SUBJECT : PERSONAL FINANCIAL PLANNING

SEMESTER : B.COM V

SESSION: 2020-21

UNIT 1 CHAPTER 2 INVESTOR LIFE CYCLE

Topics to be Covered:

(1).Meaning of investor and investement.

(2). Phases of Human Life Cycle

(3). Phases of Investor Life Cycle

(4). Financial Objectives of an investor

(5). Risk Profiling of an investor.

 1. Meaning Of Investor:

An individual investor is a person who manages his/her own money in order to achieve personal
financial goals. Therefore, an individual investor needs to know the stock market thoroughly, inside
and out. An individual investor studies financial news, earnings reports, and so on, in order to make the
most informed decisions regarding personal investing. Most of the research an individual investor does
tends to be via the Internet. In fact, trading through the Internet has become a very popular way for an
individual investor to conduct business.

An investor is a party that makes an investment into one or more categories of assets --- equity, debt
securities, real estate, commodity, derivatives such as put and call options with the objective of
making a profit

So it can be concluded that a investor is a person who contributes his money in some or other
investment opportunities in order to earn profit in return.

There are different categories of investors. The investment strategies differ from each other,
with regard to size of the investment, time-period, objectives, risk appetite etc. The investors
can be classified into:
Individual investors
Corporate investors
Institutional investors – Domestic and Foreign
Pension Funds
Government
The investor talked about in the present context refers only to individual investors

2. Meaning Of an Investment:

Investment is any vehicle into which funds can be placed with the expectation that it will generate
positive income and/or that its value will be preserved or increased.

An investment is an asset or item acquired with the goal of generating income or appreciation. In an
economic sense, an investment is the purchase of goods that are not consumed today but are used in
the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that
the asset will provide income in the future or will later be sold at a higher price for a profit.

An investment is essentially an asset that is created with the intention of allowing money to grow. The
wealth created can be used for a variety of objectives such as meeting shortages in income, saving up
for retirement, or fulfilling certain specific obligations such as repayment of loans, payment of tuition
fees, or purchase of other assets.

Financially speaking, an investment means an asset that is obtained with the intention of allowing it to
appreciate in value over time. Generally, investments fall in any one of three basic categories, as
explained below.
Investment is using money to purchase assets in the hope that the asset will generate income over
time or appreciate over time. Consumption, on the other hand, is when you purchase something with
the immediate intent of personal use and with no expectation that it will generate money or increase
in value.
Investment also helps grow the economy because it creates economic activity, such as the buying and
selling of goods and services and employing people. Employed people get paid and either save, invest,
or spend their money. If they spend their money, businesses make more profits. Businesses can then
reinvest the profits in further business activities that expand the economy.
Investment or investing means that an asset is bought, or that money is put into a bank to get a
future interest from it. Investment is total amount of money spent by a shareholder in buying shares of
a company. In economic management sciences, investments means longer-term savings.
It is a term used in business management, finance and economics, related to saving or
deferring consumption. Literally, the word means the "action of putting something in to somewhere
else"

Types of Investments

1. Ownership Investments

Ownership investments, as the name clearly suggests, are assets that are purchased and owned by the
investor. Examples of this kind of investment include stocks, real estate properties, and bullion, among
others. Funding a business is also a kind of ownership investment.
2. Lending Investments

When you invest in lending instruments, you’re essentially behaving like the bank. Corporate bonds,
government bonds, and even savings accounts are all examples of lending investments. The money you
park in a savings account is basically a loan that you give the bank. This money is used by the bank to
fund the loans it gives out to its customers.

3. Cash Equivalents

These are investments that are highly liquid and can easily be converted into cash. Money market
instruments, for instance, are excellent examples of cash equivalents. Cash equivalents generally offer
low returns, but correspondingly, the risk associated with them is also negligible.

Examples with meaning of an investments:

(1). the act of putting money, effort, time, etc. into something to make a profit or get an advantage,
or the money, effort, time, etc. used to do this:
Eg: The government wanted an inflow of foreign investment.
Stocks are regarded as good long-term investments.
The account requires a minimum investment of €1,000.
There's been a significant investment of time and energy in order to make the project a success.
(2).the act of putting money or effort into something to make a profit or achieve a result:
Eg: real estate investments

(3). the act of putting money into a business to buy new stock, machines, etc., or
a sum of money that is invested in a business in this way:
investment in research The company has increased its investment in research.
They plan to maintain their current level of investment.
Company made a significant investment in IT.

3.Financial objectives of an investor / Investment:

Before you decide to invest your earnings in any one of the many investment plans available in
India, it’s essential to understand the reasons behind investing. While the individual objectives of
investment may vary from one investor to another, the overall goals of investing money may be
any one of the following reasons.
1. To Keep Money Safe:
Capital preservation is one of the primary reasons people invest their money. Some investments help
keep hard-earned money safe from being eroded with time. By parking your funds in these
instruments or schemes, you can ensure that you don’t outlive your savings. Fixed deposits,
government bonds, and even an ordinary savings account can help keep your money safe. Although
the return on investment may be lower here, the objective of capital preservation is easily met.
2. To Help Money Grow:
Another common objective of investing money is to ensure that it grows into a sizable corpus over
time. Capital appreciation is generally a long-term goal that helps people secure their financial future.
To make the money you earn grow into wealth, you need to consider investment options that offer a
significant return on the initial amount invested. Some of the best investments to achieve growth
include real estate, mutual funds, commodities, and equity. The risk associated with these options may
be high, but the return is also generally significant.

3. To Earn a Steady Stream of Income:

Investments can also help you earn a steady source of secondary (or primary) income. Examples of
such investments include fixed deposits that pay out regular interest or stocks of companies that pay
investors dividends consistently. Income-generating investments can help you pay for your everyday
expenses after you’ve retired. Alternatively, they can also act as excellent sources of supplementary
income during your working years by providing you with additional money to meet outlays like college
expenses or EMIs.
4. To Minimize the Burden of Tax:
Aside from capital growth or preservation, investors also have another compelling incentive to
consider certain investments. This motivation comes in the form of tax benefits offered by the Income
Tax Act, 1961. Investing in options such as Unit Linked Insurance Plans (ULIPs), Public Provident Fund
(PPF), and Equity Linked Savings Schemes (ELSS) can be deducted from your total income. This has the
effect of reducing your taxable income, thereby bringing down your tax liability.

5. To Save up for Retirement:

Saving up for retirement is a necessity. It’s essential to have a retirement fund you can fall back on in
your golden years, because you may not be able to continue working forever. Additionally, it would be
unfair to depend on your children to support you later in life, particularly if they have children of their
own to raise. By investing the money you earn during your working years in the right investment
options, you can allow your funds to grow enough to sustain you after you’ve retired.

6. To Meet your Financial Goals:

Investing can also help you achieve your short-term and long-term financial goals without too much
stress or trouble. Some investment options, for instance, come with short lock-in periods and high
liquidity. These investments are ideal instruments to park your funds in if you wish to save up for short-
term targets like funding home improvements or creating an emergency fund. Other investment
options that come with a longer lock-in period are perfect for saving up for long-term goals.

7. To Invest for education:

Whether you’re saving for a child’s education or planning to return to school yourself, paying tuition
costs definitely requires forethought–and the sooner the better. With college costs typically rising
faster than the rate of inflation, getting an early start and making the most of your savings can make an
enormous difference in reducing or eliminating any post-graduation debt burden.

8. To Invest for a large purchase:

Some purchases are large enough that they require months or years of planning and saving. If you’re
renting an apartment, you may long for the day when you can put a down payment on a home of your
own. Or you might have your eye on a new automobile to replace one that’s seen better days. Or
perhaps you’d like to have a vacation home that you could rent out when you’re not using it. In some
cases, even a major appliance can be expensive enough that you need to give some thought to how
you’ll pay for it.

With all such purchases, your time horizon is particularly critical. For a purchase that’s six months
away, you probably can’t afford to be as aggressive as you might for one that’s several years off; your
priority for that money would be on assets aimed at capital preservation, such as CDs, money market
accounts, and other cash alternatives.

However, consider also the potential downside risk of not achieving your financial goal. If you’re saving
for your first home, you’ll want to make sure the money for the down payment is available at the time
of purchase; a loss at the wrong time could cripple your plans and cause major inconvenience. By
contrast, if the timing of your purchase isn’t critical, or you wouldn’t suffer greatly if your dream didn’t
come true, you might be willing and able to take greater risk with that portion of your investments.
 4.INVESTOR’S LIFE CYCLE:

Investors life cycles contains different stages, which shows the different phases of individual investor
in his/her investment life, It also include both short term and long term investments.

From finance point of view human cycle is divided into three phases :

Phase I : Ist 22- 23 years Education

Phase 2: After that till 38- late 50’s Earning

Phase 3 : Retirement & Post retirement.

❖ Depending upon this human cycle investor life cycle of an individual is base.

Individual investor life cycle indicates the investment behaviour of investor over the different age of
their life. The investment decision is based on the age, financial condition, future plans and risk
characteristics of an individual.
Investor mainly invests in getting a return which can compensate the sacrifice of present for more
future earnings and security. As a financial plan investor can adopt different insurance policies or
reserve cash for future. Although investor has to take risk of reserving cash or investing the cash they
are ready to take some risk according to their risk-taking behavior.

An investor passes through four different phases in life

• Accumulation Phase

• Consolidation Phase

• Spending Phase

• Gifting Phase

Accumulation Phase

Investor early or middle to their career tries to accumulate fund so that individual can have money to
spend in the later phase of their life. Some people accumulate the fund to buy house, car or other
important assets and some people accumulate for their children’s education cost, life peaceful life
after retirement.

Funds invested in the early phase of life gives an investor a huge amount of fund which is compounding
over the years
Consolidation Phase

Consolidation phase is the midpoint of their career, in this phase, they earn more, spends more and
pay off all their debts. In this phase moderately high risk taken by the investor but for capital
reservation some investor prefer lower risk investor. Individual invest in the capital market and
investment securities.

Spending Phase

This phase starts when an individual retires from the job. Their overall portfolio is to be less risky than
the consolidation phase; they prefer low risky investment or risk-free investment. People prefer fixed
income securities like a bond, debenture, treasury bills etc. In this phase, they need some risky investor
if they have extra money so that future inflation can be adjusted.

Gifting Phase

If individuals believe that they have enough extra funds to meet their current and future expenses then
they go for gifting money to their friends, family members or establish charitable trusts. These can
reduce their income taxes and they also keep some fun for future uncertainties.

Over the different phase, investor behaves differently and invest in their preferred sector according to
their risk-taking behavior.
 5. Risk Profiling Of an Investor:

What is Risk Profile?

Risk profile is a measure of how much risk should one be taking in one's investments considering all the
factors like one's financial situation, need and attitude towards losses.

Since most of these factors are personal, risk profile varies from individual to individual.

What is Risk Profiling?

Risk profiling is a process that helps you identify the optimal level of risk that is just right for you as an
investor. Your own risk appetite can be best understood after taking into account, the amount of risk
you are able to take, your willingness to take risks and the risk you will need to take to achieve your
financial goals. It is profiled keeping in mind multiple factors such as your habits, behaviours, family
orientation, attitude towards risk, age etc. Risk appetite refers to the amount of risk you have the
capacity to absorb, and this broadly helps determine the asset classes (equity, debt, gold, etc.) and
style of investment that you are comfortable with (growth, value, etc.)
Why is Risk Profiling needed?
Risk profile determines how you should split your money into risky investments like Equity Mutual
Funds and non-risky investments like Debt Mutual Funds or FD.
Why can't we just take a lot of risk and invest when markets (and hence Equity Mutual Funds) are
going to go up and reduce risk and exit when they are going to go down?
Because it is almost impossible to predict when the markets are going to go up and when they are
going to go down.

Even when markets have been going up for a few months or years, any month can turn out to be the
top and markets can start going down from there.

Methods of assessing Risk Profile?

(a) Rules of thumb

There are some popular rules of thumb for determining asset allocation or risk profile of which the one
below is the most well-known:

i.e. if you are 20 years old, then Equity % should be 100-20 = 80%
There are also variations of this, eg 120 - Age etc.

Another rule of thumb is to just split it equally i.e. 50-50.

(b).Risk Profile Questionnaire

A Risk Profile Questionnaire is a set of questions that have been thoughtfully framed to uncover the
various factors that determine an individual investor's risk profile.

It is not a quiz or test in the sense that there are no right or wrong answers. As long as you are
answering truthfully, you are being correct.

Based on the responses to the questions, either an objective scoring method or a human advisor
computes the Risk Profile of the investor.

Usually Risk Profile Questionnaires measure Risk Profile as Low, Moderate or High rather than specific
Equity-Debt % allocations since the exact allocation would depend on a lot of other things (time
horizon and purpose of the goal for eg).

It is a more comprehensive and useful way of measuring risk profile of investors as compared to
simplistic rules of thumb.

Components of Risk Profile assessment:

There are three components of an individual's risk profile:

1. Capacity to take risk

2. Risk tolerance
3. Need to take risk
All three together determine the risk profile of an investor.

(A).Capacity to take risk

Capacity to take risk or Risk Capacity is simply a measure of how much risk you are capable of taking
given your current financial situation.

(Note: Just because you are capable of taking a particular risk does not mean that you should.)

Your financial situation involves the following:

1. Age

Age plays a huge role in your capacity to take risk. Younger investors have a longer time horizon to
invest for and they also have an income stream that will keep increasing for a long time. Hence, they
can take more risks than older investors who might be looking to conserve wealth as they near
retirement.

2. Nature of income

If your income is unpredictable (eg freelancers, seasonal income sources) then your ability to deal with
losses on your investments will be low. However, if your income stream is predictable and upward
trending, then you can take higher risk with your investments.

3. Amount of savings till date

If you don't have enough savings then taking high risk with whatever little amount you are saving is not
be advisable. Typically, higher the savings, higher the risk you can take.

4. Dependents

If there are people who are dependent on your income (eg retired parents, non-earning spouse), that
constrains your ability to take risks in life. Same applies to your investments as well. On the other hand,
if you and your spouse are boh earning and your parents are not dependent on you, then you can take
higher risks given other factors are also aligned.

Capacity to take risk is just one of the components of your risk profile. Just because someone has a
high capacity to take risk because of her sound financial situation does not mean she can stomach that
risk.

(B).Risk Tolerance/Appetite
Risk Tolerance or Risk Appetite or Preference for risk measures your psychological attitude towards risk
and losses. It is the willingness or appetite of investor to take risk.

Do you start feeling worried when you see losses or you can take them in your stride?

How much money can you lose without losing your sleep?

This is the most difficult to judge aspect of risk profile because it deals with emotions in a hypothetical
situation.
Investors investing under a high risk profile pinging us on chat worried after a 5% loss is not uncommon
at Goalwise.

Risk tolerance is not static. People change and so do their attitudes towards risk. Some of the factors
that affect your risk tolerance are:

1. Knowledge

Warren Buffett said - "Risk comes from not knowing what you are doing."

So one of the ways to reduce your risk (or increase your risk tolerance) is simply to get to know more.

Just like knowing how parahcutes work gives some people confidence in jumping out of an airplane,
knowledge about how investments work and their past behaviour can give you greater confidence in
investing, there by increase your risk tolerance.

2. Past experience

Once you have gone through a complete cycle of markets ups and downs without panicking, you will
see that it eventually does work if you stick through. Then going forward it will become easier for you
to stay put in the face of losses.
If you have never invested in Mutual Funds before or have not been through a down cycle or market
crash, it is better to assume you don't really know how much loss you can tolerate before pressing the
panic button.

(C).Need to take risk

Capacity to take risk and risk tolerance are the two major components of your risk profile but there is
one more aspect that needs to be taken into account - your need to take risk.

Imagine that you have a high capacity to take risk and also have a high risk tolerance but all your
financial goals are already complete. You can just keep your money in a savings account or FD then.
There is no need to take any more risk.

Although this is an extreme case, but if you start early, save a lot and plan well, you can get to a stage
in life later where you would have enough so that there will be little need to take on much risk.

How to combine Risk Capacity, Risk Tolerance and Need to take risk:
This is the most important part of determining one's risk profile.

Most questionnaires just take an average of the score on different components of risk profile.

E.g. If you have a high risk taking capacity (because you are young, have no dependents and a stable
job), low risk tolerance (don't really like the idea of seeing your investments in a loss) and moderate
need to take risk (your financial goals won't be met just by saving), your risk profile will be computed
as an average of high, low, and moderate i.e. moderate.

A better way is to use all the components as limiting factors i.e. take the minimum of the three
components - if you have high capacity to take risk, low risk tolerance and moderate need to take risk,
your risk profile is low.

ASSET ALLOCATION/INVETEMENT PATTERN ON THE BASIS OF RISK PROFILE:

❖ Your asset allocation can be created based on your risk profile. Asset allocation implies deciding
what proportion of your investments should be in various asset classes (equity, debt, etc.).
❖ Based on a comprehensive assessment of an investor’s risk capacity and risk tolerance, an
investor can be broadly categorized under any one of these risk profiles and the resultant asset
allocation:

❖ Risk profile Investor profile Possible asset allocation

Very low risk capacity and tolerance;
unable to take on risk due to having too
Equity: 0-10%
Very low risk many financial obligations and/or
Debt and cash: 90-100%
modest income and wealth build up; has
low tolerance towards risk.
Low risk capacity and tolerance; cannot
take on too much risk due to having
Equity: 10-30%
Low risk financial obligations and/or modest
Debt and cash: 70-90%
income and wealth build up; has low
tolerance towards risk; slightly higher
 ❖ Risk profile Investor profile Possible asset allocation
risk profile as compared to the ‘Very low
risk’ investor.
Medium level of risk capacity and
tolerance; can take on risk but not too
much due to financial obligations and/or
Equity: 40-60%
Medium risk modest income and wealth build up; has
Debt and cash: 40-60%
low-medium tolerance towards risk;
higher risk profile as compared to the
‘Low risk’ investor.
High level of risk capacity and tolerance;
can take on risk; financial obligations are
taken care of; has good income and
Equity: 70-90%
High risk wealth build up; has medium-high
Debt and cash: 10-30%
tolerance towards risk; higher risk profile
as compared to the ‘Medium risk’
investor.
Very high level of risk capacity and
tolerance; can take on risk; financial
obligations are taken care of; has good Equity: 90-100%
Very high risk
income and wealth build up; has high Debt and cash: 0-10%
tolerance towards risk; higher risk profile
as compared to the ‘High risk’ investor.

So, when you are looking for investment options, you should match the risk they could expose you to,
with your own risk appetite. For example, if you want to buy a 3 BHK house in 7 years, you should
invest in instruments that are moderately risky such as mutual funds, gold, corporate bonds and so on.
There could also be instances where there is a mismatch in your Risk capacity and Risk tolerance,
where you might have the capacity to take more risk but are unwilling to do so, or vice versa. So if you
don’t assess your risk profile comprehensively before you invest actively, you may end up being
uncomfortable with your investments.

For instance, you may have invested in a risk averse manner despite being able to, or being
comfortable with taking on a higher level of risk. This would eventually make you feel unhappy as you
will not be satisfied with the returns generated by your investments .
To access your risk profile there are a number of risk profiling tools and questionnaires that you can
use to assess your investment risk profile, some of which are easily available online. Assessing your risk
profile before making your investments is important since it helps you understand your investment
orientation before you build your investment plan, thereby increasing the likelihood of your sticking to
the plan over the long term. In other words, you are satisfied with the level of balance between risk
and returns while you are investing. Without assessing your risk profile appropriately, you may end up
being uncomfortable with your investments, because the risk inherent in the investments is too high
and you are not satisfied with the returns generated by the investments or because the risk inherent in
the investments is low while you may be comfortable with taking on higher risks to generate higher
returns.

***END***
SHORT ANSWER TYPE QUESTIONS:

1. Define investor and investment.

An investor is a party that makes an investment into one or more categories of assets --- equity,
debt securities, real estate, commodity, derivatives such as put and call options with the
objective of making a profit.

Investment is any vehicle into which funds can be placed with the expectation that it will
generate positive income and/or that its value will be preserved or increased.

An investment is an asset or item acquired with the goal of generating income or appreciation. In an
economic sense, an investment is the purchase of goods that are not consumed today but are used in
the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that
the asset will provide income in the future or will later be sold at a higher price for a profit.

2. What are the various types of investement?

1. Ownership Investments

Ownership investments, as the name clearly suggests, are assets that are purchased and owned by the
investor. Examples of this kind of investment include stocks, real estate properties, and bullion, among
others. Funding a business is also a kind of ownership investment.
2. Lending Investments

When you invest in lending instruments, you’re essentially behaving like the bank. Corporate bonds,
government bonds, and even savings accounts are all examples of lending investments. The money you
park in a savings account is basically a loan that you give the bank. This money is used by the bank to
fund the loans it gives out to its customers.

3. Cash Equivalents

These are investments that are highly liquid and can easily be converted into cash. Money market
instruments, for instance, are excellent examples of cash equivalents. Cash equivalents generally offer
low returns, but correspondingly, the risk associated with them is also negligible.

3. What are the financial objectives of an investment?

1. To Keep Money Safe:

2. To Help Money Grow:
3. To Earn a Steady Stream of Income:
4. To Minimize the Burden of Tax:
5. To Save up for Retirement:
6. To Meet your Financial Goals:
7. To Invest for education:
8. To Invest for a large purchase:

4. What is risk Profiling?

Risk profiling is a process that helps you identify the optimal level of risk that is just right for you
as an investor. Your own risk appetite can be best understood after taking into account, the
amount of risk you are able to take, your willingness to take risks and the risk you will need to
take to achieve your financial goals. It is profiled keeping in mind multiple factors such as your
habits, behaviours, family orientation, attitude towards risk, age etc. Risk appetite refers to the
amount of risk you have the capacity to absorb, and this broadly helps determine the asset
classes (equity, debt, gold, etc.) and style of investment that you are comfortable with (growth,
value, etc.).

5. What are the components of risk profile?

There are three components of an individual's risk profile:

1. Capacity to take risk

2. Risk tolerance
3. Need to take risk
POSSIBLE LONG QUESTIONS FROM CHAPTER:

1. Explain various phases of investor life cycle in detail.

2. What is risk profiling process? How assets can be allocated on the basis of risk profile of an
investor.