Is your investment option WISE? Find out

Why you need a certified financial planner to help achieve your long-term goals.

India is a nation with one of the highest domestic savings in the world. The savings have been in the region of 25 per cent of GDP in the last few years and are predominantly absorbed by real estate and physical assets. The remaining are financial savings. The savings choose their own investment options: out of financial behaviour, proclivity or simply out of compulsion.

Financial planning gives the choice of investment options which best suits a particular situation or phase and meets the visibility of financial goals. An important criterion is risk profile. It is essential as part of financial planning process to assess and respect a client's basic risk profile. Equally important is to seamlessly mould the client risk profile to her/his goal trajectory.

Here we first distinguish between an "investment option" and "investment decision". The former is a broad category of investment classes such as equities, debt, fixed deposits, real estate and precious metals. The latter is either one or more transactions of acquiring as well as disposing assets in an investment class. Obviously, investment option is a broader category, chosen after much deliberation and analysis of individual factors of suitability to goals, risk aptitude, risk capacity, return expectation, etc. It involves strategy and planning. Investment decisions on the other hand are means to actualise investment options. They can vary at times from being analytical and well thought of to being purely on impulse.

The other differentiation is between a 'wise' investment option and a 'right' one. The 'wise' option may not always prove to be 'right' in the short to medium term, while an investment option which comes out to be 'right' may not prima facie be 'wise'. The so-called right investment would be a result of so many factors: general market conditions related to the asset class, interest rate scenario and economic conditions of the time. The investment option chosen at the peak of the cycle, e.g. in equities at the height of the equity bull run, in long dated bonds and gilts at the bottom of the interest rate cycle, in long term locked-in fixed deposits of banks and corporate in a rising interest rate cycle, may come out later as 'not right'.

But such option chosen may not be entirely 'unwise', as the conditions stated above may exist simultaneously in the system and it would be equally ill-advised not to invest in any asset class. This is particularly emphasised as we cannot decide when the peak/bottom of the market/cycle is near. For instance equity markets can be in bullish mode for a painfully longer time after a client has been advised to switch to or remain in cash. So, the post-facto wisdom usually determines if an investment option chosen was right.

So, what determines a wise investment option? Financial planning answers this in more ways than one. The financial planning process of investing is goal-based after carefully determining "asset allocation" relative to the basic risk profile, optimum risk capacity of the individual in a particular life stage. This asset allocation in essence decides the right proportion of exposure to various asset classes. This diversifies a lot of risk in the system while targeting an "optimal" return which helps us in achieving our financial goals. It is underlined that "optimal" return may not be the best return in the system. It is good enough to fructify our defined goals.

There are some more considerations in financial planning which enable us to decide on wise investment options. The interplay of many factors, e.g. term of investment, proximity to goals, type of goals, investible surplus, risk attitude, risk capacity, asset base, etc. decides the required return from asset allocation chosen and in turn, from individual asset classes. The real tax adjusted return from assets, a return which after paying resultant taxes beats the inflation during the period is also the crux for deciding on investment options. The size and flow of savings as well as accumulated corpus is modified suitably in stages as we approach individual goals. Near the goal, capital protection assumes more importance than capital appreciation and therefore requires subtle twists at various stages leading to a long-term goal realisation. The liquidity aspect, the costs and the tax efficiency of transactions through various stages of goal-based investing decide in favour of such wisely chosen investment option to be right.             

The financial planning process and investing pattern as discussed above rationalises investment decisions and addresses behavior asymmetry characterised by fear and greed. The investment discipline imposed by financial goals sobers impulses induced by market vagaries. The optimally arrived at asset allocation pursuant to a carefully analysed financial situation and risk profile of an individual by a financial planner, preferably a Certified Financial Planner or CFP professional, sets the rule for the wise and the right exposure to various investment options in the asset portfolio.

The writer is working with Financial Planning Standards Board India (FPSB India) in the capacity of Vice Chairman and Chief Executive Officer. The views expressed here are personal, and do not necessarily represent that of the organization. FPSB India is the sole marks licensing authority for the CFP marks in India, through agreement with US-based FPSB Ltd.