Theory and Practice. Sid Mittra, Ph.D., CFP Emeritus Professor of Finance, Oakland University, Michigan

Transcription

1 Financial Flanning Theory and Practice Sid Mittra, Ph.D., CFP Emeritus Professor of Finance, Oakland University, Michigan Shailendra Kumar Rai, Ph.D. Assistant Professor of Finance, Management Development Institute, Gurgaon Anandi P. Sahu, Ph.D. Professor and Chair of Economics, Oakland University, Michigan Harry Starn, Jr., MBA, MS, CFP Executive Faculty, California Lutheran University, California ÜSAGE I TEXTS Los Angeles London New Delhi Slngapore Washington OC

2 Detailed Contents Foreword by M. Damodaran Preface to the First Indian Edition About the Authors Acknowledgments xv xvii xix xxi Part 1 Introduction to Financial Flanning and Basic Tools Chapter 1 Emerging Role of the Financial Planner 3 An Awakening Giant 3 Challenges for the Financial Flanning Community in India 4 The New Indian Dream 5 Concept of Financial Planning 8 Science and Art of Financial Flanning 10 The Client 11 Coordination with Other Professionals 14 Competence 16 Commitment to Ethics 18 Chapter 2 Personal Financial Planning Process 20 Introduction 20 Nature and Structure of Engagement 21 Collect Qualitative and Quantitative Data 24 Develop Assumptions/Analyze Financial Data 27 Analysis of Altemate Solutions 28 Implementation of Recommendations 32 Plan Implementation Timeline 32 Monitor and Review the Plan 33 Professional and Regulatory Standards 33 Chapter 3 Time Value of Money: The Universal Tool 35 Introduction 35 Simple Interest 35 Future Value: Fixed Sum 36 Present Value: Fixed Sum 40 Future Value: Annuity 41 Present Value: Annuity 43 Annuity Due: A Refinement 44 Present Value of Perpetuity 45 Nominal versus Effective Interest Rate 46 Role of Inflation in Financial Calculations 47 Internal Rate of Return 48 Problem Solving with the HP-12C Calculator 48 Budget Planning 49 Educational Planning 49 Insurance Planning 50

3 viii Financial Planning Investment Planning 54 Income Tax Planning 55 Retirement Planning 56 Part 2 Risk Management Planning Chapter 4 Life Insurance: Structure, Concepts, and Planning Strategies 61 Section I: Risk Management 61 Introduction 61 Theory of Risk Transfer: Risk Evaluation 61 Risk-management Strategy 62 Section II: Individual Life Insurance Policies 64 Introduction 64 Basic Types of Life Insurance Policies 66 Life Insurance Contract 76 Taxation of Life Insurance 80 Section III: Life Insurance Planning for the Individual 82 Introduction 82 Client Goals 82 Calculating Life Insurance Needs 83 Policy Selection 84 Insurance Company Selection 88 Section IV: Business Uses of Life Insurance 93 Introduction 93 Business Transfer and Income Replacement 93 Employee Benefits 94 Section V: Life Insurance Needs: A Real-World Example 97 Further Sophistication 99 Section VI: MisceUaneous Life Insurance Issues 100 Capital Maximization Strategy 100 Chapter 5 Health, Homeowner's, Automobile, and Liability Insurance: Structure, Concepts, and Planning 105 Section I: General Principles 105 Introduction 105 Principles of Indemnity and Loss Sharing 105 Insurance against Significant Risks 105 Shopping for Insurance 106 Loss Control through Preventive Measures 106 Organization of Personal Records 106 Section II: Health Insurance 106 Introduction 106 Health Plan Organization 108 Types of Health Insurance 110 Health Insurance Contract 112 Group and Individual Health Insurance 114 Mediclaim Policies 115 Taxation of Health Care Benefits 115

4 Detailed Contents ix Policy Selection: The Ideal Health Insurance Company 115 Health Insurance Planning Process 116 Section III: Disability Income Insurance 117 Introduction 117 Loss Sharing 117 Disability Insurance Contract 118 Group and Individual Disability Insurance 120 Taxation of Disability Benefits 121 Disability Policy Selection 121 Process of Planning for Disability 122 Section IV: Long-term Care Insurance 123 Introduction 123 Long-term Care Contracts 124 Taxation of Benefits 126 Long-term Care Planning Process 127 Who Needs LTC? 128 Disability-to-LTC Conversion Policies 128 Assessing a Family's Health Needs 129 Section V: The Homeowner's Policy 129 Introduction 129 Loss Sharing 130 Policy Forms 130 Major Homeowner Policy Provisions 135 Taxation of Benefits 137 Planning Process 137 Section VI: Automobile Insurance Policy 141 Introduction 141 Basic Coverage of Personal Auto Policy 142 Factors AfFecting Premiums 145 Miscellaneous Considerations 145 No-fault Insurance 146 ASummary 146 Tax Consequence of Settlements Received 147 Planning Process 147 Section VII: Liability Coverage 148 Introduction 148 General Characteristics 149 Director's Liability Insurance 150 Professional Liability Insurance 150 Risk Management Process 150 Part 3 Cash Management and Educational Planning Chapter 6 Cash Management, Savings, Credit, and Debt Planning 155 Introduction 155 Section I: Net Worth and Cash Management Planning 155 Net Worth Planning 155 Cash Management Planning 156

5 x Financial Planning Section II: Systematic Savings Planning 162 Starting Point 163 Goal Setting 163 Effective Savings Strategies 165 Emergency Funding Strategies 168 Criteria for Savings Media Selection 169 Section III: Credit and Debt Planning 173 Debt or Credit? 173 Sources of Consumer Credit 174 Credit History 175 Types of Credit 176 Effective Interest Rate 178 Bürden of Debt 179 Bankruptcy 179 Chapter 7 Educational Planning 182 Introduction 182 Education Costs 183 Magic of Compounding 183 Saving for College Cost 184 Education Savings 185 A.sset Allocation Strategy 185 Instruments of Educational Investment Alternatives 186 Financial Assistance 188 Forms of Financial Aid 188 Repayment of Student Loans 189 Educational Tax Incentives 190 Planning Process 191 Reduction of College Debts 192 Educational Planning: A Real-World Example 193 Education Savings Report 194 Part 4 Investment Planning Chapter 8 Investment Products and Markets: An Introduction 199 Introduction 199 Section I: Fixed-income Investments, Preferred Stocks, and Common Stock Investments 199 Fixed-income Investments 199 Preferred Stock 206 Common Stock 206 Section II: Mutual Funds 208 Introduction 208 Closed-end versus Open-end Funds 208 Advantages of Fund Investment 209 Types of Funds 209 Reading a Mutual Fund Prospectus 211

6 Detailed Contents xi Mutual Fund F ees and Expenses 213 Expense Ratio 215 Fee Reduction Strategies 215 Mutual Fund Rating Services 217 Section III: Traditional Index Funds 219 An Overview 219 Fewer Capital Gains 219 Lower Cost 220 Pitfalls of Index Funds 220 New Horizon in Index Funds 221 Section IV: Annuity and Life Investment Products 223 Deferred Annuity 223 Equity-indexed Annuity 224 Variable Life Insurance 224 Variable Universal Life 225 Unit-linked Products 225 Section V: Sophisticated Investment Products 226 Real Estate Investment Trusts 226 Investment Derivatives 226 Short Selling 228 Money Control 228. Exchange-traded Index Investing 229 Exchange-traded Funds Compared to Closed-end Funds 231 Appendix: Market Benchmarks 232 CNXNifty 232 CNX Nifty Junior 232 LIX CNX CNX CNX Nifty Mid-cap CNX Mid-cap Index 233 CNX Small-cap Index 233 S&P BSE SENSEX 234 S&P BSE S&P BSE S&P BSE S&P BSE Mid-cap Index 235 S&P BSE Small-cap Index 235 Chapter 9 Investment Management: Concepts and Strategies 236 Introduction 236 Section I: Fixed-income Securities 236 Fixed-income Security Return 236 Fixed-income Security Risk 236

7 xii Financial Planning Section II: Equity Securities Equity Return Equity Risk Trading in Equities Limiting the Risk Sale of Mutual Funds Mutual Funds and Taxes Section III: Theory of Portfolio Construction Introduction Theory of Efficient Portfolio Capital Asset Pricing Model Power of Diversification The Efficient Frontier Asset Allocation Model Sizing Up a Mutual Fund Portfolio Portfolio Management and Monetary Policy Appendix: Fundamental and Technical Analysis Fundamental Analysis Technical Analysis Chapter 10 Investment Planning Strategies Introduction Section I: Investment Planning Process Introduction Goal Setting Section II: Key Investment Planning Strategies Risk Tolerance Investor Preference Investment Portfolio Portfolio Reorganization Section III: A Real World Investment Plan Portfolio Presentation to the Rais Goal Setting Risk Tolerance Level Target Investment Portfolio Golden Retirement Years Final Thoughts Part 5 Tax Planning Chapter 11 Basic Income Tax Structure Section I: The Basic Tax Structure Introduction Computation of Taxable Income Section II: Computation of Income Tax Tax Computation Taxation of Corporations/Firms Real World Income Tax Calculations

8 Detailed Contents xiii Chapter 12 Tax Planning: Concepts and Strategies 325 Introduction 325 Section I: The Individual Taxpayer 325 Deduction 325 Diversion 327 Deferral 329 Deflection 330 Diminution 332 Section II: The Business Organization 334 Introduction 334 Sole Proprietors 335 Executives 335 Professionals 335 Limited Liability Companies 336 Amendment of Tax Return 336 Tax Audit 336 Part 6 Retirement Planning Chapter 13 Basic Structure of Retirement Income 341 Introduction 341 Section I: Government Sponsore«! Plans 343 New Pension System 343 Types of Benefits 346 Section II: Employees' Provident Fund 350 General Discussion 350 Types of Benefits 352 SBI Sarai Pension 355 SBI Life Annuity Plus 357 Chapter 14 Retirement Planning: Concepts and Strategies 359 Introduction 359 Section I: Retirement Income Needs Analysis 360 Retirement Budget 360 Section II: Distribution from Qualified Plans 364 Introduction 364 Pension Plans 364 Profit Sharing Plans 364 Other Qualified Plans 364 Required Distributions 365 Taxation of Plan Benefits 365 Taxation of the National Pension Scheme 366 Taxation of Insurance Plans 367 Other Tax Considerations 367 Section III: Retirement Income The Ultimate Decision 367 Introduction 367 Annuity, Lump Sum or Rollover: A Taxing Decision 372

9 xiv Financial Planning Pension Enhancement Strategy 373 Financial Planning Following Retirement 373 Early Retirement 374 Nonqualified Deferred Compensation Plan 375 Planning for Retirement: Additional Considerations 375 Combo Strategy 375 Part 7 Estate Planning Chapter 15 Basic Structure of Estate Planning 379 Introduction 379 Unauthorized Practice of Law 379 Dealing with Death: Psychological Implications 379 Section I: An Overview of Estate Planning 380 The Common Misconceptions 380 Obj ectives of Estate Planning 381 Tools of Estate Planning 381 Section II: Indian Law on Wills and Probate 382 Introduction 382 Who Can Make a Will? 382 Who Can Inherit Property under a Will? 383 What Property May Be Disposed of? 383 What Are the Formalities for Making a Will? 383 Procedural Aspects 384 Probate 384 Practical Issues to Keep in Mind 386 Letters of Administration 387 Succession Certificate 388 Section III: Trusts in India 389 Historical Backdrop 389 Reasons for Setting Up a Trust 389 The Indian Trusts Act 389 How to Create a Trust 390 Types of Trusts 390 Taxation of Trusts 392 Section IV: Taxation Issues 394 Estate Duty in India: Reintroduction and Consequences 394 Gift Tax in India 396 Index 1-1