Understanding the Client,

their Budget, Cash flow, 3

Credit and Loans

CONTENT AREAS

Information Required by Regulation and Law

Going Beyond the Regulatory and Minimum Legal Requirements

The Client Discovery Process

Creating a Budget and Savings Plan

Credit Planning

LEARNING OBJECTIVES
By the end of this lesson, you should be able to:

1 | List the minimum information that a licensed advisor must obtain from a client in India.

2 | Describe the different types of acceptable payments for making investments.

3 | Collect financial and non-financial data that goes beyond the simply regulatory and legal minimum
to develop a wealth plan.

4 | Apply the client discovery process to assess a client’s wealth planning needs.

5 | Analyze a net worth plan for a client.

6 | Analyze a cash management plan for a client.

7 | Outline savings strategies for a client.

8 | Differentiate between the various types of credit and lending available.

9 | Explain how the Five Cs of Credit are used to evaluate a client’s ability to borrow.

10 | Identify ways to restructure loans and reduce debt.

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KEY TERMS

Key terms appear in bold text in the chapter.

avalanche Know Your Client

blizzard liquidity requirements

bridge financing net worth

cash flow statement non-discretionary expenses

charge accounts overdraft

client discovery process Peer-to-Peer loan

credit card personal line of credit

credit limits required return

current expense control return objectives

debt restructuring risk objectives

discretionary expenses risk tolerance

Five Cs of credit rupee-cost averaging

fixed expenses snowball

goal shortfall tax management

home bias time horizon

home equity line of credit

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INTRODUCTION
Wealth management is more than a regular advisory practice. The discipline demands a client-centred approach
and a comprehensive understanding of each client’s situation. For this purpose, the industry’s established account
opening process provides an important source of basic information. However, to truly understand your clients and
ensure that you are providing appropriate advice, you need much more than basic information.
Your role as a wealth advisor is to do everything possible to help your clients set objectives and achieve their goals.
Only with a thorough understanding of their financial circumstances can you perform this role effectively. You
should know, though, that clients do not always clearly state their central concerns about their financial planning
and investment management needs. It is your job to discover what they are not telling you and help them articulate
their needs and prioritize their goals.
This process is necessary to develop a comprehensive wealth plan. Once you have collected all necessary financial
and non-financial data, you must use that information to assess your clients’ wealth planning needs. From there,
you can create a budget and savings plan based on the client’s net worth and available cash flow. Every plan should
incorporate savings strategies that suit the individual client. It should also incorporate funding strategies for any
emergencies that might arise.
In this lesson, we provide a process for getting to know everything necessary about your clients to create a
comprehensive and integrated budget and savings plan. You will learn the legal requirements in India regarding
business conduct and the collection and sharing of client information. We also discuss the account-opening
requirements of the Securities and Exchange Board of India. Furthermore, we explain how to engage in a probing
dialogue with clients to collect and document information beyond the minimum required by law. Finally, you will
learn how to calculate your clients’ net worth and cash flow to create a budget and savings plan. The plans you
create with your clients will incorporate savings strategies to help them meet their goals.
Before you begin, read the scenario below, which raises some of the questions you might have about getting to
know the client and creating a budget and savings plan. Think about these questions, but don’t worry if the answers
don’t come easily. At the end of the lesson, we will revisit the scenario and provide answers that summarize what
you have learned.

GETTING TO KNOW THE MATHURS

Ravi and Pallavi Mathur were introduced to you by their friend, who is your existing client, after a seminar you
delivered on retirement planning. The Mathurs feel that their existing advisor has been providing them with
advice that is contrary to their best interests. They have met with you and have decided that you will be their
new advisor.
In this scenario, you are meeting the Mathurs to plan their investments. During this process, you must establish
a rapport and learn about the Mathurs’ goals and needs. You must also review their situation to attain a clear
understanding of their financial resources and general financial position.
Consider the following questions:
• Beyond the Know Your Client information required by regulation, what other important information do you need
to attain a clear picture of the Mathurs’ situation?
• Considering the difference between goals and objectives, what must you understand to build an effective
investment plan and provide this couple with the right advice?
• How can you establish a comfortable rapport and gather the information you need during what may be an
emotionally charged discussion?
• Why is it important to establish the Mathurs’ current net worth?
• By examining their cash flow to determine how they spend their income, what important goal are you supporting?

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INFORMATION REQUIRED BY REGULATION AND LAW

As a wealth advisor, you must follow certain procedures during the account opening process for all types of
investments to comply with government and industry regulations. In this section, we briefly discuss the legal
requirements regarding business conduct and the collection and sharing of client information. We also explain the
requirements for various types of investments, which has been prescribed by Indian regulatory bodies including the
Reserve Bank of India (RBI), the Securities and Exchange Board of India (SEBI), and the Insurance Regulatory and
Development Authority (IRDA).

INDIAN AND INTERNATIONAL REQUIREMENTS

While processing the client’s investment into any financial instrument, financial institutions and their advisors must
comply with Indian legislation, particularly the Prevention of Money Laundering Act of 2002 and various rules framed
thereunder. This Act requires that firms and their advisors verify the identity of every client. For example, advisors
must request valid picture identification, such as a driver’s licence or a passport, and follow proper cheque-clearing
procedures. In addition, firms must follow the SEBI guidelines on accepting cash from clients to a maximum of
₹50,000 per fund, per investor, per financial year.
Even such cash transaction can be allowed only from Know Your Client (KYC) compliant non-corporate clients,
who are not located in any of the top 15 (T-15) cities: Mumbai (including Thane and Navi Mumbai), New Delhi
(including the National Capital Region), Bangalore, Kolkata, Chennai, Pune, Ahmedabad, Hyderabad, Baroda,
Panjim, Jaipur, Lucknow, Surat, Kanpur, and Chandigarh.
Furthermore, firms and their advisors must comply with any agreements India has with other countries.

SEBI KNOW YOUR CLIENT GUIDELINES

SEBI regulations have set out the minimum amount of information that firms and their advisors must collect from
their clients. The requirements are collectively known in the industry as the KYC Guidelines, one of the cornerstones
of the investment industry. The guidelines originated when the business of investment dealers mainly involved
buying and selling securities on behalf of clients. The information gathered allowed investment firms and their
advisors to determine the suitability of each proposed client trade, whether it was initiated by the advisor or the
client. These regulations are applicable to the following entities:
• All recognized stock exchanges
• Stockbrokers, through recognized stock exchanges
• Depository participants, through depositories
• Mutual funds, through the Association of Mutual Funds
• Portfolio managers
• KYC registration agencies
• Alternative investment funds
• Collective investment schemes
• Custodians

SEBI has mandated that all investors must be registered through any of its approved KYC registration agencies
before they can invest in any investments. In-person verification (IPV) is an additional rule enacted by SEBI on
January 1, 2012 that requires registered intermediaries to physically verify investors. Submission of identity and
proof of address alone is not sufficient under the new regulations.
All intermediaries in the security market are authorized to conduct IPV. In regard to mutual funds, asset
management companies and distributors who comply with the certification process of the National Institute of

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Securities Market or the Association of Mutual Funds, and who have undergone the know your distributor process,
are authorized to conduct IPV.
For any applications received directly from the investor (i.e., without being routed through a distributor), the asset
management company requires that the IPV is performed by scheduled commercial banks or authorized employees
of the asset management company (on the KYC application form).

KYC APPLICATION PROCESS

The required list of documents for the KYC application process is extensive. For ease of display, the list below
presents all items categorized as individual and non-individual documents.

INDIVIDUAL ENTITY’S DOCUMENTS

• Name: The name in the application form must match the name in the proof of identity document.
• Father’s Name: The father’s name should be provided for married women as well.
• Date of Birth: The date of birth should be provided in the format dd/mm/yyyy and all applicants must be at least
18 years old (minors are not allowed to apply for the KYC process).
• Nationality: The client’s nationality should be provided.
• Permanent Account Number (PAN): As per regulatory guidelines, quoting a PAN for all investments in mutual
funds is mandatory.
• Status: The status of the individual can be either Resident Indian or Non-Resident Indian. A PAN is mandatory
for all status of individuals. Non-Resident Indians must also submit a proof of PAN document.
• Proof of Identity: If a PAN is submitted as proof of identity, a self-attested copy of the PAN card should also be
submitted. If any other document is submitted as proof of identity a PAN should be submitted as well.
• Current Address and Permanent Address: The current address will be treated as the address for correspondence
and all communications to the client will be addressed to that address. Proof for both addresses should be
provided.
• Proof of address: The proof of address should be verified against the original copy of the document. The following
documents are admissible as proof of address:
Passport
Voter identity card
Ration card
Registered lease or sale agreement of residence
Driver’s license
Continuous discharge certificate
Telephone bill
Electricity or utility bill
Bank passbook
Bank account statement
Demat account statement
• Annual Income: The client should tick the appropriate income slab from the list provided in the KYC Application
Form (KAF). Only one of the options must be ticked.
• Occupation: The client should tick any one of the options provided in the KAF as his or her primary occupation.
Only one of the options must be ticked.

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• Signature: A signature should be provided within the space specified in the application form. Black ink is
preferred for signing the application form.
• Photograph: One recent colour photograph should be pasted (not stapled) in the specified area of the
application form. The applicant should sign across the photograph and the signature should match the signature
on the application form. The photograph should also match the photograph on the proof of identity document
provided by the client.

NON-INDIVIDUAL ENTITY’S DOCUMENTS

• Name: Name should match the name stated in the document submitted as proof of identity.
• Date of Registration or Incorporation: The date of registration or incorporation should match the date stated in
the memorandum and article of association.
• Status: The best applicable choice should be selected from the list provided in the application form.
• Current and Permanent Address: The current address will be used for all correspondence. Proof of address for
both current and permanent address should be provided and it should be verified against the original.
• Authorized Signatures: The KAF should be signed by one of the persons authorized by the board resolution to
open an account for investment in mutual funds.

KYC PROCESS – IN PERSON VS. VIDEO

In person verification (IPV):
a. It is a mandatory step in case of a first-time investor.
b. The name, designation, organisation, and signature of a duly authorized person doing the verification have to
be recorded in the form.
c. At the time of making an investment, the investor needs to furnish a proof of being KYC compliant.

Feature for Video in Person Verification (VIPV) for Individuals:

An intermediary may undertake the VIPV of an individual investor through their mobile application to enable ease
of completing IPV of an investor.
The following process shall be adopted in this regard:
a. The VIPV shall be in a live environment.
b. Intermediary through their authorized official, specifically trained for this purpose, may undertake live VIPV of
an individual customer, after obtaining his/her informed consent.
c. The VIPV shall be clear and still, the investor in the video shall be easily recognizable and shall not be covering
their face in any manner.
d. The VIPV process shall include random question and response from the investor including displaying the OVD,
KYC form and signature or could also be confirmed by an OTP.
e. The Registered Intermediaries shall ensure that photograph of the customer downloaded through the Aadhaar
authentication / verification process matches with the investor in the VIPV.
f. The VIPV should be digitally saved in a safe, secure, and tamper-proof manner bearing the date and time
stamping and it should be easily retrievable as and when required

MANDATORY DOCUMENTS TO BE SUBMITTED

Corporate Bodies:
• Certificate of incorporation (can be a part of the memorandum of agreement)
• Memorandum and article of association

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• Resolution of the board of directors to open an account for investment in mutual funds schemes
• Authorized signatories list

Partnership Firm:
• Certificate of Incorporation (for registered partnership firms only)
• Authorized signatories list

Hindu Undivided Family (HUF):

• Deed of declaration of HUF (for registered HUF)
• Bank statement for proof of address

Trusts:
• Certificate of registration (for registered trusts)
• Trust deed (for registered trusts)
• Power of attorney to transact
• Authorized signatories list

Unincorporated association or body of individuals:

• Resolution of the managing body
• Power of attorney granted to transact business on its behalf
• Authorized signatories list

Banks or institutional investors:

• Authorized signatories list
• Self-certification on letterhead

Foreign institutional investors:

• Certificate of registration with SEBI
• Authorized signatory list

Regulatory bodies:
• Authorized signatories list
• Self-certification on letterhead

Army or government bodies:

• Authorized signatories list
• Self-certification on letterhead

IDENTITY AND CREDITWORTHINESS

Learn and remain informed of the essential facts regarding every client and every order or any financial service
request accepted. In particular, you must verify the client’s identity and creditworthiness.

BUSINESS CONDUCT
Make sure that the acceptance of any order for any financial transaction is within the bounds of good business
practice.

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SUITABILITY REQUIREMENT
When recommending the purchase, sale, exchange, or holding of any security to a client, you must verify that
the recommendation is suitable for the client. Suitability is based on factors such as the client’s current financial
situation, investment knowledge, investment objectives and time horizon, and risk tolerance.

DID YOU KNOW?

You must advise clients against proceeding with applications that appear unsuitable for them. It may
be that the client’s situation has changed, in which case an update to the KYC information is in order.
Otherwise, if the client insists on proceeding with an unsuitable application, you should seek guidance
from a supervisor or from your legal or compliance department.

The following variables should be considered in determining whether a proposed financial instrument or transaction
is suitable for a particular client:
• Age, occupation, and marital status
• Income and net worth
• Number of dependents
• Risk tolerance
• Investment objectives
• Investment knowledge and experience
• Time horizon

PAYMENT INSTRUMENTS
Several modes of payment are accepted for making investments, including:
a. Local cheques and at par cheques
b. Post-dated cheques, for SIP transactions in mutual funds
c. Standing Instructions where periodic payments must be made as in the case of premium payments and
mutual fund SIPs
d. Demand drafts
e. Electronic and digital payment modes such as Automated Clearing House (ACH), Real Time Gross Settlement
(RTGS), National Electronic Funds Transfer (NEFT)
f. Cash is an accepted mode of payment for some investments such as post-office savings schemes. Insurance
premiums can also be paid in cash. For mutual funds, cash is accepted up to Rupees 50,000 per investor per
mutual fund per year
g. Applications Supported by Blocked Amount (ASBA), for New Fund Offer and initial public offer purchases

Application Supported by Blocked Amount (ASBA) is an IPO application process developed by SEBI. It is an
application containing an authorization to block the application money in the bank account, for subscribing to an
IPO issue. You cannot use the blocked amount for any purpose. However, you can continue to earn interest in the
blocked amount. If you are a non-retail investor wanting to invest in IPO, it is mandatory to apply through ASBA.
As an investor, if you apply through ASBA, your money gets debited from your bank account only if your application
is selected for allotment. It is refunded to your bank account if you do not get the IPO issue, or the issue has been
withdrawn. From 2016 onwards, the SEBI has directed that it is mandatory to fill an ASBA form if you wish to invest
in IPO.

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Some of the eligibility criteria for ASBA are as follows:

a. You are an Indian residential investor.
b. You should have a valid PAN number along with a Demat account and trading account.
c. You must apply through the blocking of funds in the bank account with self-certified Syndicate Banks.
d. You should have adequate balance in your bank account.
e. You should bid at cut off, with a single option of number of shares to bid for.
f. You should not bid under any of the reserved categories.
g. You have agreed to the terms and conditions of not revising a bid.

Some of the unique benefits for investors applying through ASBA process:
a. When money is blocked in your bank account, you do not lose out on interest income. You continue to earn
interest on the blocked amount.
b. The ASBA eliminates the need to pay money via cheques and demand drafts.
c. The ASBA facility is hassle-free and does not involve any cost. You can easily apply via Net banking without
submitting any physical documentation.
d. The investors need not worry about the refunds. In case there is no allotment of shares, the money is
unblocked from your bank account for further use.
e. The blocked amount is considered while calculating the Average Quarterly Balance in the account.

GOING BEYOND THE REGULATORY AND MINIMUM LEGAL

REQUIREMENTS
To build a comprehensive wealth plan for a client, you must go beyond the effort required to comply with the
minimum regulatory requirements. You need enough information to create a complete picture of the client’s
current situation, short- and long-term goals, and attitude toward investing. The methods you use to gather
this information can be as important as the information you collect. Good communication skills and effective
interviewing techniques will help you establish strong, trusting relationships in which your clients are comfortable
sharing the information you need.
That information falls under four categories:
• Client goals
• Financial information
• Client objectives, including risk and return
• Investment constraints

CLIENT GOALS
A defining principle of wealth management is the need to discern a client’s life goals and aspirations. With this
knowledge, you can begin to build a wealth plan to help them achieve those goals. As an advisor, you must
understand your clients’ goals from a wealth management perspective—that is, what do they want out of life?
Individual clients are complex beings; they seldom have only one goal. Young clients may envision a distant
retirement, but more likely have their hearts set on a home and a university education for their children. Older
clients might be concerned about their income today and tomorrow, as well as the financial well-being of their
children and grandchildren.

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Clients generally have goals for the following life issues:

• Family and lifestyle
• Protecting lifestyle
• Planning for the future
• Managing life savings
• Building a legacy

You must help your clients distinguish between the various goals and establish primary, secondary, and third level
goals. Occasionally, clients will need different strategies for different pools of money. It may be more convenient,
although not essential, to think in terms of savings and investing objectives for each pool.
Of course, your clients’ goals can change over time, and you must make every effort to recognize and respond
sensitively to these changes. Common events that can trigger a change in goals include the birth of a child,
marriage, divorce, and the death of a spouse. Furthermore, a client’s employment situation and income may change
because of a promotion, a career switch, or a job loss. Finally, a client’s goals may change as they become more
familiar with financial markets or simply because they are drawing closer to retirement.

FINANCIAL INFORMATION
In addition to knowing your clients’ goals, you should understand their current financial situation. For a comprehensive
wealth plan, you need accurate and detailed information about the client’s assets, liabilities, income, and expenses.
You should then organize these details into a net worth statement and a cash flow statement. This information gives
you a clear picture of the client’s situation and provides valuable insight into whether their goals are achievable.
Some financial information is easy to obtain. For example, clients who receive a salary or pension can readily
provide information on their income. Most clients also have information readily available on expenses such as
mortgage, rent, or loan payments. Other expenses, however, are harder to pin down, such as how much they spend
on clothing, entertaining, or eating out.
When you arrange a meeting with new clients, you should ask them to bring a summarized list of their assets,
liabilities, income, and expenses. Alternatively, you may ask them to collect all relevant documentation needed to
create net worth and cash flow statements.
Your clients must feel comfortable giving out information that they may consider confidential and personal. You must
therefore establish a good rapport with each client and explain why you need the information you are asking for.
There are several approaches to gathering additional information. Many advisors use a questionnaire, either paper
or electronic, provided by their firm. Questionnaires are especially helpful if you have not yet developed your own
methods to gather information from all important areas.

CLIENT OBJECTIVES
In creating a wealth plan, it is important that you distinguish between your clients’ goals and their objectives. Goals
are a client’s life needs and aspirations. For example, a 33-year-old client’s goals may be to buy a four-bedroom
home within the next three years and retire at age 63. Objectives refer to the investment returns your clients
require and the risk they must tolerate to achieve their goals. Any actions that help your clients achieve their desired
returns are also considered objectives.
Goals and objectives are interdependent. For example, some clients may have lofty life goals requiring high returns
on their investments. If they depend on those returns to achieve their goals, they will have to accept the higher risk
that goes along with high returns. For clients who cannot tolerate the necessary level of risk, the returns they can
expect must be lowered and their life goals moderated. In other words, clients must set return objectives that are
compatible with their risk objectives.

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SETTING A RETURN OBJECTIVE

The return objective is a measure of how much the client’s portfolio is expected to earn each year on average. This
measure depends primarily on the return required to meet the client’s goals, but it must also be consistent with the
client’s risk tolerance. The return objective is a measure of the portfolio’s expected annual total return. This number
is comprised of all forms of investment income, including interest and dividends, as well as realized and unrealized
capital gains.
Total return objectives can be stated in absolute or relative terms. For example, in absolute terms, the objective
might be 7% per year. In relative terms, it may be stated as “the expected annual inflation rate plus 3% per year”, or
“the annual benchmark return plus 2% per year”.
Return objectives may also include the expected effects of inflation, taxes, or both, and may be stated as follows:
• An inflation-adjusted basis (i.e., before taxes, but adjusted for expected inflation)
• An after-tax basis (i.e., before inflation, but adjusted for expected taxes)
• An after-tax, inflation-adjusted basis (i.e., adjusted for expected inflation and taxes)

MEASURING REQUIRED RETURN

Your clients’ required return is an estimate of the average annual return needed to meet their goals. The required
return should take into consideration the client’s current and expected financial situation, which means it should
include the following elements:
• Current amount of investable assets
• Timing and size of any expected additions to the portfolio (i.e., savings or any other expected new assets)
• Current and expected future spending levels

EXAMPLE
The primary goal of Harish, a retired client, is to receive an income from his portfolio to pay for living expenses.
Harish does not plan on adding more funds to the portfolio, nor does he expect his spending level to change.
Therefore, portfolio additions and future spending levels do not affect the required return.
On the other hand, Harish’s wife, Tania, plans to work for five more years, and her primary goal is saving for
retirement. Tania’s required return depends on the amount of her investable assets, her expected future savings,
and her expected spending levels during retirement.

In addition to the client’s current and expected financial situation, the required return must be sensitive to the
effects of expected inflation and taxes. For example, a client’s expected spending levels are often stated in terms of
today’s cost, even though the actual money spent will be in future cost. To take the effect of inflation into account,
expected spending should be adjusted, or else returns should be expressed as real returns.
Calculating a required return that takes into account taxes, inflation, additional savings, and anticipated
withdrawals is a complex task. Many advisors use software programs in which they input an estimated inflation rate
and marginal tax rate. The program then calculates the average annual return needed to meet a specified sum or a
series of income requirements on specific future dates.

STAYING CONSISTENT WITH RISK TOLERANCE

Before you accept a client’s required return as the return objective, you must validate it for consistency with the
client’s risk tolerance. This step requires a basic understanding of the historical risk-return trade- off of investing in
capital markets, as well as expectations about future risk and return levels.

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EXAMPLE
Your client Arjun tells you that he needs an average annual return of 15% to meet his goals, but he has a low
tolerance for risk. You should let Arjun know that his return objective is unrealistic. Given historical trends, Arjun
can only expect such a return if he is willing to accept a considerable amount of risk.

When your clients’ required returns are inconsistent with their risk tolerance, something must change. Assuming the
client’s risk tolerance is fixed, the typical solution is to increase contributions to the portfolio or decrease expected
future spending. A client who is not willing to do either, yet still wants to meet the required return objective, will
have to accept more risk.

DID YOU KNOW?

Even when a client’s tolerance for risk is high, the return the client requires may not be realistic. A
required return can be accepted as the objective only if it makes sense in light of historical and expected
capital market returns. For example, a return objective of 30% is simply not reasonable in any situation.
When clients have such unrealistic expectations, you must educate them about achievable goals.

SETTING A RISK OBJECTIVE

A client’s risk objective is a specific statement declaring how much risk the client can sustain to meet the return
objective. The risk objective is based on the client’s tolerance for risk, which, in turn, is based on both willingness and
ability to bear risk.

DETERMINING A CLIENT’S WILLINGNESS TO BEAR RISK

Determining a client’s willingness to bear risk is a subjective exercise because different clients think about risk in
different ways. Unlike investment professionals, most investors do not think of risk as the volatility of returns.
Furthermore, most people find it difficult to verbally express their attitudes toward risk.
To determine how a client defines risk, and exactly how much risk the client is willing to bear, you must ask the right
types of questions during interviews and in questionnaires. In fact, one of the primary goals of a client questionnaire
is to answer these questions. Questionnaires are generally based on common perceptions of risk, which are defined
as follows:

Risk defined in terms of Most people view risk in terms of portfolio performance and the probability of
losses losing money. For example, some clients might say they do not want to lose more
than 10% of their portfolio in any given year. They consider losses in excess of 10%
to be too risky. Other clients might say that they don’t want their portfolios to have
a greater than 10% chance of losing more than 25%.

Risk defined in qualitative Some clients define risk as the possibility of not meeting a personal or financial
terms goal. In other words, they see risk in terms of a goal shortfall. For these clients,
meeting their goals is of critical importance, and their willingness to bear risk is
limited by that need.
For example, if a client has a goal of paying for a child’s university education, the
consequences of not meeting this objective are stark. The child will either not
go to university or will have to go in debt to do so. Another example is the risk
of a retiree’s investment portfolio not generating enough return to meet fixed
expenses, such as rent or groceries.

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Risk defined in terms of Some clients deem a particular market or investment to be too risky simply because
uncertainty they lack experience in that area. For example, advisors often meet potential
clients who have invested only in conservative products such as fixed deposits,
government securities, or other debt related secured investments. These clients
may find any type of equity investment too risky.
Other clients do not take full advantage of opportunities outside India because
they are unfamiliar with how international markets operate. They favour domestic
investments, despite ample opportunities to increase the efficiency of their
portfolios through foreign investments. This attitude is called a home bias.

Risk defined in terms of Clients sometimes dwell on past investing mistakes, which can make them more
regret timid toward future investment strategies. Such regret may translate into a general
unwillingness to take on risk.

Risk defined in terms of Some clients fear being excluded from a rally in a particular investment or asset
exclusion class; therefore, they view risk in terms of missing out on an opportunity.

DETERMINING A CLIENT’S ABILITY TO BEAR RISK

Compared to willingness, the ability to bear risk is a more objective measure. To some extent, a client’s ability to
bear risk depends on the same factors that determine the required rate of return:
• The client’s current and expected financial situation (including the amount of investable assets and the timing
and size of any expected additions to the portfolio)
• The client’s current and expected future spending levels

Once you have established these two facts, you can refine your assessment by determining the relative importance
of each goal and the consequences if one or more of those goals are not met.
If all the client’s goals are equally important, and if the consequences of not meeting them all will be severe,
the client’s ability to bear risk is low. On the other hand, if some of the client’s goals are less critical, and if the
consequences of not meeting them will not be serious, the client can bear greater risk.
A client’s degree of financial security also affects the client’s ability to bear risk.

EXAMPLE
Your client Rajat is a central government employee with a generous defined benefit pension plan. Another
client, Mehtab, works for a machine tools shop with 20 employees and has no employer pension plan. Mehtab’s
employer recently laid off three employees when the company lost a high- volume customer.
Both clients earn the same salary and have similar spending and asset levels. However, Rajat is able to bear more
risk because his job is more secure and because he has a better benefits package.

ESTABLISHING RISK TOLERANCE

A client’s risk tolerance is a measure of that client’s combined willingness and ability to bear risk. If both willingness
and ability are low, your client’s risk tolerance is low; if both willingness and ability are high, your client’s risk
tolerance is also high. Problems can occur, however, when willingness and ability are at odds.
If willingness exceeds ability, you must educate your client on the potentially serious consequences of taking on
excessive risk. If ability exceeds willingness, the problem is less severe. In this case, you can explain the potential
benefits of increasing risk within the client’s ability to do so.

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EXAMPLE
Your client Dilip claims to be willing to bear heavy risk, and he backs that claim up with a current portfolio of
highly speculative securities. On the other hand, he wants to save for a down payment to buy a house in two
years, so he has a short-term horizon. Although Dilip is willing to assume high risk, he is not in a position to do
so. His goal is too important, and the likelihood of failing to achieve his investment objective on time is too high.
Another client, Rupesh, presents the opposite situation. He has a sum of money to invest over one year to fund
the first year of his daughter’s post-secondary education. He wants a 12% return on his investment, but with a
guarantee that his principal will be returned. This client’s investment objective cannot be reasonably met, given
his low tolerance for risk. As Rupesh’s advisor, you should persuade him to either reduce his expectations or
assume more risk to potentially generate his desired returns.

DEFINING THE RISK OBJECTIVE

After you and your client have determined the appropriate risk tolerance, you must explicitly state the risk
objective. You will need this information to recommend an appropriate asset allocation for the client. Many advisors
identify several potential asset allocations, each with a different level of expected return and risk. The risk for each
asset allocation is usually stated in terms of its standard deviation. As the advisor, it is your job to determine which
standard deviation is consistent with the client’s risk objective.

DID YOU KNOW?

Standard deviation measures the extent to which returns vary from the expected return. The more
individual returns differ from their expected return, the greater the volatility of returns, and the greater
the standard deviation. For example, a junior mining stock would have a high standard deviation,
whereas a blue-chip bank stock’s standard deviation would be low.

Usually, the client’s risk objective is stated in terms such as “average or moderate risk tolerance” or “lower-than-
average risk tolerance”. When the statement is consistent with the client’s return objective, it is relatively easy to
determine the appropriate standard deviation and asset allocation.
If a client’s risk tolerance is stated as “average” or “moderate”, the asset allocation with a standard deviation in the
middle range is likely to be most appropriate. For example, suppose the standard deviations of the available asset
allocations are 8%, 10%, 14%, 18%, and 20%. In this case, the asset allocation with a standard deviation of 14%
would likely be an appropriate option.
For clients who fully understand the concept of standard deviation, the risk objective can be stated as a specific
standard deviation. With a specific risk objective, such as “a standard deviation of not more than 10%”, it is easier
to identify the appropriate asset allocation. Or, if the client does not want the portfolio to decline more than a
specified percentage, the risk objective can be stated as a maximum tolerable standard deviation. For example,
the risk objective might be stated as “no more than a 20% decline in portfolio value in any given year”. Again, it is
relatively easy to identify an appropriate standard deviation based on this risk objective.

DID YOU KNOW?

Generally, the higher the potential return on an investment, the higher the risk the investor will face.
However, there is little assurance that an investor will actually earn a higher return by accepting more
risk. It is also possible that a high-risk investment could backfire. Instead of earning a higher rate of
return, the investor could lose the original amount invested. Risk is something you should consider when
discussing the trade-off between risk and return with your clients.

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INVESTMENT CONSTRAINTS
Even clients who are willing and able to bear risk face several constraints that must be factored into their wealth
plan. Common constraints include the client’s time horizon, liquidity requirements, and tax situation. The unique
circumstances particular to each client may affect their ability to earn high enough returns to meet their goals.

TIME HORIZON
A time horizon is the length of time expected to elapse before a client can meet a significant goal. When that period
is over, the client will either withdraw some of the portfolio’s assets or enter a new stage of planning that requires
an update to the wealth plan.

DID YOU KNOW?

As clients approach a defined time horizon, you should review their wealth plan more frequently. The
impact of the looming change in the wealth plan is usually managed in steps until the horizon is reached.

All clients have at least one significant goal, but many have several. Many clients therefore have multiple time
horizons, and the wealth plan must deal with each of them.
Time horizons can generally be classified as short-term, medium-term, or long-term. There is no agreed- upon
definition of how many years define a specific term, but the following rules generally apply:
• A short-term time horizon is less than three years.
• A medium-term time horizon is more than three years and less than 10.
• A long-term time horizon is 10 or more years.

Long-term time horizons are generally associated with a greater ability to bear risk. Because market cycles last
several years, clients with long-term horizons can better sustain the ups and downs of the markets than those with
short-term horizons. However, not all clients with a long-term time horizon should be exposed to higher risk.

EXAMPLE
Harsh, age 40, wants to accumulate a retirement nest egg in 20 years. Because his primary goal has a long-
term time horizon, he can probably afford to assume a sizable amount of risk to maximize the long-term return
potential. However, Harsh also wants to pay for his 16-year-old daughter’s university education starting in two
years and continuing for four years thereafter.
As Harsh’s advisor, you must balance the two time horizons and set risk and return objectives for each goal. The
objective for the long-term goal should not be set so high that it impairs Harsh’s ability to meet the shorter-term
goal. Factors to consider include which goal is more important to Harsh and how much of his net cash flow he
can divert to accomplish these goals.

The time horizon for a particular goal is usually not difficult to determine. For example, clients investing for their
retirement usually know the age at which they plan to stop working. Determining the length of the retirement
horizon is a straightforward exercise: simply subtract the client’s age from the desired retirement age.
However, clients do not always precisely state other significant time horizons. For example, they may state a desire
to buy a house “in three to five years”. In general, the sooner the goal must be met, the more precise the client
should be about its timing. It is more difficult to plan for a goal that must be met “within the next five years” than
it is to plan for a goal whose time horizon is “20 to 25 years from now”. The client can estimate a time horizon for
shorter-term goals, but the estimate should cover a reasonably narrow range—for example, “four to five years from
now” rather than “within five years”.

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DID YOU KNOW?

To define constraints around time horizons, or around each goal specified by the client, you should
always ask, “When must this goal be met?”

LIQUIDITY REQUIREMENTS
Liquidity requirements represent a client’s actual and potential cash needs. They may dictate a need for
some investments that can be converted to cash quickly, at little cost. Cost includes not only commissions and
transaction fees, but also implicit costs. For example, the bid-ask spread is an implicit cost, as is a price decline
caused by selling an investment (known as market impact).
Clients usually require liquidity in their portfolios for any or all of three reasons: ongoing income needs,
emergencies, or significant purchases they anticipate having to make in the future:

Ongoing income needs Some clients, typically those who are retired, rely on regular instalments of cash from
their portfolio as a source of income. The need for liquidity in such cases may dictate a
low tolerance for risk, but not always.
For example, if the regular instalments are small enough that the portfolio can provide
the income even after a substantial loss of value, the client can tolerate greater risk.
Of course, clients’ attitudes toward risk and toward their goals play a big part in
determining exactly how much risk they can bear.

Emergencies Many wealth management experts recommend that people have three to six months
of living expenses in cash (or near cash) on hand. This fund provides for emergencies
that might arise, such as a job loss, an uninsured medical expense, an illness, or an
urgent home repair. Different clients need different amounts of cash for emergencies.
You should inquire whether the portfolio will be the source of the emergency reserve,
or whether the need can be met by another source, such as cash in a bank account.

Anticipated significant Anticipated significant purchases often coincide with a time horizon. If the nearest time
purchases horizon is long term, the current need for liquidity is minimal. Examples of significant
purchases are a house, a car, or investing in a second home.
However, funds must be available for certain relatively large purchases such as major
household appliances. For example, for a stove or refrigerator that needs replacing
urgently, the money would most likely come out of the fund for emergencies; in some
cases, from an existing line of credit.

You should find out as precisely as possible the amounts associated with known liquidity requirements, including
ongoing income needs and anticipated significant purchases. These amounts can help you take appropriate
measures at appropriate times.
Because the cost and timing of emergencies cannot be predicted, planning for them is difficult. The recommended
reserve for emergencies may or may not be enough to cover the unknown cost of an actual emergency. When
emergencies occur, they may require drastic changes to the client’s wealth plan. For example, a job loss might
stretch over two or more years, or a shift to a precarious employment can occur due to unforeseen circumstances.

TAX SITUATION
To create a comprehensive wealth plan, you must have a complete understanding of the client’s tax situation.
Among other things, you must know the client’s marginal tax rate, contribution limit to registered accounts, and
any investment income being earned in accounts not under your management.

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When reviewing your client’s tax situation, consider the following factors:
• Taxes on investment earnings reduce the amount of money available to meet the client’s goals.
• For clients who need regular income from their portfolios, taxes reduce the amount of money available to pay
current expenses.

When you understand everything about the client’s tax situation, you can suggest or implement techniques to
reduce the amount of tax the client must pay. This aspect of wealth management is known as tax management.
Several tax management techniques are described in Table 3.1.

Table 3.1 | Tax Management Techniques

Deductions under The government has allowed certain deductions that can be claimed by taxpayers
Section 80C, 80CCC, and for investing in specified investments such as insurance, provident funds, or
80CCD pension funds. The maximum benefit that can be derived from such investments is
₹150,000 per year. The most popular investments made to gain these tax benefits
include the following products:
• Life insurance premiums
• Five-year tax saving fixed deposits
• Public Provident Fund (PPF)
• Contribution to employee provident fund
• Life insurance premiums
• Equity Linked Savings Scheme mutual funds
• National Savings Certificates
• Principal amount of a home loan

Deductions for Mediclaim The amount paid toward mediclaim premiums for the client or the client’s spouse,
premium dependant children, or parents can also be claimed as deductions from total taxable
income, under section 80D and subject to the maximum limits allowed. Currently,
the maximum amount that the client can claim is ₹25,000 for oneself or one’s
spouse or children, plus another ₹25,000 for the client’s parents. If the parents are
seniors, the maximum deductions rises to ₹50,000.

Home Loan The repayment of interest on a home loan is deductible from total income as
follows:
• If construction on the house is completed within five years of taking out the
loan, the interest amount paid is deductible to a maximum of ₹200,000
(₹300,000 for seniors).
• If construction on the house is not completed within five years, the maximum
tax exemption is ₹30,000.
• An additional exemption up to ₹50,000 is available on interest paid for loans
up to ₹3.5 million with a home priced up to ₹5 million.

Education Loan The repayment of interest on an education loan is allowed as a deduction from
total income, as per under section 80E.

Capital Gains Arising from Taxes on capital gains arising from sale of assets can be avoided if the capital gains
the Sale of Assets amount is invested in specified instruments within a specific time.

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A client’s wealth plan should summarize the clients’ current tax situation and may include specific ways to deal
with the client’s tax situation. As an advisor, be sure to keep your advice within your sphere of knowledge. When
necessary, recommend a professional, such as an accountant, to cover more complex needs.

UNIQUE CIRCUMSTANCES
Unique circumstances specific to each client must be considered to create an effective wealth plan. For example,
some clients are guided in their investing by personal ethics and a sense of social responsibility. These clients might
refuse to invest in companies they consider unsuitable, such as tobacco companies or companies that operate in
environmentally or politically sensitive areas. Or they might invest only in companies that commit to the humane
treatment of their workers and make meaningful contributions to their communities.
Some mutual funds and exchange-traded funds invest according to an agenda of social responsibility. Client
preferences in this regard are a legitimate factor and must be considered, regardless of their effect on long-term
performance.

A COMMON CONCERN: “WILL I HAVE ENOUGH MONEY?”

The overwhelming concern of many clients is whether they will have enough money to support themselves during
retirement. This concern is expressed by clients who are saving for retirement and by those who are already drawing
retirement income from their investments. In most cases, it is not an easy question to answer because of the many
variables involved. However, many software programs are available with which you can manipulate the variables
that help determine whether your clients will achieve their goals.
For example, suppose you and your client are exploring the savings and investing options available to achieve
financial independence in retirement. Six variables are involved in this exercise:
• The number of years to retirement (and therefore the time available to accumulate wealth) and the likely
number of years in retirement
• The annual income required during retirement (based on the lifestyle the client expects after leaving the
workforce)
• The amount of retirement savings already in place
• The amount of money the client can save each year
• The inflation rate between now and the date of retirement and the likely inflation rate during retirement
• The expected return on the client’s savings over the years

Most clients can control four of these variables:

• They can pick the age of retirement, which may be earlier or later than the traditional age of 60.
• They can increase or decrease the annual income required in retirement by altering their lifestyle expectations.
• They can adjust the amount of income they can save each year before retirement with changes in their lifestyle
today.
• They can control, to some extent, the returns they can expect by adjusting the asset allocation of their portfolio
and, therefore, the level of risk.

The two variables that are beyond your clients’ control are their existing savings and the inflation rate.
Clients who depend on their investment portfolios to provide steady income are able to control fewer variables.
Beyond their control are the pool of savings, the number of years the income must last, and inflation. The required
amount of income might also be beyond control if your clients are unwilling to accept a lower standard of living
in retirement than what they are used to. Furthermore, conservative clients often need both a steady income
and some growth to ensure that the purchasing power of their income does not decline over the years. For these
reasons, it can be difficult for some clients to meet all their goals.

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Low risk tolerance or investment constraints can sometimes force your clients to make compromises. The
calculations may call for a more aggressive investment strategy than they would like. If so, your clients have three
choices: learn to live with more risk, relax the constraints, or establish more modest goals.
Some software packages can accommodate several goals in addition to the goal of saving for financial
independence in retirement. For example, your clients may also want to buy a home, establish a business, or pay
for their children’s post-secondary education. It is up to you, as their advisor, to make them aware of the financial
impact of decisions made today on their goals for the future. Of particular importance is the compromise between
risk and return.

DID YOU KNOW?

Software projections can allow your clients to explore various scenarios; however, projections are
guidelines only, not precise measures. It is important to review the projections every year to ensure that
your clients’ finances remain on track.

THE CLIENT DISCOVERY PROCESS

The methods used to collect and document all the information you need to create a comprehensive wealth plan
is often called the client discovery process. This process is used to find out what the client wants to accomplish
through a wealth plan. The answer requires a probing dialogue during which you must ask personal, emotionally
charged questions that may be difficult for the client to answer. It is this early—perhaps first or second—
conversation with the client that distinguishes the truly skilled advisor from the inexperienced. With the right
approach, you should be able to establish both the profile of the client and the approach you should take as advisor.
A comprehensive interview reveals more than the client’s goals, financial situation, objectives, and constraints. It
also helps determine the strategies and products that will truly meet the client’s needs. Simply stated goals, such as
the desire to retire early or to buy a house, will be defined within a set of objectives and constraints. From there, you
can create a set of guidelines, which both you and your client will agree to follow.
Both you and your client must be completely honest during the discovery process. You may discover that you are
not comfortable with each other’s style. For example, if you are unfamiliar with complex tax strategies, you may
find it difficult to work with a client who wants to concentrate on such strategies.
Similarly, it may not be best, in the long run, for an aggressive investor to have an advisor with a conservative
philosophy. In such cases, it is better to suggest that clients seek an advisor with whom they will be more
compatible.

THE CLIENT INTERVIEW

Information gathering usually begins with an interview, the purpose of which is to identify the client’s issues and
problems. This first interview is the beginning of what may be a long-term relationship with the client. At this point,
you should determine whether you are able to deal with the client’s requirements and whether you are both likely
to be compatible.
During the interview, you should describe how you operate and explain that the client will have to make choices
about alternative strategies and products. You should also mention that the client may have to consult with
specialists in particular areas, such as risk management and estate planning.
If you and the client decide to pursue a relationship that involves wealth management, you should both sign a letter
of agreement or a formal contract. This document ensures that the client understands the services you will deliver
and their obligation to provide accurate and complete information in return. The contract also ensures that the
client understands the cost of your services and that any other professionals retained must be compensated.

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THE ART OF THE CONVERSATION

The wealth management process is designed to ascertain clients’ emotional concerns and offer financial solutions
that answer them. It is these concerns that ultimately drive the wealth plan. Because of the emotional nature of
the conversation, you will likely face challenges in collecting information beyond the minimum required as per the
KYC documents. You will find that clients are not always willing to share private information with people they do
not know well. Furthermore, they don’t always understand all of the issues that should concern them. For your part,
you may be uncomfortable asking personal questions that don’t appear to relate directly to a financial solution (e.g.,
“Are your parents in good health?” or “Do any of your children have special needs?”).
Most of us are able to carry on meaningful conversations with people we meet in social settings because we
understand the art of conversation and the rules of social etiquette. In our advisor role, however, we often adopt a
business-like attitude; we tend to drop the social graces that allow us to get to know people. Successful advisors are
able to transfer their social skills to the office and know how to make their clients feel at ease sharing information.
They personalize the planning process, rather than subjecting the client to a barrage of predictable KYC questions.
By tradition, advisors usually open the interview with small talk before moving quickly on to the formal KYC process.
In the wealth management approach, however, friendly conversation plays a large role throughout the discovery
process. This dialogue with clients serves several important purposes:
• It puts clients at ease and helps create an atmosphere of trust.
• It creates a space in which you and your client can discover what you have in common.
• It personalizes the financial and investment planning processes.
• It helps you identify the areas where you will need to ask more focused questions later in the process.

Keep in mind the following guidelines when talking to clients:

• When clients share personal information, don’t hesitate to respond with similar details about your own life. For
example, if you both have small children, you can exchange stories about the joys and challenges of parenthood.
• Don’t start selling products too soon. Especially in the initial interview, you don’t want your clients to feel you
are trying to sell them something before you understand their concerns. Allow them time to feel comfortable
enough to confide in you.
• Don’t get carried away in pleasant conversation to the point that the interview loses purpose and structure.
Make sure your clients understand where the interview is going and that you are not simply engaging in small
talk. For example, open the discussion by saying something like, “Mrs. Pednekar, bear with me for a few minutes
because I would like to get to know you a little better.”
• Pay attention to your own body language, eye contact, and facial expressions. They must all convey the
message that you are interested in the client and care about what they have to say.
• Use active listening techniques to get clients to expand on what they have just said. For example, ask open-
ended questions like “Can you tell me what you mean by that?” or “Can you give me an example?”
• Make notes as you go along; it helps to add structure to the interview and reassures clients that you won’t
forget their concerns. However, don’t let note-taking get in the way of conversation.

THE STRUCTURED CONVERSATION

The wealth management approach to client discovery has three distinct phases:
1. Setting the stage and building rapport
2. Conducting emotional discovery
3. Bridging to financial discovery

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The processes used in each phase are described below.

PHASE 1: SETTING THE STAGE AND BUILDING RAPPORT

At the outset, you should explain the wealth management approach so the client understands that you provide
more than simple investment management.

EXAMPLE
One advisor positioned his wealth management approach, using a team of professionals, as follows:
“Before we begin, I would like to explain how we work with our clients so that you can get a sense of how we might be
able to help you.
First, we take a lot of time to understand your entire situation before we make any recommendations. You will find
that we ask you a lot of questions that you may not have been asked by other advisors. We always have a reason for
asking, and we want you to feel comfortable in sharing information with us.
Second, we will spend much of our initial time clarifying your goals so that we can see the whole picture, rather
than just pieces of it. We will help you with the financial plan, but only after we appreciate what you would like to
accomplish. Is that okay with you?”

Building rapport is necessary because, as the advisor, you need your clients to feel comfortable. In the past, advisors
were trained to talk about the weather or about common interests as a way of engaging the client’s trust. The
wealth management process takes a similar approach, but it goes a step further. Rapport-building is used in this
process to uncover potential areas of concern that you should explore later in the conversation.
In general, rapport-building involves talking about family, work, interests, passions, dreams, plans, and goals. During
this conversation, you can quickly establish that you are interested in the client’s life as a whole. This approach
helps you prepare the client to talk about life issues throughout the discovery process. When done successfully, the
conversation puts the client at ease and alerts you to issues that you should explore later.

PHASE 2: CONDUCTING EMOTIONAL DISCOVERY

Emotional discovery is the art of replacing talk of financial solutions with a discussion of life issues. Most major life
issues have a financial consequence that can be addressed through financial planning and investment management.
Consequently, life issues have always been a secondary focus of those processes. However, the wealth management
approach to client discovery focuses the discussion on the life issues first, rather than financial issues.
Table 3.2 categorizes the life issues you should address in conversations with clients. It also provides a visual
overview of the scope of wealth management, which can serve as a tool to help you uncover needs that may not
have been addressed.
In the past, many advisors took a portfolio first approach by simply gathering a client’s financial data, risk
tolerance, and time horizon. This approach yielded all the information needed for investing, but revealed little of the
information needed to truly understand the client’s total situation. Developing a relevant, comprehensive wealth
plan using this method was a challenge. Furthermore, the method made it difficult for advisors to differentiate
themselves; they all asked the same questions and tended to deliver the same results.
The ”Life-First Discovery” process changes this dynamic. It helps you to truly get to know your clients and is
specifically designed to build their trust and confidence in you. With this process, you will learn about your clients’
deepest goals, hopes, and challenges, and fears. You will ask questions the client may never have been asked before
by other financial professionals. The information you gather will allow you to build a better and more thorough
wealth plan while helping you differentiate yourself from your peers. Above all, it will empower you to offer a better
experience for your clients.

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Table 3.2 | Life Issues in Wealth Management

Family and Children’s Parents’ needs Entertainment Health and Education

lifestyle needs home

Protecting Income Lifestyle Change Asset Long-term care

lifestyle maintenance maintenance management protection

Planning for Retirement Future income Housing Change Future lifestyle

the future plan options management

Managing Financial After-tax Saving for Lifestyle

savings comfort income future income
maximization

Building a Passing on Preserving Charitable Wills and trusts Living legacy

legacy estate estate giving

PHASE 3: BRIDGING TO FINANCIAL DISCOVERY

Each life issue discovered in the wealth management process carries with it multiple possible solutions. You should
bring these solutions into the discussion only after fully exploring the extent of the client’s needs and concerns.
Four general planning issues flow from emotional discovery: accumulation, protection, conversion, and transfer of
financial wealth. For each issue, you should ask certain questions:

Accumulating financial When discussing this issue, the focus should be on the client’s need to grow assets.
wealth
Ask the client:
• What areas will be helped by an asset growth strategy?
• What do you want?
• How much money will you need?
• How much can you put aside?
• How much have you currently saved?

Protecting financial Protection of wealth (i.e., risk management) is an emotional need, as well as a planning
wealth issue.
Ask the client:
• How do you feel about risk?
• What level of risk are you comfortable with?
• What do you need to protect?
• What protection by way of personal, property, and liability insurance do you
already have in place?
• What life changes do you anticipate?

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Converting financial Creating an income stream is particularly important in retirement, but it can also be
wealth to income necessary in the case of disability, unemployment, or family emergencies.
Ask the client:
• How much income do you consider to be enough?
• Where will the income come from?
• What do you have in place currently to deal with unforeseen expenses resulting
from job loss or disability?

Transferring financial Wealth transfer relates to an estate plan, as well as to building a living legacy.
wealth
Ask the client:
• What are your plans for the future?
• Do you foresee having to help your children, parents or both?
• Are you planning charitable donations?
• Do you want to create a living legacy?
• Do you need to protect your estate?

ASKING GOOD QUESTIONS

There is an art to asking good questions. When you master this art, you can obtain valuable information in a way
that is natural and yet fits into a structured conversation. Good questions keep the conversation moving in the right
direction to help you gain a complete understanding of the client’s financial and personal situation.
The wealth planning discussion should focus on total needs, rather than products. You should not assume the client
knows all the issues and that your role is simply to talk about solutions. You should focus the entire discussion on
helping the client understand the issues first, before you discuss any solutions. This approach is designed to create
an emotional connection with the client.
The most effective way to conduct an interview is to ask questions that elicit good information and help the client
think through the issues. You should ask about the client’s current situation and the possible implications of that
situation in the future.
Table 3.3 provides some examples of useful questions you can ask to help your clients focus on their current and
future issues.

Table 3.3 | Questions for Wealth Planning

Wealth Planning Area Current Situation Future Implications

Family and lifestyle • Do you have children? How old are • What are your goals for your
they? Tell me about them. children?
• Are your parents still alive? • What are the biggest concerns that
• How is your parents’ health? you have for your family in the
future?
• Who would be most affected by the
financial decisions you make? • What challenges do you see to your
lifestyle in the future?
• Will you be in a position of becoming
a caregiver for your parents?

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Table 3.3 | Questions for Wealth Planning

Wealth Planning Area Current Situation Future Implications

Protecting lifestyle • What insurance protection do you • Will your family be looked after if
have in place? anything happens to you?
• What does your current insurance • How much of your family’s income
coverage provide? depends on your continued health?
• How knowledgeable are you on the • What are the biggest concerns
insurance strategies available to that you have about your family’s
you? health?

Investment planning • What kinds of investment strategies • Have you considered whether you
do you consider to be too risky? will have enough money to meet
• Can you give me a snapshot of your future goals?
where your assets are right now? • What are the biggest worries that
you have about how your money is
invested?
• What is the best investment
decision that you have ever made?

Retirement planning • Have you and your spouse talked • What concerns you most about
about what you want your retirement?
retirement to look like? • What changes do you see happening
in your retirement life?

Legacy and estate • When did you last update your will? • Are you confident that your assets
planning • What is your view on charitable will be distributed in the way you
giving? want in your absence?
• What plans do you have in place to
protect your assets from taxes and
probate fees when your estate is
settled?

CREATING A BUDGET AND SAVINGS PLAN

Consider the types of questions a travel agent might ask a client:
• When would you like to start your trip?
• Where would you like to go?
• Can you afford the type of trip you want?
• If not, would you rather have a longer trip on a smaller budget, or a shorter trip on a luxury budget?

If a person’s life is analogous to a journey, your role as an advisor can be compared to that of the travel agent. As
such, you need to ask very similar questions of your clients.
It is important to know where your clients are right now financially, where they want to be in the future, and what
financial resources they have available to reach the destination. To continue the analogy, the client’s travel budget

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represents their current net worth, available financial resources represent their cash flow, and the final destination
represents their goals and objectives. Each of these components is discussed in detail below.

NET WORTH PLANNING

Put simply, net worth is the difference between the total assets and total liabilities of an individual, family unit, or
business. The purpose of net worth planning is fourfold:
• It helps to establish financial discipline.
• It sets out a strategy to achieve a future financial target.
• It provides a means to measure financial progress at regular intervals.
• It provides reassurance about future financial security.

The first step in the planning process is to prepare a net worth statement, which represents a snapshot of the
client’s current net financial assets. This snapshot provides a basis for comparison as net worth grows over time to
fund future spending needs. Current net worth is not as important in financial planning as the rate at which it grows.
The amount of net worth should be calculated periodically to see whether it is growing toward a specific goal.
Because the trend toward the goal is most important, a part of the planning process is the setting of a net worth
goal for the next year and future years. You must then help your client develop specific strategies for meeting those
goals. Then, your client must commit to annual reviews to confirm that benchmarks are being met.

CALCULATING NET WORTH

The starting point of net worth planning is the calculation of net worth. For an individual or family, net worth is the
basic measure of financial health. It is the total fair market value of all assets owned minus all outstanding liabilities
owed. Assets may include a house, savings accounts, mutual funds, plus stocks and bonds. Liabilities may include
a home loan, credit card balances, and other loans. Simply stated, net worth is the amount by which assets exceed
liabilities at a specific point in time.
To begin preparing a client’s financial plan and the initial calculation of net worth, you may need to pull together the
following financial records:
• Recent tax returns
• Bank statements
• Personal or educational loan repayment schedules
• Credit card information
• Itemized living expenses
• Brokerage account and mutual fund records
• Home Loan payments
• Real estate closing records
• Life insurance policies
• Disability insurance coverage
• Property insurance policies indicating fair market value (or replacement cost) of personal property
• Pension account records
• Loan repayment schedules for automobile and other big-ticket items purchased on credit

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DID YOU KNOW?

Regarding pension account records, a defined benefit pension plan can be valued on the net worth
statement at the commuted value. However, in the case of a defined contribution pension plan, the
assets are locked in and cannot be withdrawn from the pension plan until retirement.

Although your client may find it daunting to gather all the necessary documents, they are essential for net worth
planning. Beyond helping you calculate net worth, they also lay the foundation for savings, credit, debt, investment,
tax, risk management, retirement, and estate planning.
Most net worth statements have the following features in common:
• Assets are categorized as liquid, investment, or personal assets.
• Investment assets are further classified as short-term and long-term.
• Long-term assets are further classified as equity, fixed income, or miscellaneous assets.
• Liabilities are categorized as short-term or long-term.

When the statement is complete, total liabilities are subtracted from total assets to provide the net worth amount
for the client as of a given date.

Scenario | The Mohans’ Net Worth

You recently had a conversation with prospective clients Ravi and Kalpana Mohan. They told you that they have
been planning to take a trip to Hawaii in two years. They expect the trip to cost ₹800,000 and they have saved
₹400,000 in a savings account.
Ravi and Kalpana are both young professionals, each earning ₹3 million per year. Their home is worth ₹7 million and
has a home loan of ₹4 million. They also have a premium credit card with a limit of ₹150,000 and a current balance
of ₹120,000. They pay the balance in full monthly.
The Mohans currently have ₹800,000 in mutual funds. They want to develop a strategy to accumulate ₹50 million
before they retire in 30 years. Neither of them has a pension plan.
Kalpana tells you that she is hoping to talk Ravi into buying a bigger house because they want to start a family
sometime in the not-too-distant future. Ravi tells you that he is hoping to talk Kalpana into buying a luxury car.
The information below is based on your notes from your meeting with the Mohans:

Bank account: ₹400,000

House: ₹7,000,000

Home Loan: ₹4,000,000

Mutual funds: ₹800,000

Outstanding credit card balance: ₹120,000

Based on your notes, the couple’s net worth statement indicates a net worth of ₹4,080,000 on the date of your
meeting, as shown in Table 3.4.

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Scenario | The Mohans’ Net Worth

Table 3.4 | Net Worth Statement for Ravi and Kalpana Mohan—Draft

ASSETS LIABILITIES

Liquid Assets Short-Term

Liquid Assets ₹400,000 Credit Card ₹120,000

Investment Assets Long-Term

Mutual Funds ₹800,000 Mortgage ₹4,000,000

Personal Assets

Total Liabilities ₹4,120,000

House ₹7,000,000

NET WORTH ₹4,080,000

Total Assets ₹8,200,000

Total Liabilities and ₹8,200,000

Net Worth

Three weeks after your meeting, Ravi drops by your office and leaves an envelope, dated March 31, containing their
financial statements. He also drops off a pile of debit and credit receipts and mentions in passing that they have
₹230,000 outstanding on a personal loan.
After reviewing the new information, you revise the Mohans’ net worth from ₹4,080,000 to ₹3,500,000, as shown
in Table 3.5.
The Mohans’ example illustrates why it is important to get full and accurate disclosure of financial information from
your clients. In their case, revised information submitted by the Mohans resulted in a lower net worth amount. The
amount was lower by ₹580,000 because they disclosed additional debt of ₹780,000 and a higher mutual funds
investment by ₹200,000.

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Scenario | The Mohans’ Net Worth

Table 3.5 | Net Worth Statement for Ravi and Kalpana Mohan as of March 31, 2018

ASSETS LIABILITIES

Liquid Assets Short-Term

Liquid Assets ₹400,000 4.8% Credit Card ₹150,000 1.8%

Personal Loan ₹230,000 2.7%

Other debts ₹520,000 6.2%

Investment Assets Long-Term

Mutual Funds ₹1,000,000 11.9% Mortgage ₹4,000,000 47.6%

Personal Assets

Total Liabilities ₹4,900,000 58.3%

House ₹7,000,000 83.3.0%

NET WORTH ₹3,500,000 41.7%

Total Assets ₹8,400,000 100.0% Total Liabilities and ₹8,400,000 100.0%

Net Worth

Based on their retirement savings objective, the Mohans will need to develop a strategy to grow their investments
to ₹50 million. Their net worth of ₹3.5 million is their starting point. The couple will need to control their spending,
raise their income, or do both, if they expect to attain their goal.
Every year, they should recalculate their net worth and evaluate their investments to ensure that they are
progressing toward their goal. They can expect to have to adjust their strategy along the way, given that no one can
predict the future with certainty.

THE PLANNING STRATEGY

The net worth amount provides the basis for developing an appropriate net worth planning strategy involving a
target growth rate. The net worth amount at the end of a given year (or on any other date) should be compared
with the amount on the same date of the previous year.
• If the annual rate of growth meets the target rate, the client may choose to maintain the existing growth rate or
devise improved strategies to accelerate growth.
• If the current rate of growth falls short of the target rate, the client must either develop new strategies to
correct the situation or set a more realistic net worth goal.
• If net worth has declined, the client may have to revise some goals and develop more aggressive strategies to
reduce debt, reduce expenses, increase income, and increase investment return.

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DID YOU KNOW?

There is little benefit to calculating net worth unless it is done at least annually. Only by making regular
comparisons can you tell if the savings, credit, investment, and related programs measure up to the
client’s short- and long-term financial objectives.

CASH MANAGEMENT PLANNING

The net worth statement determines the value of assets and liabilities at a specific point. A cash flow statement, on
the other hand, shows how much money flows in and out of a household or business over a set period (generally,
not exceeding one year).
One of the primary ways net worth can grow is through positive net cash flow or savings. Net worth also increases
if asset values rise while liabilities decline. A prime example is one’s principal residence. In a rising market, the
property’s value goes up, and the mortgage balance declines as regular payments are made. Therefore, net worth
can increase even when net cash flow remains at zero, if the client is paying down debt.
When annual cash inflow exceeds annual outflow, savings increase. That result is precisely the basis for using cash
management planning as a dynamic wealth management tool. If total savings during a given year are not enough to
achieve the targeted growth in net worth, the client must act to correct the situation. The two options are to reduce
spending or increase income. If either strategy (or both combined) fails to generate sufficient net cash flow, your
clients may have to re-evaluate the net worth goal.

EXAMPLE
Ravi and Kalpana had a goal of raising ₹300,000 for their annual vacation in Malaysia by February 15. However,
their savings rate fell short of meeting their goal by that date. To resolve their issue, Ravi and Kalpana now have
three options to consider:
• They can reduce some other expenses and put more funds toward their annual vacation goal.
• They can increase their earnings by raising funds through another source (maybe, through part-time work).
• They can adjust their goal by delaying the trip for a year or two, until the ₹300,000 goal is reached.

Depending on the severity of the shortfall, the couple may opt for two, or even all three, of these choices.

Even in those cases where adequate savings are generated, cash management planning is valuable. It can help
clients set a higher net worth target, which they can meet by increasing their savings.
In brief, clients with inadequate savings can improve their current cash flow situation by one or both of two
methods: reducing expenses or increasing income.

REDUCING EXPENSES
Clients who opt to reduce expenses must first carefully analyze their current expenses. Flexible expenses that can be
reduced without seriously affecting the desired lifestyle are called discretionary expenses. These types of expenses
may include clothing, personal care, and entertainment. In some cases, clothing and basic appliances are not
entirely discretionary, but the amount one chooses to spend on these items may be flexible. Discretionary expenses
may also include some high-cost items such as home remodelling and vacations.
Fixed expenses that may affect the desired lifestyle if reduced are called non-discretionary expenses. These items
may require more effort to reduce without a serious impact on basic comfort or lifestyle. For example, lowering
non-discretionary expenses may require moving to a different neighbourhood or to a smaller home.

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DID YOU KNOW?

Many retired seniors move from major cities to much smaller communities, where the cost of living
is significantly lower. Often, their quality of life improves, rather than declining, with more outdoor
recreation opportunities and a healthier environment.

Any serious effort to reduce expenses requires that monthly expenses be tracked, preferably over a year. Yearly
expenses can then be totalled and a percentage calculated for each expense category. Clients can then identify the
categories where spending appears to be too high and set targets to reduce their spending in those areas.
Other ways to reduce expenses are through current expense control and debt restructuring:

Current expense control This method requires some restraint in spending on largely discretionary expenses. The
ultimate objective is to institute a workable, long-term plan of expenditure control.

Debt restructuring Debt restructuring may take several forms, including the following measures:
• Consolidate multiple high-interest credit card balances into one low-interest
personal loan or line of credit.
• Refinance the personal residence.
• Discontinue the use of credit cards.
• Defer the purchase of big-ticket items.

After debt is restructured, a budget can be prepared to guide future spending. Discretionary spending should be
reduced in the short term. Over the longer term, the client may also have to reduce non- discretionary expenditures.
Financial planners and advisors use an expense reduction worksheet to break household expenses down into
discretionary and non-discretionary expenses. Budgeting for many non-discretionary items can be reduced to some
extent, if necessary.

INCREASING INCOME
Clients should consider the following options to increase their income (although not all options are realistic for all
clients):
• Work extra hours or do some consulting work.
• Negotiate a salary increase.
• Take a higher paying job.
• Expand a business.
• Change the asset allocation to increase investment income.

The first four of these strategies are self-explanatory. To increase income by changing asset allocation, consider the
following strategies:
• Switch to investments that offer the highest consistent returns at a risk level acceptable to the investor.
• Reduce the savings bank account balance to the minimum, then shift the rest of the liquid funds into higher-
yielding money market funds and fixed deposits.
• Move funds from low-risk investments into investments in the highest-risk categories acceptable to the client
(e.g., from debt funds to balanced mutual funds).

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• Convert a growth-oriented stock portfolio into either an income-oriented stock portfolio or a bond portfolio,
thereby swapping potential capital gain for more income.
• Reposition assets (to increase cash flow) as follows:
Postpone the purchase of non-essential consumer items, such as a luxury car or jewellery.
Dispose of negative cash flow properties (such as real estate generating substantially lesser rental income
than the equated monthly installment amount for the home loan).
Move non-income-producing investments, like gold, art, coins and antiques, into income- producing assets.
The second and third repositioning strategies will increase current cash flow, but at the risk of sacrificing future
potential capital gains. There may also be adverse tax consequences.

DID YOU KNOW?

It is generally accepted that risk and reward are positively related; therefore, an investor may obtain
higher returns by moving funds from low-risk to higher-risk investments. However, there is no guarantee
that this strategy will have the desired results. Its success depends, in part, on an accurate assessment of
the investor’s risk tolerance.

PREPARING THE CASH FLOW STATEMENT

Just as net worth planning begins with a net worth statement, the starting point of cash management planning is
the preparation of a cash flow statement.
For those who maintain a regular budget or who currently track cash flow, filling out the statement should present
few problems. For those who do not maintain a budget, a review of bank account statements and credit card
statements can provide a record of historical cash receipts and expenditures.
Many financial institutions today allow for detailed cash flow information to be downloaded from their clients’
online accounts to their accounting software. Using this as a starting point, you can estimate annual cash inflow and
outflow figures. Although not completely accurate, these estimates may provide the necessary data for cash flow
planning.
The first objective of cash flow management is to ensure that sufficient funds are available for savings and
investments. Prudent management of funds is required if clients are to achieve their prioritized financial goals and
increase their net worth over the long term. A current cash flow statement shows cash inflows and outflows for the
past year. A projected cash flow statement is an estimate of future cash inflows and outflows. It provides a plan for
expenditures and savings for the coming year to ensure that clients are able to achieve their financial goals.

ANALYZING THE CASH FLOW STATEMENT

As mentioned earlier, the primary motivation for undertaking cash management planning is to determine whether
the rate of savings is adequate to meet the desired growth in net worth. For better results, you can further refine
the net worth growth target by setting up separate streams of funds for investment, children’s post-secondary
education, and retirement. By earmarking adequate funds for specific goals, you can help clients create a more
efficient system for achieving them.
Cash flow planning can also be used as an important diagnostic tool. For example, when cash flows are negative, it
means that more money is going out than coming in. You should scrutinize the client’s flexible and fixed expenses to
determine how the current situation can be reversed. The cash flow diagnostic tool can also be used to identify areas
of excess spending. Clients can then change their spending patterns to reduce cash outflow. For example, a working
couple could easily spend ₹400–₹500 per day buying lunch at a restaurant, which adds up to ₹8,000–₹10,000 per
month. The couple could easily reduce that amount by making lunches at home at least three days a week.

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After preparing an initial statement, you should ask your clients what their savings are over the period covered by
the statement. Don’t be surprised if the savings estimate does not correspond to the amount on the statement.
Most likely, there will be items not reflected in the statement. You should keep in mind during the planning process
that a great deal of money can be spent on untracked “other” or “miscellaneous” items.
In preparing a cash flow statement, you are providing your clients with a means to recognize and track where they
are spending money so that they can reprioritize, if necessary. It is not your role to tell your clients how to spend
their money. Rather, you should provide information and guidance to help them recognize problems and adjust
their spending patterns.
Most people who maintain a monthly budget focus primarily on the budget itself. In fact, preparing a monthly
budget is only a means toward achieving a much broader, and far more valuable, objective. The key to long-range
financial success is the development of a systematic savings plan. Such a plan can be used for two purposes:
• To generate the necessary savings to achieve set goals
• To systematically direct these savings toward targeted areas to achieve specific financial goals

Scenario | The Mohans’ Cash Flow

Your clients Ravi and Kalpana Mohan left an envelope containing many debit and credit receipts. When you open
the envelope, you find evidence of over-spending by both Ravi and Kalpana. Table 3.6 shows the Mohans’ current
financial situation.
Table 3.6 | Cash Flow Statement for Ravi and Kalpana Mohan

Ravi Kalpana Joint Total

INCOME

All Sources of Income ₹3,000,000 ₹3,000,000 ₹6,000,000

EXPENSES

Income Taxes ₹480,000 ₹350,000 ₹830,000

Family Needs

Home ₹1,200,000 ₹1,200,000

Insurance Premiums ₹480,000 ₹480,000

Payments on Other Debts ₹240,000 ₹180,000 ₹480,000 ₹900,000

Appliances and Major Expenditures ₹480,000 ₹480,000

Miscellaneous ₹600,000 ₹600,000

SIP ₹240,000 ₹240,000

TOTAL EXPENSES ₹4,730,000

Total Income ₹6,000,000

Total Expenses ₹4,730,000

Net Cash Flow ₹1,270,000

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Scenario | The Mohans’ Cash Flow

The cash flow statement indicates that the Mohans have a positive cash flow after maintaining their lifestyle.
However, you should ask more questions regarding their spending habits. In particular, the ₹600,000 they have
included under “Miscellaneous” needs further investigation. It seems that the Mohans will need to take control of
their spending if they want to attain their goals.

THE PROJECTED CASH FLOW STATEMENT

A client’s projected cash flow statement is a planning tool that forecasts the amounts and the timing of the client’s
cash inflows and cash outflows for a specified period, usually one year. The projected cash flow statement, which is
based on a client’s current cash flow statement, provides a comprehensive forecast of future income and expenses.
To develop a realistic and workable projected cash flow statement, clients must understand the financial trade-offs
required. In other words, they must decide to what extent they are prepared to adjust their current lifestyle so that
they may achieve their financial objectives.
A projected cash flow statement is a vital financial planning tool that helps you determine whether your
recommendations are both realistic and feasible. It is important to make realistic and conservative assumptions
regarding the stability and growth of a client’s future cash inflow and outflow.
The projected cash flow statement gives you a structure with which to integrate key recommendations for each
of the financial planning elements. Your task, as the advisor, is to strike a balance between competing financial
objectives, and to integrate the key recommendations into the projected cash flow. In this way, you enable your
client to implement the financial plan and achieve their objectives in order of priority. In short, the client will not be
able to implement the financial plan unless the projected cash flow is both realistic and feasible.
A projected cash flow statement can be used as a planning tool to help clients in the following areas:

Control spending Clients can gain control of their spending if they keep careful track of their expenses.
They must also compare those expenses to the projected cash flow statement and
continually adjust their spending accordingly.

Ensure liquidity The projected cash flow statement can help to ensure that clients can meet their
current expenses without borrowing. If a client has insufficient liquidity, the projected
cash flow statement will need to be revised to control spending.

Implement the The projected cash flow statement should integrate the financial planner’s key
financial plan recommendations relating to all of the financial planning elements. With this tool,
clients should feel confident that they can implement a workable financial plan.

SAVINGS PLANNING
The construction of the net worth and cash flow statements is not an end in itself. These statements are powerful
tools for undertaking effective financial analysis.
Most clients dream of owning a comfortable home and providing post-secondary education for their children. Many
also wish for exotic vacations, financial independence by age 60 or 65, and a large estate to pass on to their children.
However, these desires are usually more vague aspirations than clearly articulated objectives. Planning in the areas
of net worth, savings, cash management, and credit converts aspirations into well planned objectives.

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SETTING GOALS
As discussed earlier, a client’s current net worth is the base on which a savings plan is built. The annual savings are
the pieces which, when added to the foundation, will grow the client’s net worth to support their goals. In other
words, a savings plan begins with goal setting at the net worth planning stage. Financial planners and advisors use a
goal-setting worksheet for this purpose.

EXAMPLE
Your clients Sanjay and Malabika have the objective to save ₹2 million in the next 10 years to finance their
children’s post-secondary education. The couple are earning 6% compound annual interest on monthly savings,
net of inflation and taxes, and are putting that money into savings at the end of every month. Using a financial
calculator, you determine that the monthly savings required to achieve the couple’s objective is ₹12,143.38,
calculated as follows:
Future Value (FV) = +/– ₹2,000,000
Number of Months (N) = 120
Monthly Interest rate = 0.5
Present Value (PV) = 0
Therefore, solving for monthly savings payments (PMT) = ₹12,143.38

You can use the technique shown in the example above to determine the monthly savings payments required
to meet all your clients’ financial goals. Next, multiply that amount by 12 to determine the total annual savings
required. This figure should then be compared with the total annual savings amount shown in the cash flow
statement (see Table 3.6).
If total available savings are greater than or equal to the savings required, the client may want to consider increasing
the savings objective. If total available savings fall short of savings needs, the client must take steps to correct the
problem.

DID YOU KNOW?

An overall savings target is a necessary component of a savings plan. However, it is the lower-level
strategies that are at the heart of the plan. Clients can increase their net worth either by increasing their
assets or decreasing their liabilities, or through a combination of both tactics. Ideally, they will set goals
in both areas.

EFFECTIVE SAVINGS STRATEGIES

Whether or not your clients are meeting their savings objectives, they should take advantage of savings strategies
wherever they can. Some clients may need strategies to bring their savings up to the target levels. Other may
simply want to refine their savings plan.
Most of us have never been taught to treat savings as a fixed expense. We are generally unfamiliar with the idea
that we must pay ourselves first in the form of savings to ensure our own financial security. As a result, many of us
spend our entire means from month to month. When a financial crisis arises, or even a predictable need for a new
appliance or home repair, we borrow money. A practical strategy is to treat savings as a fixed, non-discretionary
expense, rather than an amount left over after all other needs have been met. This strategy can help to prevent
shortfalls in cash flow and generate additional savings. If properly channelled, those savings can accelerate the
growth rate of net worth.

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To accelerate their savings plan, your clients can use the following savings strategies:

Set realistic goals Unrealistic goal setting is perhaps the most common reason why savings plans fail. For
example, a savings objective of 20% of income for a client having trouble making ends
meet is bound to fail.
The best rule is to start with a small savings goal the client can easily meet. After some
time, the goal can be increased. Once the client becomes accustomed to the new
expenditure and savings level, the goal can be increased.

Set up an automatic A relatively painless but effective way to save is to arrange for an automatic deduction
savings plan of money from a paycheque or bank account, which is then deposited into an
appropriate savings vehicle. A good amount to consider is 10% of the client’s net pay.

Resist buying on credit We live in a consumption-oriented society, where it is extremely easy to buy on credit.
Few of us realize that our savings rate would dramatically increase if we avoided buying
items on credit. We would not only save the interest charges, but we could also benefit
from investing those savings. This is especially true if credit card balances are not paid
off promptly.

Reward yourself Saving for children’s education, retirement, vacations, or big-ticket items is a long and
difficult undertaking. When a family manages to exceed a targeted savings goal, family
members should reward themselves by spending a portion of the extra savings. The
reward can be an incentive for the family to work to meet a savings goal.

DID YOU KNOW?

Rupee-cost averaging is an investing strategy that could dovetail nicely with an automatic savings plan.
It involves purchasing a particular security (such as the shares of one company or units of one mutual
fund) on a regular schedule with a fixed amount (e.g., ₹5,000 per month). The purchase is made whether
the market is low or high. Over time, this strategy can potentially lower the investor’s average cost per
share or unit.
The rupee-cost averaging approach eliminates the effort to time the market and buy a security at the
lowest price. This strategy is readily available across all mutual fund plans and is known as a Systematic
Investment Plan.

EMERGENCY FUNDING STRATEGIES

Occasionally, even the best-structured budgetary plans can face temporary difficulties due to circumstances beyond
a client’s control. For this reason, it is important that the client have liquid fund reserves set aside for emergencies.
One of your important duties, as an advisor, is to make sure that your clients are aware of the need to have such a
fund set up.
Appropriate vehicles for an emergency fund are savings accounts, cashable fixed deposits, and money market
securities. Investments of this type are easily cashable and do not fluctuate in value with changes in interest rates or
the stock market. Ready access and stable value are necessary because the timing of emergencies is unpredictable.
As for the size of the emergency fund, many advisors recommend the equivalent of three to six months of living
expenses.

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Some clients do not want to have their funds tied up in very liquid investments, which typically have low returns. In
such cases, you can recommend that they set up a line of credit with their financial institution.

DID YOU KNOW?

When a line of credit facility is to be used as a source of emergency funds, it should be set up when
family finances are in good shape, rather than when an emergency arises. Your clients will find it much
easier to qualify for credit when their financial situation is strong and stable.

If a client has not had time to build up an adequate emergency fund, or if the initial emergency funds are exhausted,
other sources of funds can be used. Clients should be aware of the following alternative resources, but they should
use them only with great reluctance:

Loan against property A loan against property is advanced by pledging property as collateral. Most banks
allow almost 60% of the property value as the sanctioned loan amount. A client may
also be able to take out a loan by pledging a fixed deposit or mutual fund.

Life insurance Most insurance companies allow their clients to take out a loan against the surrender
value, in case of emergency. Generally, 75% to 90% of the surrender value can be taken
out as a loan. However, the client should keep in mind that the loan facility is available
only on some specific policies, such as endowment plans or whole life plans.

Public Provident Fund Withdrawing a PPF is the least advisable option, because of the negative long-term
impact on a client’s retirement assets and lifestyle. However, a client can take out a
loan at an approximate rate of 2% higher than the interest the client is receiving from
the PPF, to a maximum of 25% of the PPF balance at the end of the fiscal year that
preceded the application year. This loan facility is available only between the third
and fifth financial year from the start of the PPF account. This loan can be repaid in
installments or in lump sum payment within 36 months.
The subscriber can also withdraw up to 50% of the accumulated amount from the PPF
after the completion of the fifth financial year. The percentage of accumulated funds
that can be withdrawn increases with the vintage of the PPF account.

Employees’ Provident Clients who have an EPF at their workplace can withdraw a partial amount of the
Fund (EPF) account balance for an emergency such as medical matter, house purchase or
construction, or higher education tuition. The limit of the withdrawal depends on the
reason for the loan.
For unemployment lasting longer than one month, 75% of the account balance can be
withdrawn from the EPF.
If the employee has not completed five continuous years of service, the withdrawn
amount will be added to the employee’s taxable income.

EXAMPLE
Your client Sahana withdraws ₹50,000 from her EPF account to pursue a management course after three years of
service.
The income from the EPF withdrawal amount will be added to her other income for the year, which puts Sahana
in a 20% tax bracket. Therefore, when she files her income tax return for the year, she must pay an additional
₹10,000 in taxes on the EPF withdrawal.

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Clients should also be aware that they cannot borrow from their EPF account, except under specific circumstances,
which are outlined in Table 3.7.

Table 3.7 | Special Circumstances for Withdrawing from an EPF Account

Reason for Number of Years

Withdrawal Limit of Withdrawal of Service Criteria Other Conditions

Marriage Up to 50% of the 7 years Withdrawal is for the marriage of the

employee’s share of client or the client’s son, daughter,
contribution to the EPF brother, or sister.

Education Up to 50% of the 7 years Withdrawal is for the client’s education

employee’s share of or children’s education above grade 10.
contribution to the EPF

Purchase of For land: up to 24 times the 5 years The property is registered in the name
land; purchase monthly wage plus dearness of the employee or spouse, or jointly.
or construction allowance
of a house
For house: up to 36 times
the monthly wage plus
dearness allowance

Home loan Up to a maximum of 90% 10 years The property is registered in the name
repayment from both employee’s of the employee or spouse, or jointly.
contribution and employer
Withdrawal is permitted subject to
contribution in the EPF.
furnishing of requisite documents
as called for by the EPF organization
relating to the housing loan requested.
Accumulation in the member’s EPF
account (or together with the spouse),
including the interest, must be more
than ₹20,000.

Renovation of a Up to 12 times the monthly 5 years The property is registered in the name
house wage of the employee or spouse or jointly.

Before Up to 90% of accumulated Once the client Withdrawal is for the client.
retirement balance with interest reaches 57 years of
age (as per a recent
amendment)

CREDIT PLANNING
Clients borrow money for various reasons. Two common reasons are to purchase goods or services they could not
otherwise afford and to invest the borrowed funds to increase their standard of living. Using consumer credit to
purchase goods or services is a way of redistributing spending power over time at the expense of interest costs.
Consumer credit must be used judiciously. The immediate access to funds that consumer credit provides can lead to
monetary challenges in a client’s monthly cash flow. Debt creates a temporary imbalance where spending exceeds

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the borrower’s savings or income. Furthermore, borrowing to invest makes sense only when the assets invested
yield higher returns than the rate paid on the loan.
Consumer credit has both advantages and disadvantages, as follows:

Advantages of • It reduces the need to carry large amounts of cash.

consumer credit • It simplifies payment for diverse purchases, and in some cases extends the
manufacturer’s warranty.
• It can be used for cash flow planning by providing a monthly statement that allows
expenses to be monitored.
• It allows the borrower to take advantage of bargains when cash is limited.
• It can provide a temporary fund for emergencies.

Disadvantages of • It increases the temptation to spend as soon as credit is available, rather than
consumer credit saving for or forgoing a purchase that one cannot immediately afford.
• It may lead to the impulsive purchase of items that are not needed.
• If credit is used to its maximum, its use as an emergency reserve is nullified.

FORMS OF CONSUMER CREDIT AND LOANS

Consumer credit comes in various forms, including those described below.

OVERDRAFT
An overdraft is not normally thought of as a loan, but, nevertheless, it is a form of consumer credit. Specifically,
it is an unsecured credit facility that allows a client to overdraw a chequing account up to a pre-determined limit.
The purpose of overdraft is to ensure that authorized transactions are not declined because of insufficient funds.
Overdraft protection typically carries a high interest rate (up to 21% + overdraft fee) and charges a fee per use.
Overdraft facilities are intended to be temporary and must be brought into a credit balance for at least one day
during a set period. Depending on the policy of the individual financial institution, the period may be at least
30 days and up to 90 days.

CREDIT CARD
A credit card is an open, revolving form of loan typically used by clients to make immediate purchases. Credit cards
offer various options to meet the particular needs of different clients. There are two common types of credit cards
available: those issued by financial institutions (and some finance companies) and those issued by retailers. The
different types are characterized as follows:

Credit cards issued by Financial institutions offer a large selection of card options that provide purchasing
financial Institutions access to a global network of merchants. Options range from basic, no-fee cards to
premium cards offering low rates, travel reward points, travel insurance, and extended
warranties.
The interest rate charged on unpaid balances is often lower than that charged on retail
cards because the financial institution can drive revenue from other related sources.
For example, banks can charge annual membership fees, merchant transaction fees,
optional balance protection, and insurance premiums.
Common cards in this category include Visa, MasterCard, and American Express.

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Credit cards issued Retail credit cards are normally issued only by large retail companies.
by retailers
The interest rate charged on unpaid balances is often much higher because there
are no related sources of revenue for the retailer. Cards are mostly limited to paying
immediately for goods and services purchased from the retailer. Cash advances are
restricted, and the cards are generally not honoured by other merchants. Any benefits
or rewards associated with the cards are redeemable only at the retailer.
Cards in this category include those offered by Hudson’s Bay, Shell, and Lowe’s.

CHARGE ACCOUNT
Only a few retailers offer charge accounts, which typically have strict, structured repayment requirements. These
accounts are a type of revolving credit, meaning that the borrower can re-borrow. However, the balance owing must
be repaid in full within a specified time, typically 30 days. Some retailers allow instalment payments, with interest
accruing on unpaid balances. Features and rates vary, including credit limits and minimum use requirements.
Home Depot, for example, may offer a charge account to a paint contractor or tradesperson in the home renovation
business.

PERSONAL LINE OF CREDIT

A personal line of credit is an open, revolving loan that allows clients to re-borrow funds (up to an available limit)
without having to re-apply for the loan. A line of credit normally requires a minimum monthly repayment (often
interest only) at the end of a 30-day period. The interest rate is applied to the amount drawn from the line of credit.
The rate is based on two factors: bank’s prime rate (which fluctuates regularly) plus a number of basis points to
account for borrower risk.
A line of credit can be either secured or unsecured. A secured line of credit is guaranteed by an underlying asset of
unchanging value that can be liquidated to reimburse the outstanding debt if the borrower defaults on repayment.
A secured line of credit receives a preferential interest rate compared to one that is unsecured. For example, an
unsecured line of credit may charge an interest rate equal to the prime rate plus a mark-up. A secured line of credit
for the same amount may charge slightly more than the prime rate. Whether secured or unsecured, a line of credit
charges interest beginning on the day funds are withdrawn.

EXAMPLE
A client withdraws $5,000 from an unsecured line of credit and then repays the same amount five days later. On
the day of repayment, the client must also pay five days’ worth of interest at a rate of 5.45% (assuming a prime
rate of 3.45% plus 2%).

HOME EQUITY LINE OF CREDIT

A home equity line of credit (HELOC) is a borrowing facility linked to the available equity of an existing property.
A HELOC allows a borrower to borrow funds in the form of a line of credit or mortgage, or a combination of both.
Some financial institutions also allow for the inclusion of a credit card and overdraft.

PERSONAL LOAN
There can be certain issues faced by an individual in their lifetime where money is required to be spent for personal
reasons like weddings, travel, any medical emergency or even buying some gadget but an individual doesn’t have
enough funds to be able to do so. At these times personal loans can be taken as there is no restriction in terms
of the reason required to borrow the money. As freedom always comes with a price, personal loans are far more

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expensive than other loans which are backed by an asset. One should be very careful while taking this loan as it is
really easy to get but can prove to be difficult while repaying.

DEMAND LOAN
A demand loan is a short-term loan granted with plenty of collateral. The interest rate is variable, and full
repayment may be demanded by the lender at any time. Likewise, the borrower can repay the loan in full at any
time, without penalty, upon written notice. This type of loan is commonly used in real estate transactions to fund
the down payment on a new property while the buyers wait for the sale of their existing property. When used this
way, the loan is known as bridge financing. Such loans are offered by most banks subject to certain terms and
conditions. They must be supported by a letter of undertaking and a copy of the firm sale agreement of the sold
property.

DID YOU KNOW?

Bridge financing is only provided to clients awaiting the proceeds on a guaranteed sale of the buyer’s
existing property. Normally, if the property has not yet been sold, no bridge financing is provided, unless
a lien is taken on the property.

EXAMPLE
Manish has purchased a new house and must make the down payment on the closing date of November 1. Funds
for the down payment will come from the sale of his existing house, which will not close until November 30. He
therefore requires financing for 29 days. The contract is made for 45 days, in case the sale of John’s house sale is
delayed. However, John can repay the full amount at any time.

HOME LOAN
A home loan is taken for the purchase of a housing property. Individuals who seek to purchase a house to either
live in or for investment purposes can take the loan. The property can be already constructed or can be under
construction phase. The cost of any housing property tends to be very high due to which a loan is taken. These loans
are long term and the period for this can even stretch up to 35 years. The home loan can be borrowed from financial
institutions. Home loans are significant in nature due to the amount and interest being paid for the same tend to be
very high. Home loans can be taken against the property itself and once the loan is repaid completely, the financial
institution transfers the documents in the name of the owner.

VEHICLE LOAN
As the name suggests clearly, a vehicle loan is the amount borrowed from financial institutions for the purchase of
a vehicle which could be a two-wheeler or a four-wheeler. The lack of proper public transport plus the convenience
of an owned vehicle makes this an essential asset. The vehicle loan is usually taken for a period of 3 to 7 years. An
individual can calculate and choose the time period of repayment and the EMI which suits him the best.

EDUCATION LOAN
Education loan is the one which is taken to finance the education of a child. In this world of growing inflation,
people who don’t have large assets or have less savings, find it impossible to finance their children’s education. The
expenses of higher studies or even graduation is increasing with each passing year. Education loan is very important
and proves to be lifesaving as the repayment of the same starts after the completion of one’s education. The time
period of repayment is usually 5-8 years. The loan can be repaid by the parent or by the child for whom the loan was
taken.

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BUSINESS LOAN
An amount which is borrowed for the purpose of conducting business is a business loan. The lending institution
studies the financial position of a business and various turnover ratios along with its balance sheet to make sure if
the business will be able to repay the borrowed amount.
Depending on the nature of the business and the economic cycle, there could be different amounts that can be used
in this loan at varying time periods. This loan can be taken against the security of an asset so that if the business fails
to repay the amount within the given time period, the lending institution can take over the asset against which the
loan was taken.

LOANS AGAINST SECURITIES, GOLD ETC..

There is a category of loans which is in the nature of secured loans. Under this category, an individual can take loans
against various assets available with them like gold, mutual fund investments etc. If a high amount is required
then one can take a loan against their property as well. The individual is not required to sell any asset. They can
use it as collateral and get a loan which has to be repaid as per the schedule set up. The amount of loan is decided
at a certain percentage of the value of the asset as per the RBI guidelines. As applicable in other loans as well, the
repayment capacity of the borrower is considered in deciding the amount. An extra feature of this type of loan is
that if there is a depreciation in the price of the asset, then the lending body might ask the borrower to deposit
some money to cover the change in the value.

P2P LOANS
This is known as Peer-to-Peer loans. In this category there is no financial institution involved. It is a platform where
a person lends money to another person based on certain background checks. There is a high risk involved in this
category for the lenders as there is always a risk of not getting repaid. That’s why an amount is given for a short
term with a very high interest rate. If the borrower is not able to repay the amount, then the lender has no way to
recover the amount given as there is no asset involved. This is a growing field because it is an easy way to get some
funds when there is an immediate need but the lenders and borrowers need to be very careful about the conditions
and features of the loan when they use this mode to transact.

LENDING SCENARIO

How do you determine the best credit product to suit a particular client’s needs? Complete the online
learning activity to assess your knowledge.

ASSESSING A CLIENT’S ABILITY TO REPAY CREDIT

Decisions to grant credit, whether for personal loans, credit cards, or home mortgages, are generally all made on the
basis of two factors: credit history and affordability.

AFFORDABILITY
When determining mortgage affordability, financial institutions consider borrowers’ present and future ability to
handle their financial obligations. They calculate two debt service ratios that determine the amount of debt that
borrowers can afford to carry. In addition, the borrowers must pass a stress test, which calculates their ability to
pay debt if interest rates climb higher than the current average. This information will be covered in the Residential
Mortgages chapter.

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CREDIT HISTORY
Clients’ success in obtaining credit depends on their financial situation and the way they present their situation to
the lending institution. The primary method used for this assessment is the Five Cs of credit approach, which is
based on the following factors:

Character Character refers to the client’s honesty, reliability, repayment history, and intention
to repay the credit. Character is assessed based on the client’s existing level of assets
and debt, employment record, residence stability, and purpose for the loan. Accurate
assessment relies on full disclosure by the client.

Capacity Capacity refers to the client’s ability to repay the loan. Capacity is assessed based on
the client’s current income, job stability, assets, and future considerations.
Government employees as well as those employed in large corporations are considered
to have greater job security and stability than those who are employed informally
or those who are self-employed. Similarly, those with no dependents are considered
to be more credit-worthy than those who are the sole earners for their dependent
families. The Debt-to-Income (DTI) Ratio, which expresses the ratio of the current debt
to current income is also looked into as it gives a clear picture of the capacity to the
borrower to service new debts.

Credit Credit refers to the client’s past credit history, which the lender considers an indicator
of how debt may be handled in the future.
Credit assessment is determined by the client’s current use and availability of existing
credit, payment history, delinquencies, and any records of outstanding judgments.
In some cases, credit scores may be assigned to express one’s creditworthiness
numerically. A common standard is a Credit Score – which consolidates data from
credit reporting bureaus, i.e., Cibil, Experian, Equifax, and calculates an individual’s
credit score. A high score signifies less risk for the lender. For example, most institutions
consider a Cibil score in excess of 750 as decent, 700-750 as average and below 700 is
below-average.

Collateral Collateral refers to property that can be used to secure a loan. Lenders may require
collateral as security if the loan is substantial relative to the client’s net worth. If
the loan is in default, the assets pledged as collateral are liquidated to provide for
repayment of the loan.

Capital Capital refers to net worth and is based on the client’s total assets and general financial
situation. Capital is viewed as an extension of the client’s character, an indicator
of their financial management skills, and a source of collateral. A high score in this
category can indicate that the client has a secondary source of funds for repayment in
case their regular income is disrupted.

As an advisor, you should analyze these five factors alongside other aspects, such as the credit bureau report.
Together, these factors should help you identify areas of weakness and risk in your clients’ credit applications. The
results of your analysis can help you determine whether your clients are likely to receive or be denied their credit
request.

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LOANS RESTRUCTURING
Loan restructuring refers to an agreement between the lender and the borrower to amend the agreements of an
ongoing debt. The need for restructuring a loan can arise when a borrower who has genuine intent to repay a loan
but is facing challenges in meeting his repayment commitments due to loss or is facing substantial reduction in
income. The lender may agree to make changes to the loan agreement in various combinations to ensure that the
loan is continued to be serviced as well as the borrower gets an opportunity to continue his or her venture. Some of
the most commonly used methods of restructuring a loan are:
1. Reduction in interest rate
2. Increasing the repayment period
3. Taking a ‘haircut’ on the loan
4. Conversion of the loan or a part of it to equity

The various loan structuring methods are hereby further explained:

1. REDUCTION IN INTEREST RATE

A reduced interest rate while the repayment tenure and the balance outstanding remain the same leads to a lower
EMI, and helps the borrower by having a lower regular cash outflow and more savings to support the business.

2. INCREASING THE REPAYMENT PERIOD

An increment in the repayment tenure while keeping the balance outstanding and interest rate constant leads to a
lower regular pay-out and more flexibility.

3. TAKING A ‘HAIRCUT’ ON THE LOAN

A haircut on a loan refers to the lender agreeing to reduce the liability of a loan to ensure that the borrower is able
to pay off the loan immediately. For example, a loan account has an outstanding of Rs. 75 Lakh and the lender
agrees to a 20% haircut, in that case the loan account will be closed off if the borrower makes an immediate
payment of Rs. 60 Lakh.

4. CONVERSION OF THE LOAN OR A PART OF IT TO EQUITY

A lender may also agree to convert a part of the loan into equity of the borrowing company if it believes that it can
turn around the profitability and sustainability of the entity. In that case, the lending company becomes one of the
equity holders of the corporation.

STRATEGIES TO REDUCE DEBT

A borrower may have different types of loans such as home loans, education loans, personal loans, car loans, credit
cards etc with corresponding loan amounts and interest. The individual or entity may decide to reduce his loan
exposure and adopt certain strategies to attain the stated goals. Some of the major strategies that one may look at
for reducing their debts faster are as follows:

SNOWBALL
The focus of this strategy is to target paying off those loans which have the least amount of the balance outstanding
and then moves to the higher amount that is outstanding. This strategy helps in paying off loans easily as the
amount required to clear the least debt is relatively small. The snowball strategy results in success relatively quickly
adding a sense of achievement for the borrower. However, there is a flip side to the strategy, which is the fact that
the rate of interest is not taken into account for this strategy.

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AVALANCHE
The avalanche strategy emphasizes on clearing the loan accounts which have the highest rate of interest and hence
are the costliest. This is usually the most logical way of going about the repayment process because the highest
interest rate loans are the costliest and hence this is expected to bring down the interest burden.

BLIZZARD
The blizzard approach of pairing down debt encompasses both the snowball and avalanche methods. It starts off
with the snowball method, whereby the lowest amount of debt is paid off first. Once the tendency to pay off loans
gains momentum, then the strategy swings to the avalanche method and paying off the loans with the highest
interest rate.
We have to take into consideration that each borrower will have individual preferences and unique circumstances,
and hence the approach that they employ will vary. As long as someone is taking on debt responsibly and is
targeting settling his or her loans on or before time, we should be okay with the concept of loans as part of our
financial journey.

CHOOSE BETWEEN INVESTING OR PAYING LOAN OFF FIRST

An individual who has an outstanding debt may get a lump sum amount of funds from an unexpected source or as a
windfall. In this case, it would be natural for the borrower to ponder whether to utilise the available funds for paying
off the outstanding loans or to invest it. The decision to this query would be based on various aspects concerning
the borrowing, some of which are discussed below:
1. One of the key factors that one has to consider would be the rate of interest on the current loan and the
expected return from the investment. If the return expected from the investment options are substantially
more than the interest rate of the loan, it may make sense to go ahead with the investment. It also makes
sense to check if the investment returns are guaranteed or highly expected as the debt interest rate will have
to be serviced irrespective of the returns that may be generated.
2. The amount of funds available, both in terms of relative as well absolute size needs to be taken into account.
In case the amount available is small, it would make sense to pay the loan to whatever extent possible and
work towards being debt-free as soon as possible. However, if the borrower comes across a substantial
amount of funds, various options as stated above need to be looked at.
3. The borrower may decide to pay off the loan no matter what returns may be available in the investment
options if he values mental peace. The large number of salaried individuals are usually observed to choose to
reduce their liability at the earliest when the cashflow is available.
4. Another factor that may influence the decision of a borrower on whether to invest or to repay a loan earlier is
the taxation involved. Certain loans such as home loans offer tax benefits to those who repay regularly up to
a certain amount, while certain investments also come under tax benefit which may help to decide if it makes
more sense to continue with the debt while repaying regularly or to pay off and close the debt immediately.

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LEARNING MORE ABOUT THE MATHUR’S FINANCIAL SITUATION

At the beginning of this chapter, we presented a scenario in which you had to get a clear understanding of the
Mathur’s financial resources and general financial position.
Now that you have read this chapter, we’ll revisit the questions we asked and provide some answers.
• Beyond the Know Your Client information required by regulation, what other important information do you need
to get a clear picture of the Mathur’s situation?
You should be able to perform an effective client discovery to determine the Mathur’s goals. You should be
able to articulate those goals in meaningful terms, rather than numbers alone.
By understanding, prioritizing, and connecting goals together, you can create a holistic plan. The plan
should have real meaning so that they are likely to stick to it over time.
• Considering the difference between goals and objectives, what must you understand to build an effective
investment plan and provide this couple with the right advice?
Most clients can tell you in a general way what they want to achieve. They may also have an idea of
what they can afford to invest to achieve it. However, few clients are able to connect their goals to
realistic savings objectives and time horizons. It is your role as their advisor to educate your clients about
reasonable expectations regarding investments and savings plans.
• How can you establish a comfortable rapport and gather the information you need during what may be an
emotionally charged discussion?
Clients often do not know what information they should provide, so an effective client discovery process is
important for both you and your clients.
Establishing rapport with the client and asking relevant and meaningful questions are all part of the art of
the conversation.
A phase often overlooked is the emotional discovery phase, where you focus on life issues. In some cases,
rather than focusing on restructuring their portfolio, you can help clients achieve their goals by helping
them come to terms with the physical and mental changes brought about by aging.
• Why is it important to establish the Mathur’s current net worth?
Establishing net worth and then building a net worth strategy will put you in a better position to advise
your clients. It will help you determine the best way to work together to build their net worth towards
specific annual targets and ultimately achieve their goals.
• By examining their cash flow to determine how they spend their income, what important goal are you
supporting?
By examining the Mathur’s spending patterns and building a cash flow statement, you can help them
realize where they are overspending on discretionary items. The cash flow statement can also help them
manage their income to provide more after-tax cash flow, which they can set aside for their retirement
years.
• How will a financial institution typically evaluate the Mathur’s ability to borrow?
A financial institution will typically use two main factors to evaluate the Mathur’s ability to borrow:
affordability and credit history. Debt service ratios come into the picture when affordability is assessed,
and credit history includes consideration of the Five Cs of credit, namely, character, capacity, credit,
collateral, and capital.

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SUMMARY
Now that you have completed this lesson, let’s revisit the learning objectives:
1. List the minimum information that a licensed advisor must obtain from a client.
• SEBI regulations have set out the minimum amount of information that firms and their advisors must collect
from their clients. The requirements are collectively known in the industry as the KYC Guidelines, one of the
cornerstones of the investment industry. The required list of documents for the KYC application process is
extensive, for both individual and non-individual clients.

2. Describe the different types of acceptable payments for making investments.

Several modes of payment are accepted for making investments.

3. Collect financial and non-financial data that goes beyond the simply regulatory and legal minimum to develop
a wealth plan.
• To help your clients create a financial plan, you must get to know them beyond the legal and regulatory
minimum requirement. The process begins when you open a client account. At that point, you must comply
with various rules and laws at this stage, including Indian legislation, some international agreements, and
RBI and SEBI’s KYC regulations.

4. Apply the client discovery process to assess a client’s wealth planning needs.
• You must use the client discovery process to learn about your clients’ goals and current financial situation,
their risk and return objectives, and their investment constraints.
• Goals are a client’s life needs and aspirations. Objectives refer to the investment return clients require and
the amount of risk they are willing and able to tolerate to achieve their goals. When their willingness to take
on risk exceeds ability, you should warn them of the consequences of taking on too much risk.
• Several constraints must be factored into every client’s wealth plan, including the client’s time horizon,
liquidity requirements, and tax situation. Constraints can sometimes force clients to make compromises:
take on more risk than they’re comfortable with, relax the constraints, or establish more modest goals.
• The purpose of the client discovery process is to find out what your clients want to accomplish through a
wealth plan. Emotional discovery relates to life issues such as family and lifestyle, planning for the future,
managing savings, and building a legacy. Financial discovery is the process of setting a plan to accumulate,
protect, convert, and transfer wealth.

5. Analyze a net worth plan for a client.

• Wealth planning requires both a budget and a strategy. The basic tools used to build the plan are the net
worth statement and the cash flow statement. The net worth statement determines the amount of assets
and liabilities at a specific point.

6. Analyze a cash management plan for a client.

• A cash flow statement shows how much money flows in and out of the client’s accounts over a set period.
• Clients with inadequate savings can improve their current cash flow situation by reducing expenses or
increasing income. They should also have effective savings strategies in place. One such strategy is to have
money deducted automatically from every paycheque and deposited in a savings vehicle.

7. Outline savings strategies for a client.

• Occasionally, even the best-structured plan can face temporary difficulties due to circumstances beyond
a client’s control. For this reason, it is important that clients have liquid fund reserves set aside for
emergencies.

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8. Differentiate between the various types of credit and loans available.

• The various types of credit include overdrafts, credit cards, charge accounts, personal lines of credit, personal
loans, demand loans and home loans vehicle loans, education loans, business loans, P2P loans and loans
against securities.

9. Explain how the Five Cs of Credit are used to evaluate a client’s ability to borrow.
• Whether or not clients qualify for credit depends on their financial situation and how they present their
situation to the lending institution. The Five Cs of credit, which help to determine creditworthiness, stand for
character, capacity, credit, collateral, and capital.

10. Identify ways to restructure loans and reduce debt.

• Reduce interest rates, lengthen term, taking a haircut, converting to equity, restructure loan (snowball,
avalanche, blizzard)

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3 • 48 ACCUMULATING WEALTH FOR CLIENTS | COURSE 1

APPENDIX – LOAN CALCULATIONS

We will now have a look at some basic numerical calculations for loans using the Casio FC 200V Calculator:
Question 1:
Find the EMI of a loan with the following characteristics:
Loan Amount: Rs. 1,00,00,000
Repayment tenure: 25 years
Interest rate: 9% per annum (compounded monthly)
Step 1: CMPD (Finding the required EMI)
Set: END
N: 25*12
I%: 9
PV: 1,00,00,000
PMT: SOLVE (-83919.64) ------ ANSWER
FV: 0
P/Y: 12
C/Y: 12
_________________________

Question 2:
Find the Balance Outstanding after 5 years of a loan with the following characteristics:
Loan Amount: Rs. 60,00,000
Repayment tenure: 30 years
Interest rate: 8.25% per annum (compounded monthly)
Step 1: CMPD (Finding the initial EMI)
Set: END
N: 30*12
I%: 8.25
PV: 60,00,000
PMT: SOLVE (-45076)
FV: 0
P/Y: 12
C/Y: 12
Step 2: AMRT (Finding the balance outstanding after 5 years, i.e. 60 EMIs)
PM 1: 1
PM 2: 60
BAL: SOLVE (5717038) -----ANSWER
____________________________

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 CHAPTER 3 | UNDERSTANDING THE CLIENT, THEIR BUDGET, CASH FLOW, CREDIT AND LOANS 3 • 49

Question 3:
Find the new EMI of a loan with the following characteristics:
Loan Amount: Rs. 2,00,00,000
Repayment tenure: 20 years
Interest rate: 8.50% per annum (compounded monthly)
If the interest increases by 75 bps after 8 years
Step 1: CMPD (Finding the initial EMI)
Set: END
N: 20*12
I%: 8.50
PV: 2,00,00,000
PMT: SOLVE (-173564.65)
FV: 0
P/Y: 12
C/Y: 12
Step 2: AMRT (Finding the balance outstanding after 8 years, i.e. 96 EMIs)
PM 1: 1
PM 2: 96
BAL: SOLVE (15635672)
Step 3: CMPD (Finding the new EMI given that the interest rate has been changed)
Set: END
N: 20*12 - 96
I%: 9.25
PV: 15635672
PMT: SOLVE (-180147.39) ------ANSWER
FV: 0
P/Y: 12
C/Y: 12

Question 4:
Find the breakup of the 100th EMI of a loan with the following characteristics:
Loan Amount: Rs. 55,00,000
Repayment tenure: 15 years
Interest rate: 10% per annum (compounded monthly)
Step 1: CMPD (Finding the EMI)
Set: END
N: 15*12
I%: 10
PV: 55,00,000
PMT: SOLVE (-59103.28)
FV: 0
P/Y: 12
C/Y: 12

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3 • 50 ACCUMULATING WEALTH FOR CLIENTS | COURSE 1

Step 2: AMRT (Finding the Interest and Principal component of the 100th EMI)
PM 1: 100
PM 2: 100
PRN: SOLVE (-30177.10) --------ANSWER
INT: SOLVE (-28926.18) --------ANSWER
_________________________________________________

Question 5:
Find the total interest paid in the 5th year of a loan with the following characteristics:
Loan Amount: Rs. 50,00,000
Repayment tenure: 20 years
Interest rate: 9% per annum (compounded monthly)
Step 1: CMPD (Finding the EMI)
Set: END
N: 20*12
I%: 9
PV: 50,00,000
PMT: SOLVE (-44986.30)
FV: 0
P/Y: 12
C/Y: 12
Step 2: AMRT (Finding the Total Interest in the 5th year, i.e. between the 49th and 60th EMIs)
PM 1: 49
PM 2: 60
Summation INT: SOLVE (-405805) ----------ANSWER

© CANADIAN SECURITIES INSTITUTE