to short term borrowings which are extremely costly in terms of interest rates. This could lead to a part of the amount that is being finally saved to be directed towards paying off the debt incurred due to the cash flow mismatch. One of the ways to ensure that there is no cash flow problem is to have a budget. A budget is nothing but a list of the inflows and outflows that an individual will witness along with the time period when this will take place. A monthly budget will help a person to know whether they are managing their income properly. A budget has a list of all the items of income and expenses along with their amounts. This ensures that with a single look it is possible to know what the exact financial position is and whether there is adequate savings taking place. Every person should make their own personal budget. A lot of people pay attention to the Union Budget but fail to do budgeting for their ownselves.

### Instruction: ('Insurance Planning',) ### Response:Several unexpected expenses that can cause an imbalance in the income and expenses of a household can be managed with insurance. Insurance is a risk transfer mechanism where a small premium payment can result in payments from the insurance company to tide over risks from unexpected events. The temporary loss of income from disabilities and permanent loss of income from death can be covered with life insurance products. Health and accident insurance covers help in dealing with unexpected events that can impair the income of a household, while increasing its expenses on health care and recuperation. General insurance can provide covers for loss and damage to property and other valuables from fire, theft and such events. Insurance planning involves estimating the losses to the household from unexpected events and choosing the right products and amounts to cover such losses.

### Instruction: ('Debt management and counselling',) ### Response:Investment Advisers help households plan their liabilities efficiently. It is common for households to borrow in order to fund their homes, cars and durables. Several households also use credit cards extensively. To borrow is to use tomorrow’s income today. A portion of the future income has to be apportioned to repay the borrowings. This impacts the ability to save in future and in extreme cases can stress the ability to spend on essentials too. The asset being funded by borrowing may be an appreciating asset such as property, which is also capable of generating rental income. Or the loan could be funding a depreciating asset such as a car, which may require additional expenses on fuel and maintenance, but provide better lifestyle and commuting conveniences. Evaluating which assets or expenses can be funded by borrowings is a function Investment Advisers can perform. They can advise households about how to finance their assets, how much to borrow, how to provide for repayment, how to ensure that credit scores are not unfavourably impacted. Sometimes, excessive borrowings may lead a household into a debt trap. Such borrowers need counselling and handholding to be able to get out of debt. Sometimes assets may have to be liquidated to pay off debts. Advisers help households to deal with their borrowings taking into account their need and ability to repay debt.

### Instruction: ('Investment Planning and Asset Allocation',) ### Response:A crucial component in financial planning and advisory is the funding of financial goals of a household. Investment planning involves estimating the ability of the household to save and choosing the right assets in which such saving should be invested. Investment planning considers the purpose, or financial goals for which money is being put aside. These goals can be short-term such as buying a car, taking a holiday, buying a gift, or funding a family ceremony or can be long-term such as education for the children, retirement for the income earners, or high-expense goals such as marriage of children. An Investment Adviser helps with a plan to save for these goals, and suggests an appropriate asset allocation to pursue. The Investment Adviser does not focus on the selection of stocks or bonds, but instead takes a top down approach of asset allocation. The focus is on how much money is invested in which particular asset class in order to deliver the expected return within the risk preference of the investor. The adviser’s job is to construct a portfolio of asset classes, taking into account the goals, the savings, the required return, and the risk taking ability of the investor. This is one of the core functions of the adviser and many specialise in asset allocation and investment planning.

### Instruction: (' Importance of cash flow management in personal finance',) ### Response:Personal finance involves looking at the various sources of income and expenses and ensuring that there is some surplus savings which is allocated to various investments to meet the different goals in the future. One of the key aspects of the entire process is to look at the cash flow that is generated by the individual or household and how this is handled. There are several factors that make the entire process of managing the cash flow very significant in the personal finance management process. The cash flow is the starting point of the whole personal finance process. The time and the amount of income that is generated and the time and the amount when this is spent as expense is critical to ensure that there is a proper balance maintained between the two. The time of the cash flow becomes critical because the income has to be available when expenses crop up. A very good example of a balance between income and expense is that of a salaried individual who gets a monthly income in the form of salary and whose expenses are also due monthly like payment of electricity, telephone bill, salary to household staff etc.. Even a slight mismatch between the cash flow can lead to the need for debt which is costly for the individual. If there is a situation wherein the income comes in at unspecified time intervals, but the expenses are evenly spread out then this can lead to a short term mismatch. This has to be met through debt, which comes at a cost in the form of interest. The interest becomes an extra outgo, which reduces the savings further. There has to be adequate income coming in at all points of time so that a surplus is generated. This surplus called savings is essential because this is necessary for difficult times. Cash flow mismanagement can become a source of tension for the individual and family. This can disrupt normal life and peace in the family which becomes a crucial factor to consider. This can further lead to health problems if the tension persist over a period of time. Cash flow management ensures that there is a control over the finances in a family and for an individual. There is a sense of empowerment that this gives, because there is confidence that things are being handled in a proper manner. It also makes for smooth running of the household as funds are available as and when required

### Instruction: ('What are the key aspects involved in evaluating the financial position of clients?',) ### Response:Cash flow management in personal finance, knowledge about the preparation of a household budget, understanding cash inflows and outflows, budgeting and forecasting, importance of monitoring budgets and provision for savings, creating a personal balance sheet and net worth, developing a budget and savings plan, understanding contingency planning, and overall evaluation of the financial position of clients.

### Instruction: ('Preparing Household Budget',) ### Response:The investment adviser performs an important role in helping the household or an individual understand a household budget. Preparing a household budget entails an understanding of the sources from which the household or individual receives income, and the application of these funds in a typical month. A sample household budget is shown in Table 3.1. The way to go about preparing a household budget is to first start with the various heads of income. All the amount that is received from various sources has to be listed out and this will become the income. Some of it might be regular in nature while there might be heads like investment income that is not regular and which comes infrequently. On the expense side there are some amounts that have to be compulsorily spent and these are called mandatory expenses. Others are essential living expenses, which are necessary for daily use. Finally comes the discretionary expenses and these are the expenses that can be cut in case there is need for a control on the total amount spent. The total expenses when reduced from the total income would give the savings that are managed by the household. In some cases there could be just a single family member who is earning while in other families there could be more than one earning family member. The difference between monthly surplus in hand and savings is to be noted. The monthly surplus in hand is calculated after mandatory deductions for contributions to funds and various investments. These are added back to the monthly surplus in hand to arrive at the savings. Let us assume that 6 months expenses need to be covered. Monthly expenses to consider are Rs.79,000(regular expenses) and Rs.12,000 (loan servicing) i.e. Rs.91,000.

### Instruction: ('Cash management',) ### Response:One of the important aspects of the household budget management process is the handling of the cash. On paper there could be a situation wherein there is some savings or surplus that is being seen, but this has to match with the actual cash flow because the income and expense figures have to be backed by actual cash. This aspect of handling the income and expense flow, so that there is proper balance between the need and availability of cash is known as cash management. For example, consider a situation wherein Sunita earns Rs 50,000 a month. This will ensure that the income side has this inflow and the various expenses will be considered against this to see how the savings work out. In reality there is something more that needs to be seen and this is whether the full amount of Rs 50,000 has been received every month. It could be that there are several components to Sunita’s salary and this includes Rs 15,000 of various reimbursements that need to be claimed. If in a particular month this figure has not been claimed, then the actual cash inflow would be just Rs 35,000. This can throw the entire calculation out of control and there could be a cash crunch that could arise. On the expense side too there has to be look at the cash aspect because this can cause some mismatch too. If too many expenses come right at the start of the month then the overall cash balance could run low, which would leave less amounts available for spends during the rest of the month. In case there is a situation where some additional expenses spring up, then again there could be cash mismatch that is witnessed. Too many expenses right in the first few days of the month can also lead to a problem if the income is delayed for even a few days. This is where the entire cash management comes into play. Taking all these factors and possibilities into consideration, the individual and the household has to ensure that there is enough cash available for various expenses. In addition, there is also the need to ensure that some delays or disruption would not lead to a crisis. The way in which this would work out is that a surplus amount would always be maintained in the bank or in cash. This would ensure that there is adequate balance available for even some extra expenses that might suddenly arise. The other way to tackle this is through the creation of a separate fund set aside for this purpose. This is different from an emergency fund that is used to tackle income disruption. This separate fund just helps to tackle some short term cash mismatch. Effective cash management is thus at the heart of every budget because this will ensure that there is no crisis that arises because there is not enough money to meet the expenses when required. It takes some understanding of the exact nature of the income and the expenses to be able to create the right cash handling position

### Instruction: (' Income and expenditure statement',) ### Response:An income and expenditure statement gives a view of the financial flows for an individual or household for a specific time period. There is always a time period for which the income and expenditure statement is prepared and this could be a year or month. The income and expenditure statement shows the actual amount of income earned during the period and the actual amount of expenses that have been made. This is a very useful tool because the actual figures can be compared with the amounts that have been taken in the budget. All the income that has been earned is taken on one side and this is considered against the expenses that have been incurred. There is a slight difference between the income and the expenditure statement as compared to the cash statement because there can be some items in the income and expenditure statement that have not been received or paid yet. A very good example of this is say income from salary. An individual might be receiving their salary on the first of the next month. However, the income and expenditure figure would include the figure in the previous month since this pertains to the previous month. The amount is received a day later, but for calculation purpose it goes into the earlier time period. Similarly, there can be expenses made using a credit card but the payment for this could be due later when the free credit period is over and the bill is generated. Still, this would have to be included in expenditure statement for the period in which the expense was actually made. The income and expenditure statement shows the extent of the surplus or savings that is generated and this can also give an idea about where the money is actually going and what needs effective control.

### Instruction: ('Budgeting and forecasting',) ### Response:The income of a household or individual has to be adequate to meet the current expenses as well provide the savings to create the assets that will help meet future expenses. If the current expenses are controlled, then it is better possible to secure the financial future of the household. It is essential to understand the nature of income and expenses of the household to be able to manage the personal financial situation. Income has to be regular and stable to be able to be assigned to expenses. The income is first used to meet mandatory expenses such as repayment of loans and payment of taxes. The remaining income is next used to meet essential expenses, such as the living expenses. Discretionary expenses, such as those on entertainment and recreational activities, are next met out of available income. The excess income available is the savings of the household. However, meeting goals and future needs cannot be done if savings is adhoc. Prudent financial management requires that a defined level of savings should be targeted that is essential to meet goals. A budget helps a household plan its income and expenses so that the income available is utilized in the best possible way to meet current and future requirements. The steps to making a budget are the following: 1. List and total the regular and definite incomes that will be received in the period. 2. List and deduct the mandatory expenses from the total income. What is left is the disposable income. 3. Identify essential living expenses of the household and deduct from the disposable income. 4. List the discretionary expenses and deduct it from available income to arrive at the savings. Once the incomes and expenses are identified and listed, it will be easy to assess where the problem lies, if the savings are seen to be inadequate. The income cannot be expanded beyond a certain level. The focus should be on managing the expenses to enhance savings. If the mandatory expenses are too high, it may be because of the pressure from loan repayments. A debt rationalisation exercise with a financial planner may help reduce the burden to some extent. Discretionary expenses and living expenses to some extent are areas where a household can focus on cutting back or postponing till the income expands to accommodate them without compromising on the required savings. Forecasting or projecting is the ability to look ahead and plan for the future. Forecasting requires looking at the various data and conditions that are present and based on this and the expected changes there is an estimate of the various figures going forward. There are some conditions that are related to forecasting that needs to be understood. 1. This involves predicting the future situation that is expected to arise. This requires the individual or the household to look at how various events will play out because the final forecast will be based on the conditions prevalent at that point of time. 2. There has to be a specific basis on which forecasting is done. This means that it is not just a random exercise but there is a basis for which the predictions are made. Arriving at the basis for forecasting thus becomes a key aspect. 3. The various evolving conditions are taken into consideration when the forecasting is made. This makes forecasting a dynamic exercise. 4. There are several assumptions that are made when the forecasting is undertaken so these assumptions need to be looked at closely. Assumptions can also change along with the change in the overall conditions. 49 5. There might be a need for several experts or expert opinion in the way in which things are considered, so this assumes an important role in the overall plan. This is needed as one person might not know about all the areas and factors that impact decision making. 6. There has to be some experience present for the person making the forecasts. Hence, the more one does it, the better it gets because there is a proper idea of how things will work out under different circumstances. Forecasting is an exercise and this can be used to move ahead with budgeting as it can be the basis for the budget that is prepared. The forecast also has to be seen in the context of what actually happens so that the real situation is understood and deviations if any are plugged.

### Instruction: ('Monitoring budgets and provision for savings',) ### Response:Understanding the concept of budgeting is the first step in the entire process of maintaining control over the finances of the household or the individual. Once the concept is known the next step is to actually prepare a budget. This will give a complete picture about how the financial flows look like and it will also give an idea about the areas in which action needs to be taken. This does not complete the process, because one of the most important steps remains i.e. monitoring of the budget. The process of monitoring of the budget involves recording the actual income and the expenses that have arisen. This shows the real situation that is faced by the household or the individual and it has a vital role to play in decision making. The actual figures when compared to the budget plan, will give an idea of how robust the budget planning actually was. It is not likely that every item considered in the budget will end up with the same actual figure, thus the variation witnessed gives a better picture of the strength of the budgeting process. The monitoring of the budget has to be done on a continuous basis and after looking at the difference seen in the figures further action needs to be taken. This action has to be in the form of correcting the budget figures going ahead. If there is an area where there is a constant miss of the budget target then the planning is off track and this needs to be improved through future changes. For example, if there is a provision of Rs 4,000 a month for conveyance and the average conveyance expense comes to Rs 6,000 for a few months then it is clear that either the budget figure has to be raised or the individual has to change the mode of conveyance to reduce cost. The ability to provide various areas of action through monitoring ensures that the budget improves over a period of time. This is the desired outcome from the effort of monitoring. There can be an end of the month monitoring that will give an idea about the actual situation but the effort also depends on the kind of record keeping that is taking place. If there is a regular noting down of expense, then even a mid month review can be made so that a better idea is available about the manner in which the trend is going and if some specific action is required in the remaining part of the month. The final objective of the budgeting process is to have some element of extra amounts left with the individual or the household. This means that the income has to be more than the expenses that are made. This balance figure is the savings that can then be put to better use for the future. All the further steps in the financial planning process can arise only if there are savings generated. The amount of savings that is actually seen has to be checked in the light of the requirements of an individual or household. For example, a person could have a savings of Rs 15,000 per month but if the goals require an investment of Rs 30,000 a month then this is not enough. The budget and its monitoring will also give a direction about the steps to be undertaken so that the savings can rise and reach to the desired level or target. There might be a small difference between the savings desired and the actual amount of savings done. If this is there then bridging the gap is not a difficult task. The real challenge is when the gap between the actual and the desired savings is huge. This will require a step by step approach to raise the savings level. It can consist of some of the following steps. 1. A target of raising the savings rate by a specified percentage might be set. This could be something like 10 % which is not too difficult to achieve. 2. The target once achieved would result in a further target being set. This will ensure that there are constant efforts to raise the savings rate. 3. The manner in which the savings come about is also significant. Elimination of wasteful expenditure and cutting down on discretionary expenses are a good way to raise the savings rate. 4. Lumpsum of large receipts should be directly diverted towards savings. This can give a boost to the overall savings rate. 5. Higher income should not be committed to some additional expense but this should be left free for contribution to the savings rate.

### Instruction: ('Creating a personal Balance Sheet and net-worth',) ### Response:Creating a personal balance sheet for an individual will require that various assets and liabilities are brought together and shown at a single place. A balance sheet shows the financial position of the individual or household in the form of assets and liabilities at a particular date. Things can change after the date and the balance sheet will also change but it is necessary to see how things are stacked up at a particular time and this what the balance sheet actually provides. Assets for an individual will include physical assets like property, car etc. and financial asset like investments in equity, debt and mutual funds. There might be some advances received by them along with their cash and bank balances which would form current assets. On the liabilities side the various loans that they have plus other payments outstanding including short term debt like credit card dues would make up the list. The different between the assets and the liabilities would be the net worth of the individual or the household. The income of a household or individual is at the base of all financial activities it undertakes. The income is used to meet current expenses and a portion is set aside to meet expenses in the future. The portion of current income earmarked for future needs is called savings. The adequacy of the income of a household is always relative to its expenses. If the expenses are managed within the income and there is surplus to save, then the household’s finances are seen as stable. Short-term imbalances in income and expenses can be managed by loans and advances. The loans are a liability and come at a cost which may further strain the future income. The option of loans to fund expenses must be used with discretion since it weakens the financial situation of the household. The savings of a household are put to work by investing them in assets. Assets are broadly classified as physical assets and financial assets. Assets may be appreciating in value or depreciating. All assets have a resale value. Investors hold assets for the returns they provide. The nature of return that an asset provides classifies them as growth-oriented, incomeoriented or a combination of the two. Physical assets are tangible assets and include real estate, gold and other precious metals. Physical assets have an intrinsic value though the actual price at which they trade is impacted by demand and supply. They are usually seen as natural hedges against inflation since their price show a positive correlation with inflation. Physical assets are more growth investments that are bought for the appreciation in value rather than the income they generate. Some such as real estate provide both income and growth while others such as gold are pure growth-oriented assets. The primary drawbacks of physical assets are illiquidity, lack of regulation/limited regulation and the need for specific skills to identify investment opportunities, assess the merits of the investment, arrange for the purchase of the asset and its management and sale of the asset when required. The other limitation of physical assets as an investment is that they are typically large ticket investments and require substantial savings or a combination of savings and loan to acquire. Financial assets represent a claim that the investor has on benefits represented by the asset. For example, a bank deposit gives the benefit of periodic interest and repayment of principal amount to the holder of the asset, an equity share provides periodic dividend paid, if any, and the appreciation or depreciation in its value is also to the account of the holder. These assets may be structured as growth-oriented assets, such as equity investments, or as incomeoriented, such as deposits, or a combination of the two, such as all listed securities. Financial assets are typically standardized products and controlled by the regulations in force at the point in time. They may differ on liquidity features, with some such as listed securities enjoying high liquidity, while others such as privately placed instruments featuring low liquidity. The standardization of financial assets and the mandatory information made available makes evaluation and comparisons more efficient. These assets lend themselves to investment in small amounts and units. Together, the physical and financial assets represent the investments made by the investor. While these assets represent financial benefits and returns to the holder, the financial strength of the household depends upon how the assets are acquired. Loans and borrowings used to buy assets create a liability and impose a repayment obligation on the buyer and a charge on the future income of the household. Loans taken to buy appreciating assets add to the long-term wealth. Loans taken to buy financial assets, also called leveraging, is risky because of the higher volatility in the price of such assets. Assets acquired with savings and without taking on a liability add to the financial strength of the household. An assessment of the financial well-being of the household can be made by calculating the Net worth. The net worth is calculated as Assets – Liabilities. Higher this number better is the financial position of the household. Net worth should be calculated periodically, and the progress tracked to bring the financial situation to the desired stage. An example of a personal budget for Lakshmi is given below. A brief analysis of this will give a better idea about the existing financial situation for her. There is a fixed asset in the form of a house and a car that is present. As compared to the value of the house, the investment figure is still a bit less and these are also not much into growth assets like equity and equity oriented mutual funds. The amount lying in the bank is also not very high. On the other side the net worth figure is relatively low because most of the assets have been acquired through loans and a large part of these are still outstanding. Over a period of time the changes in the net worth can be seen to see how this is rising along with the value of the assets. The net worth is the total assets of Rs 36,22,000 reduced by the total liabilities of Rs 12,07,000 ( Rs 12,02,000 +5,000) giving the amount as Rs 24,15,000.

### Instruction: ('Creating a budget and savings plan',) ### Response:There are several steps that need to be taken when a budget and savings plan is created. This will ensure that the process is done in a step by step manner and nothing has been missed out. The following steps would be useful in the budget creation process a) Start by gathering all the relevant details about the various sources of income and expenses for the individual or the household. The availability of the basic information is the most crucial part of the process, so unless this is present the budget would not reflect the true situation. b) Check to see that some area has not been missed out in terms of the heads of income or the heads of expenses. This requires going back and looking at the details over and over again. The wider the coverage of the areas, the better the budget will turn out to be. c) Base the budget figures on either actual expenses that have been made in the past or if this has changed, then the kind of expense that are likely. A record of various expenses would be very useful to arrive at the correct estimate. d) There has to be some element of change in the various figures in the budget based on the time period for which this is done. For example, when vegetable prices show a seasonal spike a higher amount needs to be allocated here. A month in which there are a couple of birthdays in the family might need a higher allocation for discretionary expenses. e) There has to be a contingency figure that is present in the budget. There are times when a sudden change disrupts everything but this feature would ensure that the budget remains robust. 54 f) The amount of savings needed would have to be achieved through the curtailment of expenses within limits. So, the required savings figure based on the goals needs to be present. g) There has to be a proper allocation of the savings amount and this should be done before the figure is spent elsewhere. This is why there has to be a direct transfer to the various investments, so that the amount automatically goes each month in the required investments. Make the savings plan a part of the fixed figure in the budget and this will ensure that there are no variations here and that the goal is met

### Instruction: (' Contingency Planning',) ### Response:Investment advisers need to prepare the client for various contingencies that might come up. The household or individual’sfinancial strategy needs to provide for these risks. The following are typical contingencies to provide for: * A family that is dependent on incomes of both its earning members needs some protection. If anything were to happen to either earning member, the family will be in dire straits. Life insurance mitigates this risk. * Healthcare costs are another financial risk for any family. Medical insurance, addresses this risk. *Income streams are also affected if people lose their jobs. The double income can offer some kind of insurance against the job loss risk. If one loses the job, the other hopefully will retain the job. This would ensure that some income keeps coming in every month. * An emergency fund needs to be the first goal towards which a household or individual should save as a protection against the possibility of loss or reduction of income. The fund should be adequate to meet the expenses for six months, in the event the regular income is not available. The emergency fund should be held in liquid assets, to enable easy access as and when required. If income security is high, the fund can also be held in a laddered way, with the equivalent of around three months’ expenses being held in liquid assets, and the rest of the funds being held in a less liquid assets but which gives better returns. If the emergency fund is used then efforts must be made to replenish it as soon as possible. The adequacy of the emergency fund should also be periodically reviewed. It should be done annually or whenever there is a large addition, such as an EMI, to the monthly expenses. * Separation (divorce) is another risk that families face. In developed countries, the wealthy go in for pre-nuptial agreements. This is an agreement, entered into before marriage, which details how the finances (and any other matter) will be dealt with, in the event of a separation. The legality of such pre-nuptial agreements in India has not been established. 55 * The Investment Adviser should ensure a healthy distribution between both spouses of the holdings of the family’s assets and liabilities. For example, in some investments, one partner will be the first holder, while the other may be a joint holder; the holding pattern can be reversed in some other investments. * In the case of double income families, the holding pattern can be closely aligned to the source of income of the investment. Investment made out of incomes of one partner can be held with that partner as the first holder. * Another approach would be to keep the salary account of each partner distinct (with the other partner as joint holder). This account is to be used only for investments, or to transfer funds to another joint account that is used for meeting household expenses. Such segregation of investment flows and household expense flow helps in better expense monitoring, as well as investment record keeping and tax record keeping. * When a housing loan is taken for purchase of property, the partners can be joint owners of the property as well as joint borrowers for the loan

### Instruction: (' Evaluation of financial position of clients',) ### Response:The personal financial situation of an individual or a household primarily refers to its ability to manage its current and future needs and expenses. The income available to do this may be drawn from salary, a business or profession or from the assets created over time by saving and investing a portion of the income. Typically, assets are created to meet the future expenses of the household, and financial planning helps apportion the available current income to immediate expenses and savings for the future. Loans are used to meet expenses and to create assets, if the income is inadequate to meet all the needs. This creates a liability for the household which also has to be settled in the future from the income. The efficiency with which the interplay between income, expenses, assets and liabilities are handled by the household determines its financial situation. Insurance planning is an essential element of a financial plan. Insurance is an efficient way of protecting the household finances from a loss of income or a large, unexpected expense that can derail the financial situation. Similarly, meeting income needs in retirement is an important concern and financial goal for all households. Just as analysts use various ratios to assess the financial position of companies, similarly, investment advisers use various personal finance ratios to assess the financial position of their clients. These ratios are calculated using the income, expenses, savings and investment data for each client and gives a numerical snapshot of their current situation. It helps identify areas that require changes and helps set the course of action for the future. Personal finance ratios thus form an important input in the financial planning process. Some of the important ratios are as follows: 1 Savings Ratio & Expenses Ratio. 2 Total Assets 3 Total Liabilities. 4 Leverage Ratio. 5 Net Worth. 6 Solvency Ratio. 7 Liquid Assets. 8 Liquidity Ratio. 9 Financial Assets Ratio. 10 Debt to Income Ratio

### Instruction: ('Savings Ratio & Expenses Ratio',) ### Response:Savings Ratio is the percentage of annual income that a person is able to save. It is calculated as Savings per year/Annual Income. ABC earns an annual income of Rs. 6 lakhs and saves Rs. 60,000 from the income. The savings ratio is Rs. 60,000 ÷ Rs. 6,00,000 = 10%. Savings is not limited to money that is retained in the savings bank account. Money invested in fixed deposits, mutual funds, shares, debentures, public provident fund, national savings certificates, post office deposits, real estate, gold and others during the year also form part of the savings. Some savings may not even reach the investor during the year. For example, the company’s contribution to provident fund or superannuation fund on account of the investor. The money will not go to the investor immediately, but it belongs to the investor and will be available in the investor’s account with the provident fund or superannuation fund and will form part of the savings during the year. Annual income will include all income earned from employment or business and in the form of interest, dividend, rent and such other items during the year. Consider the following information. XYZ earned a gross salary of Rs. 10,000, including company’s contribution to provident fund of Rs. 500. Net take home salary was Rs. 9,000 after deducting Rs. 500 towards employee’s contribution to provident fund. XYZ earned Rs. 200 towards interest in the savings bank account. Expenses during the month were Rs. 7,000. What is the savings ratio? Total Income: Gross salary + Interest income = Rs10,000 + 200 = Rs10,200 Savings: (Net salary + Interest income + Contributions of employer and employee to provident fund)–(Expenses) = Rs9,000 + Rs200 +Rs500 + Rs500 – Rs7,000 =Rs3,200. Savings Ratio: Savings /Total Income = Rs3,200 ÷ Rs10,200 =31.4%. The Savings to Income ratio measures the total accumulated savings of the individual relative to the annual income. It is calculated as Total Savings/Annual Income. Consider the following information of the financial situation of GGN. Annual salary: Rs.12,00,000 57 Accumulated investments, including PF balance, value of bank deposits, mutual fund units, PPF, NSC: Rs. 15,00,000 Savings to Income ratio: Rs.15,00,000/Rs.12,00,000= 1.25 This ratio measures the preparedness to meet long term goals such as retirement. The current value of the investments and assets, after accounting for any outstanding loans taken to acquire the same, is taken to compute the total savings. Self-occupied home is typically not included when calculating the savings level. The appropriate level for this ratio will depend upon the age of the individual. When the individual is young, expenses are high relative to the income available and the accumulated savings are likely to be low. Moreover, at this stage much of the available surplus is likely to go towards servicing a home loan. The ratio is expected to improve over time, as income goes up and expenses stabilize. A suitable savings to income ratio in the early 40s is at least 3 times the annual income. This means that the annual savings rate, or the annual savings relative to income, has to be stepped up as income levels go up, so that the savings can be built to a level that is suitable to the age and stage in life. In the earlier example, if ABC has saved Rs. 60,000 out of an income of Rs. 6 lakhs, it stands to reason that Rs. 6,00,000 – Rs. 60,000 i.e. Rs. 5,40,000 was spent towards various expenses. The Expenses Ratio is calculated as Annual Recurring Expenses ÷ Annual Income. In the case of ABC, it amounts to Rs. 5,40,000 ÷ Rs. 6,00,000 = 90%. Expenses Ratio can also be calculated as 1 – Savings Ratio. Similarly, Savings Ratio is 1 – Expenses Ratio. Non-recurring expenses are kept out of the expense ratio. For example, if a person incurred a one-time medical expenses of Rs. 50,000 in a year, then that would be excluded. However, if it is found that on an average, every year the family spends Rs. 30,000 towards healthcare expenses (beyond any re-imbursement from employers or insurers), then these would be included in determining the expense ratio. Suppose a family goes on a foreign holiday every 3 years, when they spend about Rs. 6,00,000, then its annual equivalent viz. Rs2,00,000 will be considered in the expense ratio. Expenses may be mandatory, such as taxes, rents, EMIs for loans and necessities for living. Discretionary expenses are those items of expenses that are not essential. Much of the reduction and rationalisation of expenses happen with respect to discretionary expenses in order to improve the savings ratio. A low expense ratio and high savings ratio is desirable for an individual’s financial security and stability.

### Instruction: ('Total Assets ',) ### Response:Savings of the individual are deployed in various forms of physical and financial assets such as shares, debentures, mutual funds, real estate, gold, provident fund, superannuation fund, and others over a period of time. The current value of these assets constitutes the investor’s total assets. Physical assets such as real estate is typically acquired with a combination of savings and loans. A conservative approach would be to exclude personal jewellery, one residential house that the investor’s family stays in, and any other form of asset meant for personal use (e.g. car) while estimating assets available to meet goals and financial needs.

### Instruction: ('Total Liabilities',) ### Response:Liabilities include loans and different forms of credit taken to meet expenses or to acquire assets. These may be taken from institutional sources, such as banks and financial institutions, or from personal sources such as friends and relatives. Liabilities may be long term and secured on assets, such as mortgage towards purchase of house and car loans. Or they may be short-term and unsecured, such as credit card outstanding and personal loans. Such liabilities tend to be more expensive. Liabilities imply an obligation to repay the loan from the future income. This impacts the ability of the household to meet other expenses and to save for other assets. It must be used with caution, ideally to acquire assets that appreciate in value. Greater is the liability, more shall be the financial pressures on the investor for repayment.

### Instruction: (' Leverage Ratio',) ### Response:This is a measure of the role of debt in the asset build-up of the investor. It is calculated as Total Liabilities ÷ Total Assets. For example, an investor owns real estate worth Rs.50lakhs, investments and bank balances valued at Rs.10 lakhs, and Rs.5 lakhs is lying in provident fund account. The real estate was bought with a loan of Rs. 30 lakhs, of which Rs. 10 lakhs is currently outstanding. The investor also has credit card dues of Rs. 2lakhs and a loan of Rs.1 lakh from a friend. Total assets = Rs. 50 lakhs + Rs. 10 lakhs + Rs. 5 lakhs i.e. Rs. 65lakhs. Total liabilities = Rs. 10 lakhs + Rs. 2 lakhs + Rs. 1 lakh i.e. Rs. 13lakhs. Leverage Ratio = Rs. 13 lakhs ÷ Rs. 65 lakhs i.e. 20%. Higher the leverage, more risky it is for the individual’s financial situation. A ratio greater than 1 indicates that the assets will not be adequate to meet the liabilities. The ratio is likely to be high immediately after a large-ticket asset, such as real estate, is purchased with debt. Over time as the asset value appreciates, the ratio will also moderate. Investor needs to look at the leverage in the context of debt servicing capability. Further, investor needs to ensure that a risky investment position is not compounded with high leverage financing it.

### Instruction: ('Net Worth',) ### Response:A strong asset position is of no use, if most of these are acquired through loans that are outstanding. Similarly, liability is not bad, if it has been used for creating an asset, such as real estate, which has the potential to appreciate in value. It is therefore normal to monitor any investor’s financial position through the net worth. It is calculated as Total assets – Total liabilities. In the previous example, Net worth = Rs. 65 lakhs – Rs. 13 lakhs i.e. Rs. 52 lakhs. Net worth is monitored over a period of time to monitor improvement or deterioration in the financial position.

### Instruction: ('Solvency Ratio',) ### Response:Despite having assets, a person may be insolvent, if the liabilities are higher than the value of the assets held. A critical benchmark is that the individual’s net worth should be positive. The extent of the investor’s solvency can be determined through the solvency ratio, which is calculated as Net Worth ÷ Total Assets. For the same asset position, higher the solvency ratio, stronger the investor’s financial position. In the above example, it is calculated as Rs. 52 lakhs ÷ Rs. 65 lakhs i.e. 80%. It can also be calculated as 1 – Leverage Ratio. Similarly, Leverage Ratio = 1 – Solvency Ratio

### Instruction: ('Liquid Assets',) ### Response:Liquid assets are those assets that can be easily converted into cash at short notice to meet expenses or emergencies. Liquid assets include money in savings bank account, fixed deposits that mature within 6 months, investment in liquid funds or other mutual funds and such other short-term assets. On the other hand, there are assets that are not easy to convert into cash. For example, it can take a long time to sell real estate at the fair value and realize it. Closed-end mutual fund units may not be as easily realizable as units of open-end mutual fund units. Some assets may be easily converted into cash but their values may fluctuate 60 widely in the short-term, thus making them unsuitable for realising cash at short notice. Shares and open-end equity schemes fall under this category. Open-end debt schemes too have a significant market element in their valuation which makes their return volatile, and therefore unsuitable to meet the need for funds at short notice. More the money in liquid assets, lesser are the chances of the investor getting caught in a liquidity crunch. However, keeping the entire money in liquid assets is not a sensible solution. Liquidity comes at a cost. For example, banks usually offer lower rate of interest on shorterterm fixed deposits; liquid schemes may yield a lower return than longer-term debt schemes. Investors therefore need to balance their liquidity and return needs. Keep enough in liquid assets to meet liquidity requirements, and invest the balance in longer term assets with a view to earning superior return

### Instruction: ('Liquidity Ratio',) ### Response:The role of liquid assets is to meet the near-term liquidity needs of the individual. It is normal to calculate the liquidity needs as the expenses that an investor will incur over the following 6 months (including loan repayments). In exceptional situations, expenses over a longer period may be considered. Liquidity ratio measures how well the household is equipped to meet its expenses from its short-term assets. It is calculated as: Liquid Assets/Monthly Expenses. A ratio of at least 4 to 6 indicates a comfortable level for the household to meet its expenses for 4 to 6 months, even if there was a loss or decline in regular income. Consider the financial situation of NFG. The monthly expense incurred, including loan repayments, is Rs.1.5 lakh. The market value of the assets held are as follows: Equity Shares Rs.3 lakhs Savings bank account Rs.7lakhs Short-term Fixed Deposits Rs.2lakhs Long-term Fixed Deposits Rs.6lakhs Open-end liquid mutual fund schemes Rs.4 lakhs Other open-end mutual fund schemes Rs.5 lakhs Closed-end mutual fund schemes Rs.12 lakhs Liquid assets = Rs.7lakhs + Rs.2lakhs + Rs.4lakhs = Rs.13lakhs. Liquid Ratio = Rs.13lakhs ÷ Rs.1.5lakhs= 4.66. A ratio of around 6 indicates a comfortable situation to manage short-term obligations. Note: Shares have not been included in liquid assets because the uncertainty in the value of the share makes it risky for an investor to include in liquid assets. Another liquidity ratio that is tracked is the Liquid assets to Net worth ratio. This ratio has to be interpreted in light of the goals of the individual. If there is a longer period to the goals, then this ratio should be low. A high ratio would indicate that a large portion of the savings are held in liquid assets and would be earning low returns. This will affect the ability to meet their long-term goals efficiently. If goals have to be met in the near term, then adequate assets must be held in easily realisable assets. In this situation the ratio needs to be higher.

### Instruction: (' Financial Assets Ratio',) ### Response:Assets can broadly be categorised as financial assets such as shares, debentures, bank deposits, Public Provident Fund, mutual fund investments and others, and physical assets such as gold, other precious metals, diamonds and real estate. Financial assets have the advantage of greater liquidity, flexibility, convenience of investing and ease of maintaining the investments. They are primarily income generating investments, though some of them, such as equity-oriented investments are held for long-term capital appreciation. There is greater ease of investing in such assets as it lends itself to small and frequent investments. Consider the assets held by PQR: Shares Rs. 5 lakhs, Fixed Deposits Rs. 10 lakhs, Mutual Fund Investments Rs. 12 lakhs, Land Rs. 9 lakhs and Gold Rs. 14 lakhs Financial assets are Rs. 27 lakhs (5 + 10 + 12) Physical assets are Rs. 23 lakhs (9 + 14) Total assets are Rs. 50 lakhs (27 + 23) Financial assets ratio= [(Rs. 27 lakhs ÷ Rs. 50 lakhs)*100]= 54%. A higher proportion of financial assets is preferred especially when goals are closer to realisation and when there is a need for income or funds to meet the goals.

### Instruction: ('Debt to Income Ratio',) ### Response:Leverage ratio measures the extent of debt use in asset acquisition. It however does not directly measure the ability of the individual’s income to service or meet the obligations arising from all debt outstanding. Debt to income ratio is an indicator of the individual’s ability to manage current obligations given the available income and a parameter used by lenders to determine eligibility for additional loans. It is calculated as Monthly Debt Servicing Commitment ÷ Monthly Income. Debt servicing refers to all payments due to lenders, whether as principal or interest. Consider an example where an individual has a monthly income of Rs.1.5 lakh and has loan commitments of Rs. 60,000 per month. The Debt to Income ratio = Rs.60,000/Rs.150,000= 40%. A ratio higher than 35% to 40% is seen as excessive. A large portion of the income of the household is committed to meet these obligations and may affect their ability to meet regular expenses and savings. Obtaining loans in the case of an emergency may also become difficult. Any reduction in income will cause stress to the household’s finances. Personal Finance Ratios need to be calculated periodically, say once a year, and compared with past numbers to identify trends. They help identify areas where corrective action needs to be taken to improve the financial situation. The trends also show the efficacy of actions already taken. While benchmarks have been established for each of the ratios, they may have to be customized to each individual’s situation.

### Instruction: ('What are the key aspects related to debt management and loans?',) ### Response:The need for debt, the role and impact of debt in cash flow management, understanding leverage and debt counseling, calculation of debt servicing requirements, responsible borrowing practices, the concept of secured and unsecured loans, familiarity with loan-related terms, types of borrowings, comprehension of various loan calculations, knowledge about loan restructuring and present value of future payments, repayment schedules with varying interest rates, criteria for evaluating different loans, considerations when opting for changes in EMI or tenure due to interest rate fluctuations, the decision between investing money or paying off outstanding loans, and strategies to expedite the process of getting rid of debt faster.

### Instruction: ('The purpose or need of debt',) ### Response:Debt is used to finance goals when available funds (self-funding) are inadequate. Even though income might be higher than expenses it is not possible to finance every purchase or asset with just the existing savings. For example, most people cannot buy a house without a loan. This is because the cost of a house is huge and if people waited till they had enough savings to buy a house then it is likely that this would not be possible till they near retirement. Lenders protect themselves by securing their loan against a charge or security or pledge or mortgage on the property. Such loans are also called ‘mortgages’. Other debt includes auto loans, credit taken for buying consumer durables, personal loans and credit card outstanding. However, debt comes at a cost and imposes a repayment obligation on the borrower. The decision on whether or not to use debt will depend upon the ability of the available income to bear the additional charge of interest cost and repayment. Debt is not always bad. In some cases, the decision to use borrowed funds over own funds, also called leverage, may actually increase the return made on an investment (ModiglianiMiller Theorem (M&M)). In some cases, a loan may make more sense in a given situation. For example, an education loan may be a better choice than drawing from a retirement account to fund the children’s education. The future income would be easily able to repay the loan LEARNING OBJECTIVES: After studying this chapter, you should know about: • Need of debt • Role and impact of debt in cash flow management • Know about Leverage and Debt Counselling • Calculation of debt servicing requirements • Understand Responsible Borrowing • Concept of secured and unsecured loans • Know certain terms related to loans • Types of borrowings • Understand various Loan calculations • Know Loan restructuring – present value of future payments • Repayment schedules with varying interest rates • Criteria to evaluate various loans • Opting for change in EMI or change in tenure for interest rate changes? • Invest the money or pay off outstanding loan? • Know the Strategies to get rid of debt faster 64 and at the same time the existing funds can continue to earn without losing the benefit of compounding. It can be seen that debt is needed under various circumstances and sometimes it can be also for temporary use of funds. This kind of short term needs might arise due to some emergency or some cash flow mismatch but it can ensure that an individual is able to continue on their life path without facing sudden disruptions

### Instruction: ('Role and impact of debt in cash flow management',) ### Response:While some debt is good and may even be recommended, how much debt is good depends upon the financial situation of each household. A good indicator is the debt to income ratio (DTI) that measures the ability to meet the obligations arising from debt with the available income. There is no "perfect or optimal" DTI ratio that lenders require, but all lenders tend to agree that a lower DTI is better. Depending on the size and type of loan they're issuing, lenders set their own limits on how low your DTI must be for loan approval. Consider a salaried employee who draws a salary of Rs. 15,000 per month, and is paying Rs7,500 towards debt servicing. The debt servicing ratio comes to Rs.7,500 ÷ Rs15,000 i.e. 50%. This is too high. If 50% goes towards debt servicing, it affects the ability to meet other regular expenses, provide for emergencies and the person may have nothing left to invest for the future. The interest rate and the amount of debt play an important role as far as the measurement of the impact of the debt is concerned. A higher interest rate will raise the repayment amount that will have to be paid and similarly a higher loan amount will also increase the monthly repayment amount. One has to look at the cash flow and then decide on the amount of debt that will be taken. All this needs to be done to ensure that the debt and its outflow do not disrupt the entire cash flow management plan laid out. Often there could be a situation wherein the debt servicing needs are high and at the same time a crisis on some other front can leave little room for borrowing some more amounts to tide over it. This is also the reason why the debt servicing amount needs to be low so that there is scope for raising some more funds in case this is required.

### Instruction: ('Differentiating between consumption expenditure and investment expenditure',) ### Response:Many clients have an endless list of lifestyle expenses. The Investment Adviser should be able to influence the client to be prudent in the expenditure. This can be done by highlighting how expenditure might affect the chances of the family being able to fulfil some other financial goal. One way to differentiate the various expenditures is by classifying them as consumption expenditure and investment expenditure. Consumption expenditure is that amount which 65 once used does not create any asset that generates further income. Amount spent at a restaurant or for buying clothes or expenses made at a saloon are some examples of consumption expenditure. On the other hand investment expenditure will lead to the creation of an asset, which then can generate further income in the future. The trade-offs should be clearly understood by the client. For example, buying a bond or a property can be investment expenditure. Some outflows, like providing education to children, may appear to be consumption expenditure. But they may be a useful investment, if the children do well and are able to raise the family’s income. Such expenditure needs to be prioritized. A budget that clearly demarcates mandatory and legal payments such as taxes, contributions to provident fund and gratuity and loan commitments, essential living expenses such as food and shelter and discretionary expenses such as lifestyle expenses, will help allocate income better between current and future needs. Allocate savings for goals before considering the discretionary expenses. This will make sure that the future needs are taken care of. Systematic investment plan (SIPs), especially when automatically transferred from the salary, helps in prioritizing the investment expenditure.

### Instruction: ('Identifying the holes in the household budget ',) ### Response:A household may not be managing its income and expenses efficiently to enable savings for goals. Some common errors that make it seem as if savings are not possible include not being clear if an expense is an essential living expense or discretionary in nature, incorrect (higher) allocation for expenses, not ‘paying self’ before allocating for discretionary expenses, not tracking expenses regularly and hence going over-budget, among others. Very often, clients do not realise how much money goes in various avoidable expenses. The adviser should inculcate the habit in the client, to note down all expenses above a specific level. The limit may be Rs.500 for some clients; Rs.5,000 for some others. The actual figure would depend on the income level of the client. A summarisation of the list of expenses at the end of the month can be enlightening, even for the client. For example, the amount that went in eating out or entertainment might be pretty high but this might not register for the client because all payments were made by credit card so this was not actually tracked. When the client recognises the scale of the lost opportunity to save, there is better likelihood of prudence in future. An adviser’s primary role is to identify and eliminate these lacunae that inhibit savings. There are often cases where a lot of money is spent on buying the latest gadgets when this is not necessary. Spending on a gadget like a phone or a laptop is necessary because it helps in work and increases efficiency and learning for an individual or the household. However constant upgradation just so that they have the latest model to show off is not a wise way to spend money and the amount saved from such expenses can be used at several other places.

### Instruction: ('Allocation to various categories of expenses',) ### Response:The monthly summary of outflows helps in understanding the current prioritization. If unusual expenses are kept out (for instance, a hospitalization that was not covered by insurance), the balance outflows can be categorized as mandatory contributions to provident fund and other retirement savings, loan servicing, essential expenses and lifestyle expenses. Families vary in their financial circumstances. The advisor should work with the family in setting limits on various categories of outflows. The household can make additional savings possible by changing their choices on the expenses they incur. An essential expense does not lend itself to much reduction but lifestyle expenses can be controlled to a large extent. Considering the alternate use to which the income can be used instead of spending it on discretionary expenses is one way in which such expenses can be controlled

### Instruction: ('Windfalls',) ### Response:Clients occasionally earn a windfall such as unexpectedly high annual bonus, inheritance, winning a lottery, etc.. A healthy portion of such unexpected income should be set apart for the future, since the family is used to living without that windfall. This can also be the time to take a look at the outstanding loans and consider pre-paying some of them. Windfall gain need not be invested immediately, as appropriate investment opportunities may not be available at the time gain occurs. The gain may be held in risk free liquid assets, till investment decision is reached. The amount of the windfall should be properly allocated as the extent of the windfall matters. For example, a very high annual bonus a year can be used to prepay loans and at the same time make some additional investments too, which can yield a return in the future. One should not expect a windfall to occur regularly in the hope that this will save a bad financial situation, as this can encourage wayward financial behaviour and still end up with a higher amount of debt when the windfall does not materialise.

### Instruction: ('Leverage and Debt Counselling',) ### Response:Investment Advisers need to consider various aspects when they are advising clients on debt as this can have a big role in the kind of financial behaviour that is witnessed. Many factors will vary for a client and each of these needs to be taken into consideration when a specific plan is put forward. Some of the factor here includes the following: 1 Purpose of the debt.2 Cost of debt. 3 Maturity of debt. 4 Debt Re-scheduling

### Instruction: ('Purpose of the debt',) ### Response: Debt or loan should ideally be taken for acquiring appreciating assets such as real estate. Some debt may be recommended to meet an expense that will increase the value of an asset, say an education loan to upskill, so that the income generating ability of the person goes up. Financing risky or volatile investment propositions with debt may entail high risk and may put 67 the entire financial security of the individual or household at risk. Margin financing for stock market investing is one such investment. A fall in the value of the investment will magnify the loss since the cost of debt will also have to be accounted for. Debt should certainly not be used for financing one’s regular expenses. If a person starts borrowing to meet expenses, then he is clearly living beyond his means and likely to be in a debt trap. Taking short term debt to tide over temporary liquidity problems may be fine, as long as the borrower knows the risk and has a plan to repay the debt as soon as possible.

### Instruction: ('Cost of debt ',) ### Response:Higher the rate of interest at which money is borrowed, more will be the outgo in servicing the debt. Secured loans, such as mortgages, and education loans are relatively cheaper as there is the benefit of the security available to the lender. Unsecured loans such as personal loans and credit card debt are very expensive and must be used with caution. Credit card is an interest free borrowing option only if the use is within the limits specified, and the repayments are made by the due date each month. When the credit card user does not pay the entire amount i.e. some amount is carried over for payment in the following business cycles, it is called “revolving credit”. If a credit card company charges 3% p.m. as interest, the compounded annual cost is (1+3%)^12-1 i.e. 42.6%. Given the exorbitant cost, revolving credit should be avoided. A similar argument can be made for loansfor unorganized sector like pawn traders or money lenders who charge as high as 60-80% interest rate or 5% a month from people

### Instruction: ('Maturity of debt ',) ### Response:Shorter the tenor of the loan; more will be the periodic repayment putting pressure on available income. Even if the cost of debt is low, short loan tenor can put financial pressures in repayment. Therefore, loan tenor should be decided keeping in mind the repayment capacity of the borrower. A longer tenor loan translates into higher interest paid over the term. The debt to income ratio can be used as an indicator of what the household income can take on as repayment obligations, and decide on the tenor accordingly.

### Instruction: ('Debt Re-scheduling',) ### Response: If the borrower is unable to manage the debt repayments, then it helps to work out a solution as soon as possible. Potential solutions are as follows: * Rank debt in order of their cost and deal with the costliest debt first. Typically, credit card dues and personal loans will be the most expensive, and work to eliminate them from the outstanding debt list. Low cost debt and debt that provide tax benefits such as home loans and education loans can be dealt with later when finances permit. 68 * If the debt was taken for purchasing an asset, then the asset can be sold and the proceeds used for pre-paying the debt. While doing this, the borrower should also plan for any prepayment charges that the bank may levy. * If the cost of debt is high, then cheaper re-financing is an option. A lower cost loan can be availed to repay the costlier loan. A credit card balance transfer is an example of such refinancing. * If the problem is with the tenor of the loan, then the possibility of extending the tenor of the loan can be explored. This will reduce the monthly outgo in debt servicing. However, the loan will be repaid over a longer period of time and the total interest paid over the tenor of the loan will go up. * If none of these is possible, then the borrower should inform the lender about the problem and explore a revised loan schedule. It should however be noted that such re-scheduling of loans hurts the borrower’s credit history (also known as credit score like Cibil score). This will affect the chances of obtaining loans in future or the cost at which they will become available

[INST] ('What is Financial Planning?',) [/INST] Financial planning aims at ensuring that a household or individual has adequate income or resources to meet current and future expenses and needs. The regular income for a household or individual may come from sources such as profession, salary, business or even investments. The normal activities of a household or individual and the routine expenses are woven around the regular income and the time when this is received. However, there are other expenses that may also have to be met out of the available income. The current income that is received must also provide for a time when there will be no or low income being generated, such as in the retirement period. There may be unexpected expenses which are not budgeted, such as a large medical expense, or there may be needs in the future that require a large sum of money, such as education of children or buying a home, all of which require adequate funds to be made available at the right time. A portion of the current income is therefore saved and applied to creating assets that will meet these requirements. Financial planning refers to the process of streamlining the income, expenses, assets and liabilities of the household or individual to take care of both current and future need for funds.

[INST] ('Example of Financial Planning',) [/INST] Example Vinod is 40 years old and earns Rs.2 lakhs a month. He is able to save about Rs.40,000 a month after meeting all the routine expenses of his family, paying the loans for his house, car and other needs. His investments include those for tax savings, bank deposits, bonds and some mutual funds. He pays premiums on life insurance for himself and his wife. Vinod is the sole earning member of his family and he believes he takes care of his finances adequately to take care of his current and future needs. How would financial planning help him? The following are a set of indicative issues that financial planning will help Vinod resolve: LEARNING OBJECTIVES a) As the sole earning member has he made provisions for taking care of his expenses by creating an emergency fund if his current income is interrupted for any reason? b) Does he have adequate insurance cover which will take care of his family’s requirements in the event of his untimely demise? c) Does the family have adequate health insurance cover so that any medical emergency does not use up all the accumulated savings? d) What are his specific future expenses and how will he fund them? e) If Vinod has to create a corpus to fund large expenses in the future, what is the size of the investment corpus he should build? f) Given his current income and expenses is he saving enough to create the corpus required? g) Will he have to cut back on his current expense or can he increase his current income so that his expenses in the present and the savings for the future are met? h) What is the wealth Vinod has so far built from his savings and how can he best use it to meet his needs? i) How should his saving be deployed? What kinds of investments are suitable for Vinod to build the required corpus? j) How much of risk is Vinod willing and able to take with his investments? How would those risks be managed? k) How should Vinod ensure that his savings and investments are aligned to changes in his income, expenses, future needs? A formal treatment of the issues that Vinod faces will require a financial planning process to assess the current situation; identify the current and future needs; determine the savings required to meet those needs and put the savings to work so that the required funds are available to meet each need as planned.

[INST] ('Understand the need for financial planning',) [/INST] There is a large range of financial products and services that are available for investors today and these need to be linked to the specific needs and situations of the client. Not every product may be suitable to every client; nor would a client be able to identify how to choose and use products and services from the choices that are available in the market. Financial planning bridges this gap as the Investment Adviser possesses the expertise to understand the dynamics of the products on the one hand and the needs of the client on the other. This makes them best suited to use such products and services in the interest of the client.

[INST] ('Role of the Financial Planner',) [/INST] The Financial Planner has a significant role to play when it comes to advising clients because the needs of each person is different front that of the other. a) The financial planner has to recognise the exact needs and goals of an individual and a household or family and then make efforts to ensure that these needs or goals are achieved. b) Personal financial management requires time and attention to recognize income and expense patterns, estimates of future goals, management of assets and liabilities, and review of the finances. c) Individuals do not have time to undertake all these detailed financial activities in a busy world and they need someone like a financial planner to focus on this area and help them in their efforts. d) It is not easy to set financial goals and this requires specific expertise and skill which may not be present with most individuals. e) Every financial goals requires finding a suitable product and a proper asset allocation to different asset classes so that this can be achieved, which is where the financial planner steps in. f) Selecting the right investment products, choosing the right service providers and managers, selecting insurance products, evaluating borrowing options and such other financial decisions may require extensive research. A financial planner has capabilities to compare, evaluate and analyse various products which enables making efficient choices from competing products. g) Asset allocation is a technical approach to managing money that requires evaluating asset classes and products for their risk and return features, aligning them to the investor’s financial goals, monitoring the current and expected performance of asset classes and modifying the weights to each asset in the investor’s portfolio periodically to reflect this. Financial planners with technical expertise enable professional management of assets. h) Financial planning is a dynamic process that requires attention to the constantly changing market and product performances and matching these with the dynamic changes in the needs and status of the client. This kind of attention can be provided by a financial planner.

[INST] ('How is financial planning different from a typical financial advisory services?',) [/INST] Financial planning requires following of a specific process wherein the client along with their overall needs and goals are at the core of everything being done. Other financial advisory services would normally look at meeting just a specific need like advising on stocks or debt but the relation with other aspects might be missing.The financial planning effort is a comprehensive process as it covers all aspects of a client’s personal financial requirements including retirement, insurance, investment, estate and others. A typical financial advisory service is more likely to look at just a small part of the total financial requirements. Goal setting becomes the central part of the financial planning process and all efforts are then directed towards meeting the goals. Overall goals might not be given too much importance in a normal financial advisory activity, where some specific target is sought to be achieved. Financial planning looks to ensure that all the financial activities are not at cross purposes with each other. As against this, a typical financial advisory service might not even realise that some steps suggested would be working against some other goal or requirement. For example, financial planning would ensure that the asset allocation for an older individual meets their risk taking ability and that their equity exposure across asset classes is kept in check. This might not happen when normal advise is taken just for say equity mutual funds investment without knowing the equity exposure elsewhere. Monitoring the situation and then taking action to ensure that things remain on track is a key part of the financial planning process. It is inbuilt to the entire effort, so this becomes a natural part of the activity. This might not happen with respect to a normal financial advisory where the individual might have to take the initiative themselves and see that things are going according to plan. Financial planning looks to select what is right for an individual and this would differ from person to person. This takes into account both the returns as well as the risk which is vital. This might not happen for a normal financial advise, where the goal might be completely different like earning higher return and where risk might be ignored. There has to be continuity in financial planning efforts which sets it apart from other financial advisory wherein this could be a short one time exercise or even piecemeal efforts at different periods of time.

[INST] ('Personal financial analysis:',) [/INST] • Goal setting with prioritizing of goals The financial planning process starts with the goal setting process. Goals refer to what has to be achieved. This gives a clear target that has to be reached. There are several features that are important when the goals are set. There should be some specific detail with respect to the goal. For example, saying that I want to be rich is a vague term because it can mean different things to different people. Saying that I want to earn an income of Rs. 50 lakh a year is specific. The goals have to be measurable, so that a person knows the exact amount that will help them reach the goal. At the same time the goals have to be realistic. If an individual is able to save around Rs 20,000 a month, then a goal which requires an investment of Rs 50,000 a month is not realistic. Finally, goals also have to be time bound so the individual has a clear idea of when they need to be reached. A goal of wanting to retire in 20 years with Rs 5 crore as corpus is clear because there is a time period attached to it which will help in planning to reach the goal. Once all these features are considered in the goal setting process there will be a list of goals that will be available. However, every individual has restrictions in terms of the income earned and amount saved. This will require that the goals be ranked in order of priority. Important goals need to be put first. So, things like children’s education and retirement should come in front of something like spending on a luxury car or other expense that does not create an asset. It is easy to look at short term needs but this can come at the cost of long term disruption of the goals. This is why there has to be priority to goals that improve the financial health of the individual. For example, there might be a large credit card outstanding and some extra income is earned by the individual. In such a situation, instead of spending the amount, it should be used to pay off the credit card debt. This might not add to an asset but it still improves the financial condition of the individual. • Focus on important goals Goals such as retirement and education of children are important financial goals for which adequate provision of funds have to be made. Long-term goals such as retirement often get lower priority for allocation of savings because it has time on its side. The urgent, shorter- term goals often get higher claim on the available savings. While this may be acceptable for shorter-term goals that are also important, such as accumulating funds for down payment on a home, it may not be right to prioritize consumption goals, such as holidays and large purchases, over long-term important goals. The delay in saving for such goals will affect the final corpus, since it loses the longer saving and earning benefits including that of Clients often believe that the provident fund, superannuation and gratuity corpus they will receive on retirement will be adequate to ensure a comfortable living during the retirement years. In many cases, it turns out to be inadequate. Therefore, every client needs a retirement plan. The Investment Adviser needs to go through the numbers and demonstrate the inadequacy. The objective is to ensure that the client saves enough during the earning years for a comfortable retired life. • Staggering the timing of certain goals The financial situation of an individual may not allow all the financial goals to be provided for. Some financial goals may have to be deferred to ensure that the critical financial goals are not compromised. There are situations when it is not possible to achieve a financial goal in a specific time period. An example could be a person wanting to buy a house within the next year, which would require a down payment of Rs 20 lakh plus an Equated Monthly Instalment (EMI) of Rs 30,000 a month. It could be that the current income situation is not able to support such a situation. Instead of cancelling the goal there is another route available. This is to push back the goal by some time, which will enable the individual to get the required finances in order. Instead of 1 year, if the goal is sought to be achieved after 3 years, then there is a good chance that the desired financial position will be achieved by then. For instance, around the time that the family proposes to buy a house, the annual holiday may need to be reviewed. The holiday may be shorter or planned at a less expensive location. Some financial goals need to be fulfilled within a specified time frame. For instance, education of the child has to happen as per the normal age and progression. Prudent use of debt in the form of loans can be used to tide over any shortage of funds.

[INST] ('Cash flow management and budgeting',) [/INST] There is a certain income that is earned by an individual along with the expenses made. Having a plan to ensure that there are savings and these are invested is one part of the process. It is also vital that there is a cash flow match so that the household or the individual does not run into any cash flow problems. This happens when the inflows and outflows of cash do not match. There can be a situation wherein a person spends less than what they earn but still run into cash flow problems. For example, if there is a large expense made at the start of a month it can lead to a cash crunch if there is a delay in the receipt of income unless there is a reserve present. In fact, it could lead to short term borrowings which are extremely costly in terms of interest rates. This could lead to a part of the amount that is being finally saved to be directed towards paying off the debt incurred due to the cash flow mismatch. One of the ways to ensure that there is no cash flow problem is to have a budget. A budget is nothing but a list of the inflows and outflows that an individual will witness along with the time period when this will take place. A monthly budget will help a person to know whether they are managing their income properly. A budget has a list of all the items of income and expenses along with their amounts. This ensures that with a single look it is possible to know what the exact financial position is and whether there is adequate savings taking place. Every person should make their own personal budget. A lot of people pay attention to the Union Budget but fail to do budgeting for their ownselves.

[INST] ('Insurance Planning',) [/INST] Several unexpected expenses that can cause an imbalance in the income and expenses of a household can be managed with insurance. Insurance is a risk transfer mechanism where a small premium payment can result in payments from the insurance company to tide over risks from unexpected events. The temporary loss of income from disabilities and permanent loss of income from death can be covered with life insurance products. Health and accident insurance covers help in dealing with unexpected events that can impair the income of a household, while increasing its expenses on health care and recuperation. General insurance can provide covers for loss and damage to property and other valuables from fire, theft and such events. Insurance planning involves estimating the losses to the household from unexpected events and choosing the right products and amounts to cover such losses.

[INST] ('Debt management and counselling',) [/INST] Investment Advisers help households plan their liabilities efficiently. It is common for households to borrow in order to fund their homes, cars and durables. Several households also use credit cards extensively. To borrow is to use tomorrow’s income today. A portion of the future income has to be apportioned to repay the borrowings. This impacts the ability to save in future and in extreme cases can stress the ability to spend on essentials too. The asset being funded by borrowing may be an appreciating asset such as property, which is also capable of generating rental income. Or the loan could be funding a depreciating asset such as a car, which may require additional expenses on fuel and maintenance, but provide better lifestyle and commuting conveniences. Evaluating which assets or expenses can be funded by borrowings is a function Investment Advisers can perform. They can advise households about how to finance their assets, how much to borrow, how to provide for repayment, how to ensure that credit scores are not unfavourably impacted. Sometimes, excessive borrowings may lead a household into a debt trap. Such borrowers need counselling and handholding to be able to get out of debt. Sometimes assets may have to be liquidated to pay off debts. Advisers help households to deal with their borrowings taking into account their need and ability to repay debt.

[INST] ('Investment Planning and Asset Allocation',) [/INST] A crucial component in financial planning and advisory is the funding of financial goals of a household. Investment planning involves estimating the ability of the household to save and choosing the right assets in which such saving should be invested. Investment planning considers the purpose, or financial goals for which money is being put aside. These goals can be short-term such as buying a car, taking a holiday, buying a gift, or funding a family ceremony or can be long-term such as education for the children, retirement for the income earners, or high-expense goals such as marriage of children. An Investment Adviser helps with a plan to save for these goals, and suggests an appropriate asset allocation to pursue. The Investment Adviser does not focus on the selection of stocks or bonds, but instead takes a top down approach of asset allocation. The focus is on how much money is invested in which particular asset class in order to deliver the expected return within the risk preference of the investor. The adviser’s job is to construct a portfolio of asset classes, taking into account the goals, the savings, the required return, and the risk taking ability of the investor. This is one of the core functions of the adviser and many specialise in asset allocation and investment planning.

[INST] (' Importance of cash flow management in personal finance',) [/INST] Personal finance involves looking at the various sources of income and expenses and ensuring that there is some surplus savings which is allocated to various investments to meet the different goals in the future. One of the key aspects of the entire process is to look at the cash flow that is generated by the individual or household and how this is handled. There are several factors that make the entire process of managing the cash flow very significant in the personal finance management process. The cash flow is the starting point of the whole personal finance process. The time and the amount of income that is generated and the time and the amount when this is spent as expense is critical to ensure that there is a proper balance maintained between the two. The time of the cash flow becomes critical because the income has to be available when expenses crop up. A very good example of a balance between income and expense is that of a salaried individual who gets a monthly income in the form of salary and whose expenses are also due monthly like payment of electricity, telephone bill, salary to household staff etc.. Even a slight mismatch between the cash flow can lead to the need for debt which is costly for the individual. If there is a situation wherein the income comes in at unspecified time intervals, but the expenses are evenly spread out then this can lead to a short term mismatch. This has to be met through debt, which comes at a cost in the form of interest. The interest becomes an extra outgo, which reduces the savings further. There has to be adequate income coming in at all points of time so that a surplus is generated. This surplus called savings is essential because this is necessary for difficult times. Cash flow mismanagement can become a source of tension for the individual and family. This can disrupt normal life and peace in the family which becomes a crucial factor to consider. This can further lead to health problems if the tension persist over a period of time. Cash flow management ensures that there is a control over the finances in a family and for an individual. There is a sense of empowerment that this gives, because there is confidence that things are being handled in a proper manner. It also makes for smooth running of the household as funds are available as and when required

[INST] ('What are the key aspects involved in evaluating the financial position of clients?',) [/INST] Cash flow management in personal finance, knowledge about the preparation of a household budget, understanding cash inflows and outflows, budgeting and forecasting, importance of monitoring budgets and provision for savings, creating a personal balance sheet and net worth, developing a budget and savings plan, understanding contingency planning, and overall evaluation of the financial position of clients.

[INST] ('Preparing Household Budget',) [/INST] The investment adviser performs an important role in helping the household or an individual understand a household budget. Preparing a household budget entails an understanding of the sources from which the household or individual receives income, and the application of these funds in a typical month. A sample household budget is shown in Table 3.1. The way to go about preparing a household budget is to first start with the various heads of income. All the amount that is received from various sources has to be listed out and this will become the income. Some of it might be regular in nature while there might be heads like investment income that is not regular and which comes infrequently. On the expense side there are some amounts that have to be compulsorily spent and these are called mandatory expenses. Others are essential living expenses, which are necessary for daily use. Finally comes the discretionary expenses and these are the expenses that can be cut in case there is need for a control on the total amount spent. The total expenses when reduced from the total income would give the savings that are managed by the household. In some cases there could be just a single family member who is earning while in other families there could be more than one earning family member. The difference between monthly surplus in hand and savings is to be noted. The monthly surplus in hand is calculated after mandatory deductions for contributions to funds and various investments. These are added back to the monthly surplus in hand to arrive at the savings. Let us assume that 6 months expenses need to be covered. Monthly expenses to consider are Rs.79,000(regular expenses) and Rs.12,000 (loan servicing) i.e. Rs.91,000.

[INST] ('Cash management',) [/INST] One of the important aspects of the household budget management process is the handling of the cash. On paper there could be a situation wherein there is some savings or surplus that is being seen, but this has to match with the actual cash flow because the income and expense figures have to be backed by actual cash. This aspect of handling the income and expense flow, so that there is proper balance between the need and availability of cash is known as cash management. For example, consider a situation wherein Sunita earns Rs 50,000 a month. This will ensure that the income side has this inflow and the various expenses will be considered against this to see how the savings work out. In reality there is something more that needs to be seen and this is whether the full amount of Rs 50,000 has been received every month. It could be that there are several components to Sunita’s salary and this includes Rs 15,000 of various reimbursements that need to be claimed. If in a particular month this figure has not been claimed, then the actual cash inflow would be just Rs 35,000. This can throw the entire calculation out of control and there could be a cash crunch that could arise. On the expense side too there has to be look at the cash aspect because this can cause some mismatch too. If too many expenses come right at the start of the month then the overall cash balance could run low, which would leave less amounts available for spends during the rest of the month. In case there is a situation where some additional expenses spring up, then again there could be cash mismatch that is witnessed. Too many expenses right in the first few days of the month can also lead to a problem if the income is delayed for even a few days. This is where the entire cash management comes into play. Taking all these factors and possibilities into consideration, the individual and the household has to ensure that there is enough cash available for various expenses. In addition, there is also the need to ensure that some delays or disruption would not lead to a crisis. The way in which this would work out is that a surplus amount would always be maintained in the bank or in cash. This would ensure that there is adequate balance available for even some extra expenses that might suddenly arise. The other way to tackle this is through the creation of a separate fund set aside for this purpose. This is different from an emergency fund that is used to tackle income disruption. This separate fund just helps to tackle some short term cash mismatch. Effective cash management is thus at the heart of every budget because this will ensure that there is no crisis that arises because there is not enough money to meet the expenses when required. It takes some understanding of the exact nature of the income and the expenses to be able to create the right cash handling position

[INST] (' Income and expenditure statement',) [/INST] An income and expenditure statement gives a view of the financial flows for an individual or household for a specific time period. There is always a time period for which the income and expenditure statement is prepared and this could be a year or month. The income and expenditure statement shows the actual amount of income earned during the period and the actual amount of expenses that have been made. This is a very useful tool because the actual figures can be compared with the amounts that have been taken in the budget. All the income that has been earned is taken on one side and this is considered against the expenses that have been incurred. There is a slight difference between the income and the expenditure statement as compared to the cash statement because there can be some items in the income and expenditure statement that have not been received or paid yet. A very good example of this is say income from salary. An individual might be receiving their salary on the first of the next month. However, the income and expenditure figure would include the figure in the previous month since this pertains to the previous month. The amount is received a day later, but for calculation purpose it goes into the earlier time period. Similarly, there can be expenses made using a credit card but the payment for this could be due later when the free credit period is over and the bill is generated. Still, this would have to be included in expenditure statement for the period in which the expense was actually made. The income and expenditure statement shows the extent of the surplus or savings that is generated and this can also give an idea about where the money is actually going and what needs effective control.

[INST] ('Budgeting and forecasting',) [/INST] The income of a household or individual has to be adequate to meet the current expenses as well provide the savings to create the assets that will help meet future expenses. If the current expenses are controlled, then it is better possible to secure the financial future of the household. It is essential to understand the nature of income and expenses of the household to be able to manage the personal financial situation. Income has to be regular and stable to be able to be assigned to expenses. The income is first used to meet mandatory expenses such as repayment of loans and payment of taxes. The remaining income is next used to meet essential expenses, such as the living expenses. Discretionary expenses, such as those on entertainment and recreational activities, are next met out of available income. The excess income available is the savings of the household. However, meeting goals and future needs cannot be done if savings is adhoc. Prudent financial management requires that a defined level of savings should be targeted that is essential to meet goals. A budget helps a household plan its income and expenses so that the income available is utilized in the best possible way to meet current and future requirements. The steps to making a budget are the following: 1. List and total the regular and definite incomes that will be received in the period. 2. List and deduct the mandatory expenses from the total income. What is left is the disposable income. 3. Identify essential living expenses of the household and deduct from the disposable income. 4. List the discretionary expenses and deduct it from available income to arrive at the savings. Once the incomes and expenses are identified and listed, it will be easy to assess where the problem lies, if the savings are seen to be inadequate. The income cannot be expanded beyond a certain level. The focus should be on managing the expenses to enhance savings. If the mandatory expenses are too high, it may be because of the pressure from loan repayments. A debt rationalisation exercise with a financial planner may help reduce the burden to some extent. Discretionary expenses and living expenses to some extent are areas where a household can focus on cutting back or postponing till the income expands to accommodate them without compromising on the required savings. Forecasting or projecting is the ability to look ahead and plan for the future. Forecasting requires looking at the various data and conditions that are present and based on this and the expected changes there is an estimate of the various figures going forward. There are some conditions that are related to forecasting that needs to be understood. 1. This involves predicting the future situation that is expected to arise. This requires the individual or the household to look at how various events will play out because the final forecast will be based on the conditions prevalent at that point of time. 2. There has to be a specific basis on which forecasting is done. This means that it is not just a random exercise but there is a basis for which the predictions are made. Arriving at the basis for forecasting thus becomes a key aspect. 3. The various evolving conditions are taken into consideration when the forecasting is made. This makes forecasting a dynamic exercise. 4. There are several assumptions that are made when the forecasting is undertaken so these assumptions need to be looked at closely. Assumptions can also change along with the change in the overall conditions. 49 5. There might be a need for several experts or expert opinion in the way in which things are considered, so this assumes an important role in the overall plan. This is needed as one person might not know about all the areas and factors that impact decision making. 6. There has to be some experience present for the person making the forecasts. Hence, the more one does it, the better it gets because there is a proper idea of how things will work out under different circumstances. Forecasting is an exercise and this can be used to move ahead with budgeting as it can be the basis for the budget that is prepared. The forecast also has to be seen in the context of what actually happens so that the real situation is understood and deviations if any are plugged.

[INST] ('Monitoring budgets and provision for savings',) [/INST] Understanding the concept of budgeting is the first step in the entire process of maintaining control over the finances of the household or the individual. Once the concept is known the next step is to actually prepare a budget. This will give a complete picture about how the financial flows look like and it will also give an idea about the areas in which action needs to be taken. This does not complete the process, because one of the most important steps remains i.e. monitoring of the budget. The process of monitoring of the budget involves recording the actual income and the expenses that have arisen. This shows the real situation that is faced by the household or the individual and it has a vital role to play in decision making. The actual figures when compared to the budget plan, will give an idea of how robust the budget planning actually was. It is not likely that every item considered in the budget will end up with the same actual figure, thus the variation witnessed gives a better picture of the strength of the budgeting process. The monitoring of the budget has to be done on a continuous basis and after looking at the difference seen in the figures further action needs to be taken. This action has to be in the form of correcting the budget figures going ahead. If there is an area where there is a constant miss of the budget target then the planning is off track and this needs to be improved through future changes. For example, if there is a provision of Rs 4,000 a month for conveyance and the average conveyance expense comes to Rs 6,000 for a few months then it is clear that either the budget figure has to be raised or the individual has to change the mode of conveyance to reduce cost. The ability to provide various areas of action through monitoring ensures that the budget improves over a period of time. This is the desired outcome from the effort of monitoring. There can be an end of the month monitoring that will give an idea about the actual situation but the effort also depends on the kind of record keeping that is taking place. If there is a regular noting down of expense, then even a mid month review can be made so that a better idea is available about the manner in which the trend is going and if some specific action is required in the remaining part of the month. The final objective of the budgeting process is to have some element of extra amounts left with the individual or the household. This means that the income has to be more than the expenses that are made. This balance figure is the savings that can then be put to better use for the future. All the further steps in the financial planning process can arise only if there are savings generated. The amount of savings that is actually seen has to be checked in the light of the requirements of an individual or household. For example, a person could have a savings of Rs 15,000 per month but if the goals require an investment of Rs 30,000 a month then this is not enough. The budget and its monitoring will also give a direction about the steps to be undertaken so that the savings can rise and reach to the desired level or target. There might be a small difference between the savings desired and the actual amount of savings done. If this is there then bridging the gap is not a difficult task. The real challenge is when the gap between the actual and the desired savings is huge. This will require a step by step approach to raise the savings level. It can consist of some of the following steps. 1. A target of raising the savings rate by a specified percentage might be set. This could be something like 10 % which is not too difficult to achieve. 2. The target once achieved would result in a further target being set. This will ensure that there are constant efforts to raise the savings rate. 3. The manner in which the savings come about is also significant. Elimination of wasteful expenditure and cutting down on discretionary expenses are a good way to raise the savings rate. 4. Lumpsum of large receipts should be directly diverted towards savings. This can give a boost to the overall savings rate. 5. Higher income should not be committed to some additional expense but this should be left free for contribution to the savings rate.

[INST] ('Creating a personal Balance Sheet and net-worth',) [/INST] Creating a personal balance sheet for an individual will require that various assets and liabilities are brought together and shown at a single place. A balance sheet shows the financial position of the individual or household in the form of assets and liabilities at a particular date. Things can change after the date and the balance sheet will also change but it is necessary to see how things are stacked up at a particular time and this what the balance sheet actually provides. Assets for an individual will include physical assets like property, car etc. and financial asset like investments in equity, debt and mutual funds. There might be some advances received by them along with their cash and bank balances which would form current assets. On the liabilities side the various loans that they have plus other payments outstanding including short term debt like credit card dues would make up the list. The different between the assets and the liabilities would be the net worth of the individual or the household. The income of a household or individual is at the base of all financial activities it undertakes. The income is used to meet current expenses and a portion is set aside to meet expenses in the future. The portion of current income earmarked for future needs is called savings. The adequacy of the income of a household is always relative to its expenses. If the expenses are managed within the income and there is surplus to save, then the household’s finances are seen as stable. Short-term imbalances in income and expenses can be managed by loans and advances. The loans are a liability and come at a cost which may further strain the future income. The option of loans to fund expenses must be used with discretion since it weakens the financial situation of the household. The savings of a household are put to work by investing them in assets. Assets are broadly classified as physical assets and financial assets. Assets may be appreciating in value or depreciating. All assets have a resale value. Investors hold assets for the returns they provide. The nature of return that an asset provides classifies them as growth-oriented, incomeoriented or a combination of the two. Physical assets are tangible assets and include real estate, gold and other precious metals. Physical assets have an intrinsic value though the actual price at which they trade is impacted by demand and supply. They are usually seen as natural hedges against inflation since their price show a positive correlation with inflation. Physical assets are more growth investments that are bought for the appreciation in value rather than the income they generate. Some such as real estate provide both income and growth while others such as gold are pure growth-oriented assets. The primary drawbacks of physical assets are illiquidity, lack of regulation/limited regulation and the need for specific skills to identify investment opportunities, assess the merits of the investment, arrange for the purchase of the asset and its management and sale of the asset when required. The other limitation of physical assets as an investment is that they are typically large ticket investments and require substantial savings or a combination of savings and loan to acquire. Financial assets represent a claim that the investor has on benefits represented by the asset. For example, a bank deposit gives the benefit of periodic interest and repayment of principal amount to the holder of the asset, an equity share provides periodic dividend paid, if any, and the appreciation or depreciation in its value is also to the account of the holder. These assets may be structured as growth-oriented assets, such as equity investments, or as incomeoriented, such as deposits, or a combination of the two, such as all listed securities. Financial assets are typically standardized products and controlled by the regulations in force at the point in time. They may differ on liquidity features, with some such as listed securities enjoying high liquidity, while others such as privately placed instruments featuring low liquidity. The standardization of financial assets and the mandatory information made available makes evaluation and comparisons more efficient. These assets lend themselves to investment in small amounts and units. Together, the physical and financial assets represent the investments made by the investor. While these assets represent financial benefits and returns to the holder, the financial strength of the household depends upon how the assets are acquired. Loans and borrowings used to buy assets create a liability and impose a repayment obligation on the buyer and a charge on the future income of the household. Loans taken to buy appreciating assets add to the long-term wealth. Loans taken to buy financial assets, also called leveraging, is risky because of the higher volatility in the price of such assets. Assets acquired with savings and without taking on a liability add to the financial strength of the household. An assessment of the financial well-being of the household can be made by calculating the Net worth. The net worth is calculated as Assets – Liabilities. Higher this number better is the financial position of the household. Net worth should be calculated periodically, and the progress tracked to bring the financial situation to the desired stage. An example of a personal budget for Lakshmi is given below. A brief analysis of this will give a better idea about the existing financial situation for her. There is a fixed asset in the form of a house and a car that is present. As compared to the value of the house, the investment figure is still a bit less and these are also not much into growth assets like equity and equity oriented mutual funds. The amount lying in the bank is also not very high. On the other side the net worth figure is relatively low because most of the assets have been acquired through loans and a large part of these are still outstanding. Over a period of time the changes in the net worth can be seen to see how this is rising along with the value of the assets. The net worth is the total assets of Rs 36,22,000 reduced by the total liabilities of Rs 12,07,000 ( Rs 12,02,000 +5,000) giving the amount as Rs 24,15,000.

[INST] ('Creating a budget and savings plan',) [/INST] There are several steps that need to be taken when a budget and savings plan is created. This will ensure that the process is done in a step by step manner and nothing has been missed out. The following steps would be useful in the budget creation process a) Start by gathering all the relevant details about the various sources of income and expenses for the individual or the household. The availability of the basic information is the most crucial part of the process, so unless this is present the budget would not reflect the true situation. b) Check to see that some area has not been missed out in terms of the heads of income or the heads of expenses. This requires going back and looking at the details over and over again. The wider the coverage of the areas, the better the budget will turn out to be. c) Base the budget figures on either actual expenses that have been made in the past or if this has changed, then the kind of expense that are likely. A record of various expenses would be very useful to arrive at the correct estimate. d) There has to be some element of change in the various figures in the budget based on the time period for which this is done. For example, when vegetable prices show a seasonal spike a higher amount needs to be allocated here. A month in which there are a couple of birthdays in the family might need a higher allocation for discretionary expenses. e) There has to be a contingency figure that is present in the budget. There are times when a sudden change disrupts everything but this feature would ensure that the budget remains robust. 54 f) The amount of savings needed would have to be achieved through the curtailment of expenses within limits. So, the required savings figure based on the goals needs to be present. g) There has to be a proper allocation of the savings amount and this should be done before the figure is spent elsewhere. This is why there has to be a direct transfer to the various investments, so that the amount automatically goes each month in the required investments. Make the savings plan a part of the fixed figure in the budget and this will ensure that there are no variations here and that the goal is met

[INST] (' Contingency Planning',) [/INST] Investment advisers need to prepare the client for various contingencies that might come up. The household or individual’sfinancial strategy needs to provide for these risks. The following are typical contingencies to provide for: * A family that is dependent on incomes of both its earning members needs some protection. If anything were to happen to either earning member, the family will be in dire straits. Life insurance mitigates this risk. * Healthcare costs are another financial risk for any family. Medical insurance, addresses this risk. *Income streams are also affected if people lose their jobs. The double income can offer some kind of insurance against the job loss risk. If one loses the job, the other hopefully will retain the job. This would ensure that some income keeps coming in every month. * An emergency fund needs to be the first goal towards which a household or individual should save as a protection against the possibility of loss or reduction of income. The fund should be adequate to meet the expenses for six months, in the event the regular income is not available. The emergency fund should be held in liquid assets, to enable easy access as and when required. If income security is high, the fund can also be held in a laddered way, with the equivalent of around three months’ expenses being held in liquid assets, and the rest of the funds being held in a less liquid assets but which gives better returns. If the emergency fund is used then efforts must be made to replenish it as soon as possible. The adequacy of the emergency fund should also be periodically reviewed. It should be done annually or whenever there is a large addition, such as an EMI, to the monthly expenses. * Separation (divorce) is another risk that families face. In developed countries, the wealthy go in for pre-nuptial agreements. This is an agreement, entered into before marriage, which details how the finances (and any other matter) will be dealt with, in the event of a separation. The legality of such pre-nuptial agreements in India has not been established. 55 * The Investment Adviser should ensure a healthy distribution between both spouses of the holdings of the family’s assets and liabilities. For example, in some investments, one partner will be the first holder, while the other may be a joint holder; the holding pattern can be reversed in some other investments. * In the case of double income families, the holding pattern can be closely aligned to the source of income of the investment. Investment made out of incomes of one partner can be held with that partner as the first holder. * Another approach would be to keep the salary account of each partner distinct (with the other partner as joint holder). This account is to be used only for investments, or to transfer funds to another joint account that is used for meeting household expenses. Such segregation of investment flows and household expense flow helps in better expense monitoring, as well as investment record keeping and tax record keeping. * When a housing loan is taken for purchase of property, the partners can be joint owners of the property as well as joint borrowers for the loan

[INST] (' Evaluation of financial position of clients',) [/INST] The personal financial situation of an individual or a household primarily refers to its ability to manage its current and future needs and expenses. The income available to do this may be drawn from salary, a business or profession or from the assets created over time by saving and investing a portion of the income. Typically, assets are created to meet the future expenses of the household, and financial planning helps apportion the available current income to immediate expenses and savings for the future. Loans are used to meet expenses and to create assets, if the income is inadequate to meet all the needs. This creates a liability for the household which also has to be settled in the future from the income. The efficiency with which the interplay between income, expenses, assets and liabilities are handled by the household determines its financial situation. Insurance planning is an essential element of a financial plan. Insurance is an efficient way of protecting the household finances from a loss of income or a large, unexpected expense that can derail the financial situation. Similarly, meeting income needs in retirement is an important concern and financial goal for all households. Just as analysts use various ratios to assess the financial position of companies, similarly, investment advisers use various personal finance ratios to assess the financial position of their clients. These ratios are calculated using the income, expenses, savings and investment data for each client and gives a numerical snapshot of their current situation. It helps identify areas that require changes and helps set the course of action for the future. Personal finance ratios thus form an important input in the financial planning process. Some of the important ratios are as follows: 1 Savings Ratio & Expenses Ratio. 2 Total Assets 3 Total Liabilities. 4 Leverage Ratio. 5 Net Worth. 6 Solvency Ratio. 7 Liquid Assets. 8 Liquidity Ratio. 9 Financial Assets Ratio. 10 Debt to Income Ratio

[INST] ('Savings Ratio & Expenses Ratio',) [/INST] Savings Ratio is the percentage of annual income that a person is able to save. It is calculated as Savings per year/Annual Income. ABC earns an annual income of Rs. 6 lakhs and saves Rs. 60,000 from the income. The savings ratio is Rs. 60,000 ÷ Rs. 6,00,000 = 10%. Savings is not limited to money that is retained in the savings bank account. Money invested in fixed deposits, mutual funds, shares, debentures, public provident fund, national savings certificates, post office deposits, real estate, gold and others during the year also form part of the savings. Some savings may not even reach the investor during the year. For example, the company’s contribution to provident fund or superannuation fund on account of the investor. The money will not go to the investor immediately, but it belongs to the investor and will be available in the investor’s account with the provident fund or superannuation fund and will form part of the savings during the year. Annual income will include all income earned from employment or business and in the form of interest, dividend, rent and such other items during the year. Consider the following information. XYZ earned a gross salary of Rs. 10,000, including company’s contribution to provident fund of Rs. 500. Net take home salary was Rs. 9,000 after deducting Rs. 500 towards employee’s contribution to provident fund. XYZ earned Rs. 200 towards interest in the savings bank account. Expenses during the month were Rs. 7,000. What is the savings ratio? Total Income: Gross salary + Interest income = Rs10,000 + 200 = Rs10,200 Savings: (Net salary + Interest income + Contributions of employer and employee to provident fund)–(Expenses) = Rs9,000 + Rs200 +Rs500 + Rs500 – Rs7,000 =Rs3,200. Savings Ratio: Savings /Total Income = Rs3,200 ÷ Rs10,200 =31.4%. The Savings to Income ratio measures the total accumulated savings of the individual relative to the annual income. It is calculated as Total Savings/Annual Income. Consider the following information of the financial situation of GGN. Annual salary: Rs.12,00,000 57 Accumulated investments, including PF balance, value of bank deposits, mutual fund units, PPF, NSC: Rs. 15,00,000 Savings to Income ratio: Rs.15,00,000/Rs.12,00,000= 1.25 This ratio measures the preparedness to meet long term goals such as retirement. The current value of the investments and assets, after accounting for any outstanding loans taken to acquire the same, is taken to compute the total savings. Self-occupied home is typically not included when calculating the savings level. The appropriate level for this ratio will depend upon the age of the individual. When the individual is young, expenses are high relative to the income available and the accumulated savings are likely to be low. Moreover, at this stage much of the available surplus is likely to go towards servicing a home loan. The ratio is expected to improve over time, as income goes up and expenses stabilize. A suitable savings to income ratio in the early 40s is at least 3 times the annual income. This means that the annual savings rate, or the annual savings relative to income, has to be stepped up as income levels go up, so that the savings can be built to a level that is suitable to the age and stage in life. In the earlier example, if ABC has saved Rs. 60,000 out of an income of Rs. 6 lakhs, it stands to reason that Rs. 6,00,000 – Rs. 60,000 i.e. Rs. 5,40,000 was spent towards various expenses. The Expenses Ratio is calculated as Annual Recurring Expenses ÷ Annual Income. In the case of ABC, it amounts to Rs. 5,40,000 ÷ Rs. 6,00,000 = 90%. Expenses Ratio can also be calculated as 1 – Savings Ratio. Similarly, Savings Ratio is 1 – Expenses Ratio. Non-recurring expenses are kept out of the expense ratio. For example, if a person incurred a one-time medical expenses of Rs. 50,000 in a year, then that would be excluded. However, if it is found that on an average, every year the family spends Rs. 30,000 towards healthcare expenses (beyond any re-imbursement from employers or insurers), then these would be included in determining the expense ratio. Suppose a family goes on a foreign holiday every 3 years, when they spend about Rs. 6,00,000, then its annual equivalent viz. Rs2,00,000 will be considered in the expense ratio. Expenses may be mandatory, such as taxes, rents, EMIs for loans and necessities for living. Discretionary expenses are those items of expenses that are not essential. Much of the reduction and rationalisation of expenses happen with respect to discretionary expenses in order to improve the savings ratio. A low expense ratio and high savings ratio is desirable for an individual’s financial security and stability.

[INST] ('Total Assets ',) [/INST] Savings of the individual are deployed in various forms of physical and financial assets such as shares, debentures, mutual funds, real estate, gold, provident fund, superannuation fund, and others over a period of time. The current value of these assets constitutes the investor’s total assets. Physical assets such as real estate is typically acquired with a combination of savings and loans. A conservative approach would be to exclude personal jewellery, one residential house that the investor’s family stays in, and any other form of asset meant for personal use (e.g. car) while estimating assets available to meet goals and financial needs.

[INST] ('Total Liabilities',) [/INST] Liabilities include loans and different forms of credit taken to meet expenses or to acquire assets. These may be taken from institutional sources, such as banks and financial institutions, or from personal sources such as friends and relatives. Liabilities may be long term and secured on assets, such as mortgage towards purchase of house and car loans. Or they may be short-term and unsecured, such as credit card outstanding and personal loans. Such liabilities tend to be more expensive. Liabilities imply an obligation to repay the loan from the future income. This impacts the ability of the household to meet other expenses and to save for other assets. It must be used with caution, ideally to acquire assets that appreciate in value. Greater is the liability, more shall be the financial pressures on the investor for repayment.

[INST] (' Leverage Ratio',) [/INST] This is a measure of the role of debt in the asset build-up of the investor. It is calculated as Total Liabilities ÷ Total Assets. For example, an investor owns real estate worth Rs.50lakhs, investments and bank balances valued at Rs.10 lakhs, and Rs.5 lakhs is lying in provident fund account. The real estate was bought with a loan of Rs. 30 lakhs, of which Rs. 10 lakhs is currently outstanding. The investor also has credit card dues of Rs. 2lakhs and a loan of Rs.1 lakh from a friend. Total assets = Rs. 50 lakhs + Rs. 10 lakhs + Rs. 5 lakhs i.e. Rs. 65lakhs. Total liabilities = Rs. 10 lakhs + Rs. 2 lakhs + Rs. 1 lakh i.e. Rs. 13lakhs. Leverage Ratio = Rs. 13 lakhs ÷ Rs. 65 lakhs i.e. 20%. Higher the leverage, more risky it is for the individual’s financial situation. A ratio greater than 1 indicates that the assets will not be adequate to meet the liabilities. The ratio is likely to be high immediately after a large-ticket asset, such as real estate, is purchased with debt. Over time as the asset value appreciates, the ratio will also moderate. Investor needs to look at the leverage in the context of debt servicing capability. Further, investor needs to ensure that a risky investment position is not compounded with high leverage financing it.

[INST] ('Net Worth',) [/INST] A strong asset position is of no use, if most of these are acquired through loans that are outstanding. Similarly, liability is not bad, if it has been used for creating an asset, such as real estate, which has the potential to appreciate in value. It is therefore normal to monitor any investor’s financial position through the net worth. It is calculated as Total assets – Total liabilities. In the previous example, Net worth = Rs. 65 lakhs – Rs. 13 lakhs i.e. Rs. 52 lakhs. Net worth is monitored over a period of time to monitor improvement or deterioration in the financial position.

[INST] ('Solvency Ratio',) [/INST] Despite having assets, a person may be insolvent, if the liabilities are higher than the value of the assets held. A critical benchmark is that the individual’s net worth should be positive. The extent of the investor’s solvency can be determined through the solvency ratio, which is calculated as Net Worth ÷ Total Assets. For the same asset position, higher the solvency ratio, stronger the investor’s financial position. In the above example, it is calculated as Rs. 52 lakhs ÷ Rs. 65 lakhs i.e. 80%. It can also be calculated as 1 – Leverage Ratio. Similarly, Leverage Ratio = 1 – Solvency Ratio

[INST] ('Liquid Assets',) [/INST] Liquid assets are those assets that can be easily converted into cash at short notice to meet expenses or emergencies. Liquid assets include money in savings bank account, fixed deposits that mature within 6 months, investment in liquid funds or other mutual funds and such other short-term assets. On the other hand, there are assets that are not easy to convert into cash. For example, it can take a long time to sell real estate at the fair value and realize it. Closed-end mutual fund units may not be as easily realizable as units of open-end mutual fund units. Some assets may be easily converted into cash but their values may fluctuate 60 widely in the short-term, thus making them unsuitable for realising cash at short notice. Shares and open-end equity schemes fall under this category. Open-end debt schemes too have a significant market element in their valuation which makes their return volatile, and therefore unsuitable to meet the need for funds at short notice. More the money in liquid assets, lesser are the chances of the investor getting caught in a liquidity crunch. However, keeping the entire money in liquid assets is not a sensible solution. Liquidity comes at a cost. For example, banks usually offer lower rate of interest on shorterterm fixed deposits; liquid schemes may yield a lower return than longer-term debt schemes. Investors therefore need to balance their liquidity and return needs. Keep enough in liquid assets to meet liquidity requirements, and invest the balance in longer term assets with a view to earning superior return

[INST] ('Liquidity Ratio',) [/INST] The role of liquid assets is to meet the near-term liquidity needs of the individual. It is normal to calculate the liquidity needs as the expenses that an investor will incur over the following 6 months (including loan repayments). In exceptional situations, expenses over a longer period may be considered. Liquidity ratio measures how well the household is equipped to meet its expenses from its short-term assets. It is calculated as: Liquid Assets/Monthly Expenses. A ratio of at least 4 to 6 indicates a comfortable level for the household to meet its expenses for 4 to 6 months, even if there was a loss or decline in regular income. Consider the financial situation of NFG. The monthly expense incurred, including loan repayments, is Rs.1.5 lakh. The market value of the assets held are as follows: Equity Shares Rs.3 lakhs Savings bank account Rs.7lakhs Short-term Fixed Deposits Rs.2lakhs Long-term Fixed Deposits Rs.6lakhs Open-end liquid mutual fund schemes Rs.4 lakhs Other open-end mutual fund schemes Rs.5 lakhs Closed-end mutual fund schemes Rs.12 lakhs Liquid assets = Rs.7lakhs + Rs.2lakhs + Rs.4lakhs = Rs.13lakhs. Liquid Ratio = Rs.13lakhs ÷ Rs.1.5lakhs= 4.66. A ratio of around 6 indicates a comfortable situation to manage short-term obligations. Note: Shares have not been included in liquid assets because the uncertainty in the value of the share makes it risky for an investor to include in liquid assets. Another liquidity ratio that is tracked is the Liquid assets to Net worth ratio. This ratio has to be interpreted in light of the goals of the individual. If there is a longer period to the goals, then this ratio should be low. A high ratio would indicate that a large portion of the savings are held in liquid assets and would be earning low returns. This will affect the ability to meet their long-term goals efficiently. If goals have to be met in the near term, then adequate assets must be held in easily realisable assets. In this situation the ratio needs to be higher.

[INST] (' Financial Assets Ratio',) [/INST] Assets can broadly be categorised as financial assets such as shares, debentures, bank deposits, Public Provident Fund, mutual fund investments and others, and physical assets such as gold, other precious metals, diamonds and real estate. Financial assets have the advantage of greater liquidity, flexibility, convenience of investing and ease of maintaining the investments. They are primarily income generating investments, though some of them, such as equity-oriented investments are held for long-term capital appreciation. There is greater ease of investing in such assets as it lends itself to small and frequent investments. Consider the assets held by PQR: Shares Rs. 5 lakhs, Fixed Deposits Rs. 10 lakhs, Mutual Fund Investments Rs. 12 lakhs, Land Rs. 9 lakhs and Gold Rs. 14 lakhs Financial assets are Rs. 27 lakhs (5 + 10 + 12) Physical assets are Rs. 23 lakhs (9 + 14) Total assets are Rs. 50 lakhs (27 + 23) Financial assets ratio= [(Rs. 27 lakhs ÷ Rs. 50 lakhs)*100]= 54%. A higher proportion of financial assets is preferred especially when goals are closer to realisation and when there is a need for income or funds to meet the goals.

[INST] ('Debt to Income Ratio',) [/INST] Leverage ratio measures the extent of debt use in asset acquisition. It however does not directly measure the ability of the individual’s income to service or meet the obligations arising from all debt outstanding. Debt to income ratio is an indicator of the individual’s ability to manage current obligations given the available income and a parameter used by lenders to determine eligibility for additional loans. It is calculated as Monthly Debt Servicing Commitment ÷ Monthly Income. Debt servicing refers to all payments due to lenders, whether as principal or interest. Consider an example where an individual has a monthly income of Rs.1.5 lakh and has loan commitments of Rs. 60,000 per month. The Debt to Income ratio = Rs.60,000/Rs.150,000= 40%. A ratio higher than 35% to 40% is seen as excessive. A large portion of the income of the household is committed to meet these obligations and may affect their ability to meet regular expenses and savings. Obtaining loans in the case of an emergency may also become difficult. Any reduction in income will cause stress to the household’s finances. Personal Finance Ratios need to be calculated periodically, say once a year, and compared with past numbers to identify trends. They help identify areas where corrective action needs to be taken to improve the financial situation. The trends also show the efficacy of actions already taken. While benchmarks have been established for each of the ratios, they may have to be customized to each individual’s situation.

[INST] ('What are the key aspects related to debt management and loans?',) [/INST] The need for debt, the role and impact of debt in cash flow management, understanding leverage and debt counseling, calculation of debt servicing requirements, responsible borrowing practices, the concept of secured and unsecured loans, familiarity with loan-related terms, types of borrowings, comprehension of various loan calculations, knowledge about loan restructuring and present value of future payments, repayment schedules with varying interest rates, criteria for evaluating different loans, considerations when opting for changes in EMI or tenure due to interest rate fluctuations, the decision between investing money or paying off outstanding loans, and strategies to expedite the process of getting rid of debt faster.

[INST] ('The purpose or need of debt',) [/INST] Debt is used to finance goals when available funds (self-funding) are inadequate. Even though income might be higher than expenses it is not possible to finance every purchase or asset with just the existing savings. For example, most people cannot buy a house without a loan. This is because the cost of a house is huge and if people waited till they had enough savings to buy a house then it is likely that this would not be possible till they near retirement. Lenders protect themselves by securing their loan against a charge or security or pledge or mortgage on the property. Such loans are also called ‘mortgages’. Other debt includes auto loans, credit taken for buying consumer durables, personal loans and credit card outstanding. However, debt comes at a cost and imposes a repayment obligation on the borrower. The decision on whether or not to use debt will depend upon the ability of the available income to bear the additional charge of interest cost and repayment. Debt is not always bad. In some cases, the decision to use borrowed funds over own funds, also called leverage, may actually increase the return made on an investment (ModiglianiMiller Theorem (M&M)). In some cases, a loan may make more sense in a given situation. For example, an education loan may be a better choice than drawing from a retirement account to fund the children’s education. The future income would be easily able to repay the loan LEARNING OBJECTIVES: After studying this chapter, you should know about: • Need of debt • Role and impact of debt in cash flow management • Know about Leverage and Debt Counselling • Calculation of debt servicing requirements • Understand Responsible Borrowing • Concept of secured and unsecured loans • Know certain terms related to loans • Types of borrowings • Understand various Loan calculations • Know Loan restructuring – present value of future payments • Repayment schedules with varying interest rates • Criteria to evaluate various loans • Opting for change in EMI or change in tenure for interest rate changes? • Invest the money or pay off outstanding loan? • Know the Strategies to get rid of debt faster 64 and at the same time the existing funds can continue to earn without losing the benefit of compounding. It can be seen that debt is needed under various circumstances and sometimes it can be also for temporary use of funds. This kind of short term needs might arise due to some emergency or some cash flow mismatch but it can ensure that an individual is able to continue on their life path without facing sudden disruptions

[INST] ('Role and impact of debt in cash flow management',) [/INST] While some debt is good and may even be recommended, how much debt is good depends upon the financial situation of each household. A good indicator is the debt to income ratio (DTI) that measures the ability to meet the obligations arising from debt with the available income. There is no "perfect or optimal" DTI ratio that lenders require, but all lenders tend to agree that a lower DTI is better. Depending on the size and type of loan they're issuing, lenders set their own limits on how low your DTI must be for loan approval. Consider a salaried employee who draws a salary of Rs. 15,000 per month, and is paying Rs7,500 towards debt servicing. The debt servicing ratio comes to Rs.7,500 ÷ Rs15,000 i.e. 50%. This is too high. If 50% goes towards debt servicing, it affects the ability to meet other regular expenses, provide for emergencies and the person may have nothing left to invest for the future. The interest rate and the amount of debt play an important role as far as the measurement of the impact of the debt is concerned. A higher interest rate will raise the repayment amount that will have to be paid and similarly a higher loan amount will also increase the monthly repayment amount. One has to look at the cash flow and then decide on the amount of debt that will be taken. All this needs to be done to ensure that the debt and its outflow do not disrupt the entire cash flow management plan laid out. Often there could be a situation wherein the debt servicing needs are high and at the same time a crisis on some other front can leave little room for borrowing some more amounts to tide over it. This is also the reason why the debt servicing amount needs to be low so that there is scope for raising some more funds in case this is required.

[INST] ('Differentiating between consumption expenditure and investment expenditure',) [/INST] Many clients have an endless list of lifestyle expenses. The Investment Adviser should be able to influence the client to be prudent in the expenditure. This can be done by highlighting how expenditure might affect the chances of the family being able to fulfil some other financial goal. One way to differentiate the various expenditures is by classifying them as consumption expenditure and investment expenditure. Consumption expenditure is that amount which 65 once used does not create any asset that generates further income. Amount spent at a restaurant or for buying clothes or expenses made at a saloon are some examples of consumption expenditure. On the other hand investment expenditure will lead to the creation of an asset, which then can generate further income in the future. The trade-offs should be clearly understood by the client. For example, buying a bond or a property can be investment expenditure. Some outflows, like providing education to children, may appear to be consumption expenditure. But they may be a useful investment, if the children do well and are able to raise the family’s income. Such expenditure needs to be prioritized. A budget that clearly demarcates mandatory and legal payments such as taxes, contributions to provident fund and gratuity and loan commitments, essential living expenses such as food and shelter and discretionary expenses such as lifestyle expenses, will help allocate income better between current and future needs. Allocate savings for goals before considering the discretionary expenses. This will make sure that the future needs are taken care of. Systematic investment plan (SIPs), especially when automatically transferred from the salary, helps in prioritizing the investment expenditure.

[INST] ('Identifying the holes in the household budget ',) [/INST] A household may not be managing its income and expenses efficiently to enable savings for goals. Some common errors that make it seem as if savings are not possible include not being clear if an expense is an essential living expense or discretionary in nature, incorrect (higher) allocation for expenses, not ‘paying self’ before allocating for discretionary expenses, not tracking expenses regularly and hence going over-budget, among others. Very often, clients do not realise how much money goes in various avoidable expenses. The adviser should inculcate the habit in the client, to note down all expenses above a specific level. The limit may be Rs.500 for some clients; Rs.5,000 for some others. The actual figure would depend on the income level of the client. A summarisation of the list of expenses at the end of the month can be enlightening, even for the client. For example, the amount that went in eating out or entertainment might be pretty high but this might not register for the client because all payments were made by credit card so this was not actually tracked. When the client recognises the scale of the lost opportunity to save, there is better likelihood of prudence in future. An adviser’s primary role is to identify and eliminate these lacunae that inhibit savings. There are often cases where a lot of money is spent on buying the latest gadgets when this is not necessary. Spending on a gadget like a phone or a laptop is necessary because it helps in work and increases efficiency and learning for an individual or the household. However constant upgradation just so that they have the latest model to show off is not a wise way to spend money and the amount saved from such expenses can be used at several other places.

[INST] ('Allocation to various categories of expenses',) [/INST] The monthly summary of outflows helps in understanding the current prioritization. If unusual expenses are kept out (for instance, a hospitalization that was not covered by insurance), the balance outflows can be categorized as mandatory contributions to provident fund and other retirement savings, loan servicing, essential expenses and lifestyle expenses. Families vary in their financial circumstances. The advisor should work with the family in setting limits on various categories of outflows. The household can make additional savings possible by changing their choices on the expenses they incur. An essential expense does not lend itself to much reduction but lifestyle expenses can be controlled to a large extent. Considering the alternate use to which the income can be used instead of spending it on discretionary expenses is one way in which such expenses can be controlled

[INST] ('Windfalls',) [/INST] Clients occasionally earn a windfall such as unexpectedly high annual bonus, inheritance, winning a lottery, etc.. A healthy portion of such unexpected income should be set apart for the future, since the family is used to living without that windfall. This can also be the time to take a look at the outstanding loans and consider pre-paying some of them. Windfall gain need not be invested immediately, as appropriate investment opportunities may not be available at the time gain occurs. The gain may be held in risk free liquid assets, till investment decision is reached. The amount of the windfall should be properly allocated as the extent of the windfall matters. For example, a very high annual bonus a year can be used to prepay loans and at the same time make some additional investments too, which can yield a return in the future. One should not expect a windfall to occur regularly in the hope that this will save a bad financial situation, as this can encourage wayward financial behaviour and still end up with a higher amount of debt when the windfall does not materialise.

[INST] ('Leverage and Debt Counselling',) [/INST] Investment Advisers need to consider various aspects when they are advising clients on debt as this can have a big role in the kind of financial behaviour that is witnessed. Many factors will vary for a client and each of these needs to be taken into consideration when a specific plan is put forward. Some of the factor here includes the following: 1 Purpose of the debt.2 Cost of debt. 3 Maturity of debt. 4 Debt Re-scheduling

[INST] ('Purpose of the debt',) [/INST] Debt or loan should ideally be taken for acquiring appreciating assets such as real estate. Some debt may be recommended to meet an expense that will increase the value of an asset, say an education loan to upskill, so that the income generating ability of the person goes up. Financing risky or volatile investment propositions with debt may entail high risk and may put 67 the entire financial security of the individual or household at risk. Margin financing for stock market investing is one such investment. A fall in the value of the investment will magnify the loss since the cost of debt will also have to be accounted for. Debt should certainly not be used for financing one’s regular expenses. If a person starts borrowing to meet expenses, then he is clearly living beyond his means and likely to be in a debt trap. Taking short term debt to tide over temporary liquidity problems may be fine, as long as the borrower knows the risk and has a plan to repay the debt as soon as possible.

[INST] ('Cost of debt ',) [/INST] Higher the rate of interest at which money is borrowed, more will be the outgo in servicing the debt. Secured loans, such as mortgages, and education loans are relatively cheaper as there is the benefit of the security available to the lender. Unsecured loans such as personal loans and credit card debt are very expensive and must be used with caution. Credit card is an interest free borrowing option only if the use is within the limits specified, and the repayments are made by the due date each month. When the credit card user does not pay the entire amount i.e. some amount is carried over for payment in the following business cycles, it is called “revolving credit”. If a credit card company charges 3% p.m. as interest, the compounded annual cost is (1+3%)^12-1 i.e. 42.6%. Given the exorbitant cost, revolving credit should be avoided. A similar argument can be made for loansfor unorganized sector like pawn traders or money lenders who charge as high as 60-80% interest rate or 5% a month from people

[INST] ('Maturity of debt ',) [/INST] Shorter the tenor of the loan; more will be the periodic repayment putting pressure on available income. Even if the cost of debt is low, short loan tenor can put financial pressures in repayment. Therefore, loan tenor should be decided keeping in mind the repayment capacity of the borrower. A longer tenor loan translates into higher interest paid over the term. The debt to income ratio can be used as an indicator of what the household income can take on as repayment obligations, and decide on the tenor accordingly.

[INST] ('Debt Re-scheduling',) [/INST] If the borrower is unable to manage the debt repayments, then it helps to work out a solution as soon as possible. Potential solutions are as follows: * Rank debt in order of their cost and deal with the costliest debt first. Typically, credit card dues and personal loans will be the most expensive, and work to eliminate them from the outstanding debt list. Low cost debt and debt that provide tax benefits such as home loans and education loans can be dealt with later when finances permit. 68 * If the debt was taken for purchasing an asset, then the asset can be sold and the proceeds used for pre-paying the debt. While doing this, the borrower should also plan for any prepayment charges that the bank may levy. * If the cost of debt is high, then cheaper re-financing is an option. A lower cost loan can be availed to repay the costlier loan. A credit card balance transfer is an example of such refinancing. * If the problem is with the tenor of the loan, then the possibility of extending the tenor of the loan can be explored. This will reduce the monthly outgo in debt servicing. However, the loan will be repaid over a longer period of time and the total interest paid over the tenor of the loan will go up. * If none of these is possible, then the borrower should inform the lender about the problem and explore a revised loan schedule. It should however be noted that such re-scheduling of loans hurts the borrower’s credit history (also known as credit score like Cibil score). This will affect the chances of obtaining loans in future or the cost at which they will become available

[INST] ('The Indian Economy',) [/INST] 5.1 The Indian Economy The Indian economy has gone through phases of growth and change that has transformed it from being a primarily agriculture-oriented economy to one where services and manufacturing contribute to 3/4th of its gross domestic product. The economy requires the financial system to support growth by enabling access to resources, both financial as well as real. The banking sector provides—credit at efficient costs, secure systems for transactions and transfer of funds and the means to channelize savings of the economy in productive ways. Securities markets allow businesses seeking funds to reach out to a wider group of institutional and retail investors by issuing different types of securities, such as equity and debt securities, with different features of risk and return. The foreign exchange markets provide a platform for trading in the currencies of countries which in turn determines the costs of import of funds and commodities essential for production and enables global investing. A well-developed foreign exchange market helps to hedge the risks of movements in currency exchange rates for companies dependent upon imports as well as the earnings of export-oriented organisation. Similarly, the commodity markets enable mitigating the risk of adverse price movements in commodities to producers and users. A well-developed insurance market is necessary to ensure adequate insurance cover for people. Insurance is important to protect people’s finances from emergencies of large expenses or loss of income. This enables higher savings and investments. All these markets need to be well developed in terms of systems and regulations to enable economic growth.

[INST] ('The Indian Financial Markets',) [/INST] 5.2.1 Key Features The financial markets enable efficient transfer and allocation of resources for productive activities in the economy. Users of funds include governments, businesses and households who seek funds to run their activities. Governments, businesses and households also act as providers of surplus funds. Intermediaries such as banks, financial institutions, mutual funds and insurance companies, among others, channelize the available surplus funds from lenders to the users. The function of the financial markets is to ensure that economic activity is enabled by providing access of funds to those that need it for consumption or productive activity. They provide a way for aggregation of funds from a large number of investors and make it available for productive economic activity. For example, banks collect deposits from a large number of depositors who have surplus funds and lend it to individuals and businesses who seek loans to meet their need for funds. In the absence of financial markets such aggregation may not be possible. An efficient financial market ensures that the transfer of funds happens at a cost that makes it attractive for savers to save and lend and for users to borrow funds. The markets must enable the dissemination of relevant information to all its participants so that the decision is made after integrating all available information that determine the risk and return for the lenders and cost of funds to the borrowers. It must also allow the participants to review their funding decisions given new information and to re-allocate the resources accordingly. Therefore, providing liquidity and exit options are an important function of financial markets. Financial market regulations and regulators focus on setting up systems and processes in place to streamline the activities associated with the transfer of funds. The financial market comprises money markets that deal with the short-term lending and borrowing of funds and the securities or capital markets that enable longer term transfer of funds using debt and equity instruments. The allocation and re-allocation of resources may happen in the primary markets where securities are issued by the borrowing institutions directly to the lenders or investors or in the secondary markets which provides investors the options to exit or reallocate their resources by dealing amongst themselves. The activities in the financial markets are facilitated by the market participants such as banks, financial institutions, brokers and dealers, custodians, depositories and depository participants, among others. Institutions such as mutual funds, insurance companies and pension funds are large and informed investors who provide funds in the markets and provide liquidity and stability. They also play an important role in the proper pricing of financial assets since they can source and evaluate information better. Banks and financial institutions aid the actual transfer of funds between the participants and may also be present in the markets to source funds for their activities or as investors of funds. Fund managers and financial advisors provide the service of advising and managing funds for investors so that their savings are invested in a way that suits their requirements the best. Apart from the financial markets, economic activity is supported by the development of other markets such as the commodities markets and foreign exchange markets that protect producers, consumers and businesses against adverse price movements. Similarly, a well- developed insurance and pension markets protect the personal financial situation of households apart from playing an important role as an institutional investor in the financial markets.

[INST] ('Regulators of Financial Markets',) [/INST] 5.3 Regulation of the financial markets is motivated by the need to safeguard the interests of investors. What is paramount is to ensure that investors make informed decisions about their financial transactions on the basis of a fair understanding of various markets which enable such financial transactions. The Reserve Bank of India (RBI) regulates commercial banks, the Securities and Exchange Board of India (SEBI) regulates securities markets and commodity, the Insurance Regulatory and Development Authority of India (IRDAI) regulates insurance companies, the Pension Fund Regulatory and Development Authority (PFRDA) regulates the pension sector. The Central Government exercises a certain level of oversight on these and other regulatory institutions.

[INST] (' Ministry of Finance ',) [/INST] 5.3.1The Ministry of Finance through its Department of Financial Services regulates and overseas the activities of the banking system, insurance and pension sectors. The Department of 92 Economic Affairs regulates the capital markets and its participants. The ministry initiates discussions on reforms and overseas the implementation of law. The Ministry of Finance (MoF) has a wide range of responsibilities. It has five departments under it, whose roles are briefly described below: a) Department of Economic Affairs is the nodal agency of the Central Government to formulate and monitor India’s macroeconomic policies, covering monetary and fiscal policy as well as the functioning of the capital market including stock exchanges. b) Department of Expenditure is concerned with, among other things, the administration of various financial rules and regulations including service conditions of all Central Government employees. The department is also involved with matters such as financial assistance to states and borrowings by states. c) Department of Revenue exercises control over matters relating to direct and indirect taxes of the Central Government, through two statutory boards, viz., the Central Board of Direct Taxes and Central Board of Excise and Customs. d) Department of Financial Services administers government policies relating to: ? Public sector banks. ? Term-lending financial institutions. ? Life Insurance and General Insurance. ? Pension Reforms. e) Department of Investment and Public Asset Management oversees, among other things, all matters relating to the disinvestment of Central Government equity from Central Public Sector undertakings. The department is also concerned with the financial policy relating to the utilization of proceeds of disinvestment.

[INST] (' Ministry of Corporate Affairs ',) [/INST] 5.3.2 Ministry of Corporate Affairs The Ministry is primarily concerned with administration of the Companies Act 2013, the Companies Act 1956, the Limited Liability Partnership Act, 2008 & other allied Acts and rules & regulations framed there-under mainly for regulating the functioning of the corporate sector in accordance with law. The Ministry is also responsible for administering the Competition Act, 2002 to prevent practices having adverse effect on competition, to promote and sustain competition in markets, to protect the interests of consumers through the commission set up under the Act. Besides, it exercises supervision over the three professional bodies, namely, Institute of Chartered Accountants of India (ICAI), Institute of Company Secretaries of India (ICSI) and the Institute of Cost Accountants of India (ICAI) 93 which are constituted under three separate Acts of the Parliament for proper and orderly growth of the professions concerned.

[INST] ('Registrar of Companies ',) [/INST] 5.3.3 Registrar of Companies The Registrar of Companies (RoC) is the authority appointed under the Companies Act to register companies and to ensure that they comply with the provisions of the law.

[INST] ('Reserve Bank of India (RBI)',) [/INST] 5.3.4 Reserve Bank of India (RBI) The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as: "to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage; to have a modern monetary policy framework to meet the challenge of an increasingly complex economy, to maintain price stability while keeping in mind the objective of growth." The main functions of RBI are explained in Box 5.1. 94 5.3.5 Securities and Exchange Board of India (SEBI) The Securities and Exchange Board of India (SEBI), a statutory body appointed by an Act of Parliament (SEBI Act, 1992), is the primary regulator of securities markets in India. The Preamble of the Securities and Exchange Board of India describes the basic functions of the Securities and Exchange Board of India as "...to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto". Box 5.1: Main Functions of RBI Monetary Authority: Formulates, implements and monitors the monetary policy. Objective: maintaining price stability while keeping in mind the objective of growth. Regulator and supervisor of the financial system: Prescribes broad parameters of banking operations within which the country's banking and financial system functions. Objective: maintain public confidence in the system, protect depositors' interest and provide cost-effective banking services to the public. Manager of Foreign Exchange Manages the Foreign Exchange Management Act, 1999. Objective: to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India. Issuer of currency: Issues and exchanges or destroys currency and coins not fit for circulation. Objective: to give the public adequate quantity of supplies of currency notes and coins and in good quality. Developmental role Performs a wide range of promotional functions to support national objectives. Regulator and Supervisor of Payment and Settlement Systems: Introduces and upgrades safe and efficient modes of payment systems in the country to meet the requirements of the public at large. Objective: maintain public confidence in payment and settlement system Related Functions Banker to the Government: performs merchant banking function for the central and the state governments; also acts as their banker. Banker to banks: maintains banking accounts of all scheduled banks. Source: RBI

[INST] ('Insurance Regulatory and Development Authority of India (IRDAI)',) [/INST] 5.3.6 Insurance Regulatory and Development Authority of India (IRDAI) IRDAI regulates the insurance sector in India in accordance with the terms of the IRDA Act of 1999. IRDAI is the licensing authority for insurance companies and defines the capital and networth requirements for insurance companies. It ensures the adherence of insurance products to the rules laid down and defines the rules for the terms and conditions of insurance contracts such as sum assured, surrender value, settlement of claims, nomination and assignment, insurable interest and others. It regulates the distribution of insurance products by laying down the qualification and training requirements of intermediaries and the payment of commission to distributors. IRDAI supervises the functioning of the Tariff Advisory Committee that determines the rates for general insurance products. It also lays down the modalities for investment of funds by insurance companies.

[INST] ('Pension Fund Regulatory and Development Authority (PFRDA)',) [/INST] 5.3.7 Pension Fund Regulatory and Development Authority (PFRDA) The PFRDA is the authority entrusted to act as a regulator of the pension sector in India under the PFRDA Act, 2013. PFRDA regulates the National Pension System (NPS) and any other pension scheme specified under its ambit. It is responsible for registering the various constituents such as the fund managers, custodians, central record keeping agency and trustee banks and to define the parameters of their roles and responsibilities. The Act and its provisions apply to the National Pension System (NPS) and other pension schemes not regulated by any other enactment. The NPS will be based on defined contributions. It will also offer a menu of investment choices and Fund Managers. The functions and responsibilities of the PFRDA under the Act include: ? Regulating the National Pension System and any other pension schemes to which the act applies. ? Approving the schemes and their terms and investment guidelines to manage the corpus. ? Registering and regulating intermediaries. 97 ? Protecting the interests of the subscribers by ensuring the funds are managed according to the mandate received, costs of management are reasonable and establishing a mechanism for redressal. ? Educating subscribers and the general public on matters relating to retirement savings Different regulators have developed different systems and platforms for providing a redressal mechanism to investor grievances.

[INST] ('Role of Self-Regulatory Organizations (SRO)',) [/INST] 5.3.8 Role of Self-Regulatory Organizations (SRO) Additionally, intermediaries representing some segment of the securities markets may form a Self-Regulatory Organization (SRO). In the developed world, it is common for market players to create Self-Regulatory Organizations, whose prime responsibility is to regulate their own members. Wherever SROs exist, the statutory regulatory bodies set up by the Government only lay down the broad policy framework, and leave the micro-regulation to the SRO. According to SEBI (Self-Regulatory Organizations) Regulations, 2004, “Self-Regulatory Organisation” means an organization of intermediaries which represents a particular segment of the securities market and which is duly recognized by SEBI but excludes a stock exchange.” In Indian securities markets, an SRO needs to be registered and recognized by SEBI after following a registration process that lays down norms for professional competence of the Board, infrastructure and capital requirements. The SEBI (SRO) Regulations, 2004 lay down certain obligations and responsibilities on SROs. An SRO must always abide by the directions of the SEBI and act in the best interest of investors. SEBI also nominates Directors on the Board of the SRO. The SRO can also conduct inspection and audit of its members. It is bound to report any violations or non-compliance by any of its members to SEBI.

[INST] ('Structure of Financial Markets in India ',) [/INST] 5.4 Structure of Financial Markets in India 5.4.1 Banking System The banking system is at the core of the financial structure of an economy and supports its growth. It enables capital growth and formation through financial intermediation by accumulating savings from households, governments and businesses and making credit available for productive activities. The Reserve Bank of India is the regulator of the banking system and the monetary authority. The Reserve Bank of India performs the supervisory function under the guidance of the Board for Financial Supervision (BFS). The Board was constituted in November 1994 as a committee of the Central Board of Directors of the Reserve Bank of India under the Reserve Bank of India 98 (Board for Financial Supervision) Regulations, 1994. The primary objective of BFS is to undertake consolidated supervision of the financial sector comprising Scheduled Commercial and Co-operative Banks, All India Financial Institutions, Local Area Banks, Small Finance Banks, Payments Banks, Credit Information Companies, Non-Banking Finance Companies and Primary Dealers. Banks Banks act as an intermediary between those that have excess funds to invest and those that need funds by undertaking the role of mobilizing these surplus funds by taking deposits and lending it on the basis of a credit evaluation done on the ability of the borrowers to pay interest and return the principal. The banks also provide a secure system for settling financial transactions of their customers through a system of cheques and electronic payment systems. Apart from these primary banking activities, banks also provide third-party products and services to their clients by offering advice on investments and insurance. Banks tie up with mutual funds, portfolio management service providers, insurance companies and others and offer their products and services. Commercial banks may be scheduled commercial banks which include public sector banks, private sector banks, foreign banks and regional rural banks or non-scheduled commercial banks that include local area banks. Apart from commercial banks, there are co-operative credit institutions such as the urban co-operative banks and state and district level co-operative banks that cover rural area needs. Payment banks have been notified by the RBI to encourage financial inclusion to low income households, small business and others by providing small savings accounts and payment/remittance services. Their activities include accepting current and savings deposits not exceeding Rs.100,000/- issuing ATM/Debit cards but not credit cards and providing payment and remittance services. The bank cannot undertake any lending activities. Small Finance Banks are another category of banks approved by RBI to provide a savings vehicle, banking facilities and to supply credit to small businesses, marginal farmers, micro and small industries and other entities in the unorganized sector. The capital requirements, functions and obligations and regulatory provisions of each category are defined by the RBI. Non-Banking Finance Companies and Housing Finance Companies Non-Banking Finance Companies (NBFCs) are increasingly playing an important role in the Indian financial system. They are companies that are engaged in the business of loans and advances, leasing, hire purchase, insurance business or chit business. In a way the NBFCs are in a business that is similar to banks but there are some key differences between the two. NBFCs cannot accept demand deposits nor can they have the facility of issuing cheques and 99 in addition they do not have the benefit of deposit insurance with the Deposit Insurance and Credit Guarantee Corporation. The scope of business for these entities is wide and there are different companies operating in each of these areas. NBFC’s fill in the gap of lending, where banks are unable to lend due to high risk or reach. Housing Finance Companies are those whose primary business is for the purpose of lending for purchase of property/real estate. The regulation for these companies was earlier under the National Housing Bank but now their regulation has been taken over by the Reserve Bank of India. Increasingly there are detailed guidelines being framed for the purpose of clear definition and the modes of working of the housing finance companies. P2P lending An area of lending that has witnessed a sharp rise is that of Peer to Peer (P2P) lending wherein one person lends to another person(s). This is a form of unsecured lending and it takes place through a peer to peer lending platform. These platforms are regulated by the Reserve Bank of India and there are detailed guidelines in place. The financial stability of the peer to peer lending platform is one thing but these platforms also need to conduct the required checks and due diligence on various participants especially lenders on their platform in order to reduce the risk element that is present. This is meant to ensure that a robust peer to peer lending system develops so that there is increased confidence too in the manner and operation of these platforms. Money market Money market is a part of the financial market where instruments with short term maturities (< 1 year) are traded. The money market instruments consist of call (overnight) and short- notice (up to fourteen days) money, commercial paper (CP) certificates of deposit (CDs), money market mutual funds (MMMFs), commercial bills and Treasury Bills. Among these, call and short-notice money and Treasury Bills consist of the most significant segments of the Indian money market. Banks, financial institutions (FIs) and Primary Dealers (PDs) are the major players in these segments of the money market with mutual funds allowed to participate as lenders in the call/notice money and bills rediscounting markets. These are usually very liquid as there are a lot of players who transact in these markets to meet their immediate requirements of funds. There is also a lot of intervention by the Reserve Bank of India in the money market in order to influence the way things are going so as to meet its policy objectives. As the depth of the market grows there is a greater choice for investors who are institutions and hence this can be considered as a wholesale market. 100 Foreign Exchange Market The growth of international trade made it necessary to be able to determine the relative value of currencies given the differences in their purchasing power. The need for exchanging one currency to another for settling trades in goods and services brought about the term foreign exchange. Since the foreign exchange is the value of a currency relative to other currencies, its value will differ for each combination of currency, called a currency pair. For example, USDINR is the currency pair of US dollars and Indian rupee. The currency quoted first in the currency pair is called the base currency and the currency quoted next is called the quoting currency. The practice in the market is to quote the price of the base currency in terms of the quoting currency. If there is a PRICE quote for USDINR as 71, it means one unit of USD has a value of 71 INR. The Indian foreign exchange market has a spot market, a forward market, and also currency trading is available on exchanges. The spot market has an interbank segment and a merchant segment. In the interbank segment, banks make market by giving two-way quotes for buying and selling a currency. In the merchant segment, the merchants are price takers who buy or sell currency based on the price given by the banks. The participants in the spot markets are the banks, the dealers and brokers, businesses, government and retail customers. The quotes offered for different currencies will depend upon the interbank rate available to the bank for different currencies. Financial Benchmark India Pvt. Ltd. (FBIL) computes and publishes the USD/INR, EURO/INR, GBP/INR and JPY/INR Reference Rates on a daily basis on all Mumbai business days. The settlement of spot market trades happens with actual delivery and receipt of currency on gross settlement basis on the value date. The value date is the second business day after trade date i.e. T+2 day. The forward market in currency can be the OTC market or the exchange traded futures market. The forward market can give quotes for any maturity but maturity less than one year has higher liquidity. RBI rules require the existence of an underlying trade contract which creates exposure to foreign exchange before taking a position in the forward market. The exchange traded derivative market in currency consists of futures and options. Hedgers, speculators and arbitrageurs trade in the derivatives market. Credit Information Companies Credit reporting addresses a fundamental problem of credit markets: asymmetric information between borrowers and lenders, which may lead to adverse selection, credit rationing and moral hazard problems. Credit reporting system consists of the institutions, individuals, statutes, procedures, standards and technology that enable information flows relevant to 101 making decision relating to credit and loan agreements. Credit Reporting System in India currently consists of credit Information companies such as Trans Union CIBIL limited, Experian Credit Information Company of India Private Ltd, Equifax Credit Information Services Private Limited and CRIF High Mark Credit Information Services Pvt. Ltd. and credit institutions – Banks, All India Financial Institutions, NBFCs, Housing Finance companies, State Financial Corporations, Credit Card Companies etc., are governed by the provisions of Credit Information Companies (Regulation) Act, 2005, CIC Rules 2006 and CIC Regulation, 2006. The credit information reports (CIR) of borrowers can be obtained from the CICs by specified users listed under CIC regulations which include credit institutions, telecom companies, other regulators, insurance companies, stock brokers, credit rating agencies, resolution professionals, etc. CICs also offer value added products like credit scores. Individual borrowers can also obtain credit report from CICs. RBI has directed CICs to furnish Free Full Credit Report (FFCR) which includes credit score to individual borrowers once in a calendar year. Account Aggregators (AA) Account aggregators are financial entities that are licensed by the Reserve Bank of India whose main role is to bring together different parts of customer information and share it in a consolidated manner with third parties. This is done only with the express consent of the customer whose data is being shared. It is meant to ensure that there is proper data available so digital lending becomes easier and more people are brought into the formal credit system. The customer has the right to revoke their consent at any point of time. Also this can lead to less paperwork in the entire lending process making the experience easier and quicker.

[INST] ('Securities Market under SEBI ',) [/INST] 5.4.2 Securities Market under SEBI The securities market provides an institutional structure that enables a more efficient flow of capital in the economy. If a household has some savings, such savings can be deployed to fund the capital requirement of a business enterprise, through the securities markets. The businesses issue securities, raise money from the household through a regulated contract, lists the securities on a stock exchange to ensure that the security is liquid (can be sold when needed) and provides information about its activities and financial performance to the household. This basic arrangement in the securities markets enables flow of capital from households to business, in a regulated institutionalised framework. Definition of securities The term “securities” has been defined in Section 2 (h) of the Securities Contracts (Regulation) Act 1956. The Act defines securities to include: a) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate; 102 b) derivative 1 ; c) units or any other instrument issued by any collective investment scheme to the investors in such schemes; d) security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; e) units or any other such instrument issued to the investors under any mutual fund scheme (securities do not include any unit linked insurance policy or scrips or any such instrument or unit, by whatever name called which provides a combined benefit risk on the life of the persons and investment by such persons and issued by an insurer referred to in clause (9) of section 2 of the Insurance Act, 1938 (4 of 1938)); f) any certificate or instrument (by whatever name called), issued to an investor by any issuer being a special purpose distinct entity which possesses any debt or receivable, including mortgage debt, assigned to such entity, and acknowledging beneficial interest of such investor in such debt or receivable, including mortgage debt, as the case may be; g) government securities; h) such other instruments as may be declared by the Central Government to be securities (including onshore rupee bonds issued by multilateral institutions like the Asian Development Bank and the International Finance Corporation); i) rights or interest in securities. A security represents the terms of exchange of money between two parties. Securities are issued by companies, financial institutions or the government. They are purchased by investors who have the money to invest. Security ownership allows investors to convert their savings into financial assets which provide a return. Security issuance allows borrowers to raise money at a reasonable cost. The issuers of securities are able to reach out to a broader group of investors. For example, in the absence of a well-developed securities market, a household with surplus fund may have to hold all of their savings in a bank deposit even if they are willing to take on some risk for higher returns. But with the different types of equity and fixed income securities available with varying levels of risk and return, investors can choose to invest their surplus funds in the type of security that suits their specific preferences. Thus, the objectives of the issuer and the investor are complementary and the securities markets provides a vehicle to mutually satisfy their goals. 1As per SCRA, derivatives include a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; a contract which derives its value from the prices, or index of prices, of underlying securities; commodity derivatives; and such other instruments as may be declared by the Central Government to be derivatives. [Amended by the Finance Act 2017] 103 The issuer of the security provides the terms on which the capital is being raised. The investor in the security has a claim to the rights represented by the securities. These rights may involve ownership, participation in management or claims on assets. The market in which securities are issued, purchased by investors and subsequently transferred among investors is called the securities market. The securities market has two interdependent and inseparable segments, viz., the primary market and the secondary market. The primary market, also called the new issue market, is where issuers raise capital by issuing securities to investors. The secondary market, also called the stock exchange, facilitates trade in already-issued securities, thereby enabling investors to exit from an investment or to accumulate more, if it meets their expectations. Investors and issuers are the primary participants in the securities market. Investors are individuals or organisations with surplus funds that can be used to purchase securities. The chief objective of investors is to convert their surpluses and savings into financial assets that earn a return. Investors are divided into two categories based on the size of their investment and sophistication of their investing strategies–retail investors and institutional investors. Issuers supply securities and create a demand for capital, whereas investors buy the securities and provide the supply of capital. Issuers may have short-term and long-term need for capital and they issue securities based on their need, their ability to service the securities and meet the obligations to investors, and the cost they are willing to pay for the use of funds. Interaction between investors and borrowers is facilitated through financial intermediaries; intermediaries form the third component of the market. The entire process of issuance, subscription and transaction in securities is subject to regulatory control and supervision. Stock market The stock market is that part of the securities market where equity shares are traded among investors. Once an issuing company has raised capital through an initial public offer it will seek to facilitate the buying and selling of the shares. This is done through the stock market. There are stock exchanges who have various brokers as their members and the shares can be bought and sold on the stock exchanges. The stock market in simple words becomes a place where the buyer and seller of shares/securities are able to facilitate their transactions. The broader and deeper the stock market, the greater the number and type of companies that will be listed and traded on it. A high number of companies listed and traded will give a better choice to investors to invest in the areas where they feel there is potential to earn 104 returns. The larger the number of participants in the stock market the greater the liquidity and this will also become an attraction for investors to come and invest in the market. Bond market There are a lot of debt issuances that are used by issuers to raise money for their businesses. These also become a source of investment for investors. The part of the market where the debt securities are listed and traded is known as the bond market. The different types of securities here would include bonds, debentures, government securities etc. and it provides a place where secondary trading in these instruments takes place. The bond market is also able to provide the right kind of liquidity for various instruments which helps in further facilitating raising of money through them. Given the nature of the bond market this is dominated by large players and institutions at the current moment in India. Derivatives market A derivative is any instrument that gives exposure to another asset through it i.e. they derive their value out of underlying assets which could be equity/debt or commodity. The derivative market is where instruments like futures and options are traded. These instruments allow the investor to take a leveraged exposure and thus has the scope of high returns but higher losses too. It can be used effectively to hedge positions but can also become a source of speculation if the investor is not aware about the risks involved in the instrument. There is a vibrant derivatives market where index as well as stock options and futures are available for investors to trade in India. Mutual funds Mutual funds have emerged as one of the biggest sources of investment choices for investors. Mutual funds collect money from multiple investors and then deploy this according to the mandate in their funds. They thus represent a collective investment option for investors. Mutual funds have exposure to equity, debt, commodity and even international markets and hence they can be used to achieve a wide variety of goals. They play the role of an important intermediary who are able to channel funds from small investors in the securities market because they invest on behalf of these investors. Portfolio managers Portfolio managers have the responsibility of deploying the money of high net worth investors in the specific areas. They run portfolio management services which seek to invest the money of its investors and earn returns. They thus occupy a crucial role in the securities market. SEBI registration for the portfolio managers is essential and this enables a proper regulatory environment to be present for those looking for PMS. 105 Investment advisers There is a huge amount of choice of investment products that are present for investors in securities market. There is also the need for effective allocation and choice considering the risk appetite for the investor. This is facilitated through investment advisers, who guide their clients towards their goals through the effective creation of a portfolio of investments. The investment adviser play an important role because they enable those who do not understand the complex finance products and services to choose what is right for them. Alternative Investment Funds Alternative Investment Funds are those that privately pool money and then deploy them for investing in accordance with a defined investment policy for the benefit of its investors. The investor are sophisticated investors and hence these funds cater to a segment of investors who are well versed with the technical and other aspects so are able to take a decision on the kind of investment policy that they should follow. This is a growing segment of the Indian securities market. Credit rating agencies The actual performance and financial position of any issuer in the securities market is the key for investors to determine whether they should invest or not. Normal investors do not have access to the detailed financial position of the issues and in most cases might not be able to understand the risk that is present in these instruments. Credit rating agencies are those which look at the detailed financial position of an issuer and then they give a credit rating about a specific issue that is being made. The rating is given in standard terms so that the investor is able to know the risk element by looking at the rating. Credit rating agencies have an important role to play in case of debt securities where the investor would like to know the risk of default by an issuer. A default can lead to a large loss and the rating agency is expected to reflect the financial situation that the issuer finds itself in through its ratings. Each credit rating agency has its own way of showing the various financial positions so this has to be seen by the investor in the specific context.

[INST] ('Industy and markey under IRDAI ',) [/INST] 5.4.3 Industry and market under IRDAI The Insurance Regulatory and Development Authority of India (IRDAI) has the insurance sector under its regulation. The insurance market is a significant part of the overall financial structure that has to be developed as the economy grows. The Indian insurance market consists of the life insurance segment and the general insurance segment. The life insurance sector was opened to private service providers in 2001. 106 The life insurance products may be broadly categorized as the traditional products, variable insurance products and the unit linked products. Traditional life insurance products include term insurance, endowment policies, whole life policies and the like. Term insurance is a pure risk protection product with no benefit on maturity. If the insured event occurs, in this case loss of life insured, then the sum assured is paid to the beneficiaries. Other traditional products typically have maturity benefits and have a small savings component. Variable insurance products and unit linked products combine risk protection and investment. A portion of the premium is used for risk cover while the remaining portion of the premium is invested to provide returns linked to an index or based on the performance of the portfolio in which it is invested. On the occurrence of the event or maturity of the policy the sum assured and/or value of the fund created is returned to the policy holder or beneficiary. The products are distributed through multiple channels such as agency, bancassurance, direct agents, broking and corporate agency, among others. The non-life insurance or general insurance segment covers motor, health insurance, travel, fire and personal accident, among others. The Insurance Regulatory and Development Authority of India (IRDAI) regulates the insurance sector including registering insurance companies, clearing insurance products, licensing and establishing norms for the intermediaries and protecting policy holders’ interest. Other entities involved in the insurance sector include insurance brokers, who are licensed to offer policies from any insurance company and are paid a brokerage by the company whose policy is sold. Individual agents are certified and licensed by IRDAI and can sell policies of life insurance and general insurance companies or both. Corporate agents include institutions such as banks, and they offer the insurance products to their clients. Agents typically represent one life insurer, one general insurer and one standalone health insurance company. Surveyors and loss assessors are used by general insurance companies to assess a claim and quantum of loss. Third party administrators are used to process health insurance claims. Insurance penetration in India continues to be much below that of comparable economies. Insurance continues to be taken for tax benefits, as in the case of life insurance, or for regulatory compliance, as in the case of motor insurance or on the insistence of financiers. Low financial awareness combined with inefficient distribution lines that are unable to convey the benefits of insurance have continued to keep much of the population without adequate insurance cover.

[INST] ('Industy and markey under PFRDA',) [/INST] 5.3.4 Industry and markets under PFRDA The Pension Fund Regulatory and Development Authority (PFRDA) is the regulator of the pension market. The pension market especially the National Pension System (NPS) has been 107 growing in India as a larger part of the population has to rely on its own savings for the purpose of meeting the various needs during retirement and old age. A growing elderly population and a large unorganized employment market are two primary factors that define the pension industry in India. Much of the Indian population is still outside the formal retirement benefit cover provided by the government and its associated organisations, and companies covered under the Employees Provident Fund Organisation (EPFO) rules. The government’s pension plan has moved from defined benefit structure, where all retired employees of a particular rank get the same pension with no contributions by the employee, to a defined contribution structure, where the employee and the employer contribute to the pension fund and the pension received on retirement will depend upon the fund accumulated. The retirement benefits in the private sector are primarily covered by the Employee Provident Fund administered and supervised by the Employee Provident Fund Organisation with contributions made both by the employee and the employer. A portion of the employers’ contribution is earmarked to provide pension under the Employee Pension scheme. Some private companies may provide Superannuation plans and privately sponsored pension plans to their employees. National Pension System (NPS) is a voluntary, defined contribution retirement savings scheme designed to enable the subscribers to make optimum decisions regarding their future through systematic savings during their working life. The NPS is also available for government employees and the general public to voluntarily contribute periodically and create a retirement corpus. There are different fund managers under the NPS which offer different investment choices for the investor. The PFRDA regulates these so that there is a proper protection of the rights of the investors. The manner in which there has to be a central record keeping agency plus the various intermediaries in the NPS are all decided by the pension regulator. The type of funds and the conditions related to them that are offered by the various fund managers is monitored by the regulator. A new concept of Retirement Adviser has been introduced to help people get advice on NPS.