What is a Comprehesive Financial Planning

The outline of a comprehensive financial planning consists of

1. Executive Summary
- brief summary of the result, recommendation and action plan for the cash-flow management, risk/insurance, education, retirement, investment, estate, tax and special need planning.

2. Goals and Objectives
- goal and objective of a client in cash-flow management, risk/insurance, education, retirement, investment, estate, tax and special need planning.

3. Personal data
personal data include financial institute (bank, investment bank, estate agency, insurance company etc), dependence (official and non official if there is)

4. Current Financial Situation
- current analysis of the net worth and cash flow management by using the personal finance ratio e.g. liquidity ratio, liquid asset to net worth ratio, solvency ratio, debt to asset ratio, saving ratio, debt serving ratio etc.

5. Assumptions
- Mutual agreement between client and CFP about the assumption to be used within the agreed time frame e.g. salary increment, retirement age, share dividend increment, inflation (government official figure), inflation (personal life style figure), bank rate (fixed deposit rate, current, saving, BLR+/- rate, hire purchase rate), equity return rate, property investment ROI, rental increment rate, investment-linked return/unit trust (bond, equity, balance, index, money market etc), traditional insurance cash value rate, endowment rate, market value of a property (car, house, office etc), tax bracket based on current year income forecast, pre-retirement portfolio rate of return, post-retirement rate of return, average EPF rate of return, Amanah saham rate of return, etc.
- reference source quoted(Bank Negara Malaysia, Department of Statistic, EPF/CPF etc.)

6. Cash-Flow Management
- solution is provided after analysis (pareto on the outflow, asset distribution, liability distribution, etc)
- base line objective: reduce outflow, increase inflow, reduce liability and increase asset, depends on client willing to adjust the current life style.
- reduce outflow: pareto analysis on the high expenses, seeking the solution to minimize/optimize/reduce outflow;
- increase inflow: mutli income stream e.g. dividend income, royalty, Adsense etc.
- increase asset: asset distribution/segregation - liquid asset (e.g. equity, bond, UT, cash etc) and non liquid asset (e.g. real estate, car, collectibles etc).
- decrease liability: rule of 78 for hire purchase, car loan, credit card outstanding balance, personal loan, housing loan etc.
- Finally, improvement of the net worth and cash flow management by using the personal finance ratio e.g. liquidity ratio, liquid asset to net worth ratio, solvency ratio, debt to asset ratio, saving ratio, debt serving ratio etc, to be evaluated
- tracking: year end tracking for total inflow, total outflow, net cash flow, total liquid asset, total non liquid asset, total asset, total liability and net worth are tracked and documented.
- Millionaire Next Door method: WAQ, UAW, AAW and PAW analysis

7. Risk Management/Insurance Planning

- personal insurance need analysis (life, surgical and hospitalization and personal accident) : Human life Value and Expense Method
- property insurance: house owner, house holder (MRTA) and car insurance
- Liability insurance: professional liability
- Current existing plan matrix: all information of the insurance such as insured, agent contact, sum assured, maturity, H&S overall and annual limit, premium, term and condition, limitation etc.

8. Education Planning
- time frame: kid time frame, retirement time frame.
- education expenses forecast in today value
- overall expenses: using the XIRR/XNPV 

9. Retirement Planning
- method: target replacement ratio and expense method, principal liquidation and principal intact
- life expectancy: Malays, Chinese and Indian have different life expectancy
- shortfall/excess analysis: NIA>required, NIA=required and NIA

- approaches: sufficient retirement fund (NIA>required), financial freedom age (NIA=required, fixed ROI) and desire rate of return (NIA=required, fixed retirement age), insufficient retirement fund (NIA
- Excel Solver is used to calculate retirement age and required rate of return.

10. Investment Planning
- based on the desire return from the combined education plan, retirement plan and insurance plan, portfolio optimization is engineered accordingly to client's need.
- portfolio optimization will work on the asset allocation with the lowest risk that can offered to the client.
- Excel Solver: a) lowest risk: required ROI = expected return, seek the lowest portfolio standard deviation, b) optimize portfolio: required ROI/expected return, seek the optimize sharpe ratio

11. Estate Planning
- Will/trust/power of attorney for the asset distribution
- cost of the estate planning (charges from trust company, documentation, executor fees etc)
- nomination of the statutory asset (EPF Act and Insurance Act)

12. Tax Planning

- fully utilize the rebate and relive from the tax planning in order to save payable tax
- Tax Act section 108/110 - dividend

13. Special Needs
- financial aids for handicap child, second family, divorce etc.

14. Business Continuation
- life insurance - buy sell agreement

15. Recommendations/Implementation/Action Plan
- Time frame tracking: action plan with PIC
- Result review after a period

Portfolio Management - Expected Return and Risk Calculation

Due to most of my friends do not know how to calculate the portfolio risk, so I revisit the variance-covariance matrix construction. Hopefully every body can benefit from it.

Step 1: Data Collection

60 monthly historical prices of a security are collected. You may download the historical price from Yahoo! Finance.

Step 2: Calculate Expected Portfolio Return

E(r,i) = average expected return of 60 monthly data for stock i;

E(r,p) = expected return of a portfolio;

Let us take 3 individual securities for example.

 E(r,p) = 1.09% monthly

  

Step 3: Calculate Portfolio Risk

Calculation of the portfolio risk can be simplified by summing up all the component(s) inside the variance-covariance matrix.

 1) Variance-Covariance matrix for one number of stock, 1^2 = 1 component

2) Variance-Covariance matrix for two number of stocks, 2^2 = 4 components

3) Variance-Covariance matrix for three number of stock, 3^2 = 9 components

4) Variance-Covariance matrix for four number of stocks, 4^2 = 16 components

 5) Variance-Covariance matrix for five number of stocks, 5^2 = 25 components

 6) Variance-Covariance matrix for six number of stocks, 6^2 = 36 components

...ha ha, I have 14 investments in my portfolio, 14^2 = 196 components

Expected Return and Risk of a portfolio which are calculated here will be used to optimize the return-risk of a portfolio via Excel Solver. This optimization had been discussed earlier (see portfolio optimization).

Investment Start Age, Compound Interest and Personal Investment Strategy

Investment start age plays an important role in final return. Let us assume annual return of an investment is consistent. The investment vehicles in this discussion are fixed deposits - 2.5% p.a, EPF - 6% p.a., government unit trust - 8% p.a., unit trust - 10% p.a., stock - 12% p.a. and optimized portfolio - 15% p.a.
Every year, investors invest RM12,000 in the individual vehicle. 

Scenario#1: Investment start age in different time frame
Mr.J - Start his investment during 15 years old
Mr.K - Start his investment during 25 years old
Mr.L - Start his investment during 35 years old
Mr.M - Start his investment during 45 years old
Mr.N - Start his investment during 55 years old
Mr.O - Start his investment during 65 years old

a) Fixed deposits - 2.5% p.a.

b) EPF - 6% p.a.

c) Government unit trust - 8% p.a.

d) Unit trust - 10% p.a.

e) Stock - 12% p.a.

f) Optimized portfolio - 15% p.a.

 If you want to know your investment's compounding effect, you may use the Excel formula as below (0 for end mode while 1 for begin mode):

Observation:
1. compounding effects works perfectly for those who starts his investment earlier.
 


Scenario#2: effect of the investment return 

Observation:
1. higher return has higher compounding effect. It has a huge different between 2.5% p.a. and 15% p.a.

Here is the compounding effect of the individual investment vehicle. This is the template for calculating the expected return, provided annual return is consistent.

Discussion:
we shall start our investment earlier and invest in low standard deviation portfolio rather timing the right time in the market. Bull and bear are just two animals in the jungle.

Of course, higher return rate resulted higher expected return. However, the suitable desire rate of return shall be calculated from your needs - it could be children education fund, retirement fund, personal objective or others. The desire rate of return shall match with your risk level. An investment which only offer high return without considering the risk level endangers the particular investment, especially in the bull run - traders or retailer is blind with the high rate of return from an investment.


Personal Strategies:
Expected return, standard deviation and sharpe ratio are used to determine the quality of an investment while portfolio optimization is used to decide the asset allocation of a portfolio. Dollar cost averaging is the most effective method to secure your portfolio.

Asset allocation plays important role in a successful investment.

For an optimized portfolio - Standard deviation is lower than the expected return

For my current portfolio - Standard deviation is higher than the expected return

Expected return between my optimized and current portfolio is almost the same, but the risk level is different. That is why it results lower sharpe as I compare to optimized.

For the effective allocation accordingly to the optimization from Excel solver, my current portfolio's risk is in the reducing trend. Thus, it produces an improving sharpe ratio (However, the Sharpe ratio after September is eroded with the increment of risk free rate recently).