Scope of financial planning in India |

All about financial planning

How do you think your parents were able to buy you such modern gadgets? Through
making small savings every month and planning their wealth wisely. They probably had
a individual/firm which periodically advised them how they could grow their wealth
through different types of investments.

Similarly, organizations also take advice from such firms to plan their finances and grow
their wealth. But who are these people and firms? What are they called? What do they
do?

Let’s answer all these questions today!

Who is a financial planner?

A financial planner is like a consultant that every family needs! Right from looking after
the investments to taxation, from retirement planning to estate planning – a Certified
Financial planner can cover all the areas of personal finance. A financial planner helps
an individual invest their money wisely and grow the same. He helps in budgeting,
setting the goals and create a portfolio in such a way that all the financial goals of an
individual are achieved.

What are the different areas that a financial planner looks into?

A certified financial planner looks after every aspect of personal finance. The key areas
are as follows:

1. Investment planning

The primary component of financial planning. The planner understands the client’s
financial goals and accordingly advises when, where and how much to invest.

2. Portfolio Management

It’s the financial planner’s job to select the right combination of stocks, gold, bonds,
mutual funds, Govt. schemes for the client. The combination must be such that the client
gets maximum profit with minimum risks involved.

3. Tax Planning & ITR Filing

Nobody likes paying taxes, and there are sure shot legal ways by which individuals can
reduce the tax liabilities. As a financial planner, your job would be to analyze the
financial situation of your client and make the best use of various tax exemptions,
deductions and benefits to minimize the amount of taxes your client would have to pay.

Along with tax planning, your job as a financial planner would also mean that you may
have to file your client’s Income Tax Returns.
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4. Retirement Planning

It’s a dream for everyone to retire early and enjoy their life with their loved ones. But to
retire early, a person needs to accumulate enough wealth so that he/she doesn’t have to
be dependent on any other person. A financial planner helps in retirement planning in 2
ways – advising which scheme to invest in (such as NPS, APY, PPF etc.) & how much
to invest at each life stage (during start, middle and end of your career) and ensure that
the wealth lasts throughout the lifetime.

5. Will Writing & Estate Planning

During some point in life, a person will start thinking about his/her family’s financial
security. As a financial planner, it’s your job to help your client secure all their assets
with the help of a will. This would also help reduce future family disputes.

6. Wealth Management

What if you get Mukesh Ambani as your client? He wouldn’t be interested much in
mutual funds, stocks etc. He would want to invest Lakhs of Rupees in a way that would
earn him Crores of Rupees. A financial planner, in this case would turn into a wealth
manager and he/she would be looking for opportunities to invest the client’s money in
MNC’s, real estate etc. which give large returns.

7. Risk Management Through Insurance

Insurance is a necessity in 2022. Be it life insurance, term insurance, accidental

insurance or any other form of personal insurance. But how do you know which
insurance policy to purchase, how much coverage should be chosen? A financial
planner helps you answer all these questions.

What are the various job opportunities that one can expect as a Certified Financial
Planner?

As a financial planner, you shall be mainly working in the Banking, Financial services &
Insurance industry. The key areas where one gets work opportunity are:

1. Banks & NBFC

2. Wealth Management firms

3. Family offices

4. Insurance industry
5. Financial planning firms

6. Individual practice

As a fresher one can expect a starting salary range from Rs. 2 to 5 lakhs per annum. As one gains
experience, and reaches a senior level, a pay of Rs. 5 to 10 lakhs. Furthermore, years into the
industry, one can expect a higher package of Rs. 10 lakhs plus.

The average costs for pursuing the CFP course in India ranges anywhere between Rs. 1 lakh to
Rs. 1.5 lakes. Thus, you recover the entire costs to pursue CFP within few months of joining a
corporate. The total fees payable to FPSB for the entire program is approx. $1197. However,
under Proschool’s expert guidance, you can save up to $250 during the duration of the program.

So how can you become a Certified Financial Planner?

Well, if consulting clients on any of the above areas excites you, you should surely consider a
career in the field of financial planning. To become a financial planner, one needs to complete
the CFP program provided by Financial Planning Standards Boards (FPSB). CFP is the most
renowned certification in the field of Personal Finance and is recognized in 27 countries.

The CFP Course is 12 to 18 months program and can be pursued along with college or job.
Proschool takes pride in being one of the finest education providers for the CFP program.

Let us take you through the exam pattern and timeline for the CFP program –

1. Module 0: This is an introductory preparatory module provided specially by Proschool to

get the basics cleared of the students. Here we shall be covering the Six steps of financial
planning and key topics in financial mathematics.

Post the completion of this module, the student has to appear for the final assessment and score
minimum 70% to qualify for the actual modules.

2. Now, once the preparatory module is cleared, the students can commence their other modules
as follows:

A) Module 1 – Personal Finance Management & Investment Planning

B) Module 2 – Retirement & Tax planning module

C) Module 3 – Risk & Estate planning module

Each of the above mentioned module is covered in 2.5 -3 months in coaching followed by a 2-
week preparatory leave to complete the FPSB exams.

Do note here, the FPSB exams are conducted every month and a candidate is free to select any
month of their choice and finish off the exams.

3. Once a candidate has cleared all the three papers, he / she becomes eligible to appear for the
final paper I.E., Integrated financial planning. Here the student must submit a financial plan
provided by FPSB India. Once the plan has been completed satisfactorily, the student can book
the 3-hour written exam and appear for the same.

Do I need a financial planner?

Generally speaking, the more complex your financial situation, the more likely you are to
benefit from a financial planner.
If your finances are simple, you may be able to take a DIY approach. But financial planners
can provide an objective perspective, and bring expertise to decisions about how you should
invest your money, what your financial priorities should be and what sort of insurance
coverage and other protections you need. A financial planner can be especially helpful when
you're faced with a life change — think marriage, a divorce or an inheritance.
AD

Types of financial planners

The type of financial planner that is best for you will depend on your needs, life stage
and budget. We'll outline a few options below.
Robo-advisors
If you're just starting out, a robo-advisor may be enough to meet your needs.
Automation has enabled traditional firms such as Vanguard and Fidelity, as well as
online-only companies like Betterment and Wealthfront, to substantially lower the
price of portfolio management. These companies are ideal if you need investment
management, but not holistic financial planning.
Robo-advisors build and manage a portfolio of low-cost investments suited to your
financial goal for a small fee — many top choices charge 0.25% or less of your
account balance. The investment mix is determined by a computer algorithm and is
automatically adjusted when needed. At the basic account level, you can start
investing with $100 or even less.
The low-cost, easy-entry nature of robo-advisors reduces barriers to working toward
your financial goals. That's important because avoiding the market can starve your
retirement. You can start with a robo-advisor and add a human advisor later on if
needed.
» Ready to get started? View our list of the best robo-advisors
Traditional, in-person financial planners
For those with complicated or ongoing planning needs, a traditional, in-person
financial planner may be a better fit. A CFP can provide holistic, one-on-one advice
for the most complex financial situations. The official CFP designation indicates that a
provider has gone through a rigorous formal training and testing process.
A fee-only CFP typically charges by the hour (usually $200 to $400) or by the task (a
flat $1,000 to $3,000 fee, for example). Some might charge based on the size of the
investment portfolio they are managing for you; this is called an assets-under-
management fee and is typically 1% of your portfolio balance per year. The initial
consultation to discuss your needs and their services is usually free.
» Learn more about how much a financial advisor costs
Before you enter a relationship, ask whether the person you’re considering is a
fiduciary, a term that means they’re obligated to put the client’s best interests first.
(Members of the National Association of Personal Financial Advisors, for example, fill
both the fiduciary and fee-only requirements.)
Online financial planning services
There are several online planning services that combine computer-driven portfolio
management with access to living, breathing financial planners. In many cases, you'll
get a dedicated financial planner and a comprehensive financial plan, but you'll meet
with that advisor via phone or video conference rather than in person.
Online planning services like this typically charge more than a robo-advisor but less
than a traditional financial planner. Examples of companies in this space include Facet
Wealth and Empower.
Online financial planners like robo-advisors or online planning services often offer
virtual tours, demos and even the chance to test-drive the investment platform
before you sign up. With an online planning service, you may be able to meet with
your dedicated financial planner before deciding to sign on.
Financial planner vs. financial advisor
Financial advisor (or financial consultant) is a broad term that encompasses
many different professionals who help people with their money.
A financial planner is a type of financial advisor who typically focuses on
offering holistic financial guidance in addition to services such as investment
management. For example, financial planners can help you answer questions
like, "How do I save for retirement and my child's college fund at the same
time?"
How to find a financial planner
There are a few factors to consider when shopping for a financial planner, such as
credentials, disciplinary history and specialization.
Credentials
People often use the terms "financial planner" and "CFP" interchangeably, but that's
not always accurate. The term "financial planner" is unregulated. Anyone can call
themselves one, regardless of their training, credentials or duties. Not all financial
planners are required to act as fiduciaries to their clients.
The CFP designation, on the other hand, is regulated by the Certified Financial
Planner Board of Standards. Only financial professionals who have satisfied the
board's educational, exam, work-experience and ethical requirements may use it.
CFPs must act as fiduciaries to their clients to maintain the designation.
You can verify whether or not a financial planner is a CFP using the Certified Financial
Planner Board of Standards' CFP lookup tool.
Disciplinary history
That same lookup tool will also show you whether a financial planner has ever
received any formal complaints, or if they've ever had any legal or disciplinary actions
taken against them by the court system or the board. It's worth being cautious about
engaging a financial planner who has a history of wrongdoing.
Specialization
Some financial planners specialize in a particular type of client. Some of these
specialized planners obtain specialized credentials (potentially in addition to a CFP).
For example, Chartered Special Needs Consultant (ChSNC) is a designation that
indicates expertise in offering financial planning services to people with disabilities
and their families. It is offered and regulated by the American College of Financial
Services.
When you're considering working with a particular financial planner, it's a good idea
to look up the meaning of any abbreviations or credentials after their name, to see if
their specializations are a good fit for your financial situation.
11 Types of Securities

While it is possible to put investments into one of three categories, as

described above, there are many types within these categories. Here are 11
key examples.

1. Stocks

Stocks, also known as shares or equities, might be the most well-known and
simple type of investment. When you buy stock, you’re buying an
ownership stake in a publicly-traded company. Many of the biggest
companies in the country are publicly traded, meaning you can buy stock in
them. Some examples include Exxon, Apple and Microsoft.

How you can make money: When you buy a stock, you’re hoping that the
price will go up so you can then sell it for a profit. The risk, of course, is that
the price of the stock could go down, in which case you’d lose money.

2. Bonds

When you buy a bond, you’re essentially lending money to an entity.

Generally, this is a business or a government entity. Companies issue
corporate bonds, whereas local governments issue municipal bonds. The
U.S. Treasury issues Treasury bonds, notes and bills, all of which are debt
instruments that investors buy.

How you can make money: While the money is being lent, the lender or
investor gets interest payments. After the bond matures, meaning you’ve
held it for the contractually determined amount of time, you get your
principal back.
The rate of return for bonds is typically much lower than it is for stocks, but
bonds also tend to be a lower risk. There is still some risk involved, of
course. The company you buy a bond from could fold or the government
could default. Treasury bonds, notes and bills, however, are considered very
safe investments.

3. Mutual Funds

A mutual fund is a pool of many investors’ money that is invested broadly in

a number of companies. Mutual funds can be actively managed or passively
managed. An actively managed fund has a fund manager who picks
securities in which to put investors’ money. Fund managers often try to
beat a designated market index by choosing investments that will
outperform such an index. A passively managed fund, also known as an
index fund, simply tracks a major stock market index like the Dow Jones
Industrial Average or the S&P 500. Mutual funds can invest in a broad array
of securities: equities, bonds, commodities, currencies and derivatives.

Mutual funds carry many of the same risks as stocks and bonds, depending
on what they are invested in. The risk is often lesser, though, because
the investments are inherently diversified.

How you can make money: Investors make money off mutual funds when
the value of stocks, bonds and other bundled securities that the fund
invests in go up. You can buy them directly through the managing firm and
discount brokerages. But note there is typically a minimum investment and
you’ll pay an annual fee.

4. Exchange-Traded Funds (ETFs)

Exchange-traded funds (ETFs) are similar to mutual funds in that they are a

collection of investments that tracks a market index. Unlike mutual funds,

which are purchased through a fund company, shares of ETFs are bought
and sold on the stock markets. Their price fluctuates throughout the trading
day, whereas mutual funds’ value is simply the net asset value of your
investments, which is calculated at the end of each trading session.

How you can make money: ETFs make money from the collection of a
return amongst all of their investments. ETFs are often recommended to
new investors because they’re more diversified than individual stocks. You
can further minimize risk by choosing an ETF that tracks a broad index. And
just like mutual funds, you can make money from an ETF by selling it as it
gains value.

5. Certificates of Deposit (CDs)

A certificate of deposit (CD) is considered to be a very low-risk investment.

You give a bank a certain amount of money for a predetermined amount of
time and earn interest on that money. When that time period is over, you
get your principal back, plus the predetermined amount of interest. The
longer the loan period, the higher your interest rate is likely to be. While
the risk is low, so is the potential return.

How you can make money: With a CD, you make money from the interest
that you earn during the term of the deposit. CDs are good long-term
investments for saving money. There are no major risks because they are
FDIC-insured up to $250,000, which would cover your money even if your
bank were to collapse. That said, you have to make sure you won’t need the
money during the term of the CD, as there are major penalties for early
withdrawals.
6. Retirement Plans

A retirement plan is an investment account, with certain tax benefits, where

investors invest their money for retirement. There are a number of types of
retirement plans such as workplace retirement plans, sponsored by your
employer, including 401(k) plans and 403(b) plans. If you don’t have access
to an employer-sponsored retirement plan, you could get an individual
retirement plan (IRA) or a Roth IRA.

How you can make money: Retirement plans aren’t a separate category of
investment, per se, but a vehicle to buy stocks, bonds and funds in two tax-
advantaged ways. The first, lets you invest pretax dollars (as with a
traditional IRA). The second, allows you to withdraw money without paying
taxes on that money. The risks for the investments are the same as if you
were buying the investments outside of a retirement plan.

7. Options
An option is a somewhat more advanced or complex way to buy a
stock. When you buy an option, you’re purchasing the ability to buy or sell
an asset at a certain price at a given time. There are two types of
options: call options, for buying assets and put options, for selling options.

How you can make money: As an investor, you lock in the price of a stock
with the hope that it will go up in value. However, the risk of an option is
that the stock could also lose money. So if the stock decreases from its
initial price, you lose the money of the contract. Options are an advanced
investing technique and retail should exercise caution before using them.

8. Annuities

When you buy an annuity, you purchase an insurance policy and, in return,
you get periodic payments. These payments generally come down the road
in retirement but are often purchased years in advance. This is why many
people use annuities as part of their retirement savings plan.

Annuities come in numerous varieties. They may last until death or only for a
predetermined period of time. They may require periodic premium
payments or just one up-front payment. They may link partially to the stock
market or they may simply be an insurance policy with no direct link to the
markets. Payments may be immediate or deferred to a specified date. They
may be fixed or variable.

How you can make money: Annuities can guarantee an additional stream
of income for retirement. But while they are fairly low risk, they aren’t high-
growth. So investors tend to make them a good supplement for their
retirement savings, rather than an integral source of funding.

9. Derivatives
A derivative is a financial instrument that drives its value from another asset.
Similar to an annuity, it is a contract between two parties. In this case,
though, the contract is an agreement to sell an asset at a specific price in
the future. If the investor agrees to purchase the derivative then they are
betting that the value won’t decrease. Derivatives are considered to be a
more advanced investment and are typically purchased by institutional
investors.

The three most common types of derivatives are:

 Options Contracts: The options contract gives the investor the

opportunity to buy or sell an asset at a specific price at a specific time

in the future. Call options provide you the opportunity to buy the

asset at that price and put options allow you to sell that asset.

 Futures Contracts: Futures are contracts that commit to a sale to

being made at a specified time and on a specified date.

 Swaps: This is an agreement between two parties to exchange cash

flows in the future.

How you can make money: You can make money investing in derivatives
if you are on the right side of price fluctuations. For example, if you agree
to buy copper at $1,000 in nine months but the market price at that time is
$2,000 then you’ve essentially doubled your investment.

10. Commodities
Commodities are physical products that you can invest in. They are
common in futures markets where producers and commercial buyers – in
other words, professionals – seek to hedge their financial stake in the
commodities.

Retail investors should make sure they thoroughly understand futures

before investing in them. Partly, that’s because commodities investing runs
the risk that the price of a commodity will move sharply and abruptly in
either direction due to sudden events. For instance, political actions can
greatly change the value of something like oil, while the weather can
impact the value of agricultural products.

Here’s a breakdown of the four main types of commodities:

 Metals: precious metals (gold and silver) and industrial metals (copper)

 Agricultural: Wheat, corn and soybeans

 Livestock: Pork bellies and feeder cattle

 Energy: Crude oil, petroleum products and natural gas

One of the primary ways that investors make money with commodities is by
trading commodity futures. Investors sometimes buy commodities as
a hedge for their portfolios during inflation. You can buy commodities
indirectly through stocks and mutual funds or ETFs and futures contracts.

11. Hybrid Investments

Hybrid investments incorporate elements of equities and fixed-income

securities. One such example is preferred shares, which is an equity security
with a bond-like feature. Preferred stock generally comes with a fixed
dividend rate. Dividends to preferred shareholders are paid before
dividends to common shareholders. Another difference is that if the
company that issued the shares is liquidated, preferred stockholders will
have access to the company’s assets before common stockholders. Owners
of preferred stock are behind bondholders in line for company assets, but
they’re ahead of owners of common stock.

Another type of hybrid is a convertible bond. It is a corporate bond that can

be “converted” into shares of the company. A bond is a loan to a company,
whereas a share is a “share” of ownership in the company. When you
convert from a bond to a share, you go from being a lender to the
company to a part-owner of the company.

Investment Objectives and

Constraints
Investment objectives and constraints are the cornerstones of any
investment policy statement. A financial advisor/portfolio manager
needs to formally document these before commencing the portfolio
management. Any asset class that is included in the portfolio has to
be chosen only after a thorough understanding of the investment
objective and constraints. Following are various types of objectives
and constraints to be considered and several steps to correctly
determine these objectives.

Definition of Investment Objectives

Investment objectives are related to what the client wants to
achieve with the portfolio of investments. Objectives define the
purpose of setting the portfolio. Generally, the objectives are
concerned with return and risk considerations. These two objectives
are interdependent as the risk objective defines how high the client
can place the return objective.
Investment Objectives
The investment objectives are mainly of two types:

Risk Objective
Risk objectives are the factors associated with both the willingness
and the ability of the investor to take the risk. When the ability to
accept all types of risks and willingness is combined, it is termed
risk tolerance. When the investor is unable and unwilling to take the
risk, it indicates risk aversion.

The following steps are undertaken to determine the risk objective:

1. Specify Measure of Risk: Measurement of risk is the

most important issue in portfolio management. Risk is
either measured in absolute or relative terms. Absolute
risk measurement will include a specific level of variance
or standard deviation of total return. Relative risk
measurement will include a specific tracking risk.
2. Investor’s Willingness: Individual investors’
willingness to take risks is different from institutional
investors. For individual investors, willingness is
determined by psychological or behavioural factors.
Spending needs, long-term obligations or wealth targets,
financial strength, and liabilities are examples of factors
that determine an investor’s willingness to take the risk.
3. Investor’s Ability: An investor’s ability to take risk
depends on financial and practical factors that bound the
amount of risk taken by the investor. An investor’s short-
term horizon will negatively affect his ability. Similarly, if
the investor’s obligation and spending are less than his
portfolio, he clearly has more ability.
Return Objective
The following steps are required to determine the return objective of
the investor:

1. Specify Measure of Return: A measure of return needs

to be specified. It can be specified in an absolute term or
a relative term. It can also be specified in nominal or real
terms. Nominal returns are not adjusted for inflation,
 whereas real returns are. One may also distinguish pre-
tax returns from post-tax returns.
2. Desired Return: A return desired by the investor needs
to be determined. The desired return indicates how much
return is expected by the investor. E.g., higher or lower
than average returns.
3. Required Return: A return required by the investor also
needs to be determined. A required return indicates the
return which needs to be achieved at the minimum for
the investor.
4. Specific Return Objectives: The investor’s specific
return objectives also need to be determined so that they
are consistent with his risk objectives. An investor having
a high return objective needs to have a portfolio with a
high level of expected risk.
Definition of Investment Constraints
Investment constraints are the factors that restrict or limit the
investment options available to an investor. The constraints can be
either internal or external constraints. Internal constraints are
generated by the investor himself, while external constraints are
generated by an outside entity, like a governmental agency.

Also Read: 4 Most Important Factors Influencing Investor

Preference

Types of Investment Constraints:

The following are the types of investment constraints:

Liquidity
Such constraints are associated with cash outflows expected and
required at a specific time in the future and are generally in excess
of the income available. Moreover, prudent investors will want to
keep aside some money for unexpected cash requirements. The
financial advisor needs to keep liquidity constraints in mind while
considering an asset’s ability to be converted into cash without
impacting the portfolio value significantly.

Time Horizon
These constraints are related to the time periods over which returns
are expected from the portfolio to meet specific needs in the future.
An investor may have to pay for college education for children or
needs the money after his retirement. Such constraints are
important to determine the proportion of investments in long-term
and short-term asset classes.

Tax
These constraints depend on when, how, and if returns of different
types are taxed. For an individual investor, realized gains and
income generated by his portfolio are taxable. The tax environment
needs to be kept in mind while drafting the policy statement.
Often, capital gains and investment income are subjected to
differential tax treatments.

Legal and Regulatory

Such constraints are mostly externally generated and may affect
only institutional investors. These constraints usually specify which
asset classes are not permitted for investments or dictate any
limitations on asset allocations to certain investment classes. A trust
portfolio for individual investors may have to follow substantial
regulatory and legal constraints.

Alternative Investments

Definition

Alternative investments refer to investments made in assets classified as non-traditional

investment vehicles. It is meant for investors who wish to have a diversified portfolio with
increased returns. While traditional or conventional forms for investments are open for all
kinds of investors, alternative investments opportunities are confined to wealthy investors,
like high-net-worth individuals (HNWIs).

These non-conventional investments involve dealing in assets other than the widely invested-
in individual stocks, bonds, and commodities. With different types of options available,
investors get a chance to build their portfolios by spending on securities that could help them
build a better investment base.
Key Takeaways

 Alternative investments include types of investments made in assets that do not fall
under the traditional investment category.
 Alternative investments management is more active, ensuring constant monitoring
and recalibration of investment strategies given the complexities involved.
 These investments are classified into tangible (assets that could be touched) and
intangible (assets that could not be touched but carry value).
 The valuation of the asset classes involved is complicated as these investments require
specific knowledge and skills to be handled.

Alternative Investments Explained

Alternative investments, as a domain, are still evolving and maturing. While it is mainly
considered a prerogative of the HNWI investors, some retail investors also show a keen
interest in investing in these asset classes. After the financial crisis in 2008, where even the
best of the diversified portfolios were swayed by extreme volatility, these non-traditional
investments managed to prove their worth.
These investments differ from traditional investments in terms of complexity, liquidity,
regulatory mechanism, and mode of fund management. These asset classes usually have a
market correlation between -1 to 0, making them less susceptible to market-oriented
or systematic risk elements.

The non-traditional investments offer better diversification benefits with enhanced returns.
When a stock or bond underperforms, a hedge fund or private equity firm can make up for the
extent of losses over the long term. In addition, one can add or replace alternative assets
based on individual investment goals and risk appetite.
These investments call for the active management of funds. The complexities involved with
respect to the nature of the assets, volatility, and elevated risk level make constant monitoring
and recalibration of investment strategies a must. In addition, the valuation of these non-
conventional asset classes is complicated as these investments require specific knowledge
and skills to be handled. Plus, the assets belonging to this category are unique, making
accurate valuation difficult.
Types of Alternative Investments

Alternative investments are available in two broad categories – Tangible and Intangible.

#1 – Tangible Investments

These are the alternative investments types meant for assets having a physical existence.
When an investor spends on a real asset, personal property, or hard asset, it is considered a
tangible investment. Some of these assets are evaluated on their appreciation ability, while
the rest are held on their ability to generate income as they depreciate. For example,
collectibles have good appreciation value, and hence they are judged in accordance with that.
On the other hand, equipment taken on lease is evaluated depending on their level
of depreciation. Some of the examples of assets are as follows:
Precious Metals/Commodities

Not all investments are towards businesses or a pool of funds. Some of them are towards real
assets like precious metals or natural resources. Investing in grains, gold, silver, or other
precious metals has been preferred for ages, and they continue to be the best hedge against
market movements and currency fluctuations. Investors can invest in gold either through gold
coins, bullions, or indirectly through sector traded funds or exchange-traded funds.
Real estate

Real estate is yet another effective alternative investment for investors. Investing in plots,
houses, and reaping rental yields or commercial assets are some of the direct ways of
investing in real estate. Investors, however, can also invest in real estate indirectly
through Real Estate Investment Trusts (REITs). This type of investment is driven by the low
co-relationship between equity markets and real estate that helps in ideal hedging against
inflation.
Collectibles

Stamps, artwork, and vintage wine are normally considered mere prestigious souvenirs.
However, they are highly valuable assets for investors who are aware of how profitable these
collectibles are to invest in. Coins, art, and stamps are asset classes preferred for such
tangible alternative investments.

#2 – Intangible Investments
Intangible investment is made in assets that cannot be seen or checked, but the status and
value of which could be monitored and assessed based on their market performance. Some of
the asset classes that belong to these alternative investments types include:

Hedge funds

Hedge funds are alternative investment vehicles catering to investors with ultra-deep pockets.
In the United States, hedge funds are considered accredited investors’ options. As a result,
they are not regulated as mutual funds and give investors leeway to invest in a broader range
of securities. One thing that distinguishes hedge funds from other alternative investments is
their liquidity quotient. These funds can sell off in minutes due to their increased exposure to
liquid securities.
Private equity

The equities not listed on stock exchanges fall under the private equity label. These are funds
that institutional investors or HNWIs directly place in private companies or use in
the buyout of public companies. The firms, in turn, utilize the capital for their inorganic
and organic growth while expanding their footprint, increasing marketing operations,
technological advancement, and making strategic acquisitions.
Venture capital

Venture capital refers to the type of investment where investors spend on equity capital in
private startups, having exceptional potential for growth. The concept might sound similar to
the private equity concept, but it’s not as it invests equity capital into mature companies.
Venture capitalists usually invest in seed and early-stage businesses, while some invest at the
expansion stage. The investment horizon is typically between 3-7 years. The expected
return rate is quite high, which is a natural outcome owing to the risk quotient associated with
the investment.
Cryptocurrency

The Generally Accepted Accounting Principles

(GAAP) consider cryptocurrency an intangible asset. These currencies are recorded at
acquisition cost, which is either the price paid or the cost considered. Plus, their impairment
cost is also observed and recorded after proper testing and evaluation. According to Forbes,
the value of the cryptocurrency can be reduced over time while recorded in a balance sheet.

WHAT ARE ALTERNATIVE INVESTMENTS?

Alternative investments are asset classes that aren’t stocks, bonds, or cash. These kinds of
investments differ from traditional investment types because they aren’t easily sold or
converted into cash. It’s also common for alternative investments to be referred to as
alternative assets.

One of the most dynamic asset classes, alternatives cover a wide range of investments with
unique characteristics. Many alternatives are becoming increasingly accessible to retail, or
individual, investors—making knowing about them increasingly important for all types of
investors and industry professionals.

These types of investments can vary wildly in their accessibility and structure, but they share
a few key characteristics:

 They're more lightly regulated by the US Securities and Exchange Commission

(SEC) than traditional investments.
 They're illiquid, meaning they can’t be easily sold or otherwise converted to cash.
 They have a low correlation to standard asset classes, meaning they don’t
necessarily move in the same direction as other assets when market conditions
change.
While alternative investments share these key traits, they're also a diverse asset class. Here
are seven types of alternative investments everyone should know, what makes them unique,
and how to think about them as investment opportunities.

7 TYPES OF ALTERNATIVE INVESTMENTS

1. Private Equity

Private equity is a broad category that refers to capital investment made into private
companies, or those not listed on a public exchange, such as the New York Stock Exchange.
There are several subsets of private equity, including:

 Venture capital, which focuses on startup and early-stage ventures

 Growth capital, which helps more mature companies expand or restructure
 Buyouts, when a company or one of its divisions is purchased outright
An important part of private equity is the relationship between the investing firm and the
company receiving capital. Private equity companies often provide more than capital to the
firms they invest in; they also provide benefits like industry expertise, talent sourcing
assistance, and mentorship to founders.

2. Private Debt

Private debt refers to investments that are not financed by banks (i.e., a bank loan) or traded
on an open market. The “private” part of the term is important—it refers to the investment
instrument itself, rather than the borrower of the debt, as both public and private companies
can borrow via private debt.
Private debt is leveraged when companies need additional capital to grow their businesses.
The companies that issue the capital are called private debt funds, and they typically make
money in two ways: through interest payments and the repayment of the initial loan.

3. Hedge Funds

Hedge funds are investment funds that trade relatively liquid assets and employ various
investing strategies with the goal of earning a high return on their investment. Hedge fund
managers can specialize in a variety of skills to execute their strategies, such as long-short
equity, market neutral, volatility arbitrage, and quantitative strategies.

Hedge funds are exclusive, available only to institutional investors, such as endowments,
pension funds, and mutual funds, and high-net-worth individuals.

4. Real Estate

There are many types of real assets. For example, land, timberland, and farmland are all real
assets, as is intellectual property like artwork. But real estate is the most common type and
the world’s biggest asset class.

In addition to its size, real estate is an interesting category because it has characteristics
similar to bonds—because property owners receive current cash flow from tenants paying
rent—and equity, because the goal is to increase the long-term value of the asset, which is
called capital appreciation.

As with other real assets, valuation is a challenge in real estate investing. Real estate
valuation methods include income capitalization, discounted cash flow, and sales
comparable, with each having both benefits and shortcomings. To become a successful real
estate investor, it’s crucial to develop strong valuation skills and understand when and how to
use various methods.

5. Commodities

Commodities are also real assets and mostly natural resources, such as agricultural products,
oil, natural gas, and precious and industrial metals. Commodities are considered a hedge
against inflation, as they're not sensitive to public equity markets. Additionally, the value of
commodities rises and falls with supply and demand—higher demand for commodities
results in higher prices and, therefore, investor profit.

Commodities are hardly new to the investing scene and have been traded for thousands of
years. Amsterdam, Netherlands, and Osaka, Japan may lay claim to the title of the earliest
formal commodities exchange, in the 16th and 17th centuries, respectively. In the mid-19th
century, the Chicago Board of Trade started commodity futures trading.

6. Collectibles

Collectibles include a wide range of items such as:

 Rare wines
 Vintage cars
 Fine art
 Mint-condition toys
 Stamps
 Coins
 Baseball cards
Investing in collectibles means purchasing and maintaining physical items with the hope the
value of the assets will appreciate over time.

These investments may sound more fun and interesting than other types, but can be risky due
to the high costs of acquisition, a lack of dividends or other income until they're sold, and
potential destruction of the assets if not stored or cared for properly. The key skill required in
collectibles investment is experience; you have to be a true expert to expect any return on
your investment.

7. Structured Products

Structured products usually involve fixed income markets—those that pay investors dividend
payments like government or corporate bonds—and derivatives, or securities whose value
comes from an underlying asset or group of assets like stocks, bonds, or market indices.
Examples of structured products include credit default swaps (CDS) and collateralized debt
obligations (CDO).

Structured products can be complex and sometimes risky investment products, but offer
investors a customized product mix to meet their individual needs. They're most commonly
created by investment banks and offered to hedge funds, organizations, or retail investors.

Structured products are relatively new to the investing landscape, but you’ve probably heard
of them due to the 2007–2008 financial crisis. Structured products like CDO and mortgage-
backed securities (MBS) became popular as the housing market boomed before the crisis.
When housing prices declined, those who had invested in these products suffered extreme
losses.
Alternative Investment Strategies

Formulating strategies to crack the best investment deals is a must. As traditional investment
options are widely available, the data and information available on assets are accessible.
Thus, framing effective traditional investment strategies becomes easier.

On the other hand, alternative investments, which involve only accredited investors to invest
in the assets and securities, make available very limited information. Thus, the formulation
of alternative investments strategies rests on the shoulders of fund managers, who remain
updated and keep on studying the current and historical market trends.
While framing strategies to deal with alternative funds, there are a few things that need
careful consideration:

 The United States Securities and Exchange Commission (SEC) does not regulate
these investments.
 They possess a low liquidity rate, which means they are tough to sell or convert to
cash.
 They are less correlated to the market. It means the prices do not move in the same
direction as the market. In short, these are less volatile investments.

Examples

Let’s consider the following alternative investments examples to understand the type of
them available in the market:

Example #1

HNWI Sarah began her search for an asset that would remain unaffected even if the market
fluctuates. She consulted a stock advisor, Joe. He advised her not to go for traditional paper
assets, like individual stocks or bonds. Rather, he suggested opting for commodities like oil,
grain, gold, other metals, and natural gas less affected by the negative market movements. In
addition, he told Sarah that investing in tangible commodities will mean having a shield
against loss. Thus, the investor followed Joe’s advice and invested at least 5% of the portfolio
in tangible investments.

Example #2

The private equity industry has been out of regulatory supervision since its birth in the 1940s.
However, after the 2008 financial crisis, it has been labeled under the purview of the Dodd-
Frank Wall Street Reform and Consumer Protection Act. In addition, there has been an
increased call for transparency in recent times, and the US Securities and Exchange
Commission (SEC) has started collecting data on private equity firms.

Hedge Funds

Hedge mutual funds are a type of mutual fund that are set up as private investment limited
partnerships. Confused? Well this product is a bit complex.
In Securities and Exchange Board of India (Sebi’s) words, “Hedge funds, including fund of
funds, are unregistered private investment partnerships, funds or pools that may invest and
trade in many different markets, strategies and instruments (including securities, non-
securities and derivatives) and are not subject to the same regulatory requirements as mutual
funds.”

There are different types of hedge funds depending on the securities they invest in and the
kind of strategies used to manage them.

Regulatory requirements:

Hedge funds in India do not need to be necessarily registered with Securities and Exchange
Board of India (Sebi), our markets regulator or disclose their NAVs at the end of the day. All
other mutual funds are required to follow these regulatory requirements.

How do Hedge funds work?

These funds use different types of trading techniques because of the securities and assets they
invest in. They invest in equities, debt and also derivatives.

Examples of derivatives include futures and options. Like with equities and debt securities,
the trading technique could be trading in a stock market or buying it directly from the
company in a private placement.

For example, with futures, there is a right or an obligation to buy or sell an underlying stock
at a pre-determined price, date and time. Options trading are the same but without an
obligation. Investing in such securities automatically diversifies trading techniques.

Hedge mutual funds pool money from larger investors like high networth individuals (HNI),
endowments, banks, pension funds and commercial firms. They fall under the AIF
(alternative investment funds)-category III. This pooled money is used to invest in such
securities in national and international markets.
There is a long list of securities where hedge mutual funds can invest: Equities, bonds, real
estate, currencies, convertible securities, derivatives among others.

What are the different types of hedge funds in the market?

There are mainly three types:

 Domestic hedge funds: Domestic hedge funds are open to only those investors that
are subject to the origin country’s taxation.

 Offshore hedge funds: An offshore hedge fund is established outside of your own
country, preferably in a low taxation country.

 Fund of funds: Fund of funds are basically mutual funds that invest in other hedge
mutual funds rather than the individual underlying securities.

What are the different strategies of hedge fund investing?

These funds can also be categorised by the complex strategies their fund managers adopt to
maintain their funds.

 Event driven: There are few event driven hedge mutual funds that invest to take
advantage of price movements generated by corporate events. For example: merger
arbitrage funds and distressed asset funds.

 Market neutral: There are also some market neutral funds that seek to minimise
market risks. This category included convertible bonds, short and long equity funds
and fixed income arbitrage.

 Long/Short selling: By definition, short-selling means that you sell a security without
actually buying it but with the notion of buying it at a predetermined future date and
price. You hope for the share price to drop on this predetermined future date and book
profits.
  Arbitrage: An arbitrage-oriented strategy means buying a security in one market
where the security is trading at a lower price and then selling the same security at a
higher price in another market to book some profit. This can also be used for buying
and selling two very highly correlated securities simultaneously to book profit when
markets are moving sideways. This is called relative value arbitrage. Both the
securities could be from one asset class or multiple ones.

 Market-driven: Hedge mutual funds also take advantage of global market trends
before they make the decision to invest in securities. They look at global macros and
how they will impact interest rates, equities, commodities and currencies.

These categories comprise the top hedge funds that are available in the market. However,
there are also some other pooled investment vehicles which have some similarities with the
varying types of hedge funds.

Fees and minimum investment:

The fee structure consists of both: a management fee which is generally less than 2% and a
profit sharing technique which varies between 10 to 15%. The minimum ticket size to invest
in hedge mutual funds is Rs 1 crore per investor and an entire fund needs to have a minimum
corpus of Rs 20 crore.

How are hedge mutual funds taxed?

These funds fall under category III AIF and are taxed according to taxation rules applicable
to AIF category III. Category III AIF, as of now, are not considered as pass through vehicles.

This means that the fund on the whole has to pay a tax when it realises gains or gets income
in any form. In other words, hedge mutual funds are taxed at the fund level.
The tax obligation will not be passed through to the unit holders or its investors. This may be
one of the reasons why they have not been able to take off in India. The high tax burden acts
as a deterrent.

The taxes are withheld before the profits are distributed to you. This automatically curbs the
returns that finally end up with the domestic investors.

What are Risk and Return Profile of Hedge Funds?

The aforementioned points on relaxation of regulatory requirements speaks volumes on the

high risk level that this product carries.

Apart from the fact that the underlying securities that top hedge funds invest in also carry
high risk, the product is not legally bound for a Sebi registration or disclosure of NAV. These
two points keep the rest of the funds under a close watch and closely regulated. This does not
mean that Sebi leaves these funds unattended but no legal binding does work the risk level
upwards.

We all know that risk and returns are directly proportional. Hedge fund returns, just like its
risks, are on the higher side. Average annual returns can go as high as 15% as well and the
credit for this is attributed to the hedge mutual fund managers.

Who should invest in Hedge Funds?

Since hedge funds are those mutual funds that are managed by experts, they tend to be quite
costly. They can be easily afforded by those who are financially sound, have surplus funds,
and have a good risk appetite.

Also, if you are a beginner, you might need the assistance of a fund manager to take care of
your hedge funds. Such managers have a high expense ratio i.e the fee charged by them is
quite heavy. Thus, consider investing in hedge funds once you have substantial experience in
the field or you find a fund manager whom you can trust confidently.

How are hedge mutual funds different from mutual funds?

The basic structure of these funds is just like other mutual funds. They are a pooled
investment vehicle. They collect money from a pool of investors and use that money to invest
in other assets and there is a fund manager who manages the fund as well.

Here’s a table that explains the difference between mutual funds and hedge funds:

Sr Category Hedge Mutual Funds Mutual funds

No.

1. Regulatory No sebi registration required or disclosure of Disclosure of NAVs at the end

requirements NAVs of the day is necessary

Sebi registration is mandatory

2. Investor category HNIs, banks, commercial firms, Any domestic investor

3. Underlying Equities, money market instruments, Equities, money market

securities currencies, real estate, derivatives, instruments, cash
convertible securities

4. Risk Very high Comparatively lower

5. Minimum ticket Rs 1 crore Not uniform but as low as Rs

size 500 in some funds

6. Minimum corpus Rs 20 crore for a hedge fund Not defined

7. Investment Short selling permitted Mutual funds cannot do short

 strategy selling

Things to keep in mind before investing in hedge mutual funds

 Complicated products: These funds in short-selling and derivatives trading. Such

trading techniques are adopted only by larger investors. If you are looking to invest,
you need to be prepared for a whole lot of research and investment tracking from your
end.

 Risky: Dealing in derivatives does make the product risky but what adds to the risk
element is the low level of regulation. Sebi does not require hedge mutual funds to be
registered with them so the fund and their investors are kind of on their own.

 Expensive: The minimum investment ticket size is Rs 1 crore so for a regular

investor, putting in such a huge amount in one investment may not be feasible.

 Returns: Hedge fund returns are volatile so you need to be prepared for dips and
upsides both.

Hedge mutual funds are complex in their structure and strategy. They invest in almost every
asset so they are heavily diversified however strategies like arbitrage and long/short selling
keeps it higher on the risk rack. As an investment product, explore these only if they align
with your goals and do your due diligence in research before proceeding.
Real Life Financial Planning Case Study

Dear reader,

As part of our renewed “Yours, Personally”, we have introduced a monthly case study – the
simulation of a real life financial planning situation. We will present the case, and we
encourage you to go through it and write in to us with what you think is the best solution for
this case.

If you present the best solution you will win a 20% discount on your own Financial Plan
built by PersonalFN!

Read on for your first case study – and good luck!

Team PFN

WHAT TO DO WHEN YOUR SAVINGS DON’T SEEM TO BE ENOUGH

Meet Ram.
Ram is 30, has recently gotten married to Sapna who is 27, and he and his wife are planning
to have their first child in 3 years. He lives in a comfortable although small apartment of his
own, in a building where the society bills are very high due to major maintenance work that is
required.

Ram’s Financials
His current annual income is Rs. 10.80 lakhs, that is Rs. 90,000 per month after taxes.
His family household monthly expenses are roughly Rs. 50,000 (including building
maintenance expenses of Rs. 15,000 per month). He invests Rs. 35,000 per month, and saves
Rs. 5,000 per month. He expects his salary to grow at 10% per year. Sapna is a home maker
and hence is not earning. He had a family medical insurance that covers Sapna and himself,
for which he pays Rs. 12,000 per year. His company does not provide medical insurance. He
has no other insurance. His accumulated EPF is Rs. 40,000 and he invests Rs. 780 per month
into his EPF, which his employer matches.

Ram’s Assets and Liabilities

Ram has no liabilities.
He has a PPF account where he invests Rs. 70,000 per year and wants to continue doing so.
The current value in the account is Rs. 11 lakhs. Ram has equity mutual funds worth
approximately Rs. 4.50 lakhs, and direct equity of Rs. 1.50 lakhs. He has liquid funds worth
Rs. 75,000. Thus totally by the age of 30, Ram has accumulated Rs. 18.50 lakhs across debt,
equity and liquid funds. He has no gold exposure. His residential home is worth Rs. 2 crore
so his total net worth is Rs. 2.18 crore, distributed as follows:

Ram’s Life Goals

1. The first thing on Ram’s mind is shifting to a bigger or even a same size apartment, in a
better building. The value of his house currently is around Rs. 2.00 crore, and he knows that
if he wants to move to a better location he will need to sell his current home and also spend
an additional Rs. 50 lakhs to move into a Rs. 2.50 crore apartment. This is something that
Ram does not want to compromise on. He plans on taking a Rs. 50 lakh home loan but
doesn’t know if this is the best option for him, as he also wants to save for his retirement. He
would like to do this immediately i.e. in 2012.

2. Ram wants to buy a new small car, worth say Rs. 4 lakhs. He doesn’t mind a second hand
car. He can sell his existing vehicle and will get Rs. 1 lakh sale value. He would like to do
this in 2012 as well.

3. Ram wants to provide for a medical contingency corpus of Rs. 5 lakhs within 4 years i.e.
by 2015.

4. Since his wife and he are planning a child in 3 years time, he wants to spend Rs. 20 lakhs
in today’s terms on the child’s higher education, to be achieved when the child turns 18 that is
in 2032.

5. He would like to take his family on annual vacations worth Rs. 2 - 2.50 lakhs per year, but
this is a very low priority goal and he doesn’t mind if he doesn’t achieve this.
6. Ram would like to retire at the age of 60 in 2041. His post retirement life expenses will be
Rs. 35,000 per month.

Ram’s primary concern is shifting out of his current house into a newer building, and building
a medical contingency fund.

Ram’s brother Shyam has been trying to convince Ram that taking such a large home loan
right now is not a good idea, as with a Rs. 50 lakh home loan, the EMI will be Rs. 50,000 per
month for 20 years. This means that for the next 2-3 years Ram will have to stop all other
investments and only pay his EMI and his household expenses. Instead, he recommends Ram
to invest in a much smaller property as an investment, with a Rs. 20 lakh home loan, and give
it out on rent. When the property appreciates in value, he can sell it, repay his home loan, and
will have made a tidy profit on the sale.

Ram is also concerned about the markets right now. His brother has been telling him that now
is a good time to invest in equity, as the markets are falling so he will be able to buy low.
Ram however feels that the volatility in the equity markets is too much for him to tolerate,
and he would rather redeem his funds and go into debt.

So here are the questions:

1. Are Ram’s priorities in order? Should he first plan for his retirement and then worry about
moving to a better building? Or should Ram take the home loan?

2. Ram has very broad knowledge of insurance and wants to take a ULIP with his wife as the
nominee. He wants to know if this is a good idea, and how much premium should he invest
per year.

3. How should Ram structure his finances to achieve his life goals?