M.Com Sem IV – Personal Financial Planning-munotes

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UNDERSTANDING PERSONAL FINANCE
Unit Structure :
1.0 Objectives
1.1 Introduction
1.2 Time Value Of Money
1.3 Time Value Of Money Concept
1.4 Money Management
1.5 Income And Asset Protection
1.6 Exercise
1.0 OBJECTIVES
After reading this chapter learn er will be able to:
 Understand the fundamental principles of personal finance, including
budgeting, saving, investing, and debt management.

 Learn about different types of financial products and how to choose
the ones that are most suitable for specific ne eds and goals.

 Understand the importance of setting financial goals and how to create
a plan to achieve them.

 Develop skills in managing risk, including managing insurance
policies and creating a plan for emergencies.

 Understand the principles of retire ment planning and how to create a
retirement plan that aligns with individual goals and financial
circumstances.

 Develop skills in financial analysis, including analyzing personal
financial statements, credit reports, and investment portfolios.

 Understan d the ethical and legal considerations of personal finance,
including taxes, contracts, and consumer protection laws.
1.1 INTRODUCTION
Personal Financial Planning (PFP) in India refers to the process of
managing an individual's financial resources to achie ve financial goals and
objectives. PFP involves evaluating a person's current financial situation,
identifying their financial goals and objectives, and developing a
comprehensive plan to achieve those goals. munotes.in

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2 The process of PFP in India involves assessing the individual's income,
expenses, investments, and debt, and then creating a plan to optimize their
financial situation. This plan may include strategies for budgeting, saving,
investing, tax planning, retirement planning, and risk management.
In India, P FP has become increasingly important as the country's economy
has grown and more individuals have become financially independent.
With a range of investment options available, including equities, bonds,
and mutual funds, there is a need for individuals to understand their
investment options and make informed decisions.
PFP in India is typically carried out by financial planners, who may be
certified by organizations such as the Financial Planning Standards Board
India (FPSB India) or the Association of Mutu al Funds in India (AMFI).
These professionals help individuals make informed decisions about their
finances and develop a customized plan to achieve their financial goals.
1.2 TIME VALUE OF MONEY
1.2.1 Basic Concepts in Time Value of Money:
1. Discount Factor : The discount factor is the present value of a rupee
received in the future.
2. Compounding Factor: The compounding factor is the future value of a
rupee.

1. Present Value: A present value is the discounted value of one or more
future cash flows.
There are two different approaches to calculate the present value:
a. Present Value of Interest Factor: This method is used when there
is lump sum payments or one -time payments.
PV IF= FV X DF
PV IF= FV x
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3 Where,
PV IF = Present value of Interest Factor
FV = Future value
DF = Discounting factor

r = rate of return
n = time period in years
b. Present Value of Annuity Factor: This method is usedwhen there
is annuity payment which means payment of the same amount at regular
intervals.
PV AF=

Where,
PV AF= Present Value Annuity Factor
A = Annuity Factor or Periodic Payment
r = rate of return
n = time period in years
2. Future Value: A future value is the compounded value of a present
value.
There are two different approaches to calculate the futurevalue:
a. Future Value Interest Factor
FV = PV X CF
FV = PV x

Where,
FV = Future value
PV = Present value
CF = Compounding factor
r = rate of return
n = time period in years
FV =


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4 1.2.2 Practical Application:
Illustration 1: A bank offers a return of 12% p.a. on the investment for a
period of 10 years. If you invest a sum of 12,00,000 in the scheme, how
much amount will be received by you?
FV = PV X CF
FV = PV x

FV = 12,00,000 x (1+0.12)10
FV = 12,00,000 x (1.1 2)10
FV = 12,00,000 x 3.1058
FV = 37,26,960
Illustration 2. What will an investor receive at maturity if he invests in a
scheme a sum of ` 5,000 annually at the end of the year for 9 years at
interest rate of 11% pa compounded annually?
FV =

FV =

FV =

FV =

FV =

FV =

FV = 70,818
Illustration 3. An investor wants to find out the value of an amount of `
1,00,000 to be received after 15 years. The interest offered by bank is 7% .
Calculate the PV of this amount.
PV IF= FV X DF
PV IF= FV x

PV IF= 1,00,000 x

PV IF= 1,00,000 x

PV IF= 1,00,000 x

PV IF= 1,00,000 x

PV IF= 36,240 munotes.in

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5 Illustration 4. Mr Xavier has an investment p roposal in which he has to
invest 38,950 every year for next 15 years which offers interest @ 9.5%.
What should be the present value of such investment?
PV AF =

PV AF =

PV AF =

PV AF =

PV AF =

Illustration 05:
Mr. Ram is investing in a scheme which offers the following returns in
next five year if he invests ` 55,000 today.
Year 1 2 3 4 5
Amount
(`) 10,000 12,000 15,000 18,000 20,000
The current return on the similar investment scheme is 1 0%. Please advise
whether Mr. Ram should invest in the scheme or not?
Solution:
Year 1 2 3 4 5
Amount ( `) 10,000 12,000 15,000 18,000 20,000
DF @ 10% 0.909 0.826 0.751 0.683 0.621
PV of Future Cash Inflows 9,090 9,912 11,265 12,294 12,420
Cumulative D CF 54,981
Less: Present Value of Investment (55,000) Net Present Value (19)
Since the Net Present Value is negative , it is advised to not invest in the
plan.
1.2.3 Applications of the time value of money in the context of
Perso nal Financial Planning:
1. Retirement Planning: The time value of money plays a critical role in
retirement planning, where individuals need to save enough money to
support themselves in retirement. By understanding the time value of
money, individuals can ma ke informed decisions about how much to munotes.in

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6 save, where to invest their money, and when to start withdrawing
funds from their retirement accounts.

2. Budgeting: The time value of money is also relevant in budgeting,
where individuals need to balance their income and expenses over
time. By understanding the time value of money, individuals can
prioritize their spending, allocate their resources effectively, and avoid
overspending.

3. Debt Management: The time value of money is relevant in debt
management, where indi viduals need to pay off their debts over time.
By understanding the time value of money, individuals can make
informed decisions about which debts to pay off first, how to negotiate
with creditors, and how to manage their cash flow effectively.

4. Emergency Fund: The time value of money is important in building
an emergency fund, which is an essential part of Personal Financial
Planning. By understanding the time value of money, individuals can
make informed decisions about how much to save, where to invest
their money, and how to access their funds in case of an emergency.

5. Tax Planning: The time value of money is relevant in tax planning,
where individuals need to minimize their tax liability over time. By
understanding the time value of money, individuals c an make
informed decisions about when to pay taxes, how to invest their
money, and how to take advantage of tax deductions and credits.

6. Insurance Planning: The time value of money is also relevant in
insurance planning, where individuals need to protect t hemselves and
their families against financial risks. By understanding the time value
of money, individuals can make informed decisions about which types
of insurance to purchase, how much coverage they need, and how to
manage their premiums effectively.

7. Investment Planning: The time value of money is crucial in
investment planning, where individuals need to make informed
decisions about where to invest their money and for how long. By
understanding the time value of money, individuals can make
informed de cisions about the types of investments to make, and how
long to hold onto them.

8. Education Planning: The time value of money is relevant in
education planning, where individuals need to save for their children's
education over time. By understanding the ti me value of money,
individuals can make informed decisions about how much to save,
where to invest their money, and how to take advantage of education
savings accounts and tax benefits.

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7 1.3 TIME VALUE OF MONEY CONCEPT
1.3 Personal financial statements, C ash flow and debt management,
tools and budgets
1.3.1 Personal financial statements:
Personal financial statements are documents that provide a summary of an
individual's financial situation. They typically include information on
assets, liabilities, incom e, and expenses.
These statements are used to assess an individual's financial health and to
determine their ability to manage their finances effectively. They can also
be used by lenders and financial institutions to evaluate an individual's
creditworthin ess and ability to repay debt.
Personal financial statements can be prepared by individuals themselves,
or they can be prepared by professional accountants or financial advisors.
They are an important tool for individuals to use in creating a financial
plan and achieving their financial goals.
There are three main types of personal financial statements that
individuals can use to assess their financial health and plan for their
financial future:
1.3.1.1 Personal Financial Statements:
There are three main ty pes of personal financial statements that
individuals can use to assess their financial health and plan for their
financial future:
1. Personal balance sheet: A personal balance sheet is a summary of an
individual's assets, liabilities, and net worth. Assets include things like
cash, investments, and property, while liabilities include things like
loans, credit card balances, and mortgages. Net worth is calculated by
subtracting liabilities from assets and provides an overall picture of an
individual's financi al health.

2. Personal income statement: A personal income statement is a
summary of an individual's income and expenses over a period of
time, usually a month or a year. It includes sources of income, such as
salaries, wages, and investment income, as well as expenses like
housing, transportation, and food.

3. Cash flow statement: A cash flow statement tracks the flow of money
into and out of an individual's accounts over a period of time, usually a
month or a year. It shows how much money is coming in, how mu ch is
going out, and where the money is being spent. This can be helpful in
identifying areas where an individual can cut back on spending and
increase their savings.

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8 1.3.2 Debt Management:
Debt management refers to the process of managing and controllin g debt
to improve one's financial situation. It involves developing and
implementing a plan to pay off debt, reduce interest charges, and avoid
accumulating new debt.
Debt management typically involves analysing one's current debt
situation, creating a bud get to ensure that there is enough money to pay
down debt, and prioritizing which debts to pay off first based on interest
rates and balances. It may also involve negotiating with creditors to reduce
interest rates or establish a more manageable payment pl an.
The goal of debt management is to improve one's credit score and overall
financial health by reducing debt and avoiding late or missed payments. It
can help individuals achieve financial stability and avoid the negative
consequences of excessive debt, such as bankruptcy, foreclosure, or wage
garnishment.
1.3.2.1: Steps in debt management:
Here are the general steps involved in debt management:
1. Evaluate your debts: Make a list of all your debts, including the
creditor, balance owed, interest rate, and mi nimum monthly payment.
This will give you a clear picture of your overall debt and help you
prioritize which debts to pay off first.

2. Create a budget: Determine how much money you can realistically
allocate towards debt repayment each month. Create a budge t that
includes all your necessary expenses and allows for some extra funds
to put towards debt repayment.

3. Prioritize debts: Use your list of debts to prioritize which ones to pay
off first. Consider focusing on high -interest debts first, as they will
accumulate more interest over time and can be more costly in the long
run.

4. Negotiate with creditors: If you are having trouble making payments,
contact your creditors to see if they can offer any assistance. They may
be willing to lower your interest rate or reduce your minimum monthly
payment to help you get back on track.

5. Consider debt consolidation: If you have multiple debts with high -
interest rates, consider consolidating them into a single, lower -interest
loan. This can make it easier to manage your de bt and potentially save
you money on interest charges.

6. Stick to your debt repayment plan: Once you have a plan in place,
stick to it. Make your monthly payments on time and try to allocate
any extra funds towards debt repayment. It may take time, but stic king
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7. Avoid taking on new debt: While you are working on paying off your
existing debt, avoid taking on any new debt. This will only make it
harder to become debt -free and can lead to a never -ending cycle of
debt repayment.
Remember, debt management is a process that takes time and effort. But
by following these steps and staying committed to your debt repayment
plan, you can achieve financial freedom and improve your overall
financial well -being.
1.3.2.2: Tools for debt management
There are several tools that can be used for debt management. Here are
some of the most common ones:
1. Budgeting tools: Budgeting is a crucial part of debt management.
Using online budgeting tools like Mint, Personal Capital, and You
Need A Budget (YNAB) can help individuals create and stick to a
budget. These tools allow users to track their expenses, set financial
goals, and monitor their progress over time. By keeping track of their
spending, individuals can identify areas w here they can cut back and
redirect those funds towards paying off debt.

2. Debt consolidation loans: Personal loans from banks or online
lenders can be used to consolidate high -interest debts into a single,
lower -interest loan. This can simplify the repayme nt process and
potentially save individuals money on interest charges. It's important
to shop around for the best interest rate and terms before taking out a
consolidation loan.

3. Balance transfer credit cards: Credit cards like the Chase Freedom
Unlimited or Citi Diamond Preferred offer introductory 0% APR
periods, allowing individuals to transfer high -interest credit card
balances and pay off debt interest -free. This can save individuals a
significant amount of money on interest charges. However, it's
impo rtant to pay off the balance before the 0% APR period ends, as
the interest rate will increase substantially after that.

4. Debt management plans: Credit counselling agencies like the
National Foundation for Credit Counselling (NFCC) or Consumer
Credit Couns elling Services (CCCS) can negotiate with creditors to
create a debt management plan. This involves making a single monthly
payment to the credit counselling agency, who then distributes
payments to creditors. The debt management plan may involve
negotiati ng lower interest rates, which can reduce the overall amount
owed and make it easier to pay off debt.

5. Debt settlement: Debt settlement companies like Freedom Debt
Relief or National Debt Relief negotiate with creditors on behalf of
individuals to reduce t he amount of debt owed. Debt settlement can be munotes.in

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10 risky and can potentially harm an individual's credit score. It's
important to do research and consult with a financial professional
before deciding to pursue debt settlement.

6. Credit counselling: Non-profit c redit counselling agencies like the
NFCC or CCCS offer financial education and counselling to help
individuals manage debt and improve their credit. Credit counselling
can help individuals create a budget, negotiate with creditors, and
develop a debt payof f plan.

7. Automatic payments: Setting up automatic payments for debts can
help individuals avoid missed payments and late fees. This can also
help individuals stay on track with their debt repayment plan and avoid
accumulating additional debt.

8. Side hustles : Taking on a side hustle like freelance work, driving for
Uber, or selling items on eBay can help individuals earn extra income
to pay off debt faster. This can be a great way to accelerate debt
repayment and achieve financial freedom more quickly.
1.3.3 Types of Budgets in personal financial planning
There are several types of budgets that can be used in personal financial
planning. Here are some of the most common types:
1. Cash flow budget: A cash flow budget tracks the money that is
coming in and going ou t of an individual's accounts over a specific
period of time, usually a month. This type of budget can help
individuals to identify areas where they are spending too much money
and adjust their spending habits accordingly.

2. Zero -based budget: A zero -based budget requires that every dollar
earned be assigned a specific purpose, so that income minus expenses
equals zero. This type of budget can help individuals to be more
intentional about their spending and ensure that they are not
overspending in any one ar ea.

3. Envelope budget: An envelope budget involves dividing up cash into
envelopes for different categories of expenses, such as groceries,
entertainment, and transportation. Once the money in an envelope is
spent, there is no more money available for that category until the next
budgeting period.

4. Projected budget: A projected budget is an estimate of future income
and expenses based on past spending habits and anticipated changes in
income or expenses. This type of budget can help individuals to plan
for u pcoming expenses and adjust their spending accordingly.

5. Fixed and flexible budget: A fixed budget includes expenses that do
not change from month to month, such as rent or mortgage payments, munotes.in

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11 while a flexible budget includes expenses that can vary from mon th to
month, such as groceries or entertainment.

6. Rolling budget: A rolling budget is a type of budget that is constantly
updated and adjusted based on changes in income and expenses. This
can help individuals to be more flexible and adapt to unexpected
changes in their financial situation.
These are just a few of the types of budgets that can be used in personal
financial planning. It's important for individuals to choose the type of
budget that works best for their individual financial situation and goals .
1.4 MONEY MANAGEMENT
Money management refers to the process of managing one's finances in a
responsible and effective manner. It involves setting financial goals,
creating a budget, monitoring cash flow, and making informed financial
decisions. Here are some key points related to money management:
1. Set Financial Goals: Money management starts with setting financial
goals, such as saving for retirement, paying off debt, or buying a
home.

2. Create a Budget: A budget is a plan that tracks income and expenses
and helps individuals prioritize their spending to achieve their
financial goals.

3. Monitor Cash Flow: Monitoring cash flow involves tracking income
and expenses to understand where money is coming from and where it
is going.

4. Identify and Control Expenses: It is important to identify
unnecessary expenses and control them to avoid overspending.

5. Build Emergency Fund: An emergency fund can provide a safety net
in case of unexpected expenses or income disruptions.

6. Reduce Debt: Paying off debt, particularly hig h-interest debt, can free
up cash flow and improve an individual's financial situation.

7. Save for Retirement: Saving for retirement early can help individuals
build wealth and achieve financial security in their later years.

8. Invest Wisely: Investing can h elp individuals grow their wealth over
time, but it is important to do so wisely, taking into account risk
tolerance and long -term financial goals.

9. Monitor Credit Score: A good credit score can help individuals
qualify for loans and credit cards with bett er terms and interest rates.
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12 10. Avoid Impulse Spending: Impulse spending can undermine financial
goals and lead to unnecessary debt, so it's important to avoid it.

11. Use Banking and Financial Tools: Banking and financial tools, such
as mobile apps and online banking, can help individuals manage their
finances more effectively.

12. Seek Professional Advice: Financial professionals, such as financial
advisors or tax professionals, can provide expert guidance on complex
financial matters.
Overall, effective money ma nagement involves creating a plan,
monitoring finances regularly, and making informed decisions to achieve
financial goals and build a stable financial future.
1.4.1 Tax planning:
Tax planning refers to the process of analysing an individual's financial
situation from a tax perspective and identifying strategies to minimize tax
liability. The primary objective of tax planning is to reduce the amount of
taxes paid by an individual or business by using various tax -saving
strategies and tools. Here are some ke y objectives of tax planning:
1. Minimizing Tax Liability: The primary objective of tax planning is to
minimize tax liability by taking advantage of tax deductions,
exemptions, credits, and other tax -saving strategies.

2. Maximizing After -Tax Income: By reducin g tax liability, tax
planning can help maximize an individual's after -tax income, allowing
them to save and invest more.

3. Complying with Tax Laws: Tax planning aims to help individuals
comply with tax laws while minimizing their tax burden.

4. Filing Returns on Time: It is necessary for an individual to file the
return to avail the benefits of tax savings if the income exceeds the
maximum exemption limit.

5. Avoiding Penalties and Interest: Proper tax planning can help
individuals avoid penalties and interest c harges for late or incorrect tax
payments.

6. Achieving Financial Goals: Tax planning can help individuals
achieve their financial goals by reducing tax liability and increasing
disposable income.

7. Preserving Wealth: By minimizing tax liability and maximizin g
after-tax income, tax planning can help individuals preserve their
wealth for future generations.
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13 8. Managing Risk: Effective tax planning can help individuals manage
risk by identifying potential tax liabilities and taking steps to mitigate
them.

9. Optimiz ing Investment Returns: Tax planning can help optimize
investment returns by identifying tax -efficient investment strategies
and structures.
Overall, the main objective of tax planning is to minimize tax liability
while complying with tax laws and achievin g financial goals. By working
with tax professionals and using tax -saving strategies, individuals can
manage their tax liability effectively and improve their financial situation.
1.4.2 Managing Checking and Savings Accounts:
Managing checking and savings accounts involves a series of steps to
ensure that the accounts are being used effectively and efficiently. Here
are some key steps in the process of managing checking and savings
accounts:
1. Open Accounts: The first step in managing checking and savings
accounts is to open the accounts at a financial institution such as a
bank or credit union.

2. Understand Account Terms and Fees: It is important to understand
the terms and conditions of the accounts, including any fees associated
with them.

3. Set Up Direct Dep osits: Setting up direct deposits for income such as
paychecks or government benefits can ensure that funds are
automatically deposited into the accounts.

4. Use Online and Mobile Banking: Using online and mobile banking
services can help individuals manage their accounts more effectively,
such as checking balances, transferring funds, and paying bills.

5. Create a Budget: Creating a budget that includes income and
expenses can help individuals manage their finances more effectively
and avoid overspending.

6. Mon itor Account Balances: Monitoring account balances regularly
can help individuals avoid overdrafts and other fees.

7. Reconcile Accounts: Reconciling accounts involves comparing
account balances to statements to ensure that all transactions are
accurate and accounted for.

8. Review Transactions: Reviewing transactions regularly can help
individuals identify any errors or fraudulent activity.
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14 9. Use Automatic Transfers: Setting up automatic transfers between
checking and savings accounts can help individuals save more
effectively.

10. Evaluate Interest Rates: Evaluating interest rates on savings accounts
can help individuals maximize their savings.

11. Update Account Information: Keeping account information up to
date, such as contact information and beneficiaries, can h elp ensure
that accounts are managed effectively.

12. Close Accounts if Necessary: If an account is no longer needed or is
costing too much in fees, closing the account may be necessary.
Overall, managing checking and savings accounts involves being
organized , monitoring accounts regularly, and using tools and services
provided by financial institutions to manage accounts more effectively.
1.4.3 Maintaining Good Credit:
1.4.3.1 CIBIL
CIBIL stands for Credit Information Bureau (India) Limited. It is India's
first and largest credit information company that collects, maintains, and
provides credit information on individuals and businesses. CIBIL
maintains credit records of more than 600 million individuals and
companies in India.
Here are some key features and ch aracteristics of CIBIL:
1. Credit Information: CIBIL collects and maintains credit information
on individuals and businesses, including credit card history, loan
repayment behavior, and credit utilization.

2. Credit Reports: CIBIL generates credit reports based on credit
information collected from various sources, including banks, financial
institutions, and credit card companies.

3. Credit Scores: CIBIL calculates credit scores based on credit reports,
which provide a numerical representation of an individual's
creditworthiness. Scores range from 300 to 900, with higher scores
indicating better creditworthiness.

4. Loan Eligibility: CIBIL scores are often used by banks and financial
institutions to assess loan eligibility and determine interest rates.

5. Identity Veri fication: CIBIL provides identity verification services to
banks and financial institutions to help prevent fraud and identity theft.

6. Dispute Resolution: CIBIL provides a dispute resolution mechanism
for individuals and businesses to correct errors or ina ccuracies in their
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7. Data Security: CIBIL takes data security and privacy seriously and
uses advanced security measures to protect the confidentiality of credit
information.

8. Regulatory Compliance: CIBIL is regulated by the Reserve Bank of
India and operates in compliance with the Credit Information
Companies (Regulation) Act, 2005.
Overall, CIBIL plays a crucial role in facilitating credit availability in
India by providing credit information and scores to banks and financial
institutions, e nabling them to make informed lending decisions.
1.4.3.2 Importance of maintaining a good credit score:
1. Access to Credit: A good credit score can make it easier to obtain
loans and credit cards, and may increase the amount of credit
available.
2. Lower Intere st Rates: A good credit score can lead to lower interest
rates on loans and credit cards, saving borrowers money over time.

3. Better Loan Terms: A good credit score may qualify borrowers for
better loan terms, such as longer repayment periods or lower fees.

4. Employment Opportunities: Some employers check credit scores as
part of background checks, and a good credit score can help job
applicants stand out.

5. Housing Opportunities: Landlords may use credit scores to screen
tenants, and a good credit score can i mprove applicants' chances of
being approved for rental housing.

6. Utility Services: Utility companies may require deposits or charge
higher rates for customers with low credit scores, so a good credit
score can lead to lower bills.

7. Insurance Rates: Insura nce companies may use credit scores as a
factor in determining rates for policies, so a good credit score may lead
to lower insurance premiums.

8. Security Deposits: Landlords may require smaller security deposits
from tenants with good credit scores, as the y are seen as less likely to
cause damage or skip out on rent.

9. Negotiating Power: With a good credit score, borrowers may have
more bargaining power when negotiating loan terms or credit card
interest rates.

10. Approval Odds: A good credit score can improve applicants' odds of
being approved for credit cards, loans, and other financial products.
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16 11. Financial Stability: Maintaining a good credit score can help
borrowers manage their debt, build savings, and achieve long -term
financial stability.

12. Credit Limits: With a good credit score, borrowers may be offered
higher credit limits on credit cards and other types of loans, providing
more financial flexibility.
1.4.3.3 How to build or improve the credit score?
1. Pay Bills on Time: Late payments can harm credit scor e, so make
sure to pay all bills on time, including credit card bills, loan EMIs, and
utility bills.

2. Keep Credit Utilization Low: High credit utilization (using a large
percentage of available credit) can harm credit score, so aim to keep
credit utilizati on below 30% of available credit.

3. Monitor Credit Report: Check credit reports regularly for errors or
inaccuracies, and dispute any errors with credit bureaus.

4. Use Credit Cards Responsibly: Use credit cards for small purchases
and pay them off in full ea ch month, rather than carrying balances.

5. Apply for Credit Sparingly: Applying for multiple loans or credit
cards at once can harm credit score, so only apply for credit when
necessary.

6. Maintain a Mix of Credit: Having a mix of credit types (such as
credi t cards, personal loans, and mortgages) can improve credit score,
as it demonstrates responsible credit use.

7. Limit Credit Inquiries: Too many credit inquiries can harm credit
score, so limit credit inquiries to only necessary ones.

8. Keep Old Credit Accoun ts Open: Older credit accounts with good
payment history can improve credit score, so avoid closing them
unless absolutely necessary.

9. Build a Credit History: If new to credit, start building credit history
with a secured credit card or a small personal lo an.

10. Avoid Defaulting on Loans: Defaulting on loans can severely harm
credit score, so make sure to keep up with payments.

11. Avoid Settlements: Settling loans for less than the full amount owed
can harm credit score, so try to avoid settlements whenever pos sible.
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17 12. Seek Professional Help: Consider seeking the help of a financial
advisor or credit counsellor if struggling to improve credit score or
manage debt.
1.4.3.4 Benefits of maintaining Good Credit Scores
Maintaining a good credit score can provide sever al benefits, including:
1. Easier Access to Credit: A good credit score can make it easier to
qualify for loans, credit cards, and other credit products, as lenders are
more likely to offer favorable terms and interest rates to borrowers
with good credit.

2. Lower Interest Rates: Borrowers with good credit scores are
typically offered lower interest rates on loans and credit cards, which
can translate into significant savings over time.

3. Higher Credit Limits: Lenders are more likely to offer higher credit
limits to borrowers with good credit scores, which can help individuals
access more credit when needed.

4. Faster Loan Approvals: Borrowers with good credit scores may be
able to get loan approvals faster than those with poor credit scores, as
lenders may be more willing to approve loans quickly for low -risk
borrowers.

5. Better Insurance Premiums: Some insurance companies use credit
scores to determine premiums, so individuals with good credit scores
may be offered better rates on insurance products.

6. Improved Job P rospects: Some employers may check credit scores
as part of the hiring process, particularly for positions that require
financial responsibility or access to sensitive financial information.

7. Enhanced Negotiating Power: Individuals with good credit scores
may be able to negotiate better terms and rates on loans, credit cards,
and other financial products, as lenders may be more willing to work
with low -risk borrowers.

8. Improved Housing Options: Landlords and property managers may
check credit scores as part of the rental application process, so
individuals with good credit scores may have access to better rental
properties and more favourable lease terms.
Overall, maintaining a good credit score can provide individuals with
more financial opportunities and f lexibility, as well as potentially save
them money on loans and other credit products.

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18 1.4.4 Credit Cards and Consumer Loans
1.4.4.1 Credit Card
A credit card is a type of payment card that allows cardholders to borrow
funds from a financial institution (such as a bank or credit card company)
up to a certain limit, to make purchases or withdraw cash advances. The
borrowed amount must be repaid with interest and fees, depending on the
terms of the credit card agreement.
Credit cards typically have a revolv ing credit line, which means that the
borrower can use the available credit, pay back the amount, and then reuse
the credit line as needed. Cardholders can also choose to make minimum
payments, which may result in carrying a balance and paying interest
charges.
Credit cards can be used to make purchases at physical or online
merchants, as well as to pay bills, make reservations, and more. Some
credit cards also offer rewards or cashback programs, which provide
incentives for using the card for certain types of purchases.
To use a credit card, a cardholder must first apply for and be approved for
a credit card account. Once approved, the cardholder will receive a
physical card and/or digital access to the credit card account, where they
can track their purcha ses, make payments, and manage their credit card
balance.
1.4.4.1.1 Types of Credit Card in India
There are several types of credit cards available in India, each designed to
cater to specific needs and lifestyles. Here are some of the most common
types of credit cards in India:
1. Rewards Credit Cards: These cards offer reward points for every
transaction that can be redeemed for various rewards like gift
vouchers, cashback, discounts, etc.

2. Cashback Credit Cards: These cards offer cashback on every
transacti on, usually a percentage of the amount spent.

3. Travel Credit Cards: These cards are designed for frequent travelers
and offer benefits like air miles, lounge access, travel insurance, and
discounts on flights and hotels.

4. Lifestyle Credit Cards: These card s cater to the lifestyle needs of
customers and offer benefits like discounts on dining, shopping,
entertainment, and wellness.

5. Fuel Credit Cards: These cards offer cashback or reward points on
fuel purchases at petrol pumps.
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19 6. Business Credit Cards: These cards are designed for business owners
and offer benefits like rewards on business expenses, discounts on
office supplies, and expense management tools.

7. Premium Credit Cards: These cards offer exclusive benefits like
concierge services, access to luxury hotels and golf courses, and
personalized assistance.

8. Co-branded Credit Cards: These cards are offered in collaboration
with a brand or a company and offer benefits like discounts, cashback,
and reward points on purchases made with the brand or company.
It's worth noting that credit card offerings and features can vary from bank
to bank.
Credit cards are convenient tools for making purchases and managing your
finances. However, like any financial product, they come with both
advantages and disadvantages. H ere are some of the advantages and
disadvantages of using credit cards:
1.4.4.1.2 Benefits of using the Credit Cards
1. Convenience: Credit cards are widely accepted and provide a
convenient way to make purchases without carrying cash.
2. Rewards and benefits: Credit card companies offer various rewards
and benefits such as cashback, reward points, discounts, and other
perks, which can help you save money and earn rewards for your
spending.

3. Builds credit score: Using a credit card responsibly can help build
your credit score, which is important when applying for loans or other
forms of credit.

4. Emergency cash: Credit cards can be used in emergencies, allowing
you to access cash when you need it.

5. Fraud protection: Credit cards offer fraud protection, and you are not
liable for unauthorized charges made on your card.
1.4.4.1.3 Short Comings of using the Credit Cards
1. High -interest rates: Credit cards have high -interest rates, which can
lead to debt if not managed properly.

2. Overspending: Credit cards can encourage o verspending and lead to
debt if not used responsibly.

3. Fees: Credit cards may come with annual fees, late payment fees, and
other charges, which can add up and increase your debt.
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20 4. Temptation to buy things you can't afford: Credit cards can tempt
you to ma ke purchases that you cannot afford, leading to financial
difficulties.

5. Damage to credit score: Late payments, missed payments, and high
credit card balances can damage your credit score.
Overall, credit cards can be beneficial if used responsibly, but it 's essential
to understand the risks and use them wisely to avoid debt and financial
difficulties.
1.4.4.2 Consumer Loan
Consumer loan refers to a type of loan that is issued by banks, financial
institutions or other lending agencies to individuals to fina nce their
personal expenses such as buying a car, home renovation, education,
medical expenses, wedding expenses, or other personal needs. Consumer
loans are unsecured loans, which means they do not require any collateral
to be pledged against the loan amo unt.
These loans are generally offered for a fixed tenure and come with a fixed
interest rate or a floating interest rate based on the borrower's credit
worthiness. The loan amount, tenure, and interest rate offered depend on
the borrower's credit score, i ncome, repayment capacity, and other factors.
Some common types of consumer loans include personal loans, education
loans, auto loans, and home improvement loans. These loans provide
individuals with access to credit to fulfill their personal needs and
aspirations.
1.4.4.2.1 Needs for consumer Loan:
Consumer loans can serve various needs of individuals. Here are some
common reasons why people take consumer loans:
1. Personal Expenses: People may take consumer loans to meet their
personal expenses such as weddi ng expenses, medical emergencies,
travel expenses, home renovations, and other miscellaneous expenses.

2. Education: Consumer loans can be taken for education -related
expenses, such as tuition fees, hostel fees, and other related expenses.
Some lenders offer education loans with lower interest rates and longer
repayment periods.

3. Buying a Vehicle: Consumer loans can be used to purchase vehicles
such as cars, two -wheelers, or other modes of transportation. These
loans are usually secured against the asset bein g purchased and offer
lower interest rates than unsecured personal loans.

4. Debt Consolidation: People may take consumer loans to consolidate
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21 and other high -interest loans, into a single loan with a lower interest
rate and more manageable repayment terms.

5. Business Needs: People may take consumer loans to start or expand
their businesses. Some lenders offer specific loans designed for small
business owners with favourable interest rates a nd flexible repayment
terms.

6. Emergency Needs: In case of emergencies like medical emergencies
or natural disasters, people may need immediate financial assistance,
and consumer loans can help them meet their urgent financial needs.
Overall, consumer loans can be helpful for individuals who need access to
quick and convenient financing to meet their financial goals and needs. It
is essential to understand the terms and conditions of the loan and make
sure the repayment schedule is manageable before taking o ut a consumer
loan.
1.4.4.2.2 Sources of Consumers Loans in India:
In India, there are various sources of consumer loans available to
individuals. Some of the common sources of consumer loans in India are:
1. Banks: Banks are the most common source of consume r loans in
India. They offer personal loans, which are unsecured loans that can be
used for any purpose. Banks also offer secured loans like car loans and
home loans, where the loan is secured against the asset being
purchased. The interest rates on bank l oans are typically lower than
those offered by other lenders.

2. Non-Banking Financial Companies (NBFCs): NBFCs are financial
institutions that offer various types of loans, including personal loans,
two-wheeler loans, gold loans, and education loans. NBFCs are
regulated by the Reserve Bank of India (RBI) and can offer loans to
individuals who may not meet the eligibility criteria of banks. The
interest rates on NBFC loans are typically higher than those offered by
banks.

3. Credit Card Companies: Credit card c ompanies offer credit cards
that can be used to make purchases and access credit. The interest rates
on credit card loans are typically higher than those offered by other
lenders, but credit cards offer the convenience of a revolving line of
credit that ca n be used for any purpose.

4. Microfinance Institutions: Microfinance institutions offer small loans
to individuals who may not have access to traditional banking services.
These loans are typically used for income -generating activities such as
starting a sm all business or farming. The interest rates on microfinance
loans are typically higher than those offered by banks, but the loans
can have a significant impact on the borrower's livelihood.
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22 5. Peer -to-Peer Lending Platforms: Peer-to-peer lending platforms
connect borrowers with individual lenders, who provide loans at
competitive rates. These platforms can offer lower interest rates than
traditional lenders, but they also carry higher risk as the lenders may
not have the same level of regulation and oversight as banks and
NBFCs.

6. Co-operative Societies: Co-operative societies are organizations that
are owned and managed by their members. They offer various
financial services, including loans. Co -operative societies can offer
loans at competitive rates, but the y may have limited capacity to lend
and may only operate in specific geographic areas.

7. Employer/Company Loans: Some employers and companies offer
loans to their employees as a benefit. These loans are typically offered
at lower interest rates than other l enders, but they may be subject to
certain conditions, such as repayment through salary deductions.

8. Government Schemes: The government of India offers various loan
schemes to support small businesses, startups, and other sectors.
Examples include the Mudr a Loan scheme, Stand -up India Loan
scheme, and the Pradhan Mantri Mudra Yojana. These loans may have
lower interest rates than other lenders and may offer other benefits,
such as longer repayment periods.
Consumer loans can offer several advantages and dis advantages,
depending on the borrower's situation and the type of loan. Here are some
advantages and disadvantages of consumer loans
1.4.4.2.3 Advantages of Consumer Loans:
1. Access to funds: Consumer loans provide borrowers with access to
funds they may not have otherwise, helping them meet their financial
needs.

2. Flexible repayment terms: Many lenders offer flexible repayment
terms, such as longer repayment periods or lower monthly payments,
to make the loan more manageable for borrowers.

3. No collateral req uired: Many consumer loans are unsecured, which
means that borrowers do not have to provide collateral to secure the
loan. This can be beneficial for borrowers who do not have valuable
assets to use as collateral.

4. Quick processing: Many lenders process co nsumer loans quickly,
allowing borrowers to access funds when they need them.

5. Improved credit score: Making timely payments on a consumer loan
can help improve the borrower's credit score, making it easier to obtain
future loans at more favourable rates.
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23 6. Lower interest rates: Secured consumer loans, such as home equity
loans or auto loans, can offer lower interest rates than unsecured loans,
making them a more affordable borrowing option.

7. Consolidation of debt: Consumer loans can be used to consolidate
high-interest debt into a single, more manageable payment, potentially
saving borrowers money on interest charges.

8. Investment in assets: Consumer loans can be used to invest in assets,
such as a home or vehicle, which can appreciate in value over time,
potentially increasing the borrower's net worth.
1.4.4.2.4 Disadvantages of Consumer Loans:
1. High -interest rates: Consumer loans often come with high -interest
rates, particularly for unsecured loans or loans for borrowers with
lower credit scores.

2. Debt burden : Taking out too many consumer loans can lead to a high
debt burden, making it challenging to manage repayments and
potentially leading to financial difficulties.

3. Risk of default: If borrowers are unable to make timely payments on a
consumer loan, they ri sk defaulting on the loan, which can have
significant consequences for their credit score and financial stability.

4. Early repayment penalty: Some lenders may charge a penalty for
early repayment, which can discourage borrowers from paying off the
loan earl y, even if they have the means to do so.

5. Impact on credit score: Failing to make timely payments on a
consumer loan can have a negative impact on the borrower's credit
score, making it harder to obtain future loans or credit.

6. Fees and charges: Some lende rs may charge fees and charges
associated with consumer loans, such as loan origination fees or
prepayment penalties, which can add to the cost of the loan.

7. Lengthy repayment terms: Some lenders offer lengthy repayment
terms, which can result in borrowers paying more in interest over the
life of the loan.

8. Risk of fraud: Borrowers may be at risk of fraud when applying for
consumer loans, particularly if they are dealing with an unscrupulous
lender or applying for a loan online.
1.4.5 Vehicle and Other Majo r Purchases under consumer finance
Different assets that can be purchased through personal finance or
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24 1. Vehicle purchases: Vehicles are often one of the most significant
purchases a person will make. When planning a vehicle purchase, it is
essential to consider the cost of the vehicle, including the purchase
price, insurance, fuel costs, and maintenance expenses. It is also
crucial to determine how much you can afford to spend on a vehicle
and to consider financing options, such as auto loan s or leases.

2. Real Estate: Real estate is a tangible asset that includes property such
as a house, apartment, or land. Investing in real estate can provide
rental income and appreciation in property value.

3. Stocks: Stocks represent ownership in a company a nd can offer
potential for growth and dividends. Stock values can be volatile and
require careful research and analysis.

4. Bonds: Bonds are a type of debt security that represents a loan made
by an investor to a borrower. Bonds offer fixed income and can
provide portfolio diversification.

5. Mutual Funds: Mutual funds are investment vehicles that pool money
from multiple investors to purchase a portfolio of securities. Mutual
funds offer diversification and professional management.

6. Exchange -Traded Funds (ETFs ): ETFs are similar to mutual funds
but trade on a stock exchange like a stock. ETFs offer diversification,
lower fees, and flexibility to buy and sell throughout the day.

7. Certificates of Deposit (CDs): CDs are time deposits with a bank or
credit union th at offer a fixed interest rate over a specified term. CDs
offer low risk and predictable returns.

8. Money Market Accounts (MMAs): MMAs are savings accounts that
offer higher interest rates than regular savings accounts but have
restrictions on withdrawals. M MAs offer low risk and higher returns.

9. Gold: Gold is a precious metal that has been used as a store of value
and a hedge against inflation. Gold can be purchased in the form of
bullion, coins, or exchange -traded funds.

10. Artwork: Artwork can be purchased f or aesthetic or investment
purposes. Artwork can appreciate in value over time but requires
careful research and authentication.

11. Antiques: Antiques are collectibles that are considered to have
historical or cultural value. Antiques can appreciate in value over time
but require careful research and authentication.

12. Crypto currency: Crypto currency is a digital asset that uses
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25 new units. Crypto currency is volatile and requires careful res earch
and understanding.

13. Classic Cars: Classic cars are vintage or antique automobiles that are
considered to be valuable due to their age, rarity, or historical
significance. Classic cars can appreciate in value over time but require
careful research and maintenance.
1.5 INCOME AND ASSET PROTECTION
Income and asset protection are important components of personal
financial planning (PFP) as they help individuals safeguard their financial
well-being and provide a safety net in case of unexpected events. Her e are
some key aspects of income and asset protection under PFP:
1. Insurance: Insurance is a critical component of income and asset
protection. Health insurance can help cover medical expenses in case
of illness or injury, while disability insurance can prov ide a source of
income if an individual is unable to work due to a disability. Life
insurance can help provide financial support to dependents in case of
the policyholder's death, and property insurance can protect assets
such as homes, cars, and personal belongings from loss or damage.

2. Emergency Fund: An emergency fund is a crucial tool for income
and asset protection. It should ideally cover three to six months of
living expenses and be easily accessible in case of a financial
emergency, such as job loss or unexpected medical bills.

3. Estate Planning: Estate planning helps individuals protect their assets
and ensure that they are distributed according to their wishes after their
death. It involves creating a will, establishing trusts, and designating
benef iciaries for assets such as retirement accounts and life insurance
policies.

4. Debt Management: Effective debt management can also contribute to
income and asset protection. Paying down high -interest debt, such as
credit card debt, can help reduce financial stress and free up income
for other expenses. Consolidating debt and negotiating with creditors
can also help individuals manage debt more effectively.

5. Retirement Planning: Retirement planning is an important aspect of
income and asset protection as it h elps individuals plan for a secure
financial future. Saving for retirement through tax -advantaged
accounts such as 401(k) plans and IRAs can help individuals
accumulate wealth and create a source of income in retirement.
Overall, income and asset protectio n are key elements of personal
financial planning. By taking steps such as obtaining insurance, creating
an emergency fund, engaging in effective debt management, and planning
for retirement and estate distribution, individuals can protect their
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26 1.5.1 Steps for Income and assets protection:
To protect income and assets under Personal Financial Planning (PFP),
there are several steps that can be taken. Here are some of the key steps:
1. Establish an Emerge ncy Fund: Build an emergency fund that can
cover at least six months' worth of living expenses. This will ensure
that you have enough money to cover your expenses in case of
unexpected financial emergencies like job loss, medical expenses, or
other unfores een events.

2. Purchase Insurance: Insurance is one of the most important tools for
protecting income and assets. Consider purchasing health, disability,
life, and long -term care insurance policies to provide financial
protection against unexpected events th at could impact your income or
assets.

3. Diversify Your Investments: Diversifying your investments can help
protect your assets against market volatility. Consider investing in a
mix of stocks, bonds, mutual funds, and other assets to spread out risk.

4. Deve lop a Budget: Creating a budget can help you manage your
income and expenses and prevent overspending. This can help ensure
that you have enough money to cover your living expenses and save
for future financial goals.

5. Pay off Debt: Reducing or eliminating debt can free up more money
to invest in assets and provide greater financial security. Develop a
debt repayment plan to help pay off outstanding debts as quickly as
possible.

6. Consult a Financial Advisor: Consider working with a financial
advisor who can help you create a personalized plan to protect your
income and assets. A financial advisor can help you identify risks and
develop strategies to mitigate those risks.
Overall, protecting income and assets under PFP requires a comprehensive
approach that i ncludes emergency funds, insurance, diversified
investments, budgeting, debt reduction, and financial planning with the
help of an expert.
1.5.2 Managing Property and Liability Risk
Managing property and liability risk is an important aspect of Personal
Financial Planning (PFP). Here are some steps that can be taken to
manage property and liability risk:
1. Assess the Risk: Identify potential risks to your property and liability,
such as natural disasters, theft, accidents, and lawsuits. Determine the
likeliho od of these risks and their potential impact on your finances.
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27 2. Purchase Insurance: Consider purchasing property insurance,
including homeowners or renters insurance, to protect against damage
or loss to your property. Liability insurance, such as umbrella
insurance, can protect against lawsuits and other legal liabilities.

3. Maintain Proper Documentation: Keep all important documents
related to your property and liability in a safe place, such as a fireproof
safe or a digital storage system. This includes d eeds, titles, insurance
policies, and other important documents.

4. Implement Safety Measures: Take steps to prevent accidents and
other risks to your property and liability. This includes installing
smoke detectors, burglar alarms, and fire extinguishers in your home.
It also means keeping your property in good repair and maintaining
proper safety protocols.

5. Consider Risk Mitigation Strategies: There are other risk mitigation
strategies that can be employed to minimize property and liability
risks. This inc ludes setting up trusts, transferring ownership of assets,
and implementing business structures such as LLCs to protect personal
assets from business liabilities.

6. Work with Professionals: Consider working with professionals such
as attorneys, insurance ag ents, and financial advisors to help manage
property and liability risk. These professionals can provide valuable
advice and guidance on how to protect your assets and minimize risk.
Overall, managing property and liability risk under PFP requires a
proact ive approach that includes insurance, safety measures, proper
documentation, risk mitigation strategies, and working with professionals.
By taking these steps, you can help protect your assets and minimize the
financial impact of unexpected events.
1.5.3 Managing Health Expenses
Managing health expenses is an important part of Personal Financial
Planning (PFP). Here are some steps that can be taken to manage health
expenses:
1. Establish an Emergency Fund: Build an emergency fund that can
cover at least six mo nths' worth of living expenses, including potential
health expenses. This will ensure that you have enough money to
cover your expenses in case of unexpected health emergencies.

2. Purchase Health Insurance: Health insurance is a critical tool for
managing h ealth expenses. Consider purchasing a health insurance
policy that provides coverage for medical care, prescription drugs, and
other health -related expenses.

3. Understand Your Coverage: Be sure to understand the details of
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28 other out -of-pocket expenses. This will help you plan for potential
health expenses and avoid unexpected bills.

4. Take Advantage of Tax Benefits: There are several tax benefits
available for health -related expenses, such as Health Savings Accounts
(HSAs) and Flexible Spending Accounts (FSAs). These accounts
allow you to save money tax -free to pay for qualified medical
expenses.

5. Practice Prevention: Taking steps to prevent health problems can
help reduce overall health expens es. This includes eating a healthy
diet, exercising regularly, getting regular check -ups, and practicing
good hygiene.

6. Comparison Shop: When seeking medical care, compare prices and
services among different providers. This can help you find the most
affor dable care while still receiving high -quality medical services.

7. Negotiate Bills: If you receive a large medical bill, try negotiating
with the provider to lower the cost or establish a payment plan.
Overall, managing health expenses under PFP requires a p roactive
approach that includes health insurance, understanding coverage, tax
benefits, prevention, comparison shopping, and negotiation. By taking
these steps, you can help minimize the financial impact of unexpected
health expenses and protect your overa ll financial well -being.
1.6 EXERCISE
A. State whether the following statements are true or false
1. Personal finance planning refers to the process of managing resouces
of a company.

2. Time Value of money is useful for designing the retirment planning.

3. Money management doesnot impact the personal financial planning.

4. Tax planning aims at avoiding tax payment by misappropriation of
income.

5. An individual can preserve and increase his wealth with proper tax
planning.

6. Savings account doesnot have any costs to the customers.

7. CIBIL stands for Credit Information Bureau (India) Limited.

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29 Answers:
1 2 3 4 5 6 7
False True False False True False True

B. Choose the correct alternative
C. Answer in Brief
1. How can the concept of time value of money is useful in pers onal
financial planning?

2. What is debt management? What are the steps involved in debt
management?

3. What are the tools for debt management?

4. What is money management? What are key points related to money
management?

5. What are the importance of maintaining a good credit score?

6. What are the sources of consumer loans in India?

7. What are the various advantages and disadvantages of consumer
loans?

8. What are the different assets which are financed through consumer
finance?
D. Short Notes:
1. Personal Financial Stat ements
2. Types of Budgets in personal financial planning
3. Objectives of tax planning
4. Process of managing checking and savings accounts
5. Features of CIBIL.
6. ways to improve the credit score
7. Types of credit cards
8. Managing Property and Liability Risk
9. Managing Heal th Expenses
E. Exercise
1. Shashikant deposit ` 1,00,000 with a bank which pays 10 percent
interest compounded annually, for a period of 3 years. How much amount
he would get a maturity?
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30 2. Mr Rahul has following investments in two banks
Particulars Bank of India HDFC
Amount Invested ( `) 3,40,000 5,00,000
Compounded Rate of Interest (%) 10 8
Period 5 Years 7 Years

Calculate the value of the investments at the maturity.
3.What will an investor receive at maturity if he invests in a scheme a sum
of ` 80,000 annually at the end of the year for 5 years at interest rate of
8% pa compounded annually?
4. Calculate the present value of annuity of ` 20,000 received annually
for 5 years when discounting factor is 10%.
5. How much should Mr. Sam invest toda y to receive ` 80,000 at the end
of 5 years if the interest rate in the scheme is 9% p.a.?
6. Find the present value of the cash flows in the following two cases:
Year 1 2 3 4 5
Cash Flows ( `) 30,000 20,000 18,000 16,000 18,000
Case I: Discounting rate 12%
Case II: Discounting rate 14%

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31 2
RISK ANALYSIS & INSURANCE
PLANNING
Unit Structure
2.0 Objectives
2.1 Risk Analysis
2.2 Risk Management
2.0 OBJECTIVES
After reading this chapter, the learners will be able:
 To understand the concept of Risk Analysis
 To evaluate Personal risk management with life insurance
 To Distinguish between life and general insurance
 To identify different types of life insurance policies
 To understand the needs and plan the strategies using General
Insurance, Life Insurance, Motor Insurance and Health Insurance to
hedge the risk.
2.1 RISK ANALYSIS
2.1.1 Introduction
The process of detecting, assessing, and managing potential risks that can
have an impact on a person's financial security is known as risk analysis
and is a crucial part of personal financial planning (P FP). Identifying
potential risks is the first stage in PFP's risk analysis process. Risks
including losing your work, becoming ill or disabled, passing away,
inflation, losing money on investments, and liability exposure can be
among them. The possibility and potential consequences of each risk are
assessed in the following phase. For instance, a person's job stability, the
state of the economy, and industry developments may all be taken into
account when assessing the risk of losing their work.
The next st ep is to create methods to control or mitigate those risks after
identifying and assessing potential dangers. This can entail taking action
like getting insurance, diversifying your finances, setting up an emergency
fund, or making a contingency plan for u nforeseen circumstances.
The efficiency of the techniques implemented to control or minimise risks
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32 hazards or changes in the amount of risk exposure, tactics may need to be
adjusted or mod ified as circumstances change throughout time.
Overall, risk analysis is a crucial tool for those involved in PFP because it
enables them to recognise potential risks, assess the consequences of those
risks, and create plans to control or lessen those risk s. People can make
wise decisions to safeguard their financial security and accomplish their
long-term financial goals by adopting a proactive approach to risk
analysis.
2.1.2 Steps in Risk Analysis:
The steps of risk analysis for personal financial planni ng (PFP) are as
follows:
1. Identify potential risks: Finding potential dangers that could affect a
person's financial security is the first step. Risks including losing your
work, being sick or disabled, dying, inflation, losing money on
investments, and bei ng exposed to responsibility are a few examples.

2. Evaluate the likelihood and potential impact of each risk: The next
stage is to assess each prospective risk's likelihood and potential
consequences after potential risks have been identified. This could
entail analysing prior data, evaluating the state of the market, and
taking into account specific case situations.

3. Develop strategies to manage or mitigate risks: The next step is to
create strategies to control or lessen such risks based on the assessment
of probable dangers. This can entail taking action like getting
insurance, diversifying your finances, setting up an emergency fund, or
making a contingency plan for unforeseen circumstances.

4. Implement risk management strategies: Once strategies have been
developed, they need to be implemented. This may involve purchasing
insurance policies, creating an emergency fund, or adjusting
investment portfolios.

5. Monitor and evaluate effectiveness of risk management strategies:
Finally, it's critical to regularly a ssess the performance of the solutions
implemented to control or reduce risks. In response to new risks or
changes in the amount of risk exposure, it may be required to update or
modify methods as conditions change over time.
Individuals can maintain their financial wellbeing and reach their long -
term financial goals by using these procedures to identify potential hazards
and establish methods to control or minimise such risks.

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33 2.2 RISK MANAGEMENT
2.2.1 Meaning
Risk management is the process of identifying , evaluating, and controlling
potential risks in order to protect an individual's financial well -being. Risk
management in the context of personal financial planning (PFP) entails
identifying potential risks, assessing the likelihood and potential
conseque nces of each risk, and creating plans to control or lessen those
risks.
The protection of a person's financial assets and sources of income is the
main objective of risk management in PFP. This could entail taking
actions like getting insurance, diversifyi ng investment holdings, setting up
an emergency fund, or making a contingency plan for unforeseen
circumstances.
For those who engage in PFP, effective risk management is crucial since it
enables them to safeguard their financial security and realise their long-
term financial objectives. Individuals can identify potential risks and
create ways to control or minimise them by adopting a proactive approach
to risk management, which will lessen the impact of unforeseen
occurrences on their financial status.
2.2.2 Objectives of Risk Management
The primary objectives of risk management in personal financial planning
(PFP) are:
1. Protecting assets: The primary objective of risk management in PFP
is to protect an individual's financial assets from potential losses due to
unexpected events such as job loss, disability, illness, death, or
investment losses.

2. Minimizing risk exposure: Effective risk management aims to
identify potential risks and develop strategies to manage or mitigate
those risks, thereby minimizing an individual's exposure to financial
risks.

3. Maintaining stability: Risk management in PFP helps individuals to
maintain financial stability even in the face of unexpected events or
economic downturns.

4. Achieving financial goals: By minimizing financial risk s and
protecting financial assets, risk management in PFP helps individuals
to achieve their long -term financial goals, such as saving for
retirement or paying for education.

5. Enhancing resilience: Effective risk management in PFP can enhance
an individual 's financial resilience, allowing them to bounce back from
unexpected events and recover more quickly from financial setbacks. munotes.in

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34 6. Reducing stress: By minimizing financial risks and protecting
financial assets, risk management in PFP can reduce stress and anxi ety
related to financial uncertainty.

7. Improving decision -making: Effective risk management can improve
an individual's decision -making by providing a more complete picture
of their financial situation and potential risks.

8. Providing peace of mind: Effecti ve risk management in PFP can
provide individuals with peace of mind, knowing that they have taken
steps to protect their financial assets and achieve their long -term
financial goals.
2.2.3: Insurance decision in personal financial planning
Insurance plays a critical role in personal financial planning (PFP) as it
helps individuals protect their financial assets and achieve their long -term
financial goals. Here are some key factors to consider when making
insurance decisions in PFP:
1. Identify insurance needs : The first step in making insurance
decisions is to identify the types of insurance coverage needed based
on an individual's financial situation and goals.

2. Evaluate risks: Once insurance needs have been identified, it's
important to evaluate the risks as sociated with each need in order to
determine the appropriate amount of insurance coverage required.

3. Determine affordability: Insurance premiums can be a significant
expense, so it's important to consider the affordability of insurance
when making decisio ns. Individuals should evaluate their budget and
determine how much they can realistically afford to spend on
insurance premiums.

4. Compare coverage options: There are a wide variety of insurance
policies available, so it's important to compare coverage opt ions and
costs to find the policies that best meet an individual's needs and
budget.

5. Evaluate insurance companies: When choosing insurance policies,
it's important to evaluate the financial stability and reputation of
insurance companies to ensure they ca n provide reliable coverage and
service.

6. Consider deductibles and coverage limits: Deductibles and coverage
limits can significantly impact the cost and effectiveness of insurance
policies, so it's important to carefully consider these factors when
making insurance decisions.
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35 7. Review policies regularly: Insurance needs can change over time, so
it's important to regularly review insurance coverage and adjust
policies as needed to ensure they continue to meet an individual's
needs.

8. Work with a financial adv isor: Working with a financial advisor or
insurance agent can provide valuable guidance and expertise when
making insurance decisions, helping individuals make informed
decisions and avoid common pitfalls.
2.2.4 Insurance Decision in Personal Financial Pla nning:
Insurance is an important component of personal financial planning as it
helps individuals manage risks and protect their financial assets. Here are
some ways insurance decisions can support personal financial planning:
1. Protect against financial los s: Insurance policies can provide
financial protection against potential losses from events like accidents,
illnesses, or property damage. By transferring risk to an insurance
company, individuals can avoid bearing the full financial burden of
unexpected e vents.

2. Provide peace of mind: Knowing that one's financial assets are
protected by insurance can provide peace of mind and reduce stress
and anxiety.

3. Support long -term financial goals: Adequate insurance coverage can
help individuals achieve long -term fi nancial goals by protecting their
assets and providing a safety net for unexpected events.

4. Manage risk: Insurance policies can be used to manage risk by
transferring it to an insurance company. This can help individuals
avoid potential financial hardships that could arise from uninsured
losses.

5. Improve financial stability: Having insurance coverage can improve
an individual's financial stability by reducing the likelihood of
unexpected expenses and losses that could disrupt their financial
situation.

6. Meet legal and contractual obligations: Some insurance policies
may be required by law or contractual agreements, such as auto
insurance or homeowners insurance. Meeting these obligations can
help individuals avoid legal penalties or financial liabilities.

7. Reduce financial burden on family: Life insurance can help reduce
the financial burden on family members in the event of an individual's
unexpected death, providing a source of income or financial support
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36 Overall, insurance decision s can play a critical role in personal financial
planning by protecting assets, managing risks, and supporting long -term
financial goals. It's important to carefully evaluate insurance needs and
options, and work with a financial advisor or insurance agent to ensure the
right coverage is selected for an individual's unique financial situation.
2.2.5 Life Insurance V/s Non -Life Insurance
Life Insurance and Non -Life Insurance are two broad categories of
insurance.
1. Coverage
Life Insurance provides coverage
for the life of the insured. Non-Life Insurance provides
coverage for assets, liabilities, and
risks related to specific events.
2. Policy Period
Life Insurance policies are
generally long -term, covering the
entire life of the insured. Non-Life Insuranc e policies are
short -term, covering a specific
period usually a year.
3. Premium
Life Insurance premiums are
generally higher than non -life
insurance due to extended policy
period. Comparatively, non -life insurance
premium is lower than life insurance
premium.
4. Beneficiary
Life Insurance policies have a
designated beneficiary who
receives the death benefit in case of
the insured's death. Non-Life Insurance policies do not
have a designated beneficiary.
5. Payments
Life Insurance policies pay the
benefit amount only in case of the
insured's death or on maturity of
the policy. Non-Life Insurance policies pay the
benefit amount on the occurrence of
an insured event.
6. Insurable Interest
In Life Insurance, the insured must
have an insurable interest i n the
person whose life is being insured. Non-Life Insurance, the insured
must have an insurable interest in
the property or liability being
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37
7. Investment Component
Life Insurance policies often have
an investment component that
provides a savin gs element. Non-Life Insurance policies usually
do not have any investment
component.
8. Tax Benefits
The premiums paid for Life
Insurance policies are eligible for
tax deductions under Section 80C
of the Income Tax Act. Non-Life Insurance premiums like
insurance of stock, building, assets
are allowed as deduction in business
while, premium paid on health
insurance is allowed as deduction
under Section 80D of the Income
Tax Act.
9. Risks Covered
Life Insurance policies cover the
risk of the insured's de ath or
disability Non-Life Insurance policies cover
risks such as fire, theft, natural
disasters, and liability.

2.2.5 Different types of insurance policies:
There are various types of insurance policies available that offer protection
against different types of risks. Here are some of the most common types
of insurance policies:
1. Life insurance: Life insurance provides a death benefit to the
beneficiary upon the policyholder's death. It can help provide
financial support to dependents and cover expenses s uch as funeral
costs and outstanding debts.

2. Health insurance: Health insurance covers medical expenses such as
doctor visits, hospital stays, prescription drugs, and medical
procedures. It can be offered through an employer or purchased
individually.

3. Disability insurance: Disability insurance provides income
replacement in the event that the policyholder becomes unable to
work due to an illness or injury. It can be purchased individually or
provided through an employer.

4. Long -term care insurance: Long -term care insurance provides
coverage for expenses related to long -term care, such as nursing
home care, home health care, and assisted living facilities.
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38 5. Auto insurance: Auto insurance provides coverage for damage to a
vehicle and liability for damage or in jury caused to others in an
accident. It is typically required by law in most states.

6. Homeowners insurance: Homeowners insurance provides coverage
for damage or loss to a home and its contents. It can also provide
liability coverage for injuries that occu r on the property.

7. Renters insurance: Renters insurance provides coverage for the loss
or damage of personal property in a rented residence. It can also
provide liability coverage for injuries that occur in the rental unit.

8. Umbrella insurance: Umbrella i nsurance provides additional
liability coverage beyond what is provided by an individual's primary
insurance policies. It can be useful for individuals with high net worth
or who are at risk for lawsuits.

9. Marine Insurance: Marine Insurance is a type of in surance that
provides coverage for ships, cargo, and related property against loss
or damage during transport by sea or inland waterways. The coverage
can be extended to include other perils such as piracy, collision, and
war risks. Marine insurance polici es are generally taken by shippers,
freight forwarders, and cargo owners to protect their interests during
the transportation of goods.

10. Fire Insurance: Fire Insurance is a type of insurance that provides
coverage against losses or damages caused by fire. The policy covers
the cost of damage to the insured property, as well as any associated
expenses such as debris removal, reconstruction, and loss of rent. Fire
insurance policies can also cover damages caused by other perils such
as lightning, explosion, a nd riot. Fire insurance policies are typically
taken by property owners, landlords, and tenants to protect their
assets in case of fire or other perils.
These are just some of the many types of insurance policies available. It's
important to carefully eval uate insurance needs and options to select the
policies that best meet an individual's unique financial situation.
2.2.6 Different types of Life Insurance Policies:
Life insurance has always been considered an essential financial tool.
However, not many pe ople know that there are several types of life
insurance products. Each of these can be helpful in their own unique ways.
While some provide protection to the chief earning member’s family,
others can be seen as an investment or retirement tool.
Here are t he different types of life insurance plans and their features and
benefits, so you can pick the most suitable one:
1. Term Insurance: Term insurance is a type of life insurance that
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39 years. In this policy, if the insured person dies within the specified
term, their beneficiaries receive a lump sum amount. If the insured
person survives the term, the policy expires, and no benefit is paid.
This is the most basic and affordable type of life ins urance policy.

For example, if a person buys a 10 -year term insurance policy with a
sum assured of ` 1,00,000 and dies within the 10 years, their
beneficiaries will receive the claim amount of ` 1,00,000. If the
insured person survives the 10 years, the policy will expire, and no
benefit will be paid.

2. Term Insurance with Return of Premium: Term insurance with a return
of premium (TROP) is a type of term insurance policy that provides
the policyholder with a return of all the premiums paid at the end of
the policy term, provided the policyholder has not made any claims.
This policy is more expensive than regular term insurance, as it
provides a savings component.

For example, if a person buys a 20 -year TROP policy with a sum
assured of ` 2,00,000 and pay s an annual premium of ` 2,000, the
total premium paid over 20 years would be ` 40,000. If the insured
person dies within the 20 years, their beneficiaries will receive the
claim amount of ` 2,00,000. If the insured person survi ves the 20
years and has not made any claims, they will receive a refund of the
` 40,000 premiums paid.

3. Unit Linked Insurance Plans (ULIPs):Unit linked insurance plans
(ULIPs) are a type of life insurance policy that combines insurance
and investment. Pa rt of the premium paid is used to provide life
insurance coverage, and the remaining amount is invested in mutual
funds or other market -linked instruments. The returns on the
investment are based on the performance of the underlying
investments.

For examp le, if a person buys a ULIP policy with a sum assured of
` 1,00,000 and pays an annual premium of ` 10,000, the insurance
company will deduct a portion of the premium for life insurance
coverage, and the remaining amount will be invested in mutual funds
or other market -linked instruments. The returns on the investment will
depend on the performance of the underlying investments.

4. Endowment Plans: Endowment plans are a type of life insurance
policy that provides a combination of insurance a nd savings. Part of
the premium paid is used to provide life insurance coverage, and the
remaining amount is invested to generate a guaranteed return. The
policyholder receives the guaranteed amount plus bonuses (if any) at
the end of the policy term or up on death, whichever occurs first.

For example, if a person buys a 20 -year endowment plan with a sum
assured of ` 2,00,000 and pays an annual premium of ` 10,000, the munotes.in

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40 insurance company will deduct a portion of the premium for life
insurance coverage, and the remaining amount will be invested to
generate a guaranteed return. At the end of the 20 years, the
policyholder will receive the guaranteed amount plus any bonuses (if
any). If the policyholder dies within the 20 years, their beneficiaries
will receiv e the sum assured plus any bonuses (if any).

5. Moneyback Policy: Moneyback policies are a type of life insurance
policy that provide both insurance and savings benefits. In a
moneyback policy, the policyholder pays a premium for a specific
number of years, and in return, receives a percentage of the sum
assured at regular intervals throughout the policy term. If the
policyholder passes away during the policy term, the death benefit is
paid out to the beneficiary. The remaining portion of the sum assured
is paid out at the end of the policy term.

For example, a 35 -year-old individual purchases a moneyback policy
with a sum assured of ` 1,000,000 and a policy term of 20 years. The
policyholder pays a premium of ` 50,000 per year for the duration of
the polic y term. The policy provides for a payout of 20% of the sum
assured ( ` 2,00,000) every 5 years, and the remaining 40% of the sum
assured (` 4,00,000) is paid out at the end of the policy
term. If the policyholder passes away during the p olicy term, the death
benefit of ` 1,000,000 is paid out to the beneficiary.

6. Whole Life Insurance: Whole life insurance is a type of life insurance
policy that provides coverage for the policyholder's entire life. The
policyholder pays a premium for the duration of their life, and in
return, the policy provides both insurance and savings benefits. A
portion of the premium paid is invested in a savings account, which
accumulates cash value over time. The policyholder can borrow
against the cash value or w ithdraw it in case of financial emergencies.
If the policyholder passes away, the death benefit is paid out to the
beneficiary.

For example, a 40 -year-old individual purchases a whole life insurance
policy with a sum assured of ` 500,000. The policyholde r pays a
premium of ` 10,000 per year for the duration of their life. The
policy accumulates cash value over time, which the policyholder can
borrow against or withdraw in case of financial emergencies. If the
policyholder passes away at the age of 70, t he death benefit of `
500,000 is paid out to the beneficiary.

7. Group Life Insurance: Group life insurance is a type of life insurance
policy that provides coverage to a group of individuals, typically
employees of a company or members of an organization. The
policyholder is usually the employer or organization, and the coverage
is provided to the insured individuals as a benefit. Group life insurance
policies are usually less expensive than individual policies and do not
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41
For example, a company provides group life insurance coverage to its
employees. The policy provides coverage for a sum assured of `
100,000 per employee. If an employee passes away, the death benefit
of ` 100,000 is paid out to the beneficiary.

8. Child Insu rance Plans: Child insurance plans are a type of life
insurance policy that provides coverage to a child in case of their
untimely death. The policyholder is usually the parent or legal
guardian of the child. The policy provides both insurance and savings
benefits. The policyholder pays a premium for a specific period, and in
return, the policy provides a sum assured and savings benefits. The
policy can be used to provide for the child's education, marriage, or
other expenses.

For example, a parent purchas es a child insurance plan for their
newborn child. The policy provides a sum assured of ` 500,000 and a
savings benefit. The parent pays a premium of ` 10,000 per year for
20 years. The policy can be used to provide for the child's education,
marriage, o r other expenses. If the child passes away during the policy
term, the death benefit of ` 500,000 is paid out to the parent.

9. Retirement plans are a type of life insurance policy that provides
financial security to an individual during their retirement y ears. These
plans are designed to help individuals save and invest money during
their working years, so they can have a steady stream of income after
they retire. There are various types of retirement plans, but the most
common ones are:

a. Pension plans: Pe nsion plans are retirement plans in which the
employer makes contributions to a fund on behalf of the employee.
The contributions are invested in various securities to generate returns.
At retirement, the employee receives a fixed income for the rest of
their life.

For example, an employee works for a company that offers a pension
plan. The employee contributes a portion of their salary to the plan,
and the employer matches the contribution. The contributions are
invested in various securities such as stock s, bonds, and mutual funds.
At retirement, the employee receives a fixed monthly income for the
rest of their life.

b. Individual Retirement Accounts (IRAs): IRAs are retirement plans in
which the individual makes contributions to a fund. The contributions
are invested in various securities to generate returns. The contributions
are tax -deductible, and the returns are tax -deferred until the funds are
withdrawn at retirement.

For example, an individual sets up an IRA and contributes 6,000 per
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42 such as stocks, bonds, and mutual funds. The returns on the
investments are tax -deferred until the funds are withdrawn at
retirement.
2.2.7 Different types of Health Insuran ce Policy:
There are several types of health insurance policies in India. Here are
some of the most common types:
1. Individual Health Insurance: This policy covers the medical
expenses of an individual, including hospitalization expenses,
ambulance charges, and pre and post hospitalization expenses. The
sum insured is determined based on the individual's age, health status,
and medical history.

2. Family Floater Health Insurance: This policy covers the medical
expenses of the entire family, including spouse, chi ldren, and parents.
The sum insured is shared among all family members and can be used
by any member as per their medical needs.

3. Senior Citizen Health Insurance: This policy is designed for
individuals above the age of 60 years. It covers the medical expe nses
related to age -related illnesses and pre -existing conditions.

4. Critical Illness Health Insurance: This policy covers the expenses
related to critical illnesses such as cancer, heart attack, and kidney
failure. The policy provides a lump sum amount to the insured, which
can be used for treatment or other expenses.

5. Group Health Insurance: This policy is designed for organizations
and companies to provide health insurance coverage to their
employees. The premium is paid by the employer, and the coverage is
extended to all employees.

6. Personal Accident Insurance: This policy covers the expenses
related to accidental injuries or death. The policy provides a lump sum
amount to the insured or the nominee in case of accidental death or
permanent disability.
It's important to note that the terms and conditions of health insurance
policies can vary among different insurance providers. It's advisable to
read the policy documents carefully and choose a policy that meets your
specific needs.
2.2.8 Strategies for Risk Anal ysis & Insurance Planning:

2.2.8.1 General insurance: It is also known as non -life insurance, is a
type of insurance that provides coverage for losses and damages to
property, liability, and other related risks. When it comes to personal
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43 an individual's assets and ensuring financial security. Here are some
strategies for risk analysis and insurance planning for PFP

Need for General Insurance
1. Protects against unforeseen events: General ins urance policies
provide coverage for unforeseen events such as accidents, natural
disasters, theft, and other unexpected events that can cause financial
loss.

2. Provides peace of mind: Knowing that you have general insurance
coverage can give you peace of m ind, knowing that you are protected
against unexpected losses.

3. Mandatory requirements: Some types of general insurance, such as
motor insurance and workers' compensation insurance, are mandatory
by law. This means that you may be required to have these ty pes of
insurance to operate a vehicle or run a business.

4. Covers liability: General insurance policies can also provide coverage
for liability, which protects you in case you are held responsible for
causing injury or damage to another person or their prop erty.

5. Affordable premiums: General insurance policies offer affordable
premiums and can be customized to fit your needs and budget.

6. Helps to manage risks: General insurance policies can help
individuals and businesses to manage risks by providing financi al
protection against unforeseen events and losses.

General insurance is an essential type of insurance that provides protection
against a wide range of risks and losses. It is important to have general
insurance coverage to safeguard your financial wellb eing and protect you
against unexpected events.

Strategies for risk analysis and insurance planning though General
Insurance for PFP

a. Identify potential risks: The first step in risk analysis is to identify
potential risks that an individual may face. The se risks can include
damage to property, liability claims, theft, or loss of income due to
disability or illness. By identifying potential risks, an individual can
determine the type and amount of insurance coverage they need.

b. Evaluate the level of risk: Once the potential risks have been
identified, the next step is to evaluate the level of risk associated with
each risk. This involves determining the probability of the risk
occurring and the potential financial impact it could have on an
individual's fin ances.
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44 c. Determine the type of insurance needed: Based on the level of risk,
an individual can determine the type of insurance coverage they need.
For example, if an individual owns a home, they may need
homeowners' insurance to protect against damage to th e property.
Similarly, if an individual owns a car, they may need auto insurance to
protect against accidents or theft.

d. Shop around for the best insurance rates: It is essential to shop
around for the best insurance rates to ensure that an individual is g etting
the most value for their money. By comparing rates from different
insurance providers, an individual can find the best coverage at the
most affordable price.

e. Consider bundling insurance policies: Many insurance providers
offer discounts for bundlin g multiple insurance policies, such as home
and auto insurance. Bundling insurance policies can save an individual
money on their insurance premiums.

f. Review insurance coverage regularly: It is important to review
insurance coverage regularly to ensure tha t it is still adequate and up -to-
date. Life changes, such as buying a new car or moving to a new home,
can affect insurance needs, and it's important to adjust coverage
accordingly.
In summary, by identifying potential risks, evaluating the level of risk,
determining the type of insurance needed, shopping around for the best
insurance rates, considering bundling insurance policies, and reviewing
insurance coverage regularly, individuals can effectively manage risk and
ensure financial security through gener al insurance.
2.2.8.2 Life Insurance: In the case of a person's passing away, life
insurance offers financial security to their family or other designated
beneficiaries. Here are a few explanations as to why life insurance is
crucial.

1. Provides financial security : Life insurance provides a lump -sum
payment to the beneficiaries in the event of the insured's death. This
can help provide financial security to the family during a difficult time
and cover expenses such as funeral costs, mortgage payments, and
other out standing debts.

2. Protects dependents: If the insured is the sole breadwinner of the
family, life insurance can help protect their dependents by providing
them with financial support in case of their untimely death.

3. Covers final expenses: Life insurance ca n help cover the cost of
funeral and burial expenses, which can be a significant financial
burden for the family.
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45 4. Offers tax benefits: Life insurance policies offer tax benefits, such as
tax-free death benefits and tax -deferred savings, which can help red uce
the financial burden on the family.

5. Can be used as an investment: Some life insurance policies offer
investment components, such as cash value or dividends, which can
help the insured build wealth over time.
The following are some strategies for risk analysis and insurance planning
with respect to a life insurance policy:
1. Assess your financial needs: Before purchasing a life insurance
policy, it is essential to evaluate your financial needs. This involves
analysing your current financial situation, fut ure obligations, and
determining the amount of coverage required to meet those needs.

2. Choose the right policy: There are several types of life insurance
policies available in the market. It is essential to choose the right one
that best suits your needs. For example, if you have dependents, a term
life insurance policy may be more suitable than a permanent policy.

3. Consider the premium payment: The premium payment is a crucial
aspect of any life insurance policy. You need to consider the premium
amount and the frequency of payment before purchasing a policy. You
should also evaluate whether you can afford to pay the premiums
regularly. If required one can select the tenure of the payment of the
policy i.e., it can monthly, quarterly, half yearly or yearly.

4. Review the policy regularly: Your financial situation can change
over time, and so can your insurance needs. Therefore, it is crucial to
review your life insurance policy periodically to ensure that it still
meets your requirements.

5. Compare policies: It is always advisable to compare different life
insurance policies before purchasing one. This will help you to choose
the policy with the best features and benefits at an affordable price.

6. Take advantage of riders: Riders are additional benefits that can b e
added to a life insurance policy to enhance its coverage. You can
consider adding riders such as critical illness, accidental death, or
waiver of premium to your policy.

7. Choose the right insurer: It is essential to choose a reputable insurer
with a good track record in terms of claims settlement. You can also
check the financial ratings of the insurer to ensure that it is financially
stable.

8. Consider the Tax Planning: The premium paid for life insurance
policy is eligible for the deduction from the gros s total income under
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46 To summarize, risk analysis and insurance planning are critical to ensuring
that you choose the right life insurance policy that meets your needs and
provides financial security to your loved one s in case of an unforeseen
event.
2.2.8.3 Motor Insurance:

Need for Motor Insurance : The following points justify the Motor
Insurance Necessity.
1. Legal requirement: In many countries, it is mandatory to have motor
insurance to legally drive a vehicle on pub lic roads. This is because
accidents can happen at any time, and insurance helps to provide
financial protection to both the driver and other parties involved in an
accident.

2. Financial protection: Motor insurance provides financial protection
to the vehic le owner in case of an accident, theft, or damage caused to
the vehicle. This helps to cover the cost of repairs or replacement of
the vehicle, reducing the financial burden on the owner.

3. Protection for other parties: In case of an accident, motor insuran ce
helps to provide financial protection to third parties, including other
drivers, passengers, and pedestrians. This helps to cover the cost of
medical expenses, property damage, and other losses caused to them.

4. Peace of mind: Having motor insurance prov ides peace of mind to the
vehicle owner, as they know that they are financially protected in case
of an accident or damage to the vehicle.

5. Covers legal liability: Motor insurance also covers legal liability,
which means that the insurance company will pay for the legal
expenses in case of a lawsuit filed against the driver for causing an
accident.

6. Covers natural disasters: Motor insurance also provides coverage in
case of natural disasters, such as floods, earthquakes, or storms, which
can cause damage to the vehicle.
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47 7. Covers theft: Motor insurance also provides coverage in case of theft
of the vehicle, which is a common occurrence in many countries.

8. Covers fire: Motor insurance also provides coverage in case of fire
damage to the vehicle.

9. Offers customiz ation: Motor insurance policies can be customized to
meet the specific needs of the vehicle owner, such as including
additional coverage for accessories or modifications made to the
vehicle.

10. Helps reduce financial risk: Having motor insurance helps to red uce
the financial risk associated with owning and driving a vehicle, as the
cost of repairs or replacement of the vehicle can be substantial, and
insurance helps to mitigate this risk.
Factors to be considered while selecting a Motor Insurance Policy
1. Evalu ate your driving habits: Before selecting a policy, assess your
driving habits to determine if you are a low -mileage driver or if you
drive frequently. This information will help you choose the appropriate
policy and avoid paying for coverage you do not ne ed.

2. Compare policies: Research and compare different policies from
various insurers to find the best value. Look for policies that offer the
coverage you need at an affordable price.

3. Understand the pricing structure: Make sure you understand how
the pric ing structure works for the policy you are considering. For
example, PAYD (Pay -As-You-Drive) policies typically charge a base
rate plus a fee for every mile driven, while PHYD (Pay -How -You-
Drive) policies may use telematics technology to monitor your drivi ng
behaviour and adjust your premiums based on how you drive.

4. Consider the benefits: Look for policies that offer additional benefits
such as roadside assistance, rental car coverage, and discounts for safe
driving.

5. Check for discounts: Ask the insurer a bout any discounts you may be
eligible for, such as multi -car discounts, good driver discounts, and
loyalty discounts.

6. Read the fine print: Carefully read the policy documents to ensure
you understand the terms and conditions, coverage limits, and any
exclusions that may apply.
By following these strategies, you can make an informed decision and
select a motor insurance policy that fits your driving habits and budget.
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48 2.2.8.4: Needs for Medical Insurance
1. Medical insurance provides financial protection agai nst the high cost
of medical treatment and healthcare services.

2. It covers the cost of hospitalization, surgery, and other medical
expenses.

3. Medical insurance offers access to quality medical care and treatment
that may be otherwise unaffordable for many people.

4. It covers preventive care services, such as regular check -ups,
vaccinations, and screenings, which can help individuals stay healthy
and prevent serious illnesses from developing.

5. Medical insurance protects individuals and families against
unexpe cted medical costs and emergencies.

6. It offers peace of mind, knowing that you and your family are
protected against unexpected medical costs.

7. Without medical insurance, individuals may delay seeking medical
treatment, which can lead to more serious healt h problems and higher
medical costs in the long run.

8. Medical insurance can be customized to fit the needs and budget of
individuals and families, offering flexibility and affordability.

9. In some countries, medical insurance is mandatory by law, and
indivi duals may be required to have it to access healthcare services.

10. Medical insurance can help individuals and families maintain their
financial wellbeing by reducing the financial burden of medical costs
and expenses.
Factors to be considered while selecting a Health Insurance Policy
When selecting a health insurance policy under PFP (Preferred Provider
Organization) there are a few strategies that can help you make an
informed decision. Here are some strategies to consider:
1. Research: Conduct thorough researc h to understand the different
types of health insurance policies available under PFP, their coverage,
network of providers, and premiums.

2. Compare: Compare the policies available under PFP to identify the
ones that offer the best value for your money, in t erms of coverage and
cost.
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49 3. Network of Providers: Check the network of providers under each
policy to ensure that the providers you prefer are included in the
network. You should also check the provider's reputation, credentials,
and experience.

4. Cost: Consider the premiums, co -pays, and deductibles associated
with the policy, and ensure that you can afford them.
5. Coverage: Check the policy's coverage for pre -existing conditions,
hospitalization, emergency care, prescription drugs, and other medical
expenses to ensure that your healthcare needs are covered.

6. Benefits: Look for additional benefits offered by the policy, such as
wellness programs, preventive care services, and discounts on health -
related products and services.

7. Customer Service: Consider the qu ality of customer service provided
by the insurance company, such as their responsiveness to inquiries,
speed of claim processing, and level of support.

8. Reputation: Research the insurance company's reputation, customer
satisfaction ratings, and financial stability to ensure that you are
choosing a reliable and trustworthy provider.

9. Renewability: Check the policy's terms for renewability, such as
whether it can be renewed annually or for a longer term, and whether
the premiums will increase with age.

10. Read the Fine Print: Read the policy documents carefully to
understand the terms and conditions, limitations, and exclusions of the
policy, and ensure that you are comfortable with them.
Choose the correct alternative:
1. Which of the following is not an objec tives of risk management in
personal financial planning
a. Protecting assets b. Maintaining stability
c. Enhancing resilience d. Gaining highest return

2. _______________ is a type of insurance that provides coverage for
ships & cargo
a. Marine Insura nce b. Auto insurance
c. Renters insurance d. Umbrella insurance

3. _______________ insurance is a type of life insurance policy that
provides coverage for the policyholder's entire life.
a. Endowment Plans b. Unit Linked Insurance Plans
c. Whol e life d. Retirement plans


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50 4. ___________ is not covered under motor insurance
a. Loss by fire b. Theft
c. Health claim of driver d. Loss caused to another car in accident

5. General insurance does not cover _____________.
a. Loss by Theft b. Los s to property
c. Loss by floods d. Loss of life

1. d; 2. Marine Insurance; 3. Whole life; 4. Health claim of driver;
5.

True of False
1. Developing plans to mitigate the risk is the first step in risk
management.
2. Life insurance is a tool for risk management in personal financial
planning.
3. Comparing different motor car insurance plans of is waste of time.
4. Insurance plans are also useful to achieve long term plans.
5. Endowment plans are a type of life insurance policy that provides a
combinat ion of insurance and savings.
Answers: 1. False 2. True 3. False 4. True 5. True
Answer in Brief:
1. What are the steps in Risk Analysis for personal financial planning?
2. Distinguish between life insurance and non life insurance policies.
3. Briefly exp lain different types of Life insurance policies
4. What are the needs for motor insurance.
5. What are the factors to be considered while selecting health policies?
Short Notes:
1. Objectives of risk management.
2. Role of Insurance decision in personal fi nancial planning.
3. Different types of Life insurance policies.
4. Different types of Health Insurance Policy.
5. Strategies for risk analysis through general insurance.

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51 3
RETIREMENT PLANNING &
EMPLOYEES BENEFITS
Unit Structure
3.0 Objectives
3.1 Introduction
3.2 Meaning of Retirement Planning
3.4 Sources of Retirement Planning:
3.5 Retirement Schemes:
3.6 Exercise
3.0 OBJECTIVES
After studying this chapter, learner w ill be able:
 To Describe the need and objectives of retirement planning;
 To Understand the process of retirement planning;
 To get knowledge about the various sources of income for retirement
planning;
 To Know about the various investment options available for
retirement planning.
3.1 INTRODUCTION
One of the most significant life experiences that many of us will ever go
through is retirement. Realizing a pleasant retirement is a huge
undertaking that requires careful planning and years of perseverance, both
personally and financially. Even after reaching it, taking care of your
retirement is a constant duty that lasts well into your golden years. We all
want to be able to retire in luxury, but creating a good retirement plan may
be complicated and time -consum ing, making the process seem downright
impossible. Even yet, with a little preparation, a manageable savings and
investment plan, and a long -term commitment, it is frequently possible to
complete it with less headaches (and financial anguish) than you may
anticipate.
3.2 MEANING OF RETIREMENT PLANNING
Retirement planning, in a financial context, refers to the allocation of
finances for retirement. This normally means the setting aside of money or
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52 planning is to achieve financial independence, so that the need to be
gainfully employed is optional rather than a necessity.
The process of retirement planning aims to:
 Determine one's financial fitness for retirement based on intended
retire ment age and lifestyle; and
 Identify strategies to increase retirement preparation.
3.3 RETIREMENT PLANNING
3.3.1 Needs for Retirement Planning
We must first comprehend why we must take control of our retirement
before we can talk about how to prepare a go od retirement plan. This may
sound like a silly question, but you might be startled to hear that the
fundamentals of retirement planning go against the grain of conventional
wisdom on the most effective method of saving money for the future.
Furthermore, e nsuring appropriate execution of those crucial elements is
crucial to securing a comfortable retirement. This entails investigating all
potential retirement income sources.
1. Longer Life Expectancy: People are living longer than ever before,
which means that retirement planning is more important than ever to
ensure that you have enough money to last throughout your lifetime.

2. Inflation: Inflation can erode the purchasing power of your retirement
savings over time, making it important to plan for rising costs in
retirement.

3. Uncertainty: There are many uncertainties in life, such as health
problems, unexpected expenses, and changes in the economy.
Retirement planning can help you prepare for unexpected events.

4. Changing Social Security Benefits: Social Security benefits may
change in the future, and retirement planning can help you prepare for
those changes.

5. Medical Expenses: Healthcare costs are rising, and many people
underestimate the cost of healthcare in retirement. Retirement planning
can help you plan fo r these expenses.

6. Dependents: If you have dependents, such as children or elderly
parents, retirement planning can help ensure that you have enough
money to take care of them.

7. Lifestyle: Retirement planning can help you achieve the lifestyle you
want in retirement, whether that means traveling, pursuing hobbies, or
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53 8. Debt: If you have debt, such as a mortgage or credit card debt,
retirement planning can help you create a plan to pay off your debt
before you retire.

9. Tax Implications: Retirement planning can help you understand the
tax implications of your retirement savings and help you create a tax -
efficient retirement strategy.

10. Peace of Mind: Retirement planning can provide peace of mind
knowing that you have a plan in place to achieve your retirement goals
and to be financially secure in retirement.
3.3.2 Development of Retirement Plan:
The process of retirement planning involves several steps, including:
1. Set your retirement goals: Identifying your retirement goals i s the
first step in retirement planning. This include choosing your retirement
age, figuring out how much money you'll need, and deciding on the
lifestyle you wish to lead.

2. Make a retirement savings calculation: The amount of money you
will need to save i n order to reach your retirement goals must then be
determined. Calculating any sources of retirement income, such as
Social Security or a pension, as well as your anticipated retirement
costs, including those for housing, healthcare, and daily living, is
necessary.

3. Develop a retirement plan: You can create a retirement plan once
you've calculated your financial requirements and retirement goals. A
retirement income strategy, tax -saving strategies, and investment
decisions that are suitable for your risk p rofile and time horizon are all
included in this.

4. Review and adjust your retirement plan: Retirement planning is a
continuous process, therefore it's crucial to regularly examine and
modify your strategy. This entails keeping an eye on the performance
of your retirement investments and savings, modifying your retirement
income strategy as necessary, and updating your retirement plan when
your personal circumstances change.

5. Implement your retirement plan: Finally, you must put your
retirement plan into act ion by funding your retirement accounts,
making wise investment decisions, and taking measures to reduce your
tax liability. To give your retirement savings time to develop, it's
crucial to start carrying out your retirement plan as soon as you can.

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54 3.4 SOURCES OF RETIREMENT PLANNING:
People can use a variety of retirement planning resources in India to assist
them in making retirement plans. Typical sources include:
1. Employee Provident Fund (EPF): The majority of employees in India
are required to particip ate in the government -sponsored EPF
retirement scheme. Both employers and employees make contributions
to the retirement fund, which is accessible upon retirement.

2. National Pension System (NPS): All Indian nationals are eligible for
the government -sponsore d NPS retirement programme. The NPS
accepts contributions from individuals, and the money is invested in a
combination of government securities, debt, and equity.

3. Public Provident Fund (PPF): PPF is a savings programme offered
by the government that is acc essible to all Indian citizens. Tax
deductions are available for PPF contributions, and the funds' growth
is tax -free. Additionally, withdrawals are tax -free.

4. Individual Retirement Accounts (IRAs): In addition to EPF, NPS,
and PPF, individuals can also op en IRAs to save for retirement. There
are two types of IRAs in India: traditional and Roth.

5. Life insurance policies: Life insurance policies can provide a source
of retirement income in India. Some life insurance policies offer a
lump -sum payout at the en d of the policy term, while others provide
regular payouts throughout retirement.

6. Mutual funds and other financial instruments: Mutual funds and
other financial instruments can be an important source of retirement
income in India. Individuals can invest i n mutual funds, stocks, bonds,
and other financial instruments to save for retirement.

7. Financial advisors: Financial advisors can provide guidance and
advice on retirement planning in India, including creating a retirement
savings plan, selecting appropri ate investments, and developing a
retirement income strategy.
3.5 RETIREMENT SCHEMES:
3.5.1 Employees Provident Fund (EPF):
The Employees' Provident Fund (EPF) is a government -backed retirement
savings scheme that is mandatory for most employees in India. Under the
EPF scheme, both the employee and employer contribute a fixed
percentage of the employee's salary (12% of the basic salary plus dearness
allowance) to the EPF account. The employee can withdraw the
accumulated amount in the EPF account at the ti me of retirement or
resignation. About EPFO In terms of clientele and the volume of financial munotes.in

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55 transactions handled, EPFO is one of the largest social security
organisations in the world. It currently maintains 24.77 crore accounts for
its members (Annual R eport 2019 –20). On November 15, 1951, the
Employees' Provident Funds Ordinance was enacted, creating the
Employees' Provident Fund. The Employees' Provident Funds Act, 1952
took its place. The Employees' Provident Funds Bill, which established
provident f unds for workers in factories and other establishments, was
introduced in the Parliament as Bill Number 15 of 1952.
The Act, which covers all of India, is currently known as the Employees'
Provident Funds & Miscellaneous Provisions Act, 1952. The Central
Board of Trustees, Employees' Provident Fund, a tri -partite board made up
of members of the government (both central and state), employers, and
employees, is responsible for overseeing the Act and the Schemes created
under it.
Source: https://www.epfindia.gov.in/site_en/index.php
Key Features of EPF Scheme:
The Employees Provident Scheme (EPS) is a government -mandated
savings scheme that provides retirement benefits to employees in India.
Here are s ome key features of the Employees Provident Scheme:
1. Eligibility: The scheme is applicable to all employees who are
members of the Employees' Provident Fund (EPF).

2. Contributions: Both the employee and employer contribute 12% of
the employee's basic salary and dearness allowance to the EPF. Out of
this, 8.33% is diverted to the EPS, subject to a maximum of Rs. 1250
per month.

3. Pension benefits: The scheme provides a pension to employees after
they retire or in the event of their death. The pension amount is based
on the employee's length of service and their contribution to the
scheme.

4. Withdrawal: Employees can withdraw their EPS contributions after
10 years of service, or in the event of disability, resignation, or death.

5. Nomination: Employees can nominate their spouse or children as
beneficiaries in the event of their death.

6. Interest rate: The EPS currently offers an interest rate of 8.15% per
annum.

7. Tax benefits: Contributions to the EPS are eligible for tax deductions
under Section 80C of the Income Ta x Act, 1961.
Overall, the Employees Provident Scheme provides a reliable retirement
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56 Benefits of the EPF:
The Employees' Provident Fund (EPF) scheme in India has several
benefits for both employees and employers. Here are some of the key
benefits of the EPF scheme:
1. Retirement savings: The EPF scheme helps employees save for their
retirement. The funds accumulated in the EPF account can provide a
steady source of income in retirement.

2. Tax b enefits: Contributions made to the EPF account are tax -
deductible under Section 80C of the Income Tax Act, up to a
maximum of Rs. 1.5 lakh per year. Additionally, the interest earned on
the EPF account is tax -free.

3. Social security: The EPF scheme provides social security to
employees, ensuring that they have a financial cushion in case of
unemployment, disability, or other unforeseen circumstances.

4. Low risk: The EPF scheme is a low -risk investment option as the
funds are managed by the government and inve sted in fixed income
securities such as bonds and debentures.

5. Competitive interest rate: The EPF scheme offers a competitive
interest rate on the accumulated funds. The interest rate is determined
by the government of India every year based on the prevail ing
economic conditions.

6. Employer contribution: Employers are required to contribute an
equal amount to the EPF account as the employee. This provides an
additional source of retirement savings for employees.

7. Easy withdrawal: Employees can withdraw the a ccumulated amount
in the EPF account at the time of retirement or resignation. This makes
it easy for employees to access their retirement savings when they
need it.

8. Portability: The EPF account is portable, which means that
employees can tran sfer their account from one employer to another.
This ensures that their retirement savings are not impacted by changes
in employment.
Salary for the Purpose of calculation of = 12% of [Basic Salary +
Dearness Allowance forming part of retirement benefits + Commission
based on turnover]
= 12% of [ ` 1,80,000 + (50% × ` 1,20,000) + `8,000]
= 12% of ` 2,48,000
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57 Note 3: Employee’s contribution to RPF is not taxable. It is eligible for
deduction under section 80C.
The Table below Shows the Interest on EPF over the years.
Financial Year Annual
Interest
Rate (%) 2013-14 8.75% 2014-15 8.75% 2015-16 8.80% 2016-17 8.65% 2017-18 8.55% 2018-19 8.65% 2019-20 8.50% 2020-21 8.50% 2021-22 8.10% 2022-23 8.15%

Data Compiled from:
https://www.epfindia.gov.in/site_docs/PDFs/MiscPDFs/InterestRate_OnP
FAccumulationsSince1952.pdf
Table and Chart prepared by the author.
Tax Planning of Provident fund:
In accordance with this plan, the employee's salary has a certain amount
withheld as his contribution to the fund. Additionally, the employer often
makes a similar contribution to the fund out of his own pocket.
Investments in approved securities are made using the employer and
employee contributions. Additionally, any interest generated thereon is
added to the employee's account. As a result, the following items make up
the credit amount in an employee's provident fund account:
(i) Employee’s contribution
(ii) Interest on employee’s contribution
(iii) Employer’s contribution
(iv) Interest on employer’s contribution. 7.60%7.80%8.00%8.20%8.40%8.60%8.80%9.00%Annual Interest Rate (%) on EPF
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58 When an employee retires or resigns, the accumulated balance is paid to
him. In the event of the employee's death, the same amount is paid to his
legal heirs.The provident fund is an important source of small savings for
the government. Hence, the Income-tax Act, 1961 gives certain deductions
on savings in a provident fund account.


Tax Treatment of Contribution to different Category of Provident
Fund
Particulars Recognised PF Unrecognised PF Statutory
PF
Employer’s
Contribution Amount in excess of
12%of Salary is
taxable Not taxable Yearly Fully
Exempt
Employee’s
Contribution Eligible for
deduction u/s 80C Not eligible for deduction Eligible for
deduction
u/s 80C
Interest Credited Amount in excess of
9.5% p.a. is taxable Not taxable yearly Fully
exempt
Amount with drawn on
retirement/termination Exemptu/s
10(12)subject to
specified conditions
mentioned in the
chart below
(*#*) •Employee’s contribution
is not taxable.
•Interest on Employee’s
contribution is taxable
under the head of “Income
from Other Sources”.
•Employer’s contribution
and interest ther eon is
taxable as “Profit in lieu of
salary” u/s 17(3). Exempt u/s
10(11)
Note: Salary for this purpose means basic salary and dearness allowance -
if provided in the terms of employment for retirement benefits and
commission as a percentage of turnover.

Types of
Employees'
Provident Funds
Recognised
Provident Fund
(RPF)Unrecognised
Provident Fund
(URPF)Statutory
Provident Fund
(SPF)
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59 Illustration 01:
Mr. Ashwin retires from service after 22 years of service. Following are
the details of his income and investments for the previous year 2021-22:
Particulars Amount
(`)
Basic Pay @ ` 16,000 per month for 9 months 1,44,000 Dearness Pay (50% forms part of the retirement benefits) ` 8,000 per month for 9 months 72,000 Lumpsum payment received from the Unrecognized
Provident Fund 6,00,000 Deposits in the PPF account 40,000 Out of the amount received from the unrecognised provident fund, the
employer’s contribution was ` 2,20,000 and the interest thereon `50,000.
The employee’s contribution was ` 2,70,000 and the interest thereon `
60,000. What is the taxable portion of the amount received from the
unrecognized provident fund in the hands of Mr. A for the assessment year
2022-23?
Solution:
Taxable portion of the amount received from the Unrecognised Provident
Fund in the hands of Mr. A for the A.Y. 2022-23 is computed hereunder:
Particulars ` `
Income from Salary
Employer’s share in the payment received from the
URPF 2,20,000 Interest on the employer’s share 50,000 Income from Salary 2,70,000 Income from Other Sources
Interest on the employee’s share 60,000 Total amount taxable from the amount received
from the fund 3,30,000 Note: Since the employee is not eligible for a deduction under section 80C
at the time of contribution to the URPF, the employee's share received
from the URPF is not taxable at the time of withdrawal because this
amount has already been taxed as his salary income.
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60 Illustration 02:
What would your response be if the fund in the preceding illustration was
a recognised provident fund?
Solution:
As the fund is recognised provident fund and the maturity occurs after 22
years of service (i.e. a period more than 5 years), the entire amount
received on the maturity of the RPF will be tax-free.
Illustration 03:
Mr. Bharat is working in Sheena Ltd. and has provided with the details of
his income for the A.Y. 2022-23. You are required to compute his gross
salary from the details given below:
Particulars Amount (`)
Basic Salary ` 15,000 p.m.
D.A. (50% is for retirement benefits) `10,000 p.m.
Commission as a percentage of turnover 0.1%
Turnover during the year `80,00,000
Bonus `60,000
Gratuity `50,000
Employee’s contribution in the RPF `25,000
Employer’s contribution to RPF 20% of his basic salary
Interest accrued in the RPF @ 13% p.a. `13,000









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61 Solution:
Computation of Gross Salary of Mr. B for the A.Y.2020-21
Particulars ` `
Basic Salary [` 15,000 × 12] 1,80,000 Dearness Allowance [` 10,000 × 12] 1,20,000 Commission on turnover [0.1% × `
80,00,000] 8,000 Bonus 60,000 Gratuity [Note 1] 50,000 Employers contribution to RPF [20% of `
1,80,000] 36,000 Less: Exempt [Note 2] (29,760) 6,240 Interest accrued in the RPF@13% p.a. 26,000 Less: Exempt@9.5% p.a. [`26,000/13% x
9.5%] (19,000) 7,000 Gross Salary 4,31,240
Working Note:
Note 1: Gratuity received during service is fully taxable.
Note 2: Employers contribution to RPF is exempt up to 12% of salary.
Salary for the Purpose of calculation of = 12% of [Basic Salary +
Dearness Allowance forming part of retirement benefits + Commission
based on turnover]
= 12% of [` 1,80,000 + (50% × ` 1,20,000) + ` 8,000]
= 12% of ` 2,48,000
= 29,760
Note 3: Employee’s contribution to RPF is not taxable. It is eligible for
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62 (*#*)Summary for Exemption of RPF:

3.5.2 Public Provident Fund (PPF)
In India, the Public Provident Fund (PPF) is a long-term savings
programme backed by the government that provides enticing interest rates
and tax advantages. All Indian citizens are eligible to open PPF accounts,
which can be done at authorised post offices, nationalised banks, and
select private banks. The scheme has a tenure of 15 years and can be
extended for another 5 years.
Here are some key features of the PPF scheme:
1. Investment amount: The minimum investment amount in a PPF
account is Rs. 500 per year, while the maximum is Rs. 1.5 lakh per
year.

2. Interest rate: The interest rate on PPF is set by the government of
India and is subject to change every quarter. For the April-June 2022
quarter, the interest rate is 7.1%.

Has the employee rendered continuous service of at least
5 years with the employer?
If Yes = Fully
ExemptNo
Was Services discontinued due to
a. illness
b. discontuniuation of business by the Employer
c. Any other cause beyond the control of the employee
If Yes = Fully Exempt No
Is the entire balance standing to the
credit of the employee transferred to
his individual account in any RPF
maintained by his new employer?
If Yes = Fully
ExemptIF No = TaxableIs the entire balance standing to the
credit of the employee transferred to his
NPS account referred to in section 80CCD
and notified by the Central
If Yes = Fully
ExemptIF No = Taxable
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63 3. Tax benefits: Contributions made to the PPF account are tax-
deductible under Section 80C of the Income Tax Act, up to a
maximum of Rs. 1.5 lakh per year. Additionally, the interest earned
on the PPF account is tax-free.

4. Lock-in period: The PPF account has a lock-in period of 15 years,
after which the account holder can either withdraw the entire amount
or extend the account for a further period of 5 years.

5. Loan facility: After completing 3 years of the PPF account tenure,
account holders can avail of a loan against the balance in the account.

6. Partial withdrawal: Account holders can make partial withdrawals
from the PPF account after completing 5 years from the end of the
financial year in which the account was opened.

7. Nomination facility: PPF account holders can nominate a nominee
who will receive the funds in case of the account holder's death.
All things considered, the PPF scheme is a secure and alluring long-term
investment choice that offers tax advantages and steady profits. It is the
best choice for people who want to put money aside for long-term
objectives including retirement planning, paying for their children's
education, and other significant expenses.
Benefits of PPF:
Public Provident Fund, also known as PPF, is a long-term savings
programme introduced by the Indian government. It is a popular
investment choice among people because it provides investors with a
number of advantages. The following are a few advantages of PPF:
1. Tax benefits: Under Section 80C of the Income Tax Act, 1961,
contributions made to PPF are eligible for tax deductions. Both the
accrued interest and the maturity revenues are tax-free.

2. Guaranteed returns: The current annual rate of return offered by PPF
is 7.1 percent and is fixed and guaranteed. The government evaluates
and updates this rate every three months.

3. Long-term investment: PPF has a 15-year term that can be extended
for another 5 years. It is an enormous alternative for those who want to
make long-term investments.

4. Flexibility: PPF offers flexibility in terms of investment amount. An
individual can invest a minimum of Rs. 500 and a maximum of Rs. 1.5
lakh in a financial year. They can also make partial withdrawals after
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64 5. Safety: PPF is a safe investment option as it is backed by the
government. It offers guaranteed returns, making it a low-risk
investment option.

6. Compound interest: PPF offers compound interest, which means
interest earned in a year is added to the principal amount, and interest
is calculated on the new amount. This helps in generating higher
returns.

7. Loan facility: PPF offers a loan facility to account holders after the
third year of opening the account. The loan amount can be up to 25%
of the balance in the account at the end of the second year preceding
the year in which the loan is applied for.

8. Estate planning: PPF also offers estate planning benefits as the
account holder can nominate a nominee. In the event of the account
holder's death, the nominee can receive the maturity proceeds or
continue with the account until maturity.
Overall, PPF offers a range of benefits, making it an attractive investment
option for individuals looking for a secure and stable investment avenue.
Financial Year Annual
Interest
Rate (%)
2013-14 7.10%
2014-15 7.10%
2015-16 7.10%
2016-17 7.10%
2017-18 7.10%
2018-19 7.10%
2019-20 7.10%
2020-21 7.10%
2021-22 7.10%
2022-23 7.10%

Data Compiled from:
http://www.nsiindia.gov.in/InternalPage.aspx?Id_Pk=178
Table and Chart prepared by the author.
0.00%1.00%2.00%3.00%4.00%5.00%6.00%7.00%8.00%Annual Interest Rate
Annual Interest Ratemunotes.in

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65 Tax Treatment of Contribution to different Category of Provident
Fund
Particulars Public Provident Fund
Employer’s Contribution Not applicable as only Assessee can
contribute in this scheme.
Employee’s Contribution Eligible for deduction u/s 80C
Interest Credited Fully Exempted from Tax
Amount withdrawn on
retirement/termination Fully exempt u/s 10(11)

Illustration 04:
Mr. Rohit is working for MI Ltd. The details of the emoluments received
and investments made by him are as follows:
Particulars Amount
Basic Salary 40,000 per month.
Dearness Allowance 12.5% of Basic Salary
Other taxable allowance 25,000 per month
Contribution to PPF 1,80,000

You are required to calculate the Net Taxable income.
Solution:
Particulars Amount (`) Amount (`)
Income from Salary
Basic Salary [` 40,000 × 12] 4,80,000
Dearness Allowance [` 4,80,000 × 12.5%] 60,000
Other Taxable Allowance [` 25,000 x 12] 3,00,000
Gross Salary/Gross Total Income 8,40,000
Less: Deduction Under Chapter VI - A
80C - Contribution to PPF (WN. 1) (1,50,000) Net Total Income 6,90,000
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66 Working Note 1:
80C - Contribution to PPF (Lower of:)
a. Actual Amount Paid 1,80,000
b. Maximum Amount Allowed under 80C 1,50,000
Lower 1,50,000
3.5.3 Superannuation Fund:
Superannuation funds, like Provident Funds, are a type of retirement
benefit plan for employees. These are funds, typically established under
trusts by an undertaking, for the purpose of providing annuities, etc., to the
undertaking's employees upon retirement at or after a specified age, or
upon becoming incapacitated prior to such retirement, or for the
employees' widows, children, or dependents in the event of any
employee's earlier death. The trust invests the funds' contributions in the
manner and form prescribed. Income from these investments is exempt if
the fund is an Approved Superannuation Fund.
Key features of Superannuation Funds in India:
1. Employer-sponsored: Employers sponsor superannuation funds and
contribute a specific portion of the employee's base pay to the fund.

2. Voluntary participation: Employees may choose to opt out of the
plan at any time. Employees may choose to participate in the plan at
their own discretion.

3. Long-term investment: The Superannuation Fund contributions are
placed in long-term investments with the intention of earning a return
over time.

4. Tax advantages: Under Section 80C of the Income Tax Act of 1961,
contributions made to the Superannuation Fund are eligible for tax
deductions. Both the accrued interest and the maturity revenues are
tax-free.

5. Vesting term: After a vesting period, which is typically five years, the
employee is qualified to receive Superannuation Fund benefits.

6. Retirement benefits: After an employee retires, the Superannuation
Fund offers retirement benefits in the form of a lump sum payout or a
monthly pension.

7. Options for withdrawal: Employees have the choice of receiving
their whole accrued money as one lump sum payment or a monthly
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67 8. Estate Planning: The Superannuation Fund provides estate planning
advantages by allowing employees to name a nominee to receive
benefits in the case of their death.
In general, Superannuation Funds give employees a dependable retirement
benefit, assisting them in securing their financial future.
Types of Superannuation benefit:
Based on the investments and benefits it provides, superannuation benefits
in India are divided into the following categories:
1. Defined benefit plans: As the name implies, regardless of
contributions made to the plan, the benefit received under this type of
superannuation is already fixed. The pre-determined benefit is dependent
on a variety of variables, including the number of years of employment
with the company, pay, and the age at which the person begins receiving
the benefit. This is somewhat complicated, and the employer bears the risk
of producing such a benefit. An eligible employee who retires will receive
a fixed sum, established by the pre-existing formula, at regular intervals.

2. Defined contribution plans: The defined benefit plan is the reverse of
this superannuation benefit. A defined contribution plan has a fixed
contribution and a benefit that is directly associated with the contribution
and market forces, whereas a defined benefit plan has a fixed contribution
and a benefit that is fixed and predetermined. As the employee has no idea
how much he will earn in retirement, this sort of benefit is easier to
handle.
How does superannuation work?
The employer makes a contribution to the group superannuation policy he
owns on behalf of the employees as a superannuation benefit.
Organizations either manage their own superannuation trusts, open a
superannuation benefit fund with any of the authorised insurance
companies, or purchase the product from insurance companies like LIC's
New Group Superannuation Cash Accumulation Plan or ICICI's
Endowment superannuation plans etc., among others. The company must
contribute a defined percentage of each employee's base salary and
dearness allowance (up to a maximum of 15%), and this percentage must
be the same for each group of employees. Although the employer
contributes, superannuation should ideally be included in the cost to the
company (CTC).It should be emphasised that, in the case of defined
contribution plans, employees may also choose to voluntarily contribute
additional funds. The employee may withdraw up to one-third of the
accrued benefit at retirement and convert the remaining portion into a
regular pension. The remaining portion is then held in the annuity fund to
receive annuity returns at predetermined intervals. The employee has the
option to transfer the superannuation amount to a new employer in the
event that he switches jobs. If the new employer does not offer a
superannuation plan, the employee has two options: remove the money
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68 Benefits of Superannuation Funds:
Superannuation Funds are a well-liked retirement benefit programme in
India since they provide numerous advantages to employees. Here are a
few of the main advantages of superannuation funds:
1. Employer-sponsored: Employers sponsor superannuation funds and
contribute a specific portion of the employee's base pay to the fund.
This guarantees that workers can save for their golden years without
facing further financial hardship.

2. Tax benefits: Under Section 80C of the Income Tax Act of 1961,
contributions made to the Superannuation Fund are eligible for tax
deductions. Both the accrued interest and the maturity revenues are
tax-free.

3. Long-term investment: The Superannuation Fund's contributions are
invested for the long term with the intention of earning a return on
investment over time. This guarantees that the workers will receive a
significant retirement benefit.

4. Vesting period: After a vesting period, which is typically five years,
the employee is qualified to collect the Superannuation Fund's
benefits. The long-term investment of the staff is ensured by doing
this.

5. Retirement benefits: After an employee retires, the Superannuation
Fund offers retirement benefits in the form of a lump sum payout or a
monthly pension. This helps workers in continuing to live comfortably
after retirement.

6. Withdrawal options: Either a lump sum withdrawal of the total
accrued cash or a monthly pension payment is an option for the
employees. In terms of withdrawal possibilities, this gives the
employees flexibility.

7. Estate planning: The Superannuation Fund has an estate planning
feature that allows employees to name a beneficiary to receive benefits
in the case of their death. This makes sure that even when the
employee passes away, their family will be taken care of.
Overall, Superannuation Funds provide a secure and reliable retirement
benefit to employees, helping them to secure their financial future.
Taxation of Superannuation Fund
Superannuation is a fund that an employee receives from their employer.
As a result, superannuation funds become taxable when their value
exceeds a certain threshold. The types of tax treatments available in the
case of a superannuation fund are determined by the following categories. munotes.in

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69  Employee’s Contribution: An employee can claim a deduction under
Section 80C for funds invested in an approved scheme.

 Employer’s Contribution: The government allows an exemption of
` 1,50,000/- per employee per year. The exemption is only provided
by the government if the employer contributes to the specified funds.
The contribution may exceed `1,50,000/- in the specified
circumstances. In such cases, the balance would be taxable in the
employee's hands.

 Interest on accumulated balance: The interest on accumulated balance
is exempt from tax.

 The amount received from an approved superannuation fund is
exempted as per provisions of section 10(13).
Exemption of Superannuation fund:
Any payment from an approved superannuation fund, made under
following circumstances, shall be exempt-
1. The payment was made upon the beneficiary's death; or

2. The payment was made upon the beneficiary's death as a refund of
contributions; or

3. The payment has been made to the employee's account via transfer
under the pension scheme referred to in section 80CCD and notified
by the Central Government; or

4. The payment was made to an employee in lieu of or in commutation of
an annuity upon his retirement, at or after a specified age, or upon his
becoming incapable prior to retirement; or

5. The payment was made in the form of a contribution refund to an
employee upon leaving the service (for which the fund was
established) at or after a specified age or upon the employee becoming
incapable prior to retirement.
3.5.4 Gratuity:
Meaning: A gratuity is the sum of money that an employer gives to a
worker in appreciation for the services that the worker has provided to the
business. The gratuity sum, however, is only granted to employees who
have worked for the business for five years or longer. It is governed by the
Payment of Gratuity Act, 1972.
If an employee becomes handicapped in an accident or due to a disease,
they are eligible to receive their gratuity before the five-year mark. The
amount of your gratuity is primarily based on your most recent income
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70 Needs for Gratuity:
As per the Payment of Gratuity Act, 1972, an employee is eligible for
gratuity if he/she has completed five years of continuous service with the
same employer. Gratuity is payable on retirement, resignation,
superannuation, death, or disablement due to accident or illness.
Key features of Gratuity:
The key features of gratuity are as follows:
1. Eligibility: An employee is eligible for gratuity if he/she has
completed five years of continuous service with the same employer.

2. Calculation of Gratuity: The amount of gratuity payable to an
employee is calculated based on the employee's last drawn salary and
the number of years of service completed.

3. Maximum Amount: The maximum amount of gratuity payable under
the Payment of Gratuity Act, 1972 is Rs. 20 lakhs. However, an
employer may choose to pay a higher amount if they wish to do so.

4. Payment of Gratuity: Gratuity is payable to an employee on
retirement, resignation, superannuation, death, or disablement due to
accident or illness.

5. Tax Implications: Gratuity is exempt from income tax up to a certain
limit, which is currently Rs. 20 lakhs. Any amount of gratuity received
over and above this limit is taxable.

6. Nomination: An employee can nominate one or more persons to
receive the gratuity in case of their death.

7. Insurance Coverage: An employer may choose to take out a group
gratuity insurance policy to cover the liability of payment of gratuity
to employees.
Overall, gratuity is an important employee benefit that provides financial
security to employees and recognizes their contributions to the
organization. The key features of gratuity ensure that it is paid in a fair and
transparent manner, and provide safeguards to both employees and
employers.
Key Benefits of gratuity in are as follows:
1. Retirement Benefits: Employees receive a financial cushion when
they retire from their job after completing the required years of service.
This allows them to live comfortably in their retirement years.
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71 2. Employee Retention: Gratuity encourages employees to stay with the
same employer for a longer period of time by ensuring that they will be
rewarded for their loyalty and hard work.

3. Financial Security: In the event of an employee's death or disability,
gratuity provides financial support to their family members and
dependents. This ensures that they can maintain their standard of living
even if the earning member is not present.

4. Statutory Obligation: Employers in India are required by law to give
their employees who have completed five years of continuous service a
gratuity. Failure to do so may result in legal action being taken against
the employer.

5. Boosts Employee Morale: The payment of a gratuity boosts employee
morale by recognising their contributions to the organisation and
providing them with a sense of financial security. This, in turn, can lead
to increased productivity and loyalty to the organisation.
Overall, gratuity is an important component of the employee benefit
package in India, providing employees with financial security as well as a
sense of appreciation for their hard work and dedication.
Eligibility Criteria for Payment of Gratuity:
To receive the gratuity, you must meet the following eligibility criteria:
 Employees should be qualified for retirement benefits.
 Employee should have ended their employment.
 After five years of continuous employment with the organisation, the
employee should have resigned.
 The gratuity is provided to the nominee in cases of employee death or
to you if you become disabled due to illness or an accident.
Taxation Rules for Gratuity:
Gratuity is a retirement benefit given by an employer to an employee as a
token of appreciation for the services rendered by the employee. Gratuity
is tax-free up to a certain limit, and the taxation rules for gratuity in India
are as follows:
The tax treatment of the gratuity amount depends on the type of employee
who has to receive the gratuity.
Gratuity is a voluntary payment made by an employer in appreciation of
services rendered by the employee.
Exemption in respect of Gratuity [Section 10(10)]
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72 Category – I: Defence Service or Government Employee – Fully
Exempt
Category – II: Covered by the Payment of Gratuity Act, 1972
Gratuity is exempt from tax to the extent of least of the following:
(a) ` 20,00,000
(b) Gratuity amount actually received
(c) 15 days’ salary based on last drawn salary for each completed year of
service or part thereof in excess of 6 months
Note: Salary for this purpose means basic salary and dearness
allowance. No. of days in a month for this purpose, shall be taken as
26.
Category – III: Not Covered by the Payment of Gratuity Act, 1972
(a) ` 20,00,000
(b) Gratuity amount actually received
(c) Half month’s salary (based on last 10 months’ average salary
immediately preceding the month of retirement or death) for each
completed year of service (fraction to be ignored)
Note: Salary for this purpose means basic salary and dearness
allowance, if provided in the terms of employment for retirement
benefits, forming part of salary and commission which is expressed as
a fixed percentage of turnover.
Learners must also note the following points:
 Any gratuity you receive while you are working is completely taxable.

 When receiving a gratuity from two or more employers in the same
year, the total amount that is free from tax cannot exceed ` 20,00,000.

 The cap of `20,00,000 will be reduced by the amount of gratuities that
was exempt before in cases where gratuity was received from a former
employer in any prior year and again from another employer in a
subsequent year.
Illustration 05:
Mr. Ravi retired on 15.06.2022 after completion of 26 years 8 months of
service and received gratuity of ` 9,00,000. At the time of retirement, his
salary was:
 Basic Salary: ` 50,000 p.m.
 Dearness Allowance: ` 20,000 p.m.
 (60% of which is for retirement benefits) munotes.in

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73  Commission: 1% of turnover
 (turnover in the last 12 months was ` 10,00,000)
 Bonus: ` 12,000 p.a.
Compute his taxable gratuity assuming:
1. He is private sector employee and covered by the Payment of Gratuity
Act 1972.
2. He is private sector employee and not covered by Payment of Gratuity
Act 1972.
3. He is a Government employee.
Solution:
Particulars Amount Amount
A. Covered by Payment of Gratuity Act
Gratuity Received 9,00,000
Less: Exemption (WN. 1)
(9,00,000)
Taxable Gratuity -
B. Not Covered by Payment of Gratuity
Act
Gratuity Received 9,00,000
Less: Exemption (WN. 2)
(8,19,000)
Taxable Gratuity
81,000

C. Government Employee
Gratuity Received 9,00,000
Less: Exemption (WN. 3)
(9,00,000)
Taxable Gratuity -
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74 Working Note 1
A. Covered by Payment of Gratuity Act
Gratuity is Exempt to the least of the following:
1. Actual Amount Received
9,00,000
2. Maximum Allowed
20,00,000
3. 15/26 x Last Drawn salary x No. of Years of
Employment
10,90,385
(15/26 x 70,000 x 27)
Amount of Exemption
9,00,000
Last Drawn Salary
Salary = Basic + DA
Salary = 50,000 + 20,000
Salary = 70,000 p.m.
No. of Years of Employment = 26 years and 8 months
No. of Years of Employment = 27 years
Working Note 2
A. Not Covered by Payment of Gratuity Act
Gratuity is Exempt to the least of the following:
1. Actual Amount Received 9,00,000
2. Maximum Allowed 20,00,000
3. 1/2 x Average Salary x No. of Years of Employment 8,19,000
(1/2 x 63,000 x 26)
Amount of Exemption 8,19,000
Average Salary
Salary = Basic + DA (Terms) + Fixed Percentage of Commission on
Turnover
Basic = 50,000 p.m.
DA (Terms) = (20,000 x 60%) = 12,000 p.m. munotes.in

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Fixed Percentage of Commission on Turnover = (12,00,000 x 1%) = 12,000 p.a. Average Salary = ((50,000 x 10) + (12,000 x 10) + (12,000/12 x 10))/1063,000 No. of Years of Employment = 26 years and 8 monthsNo. of Years of Employment = 26 years
Working Note 3 Gratuity received by the Government Employee after retirement is exempted from tax.
3.5.5 Other Pension Plan: Pension: ‘Pension’ as a periodic payment made especially by Government or a company or other employers to the employee in consideratservice payable after his retirement.
Gratuity
oReceived
During
Employment
Fully
Taxable
Government
Employee
Fully Exempt
oa. Maximum
20,00,000
ob. Actual Amount
Received
oc. 15 days' salary
(based on last drawn
salary) for every
completed year of
service or part in
excess of 6 months
(No. of days in a
month to be taken as
26)Retirement Planning Fixed Percentage of Commission on Turnover = (12,00,000 x 1%) = Average Salary = ((50,000 x 10) + (12,000 x 10) + (12,000/12 x 10))/10 No. of Years of Employment = 26 years and 8 months No. of Years of Employment = 26 years Gratuity received by the Government Employee after retirement is
Pension: ‘Pension’ as a periodic payment made especially by Government or a company or other employers to the employee in consideration of past service payable after his retirement.
oReceived
During
Retirement
Non
Government
Employee
Covered
Under POGA
oExemption is
Least of the three:
Not Covered
Under POGA
oExemption is
Least of the three:
oa. Maximum
20,00,000
ob. Actual Amount
Received
oc. Half month salary
(based on avg of last 10
months salary) for
every completed year
of service
Retirement Planning & Employees
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76 Types of Pension:
1. Retiring Pension: A retiring pension shall be granted to a government
servant who retires or is retired before reaching the age of superannuation,
or to a government servant who opts for voluntary retirement after being
declared surplus.

2. Invalid Pension: If a government employee applies for retirement due
to a bodily or mental infirmity that renders him or her permanently unfit
for duty, an invalid pension may be granted. A medical report from the
competent medical board is required to support the request for invalid
pension.

3. Compensation Pension: If a Government servant is selected for
discharge due to the abolition of a permanent post, he shall have the option
unless he is appointed to another post whose conditions are deemed to be
at least equal to those of his own by the authority competent to discharge
him/her.

(a) taking the compensation pension to which he may be entitled for the
service he had rendered, or

(b) accepting another appointment at whatever pay is offered and
continuing to count his previous service for pension.

4. Compulsory Retirement Pension: A Government servant who is
compulsorily retired from service as a penalty may be granted a pension or
gratuity, or both, at a rate not less than two-thirds and not more than full
compensation pension or gratuity, or both, admissible to him on the date
of his compulsory retirement by the authority competent to impose such
penalty. The pension granted or allowed must be at least Rs. 9,000/- per
month.

5. Extraordinary Pension: Extraordinary Pension in the form of Disability
pension/extraordinary family pension may be paid to the Government
servant/his family if the Government servant's disablement/death (or
aggravation of disablement/death) during his service is attributed to the
Government service. For attributability or aggravation to be granted, there
must be a casual connection between disablement and Government
service, as well as death and Government service. The amount of the
pension, however, is determined by the category of disablement/death.
The CCS (Extraordinary Pension) Rules do not apply to government
employees hired on or after January 1, 2004.

6. Family Pension: Family pension is granted to the widow/widower and,
in the absence of a widow/widower, to the children of a Government
servant who entered service in a pensionable establishment on or after
01/01/1964 but before 31.12.2003 or who came to be governed by the
provisions of the Family Pension Scheme for Central Government
Employees, 1964 if such a Government servant: munotes.in

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77 (i) dies while in service on or after 01/01/1964 or
(ii) retired/died before 31.12.1963 or
(iii) retires on or after 01/01/1964and at the time of his death was in
receipt of pension.

7. National Pension System (NPS): The National Pension Scheme (NPS)
is a government-sponsored pension scheme that allows individuals to
contribute to their retirement savings. It is a defined contribution pension
plan in which contributions are invested in a variety of asset classes such
as equity, debt, and government securities.

8. Atal Pension Yojana (APY): The government of India launched the
APY pension scheme for workers in the unorganised sector. It provides a
guaranteed minimum pension ranging from Rs. 1,000 to Rs. 5,000 per
month, depending on the subscriber's contribution and age.

9. Pradhan Mantri Vaya Vandana Yojana (PMVVY): PMVVY is an
elderly pension plan that guarantees a 7.4 percent annual return for
financial year 2022-23. The scheme has a 10-year term and a Rs. 1.5 lakh
minimum investment. The programme is set to expire on March 31, 2023,
and will no longer be available on April 1 or in FY24 unless the
government announces an extension.

10. Annuity Plans: Insurance companies sell annuities, which provide a
steady income stream after retirement. The annuity payments can be
customised based on the individual's needs, and they can be received
monthly, quarterly, or annually.
These are some of the popular pension plans available in India. Individuals
can choose the plan that best suits their retirement goals and financial
situation.
Source: https://pensionersportal.gov.in/ClassOfPen.aspx
https://groww.in/p/savings-schemes/types-of-pension-plans
Key Features of Pension:
Pensions are retirement savings plans designed to provide a source of
income for individuals during their retirement years. Here are some key
features of pensions:
1. Employer-sponsored pensions: Employers frequently provide pensions
as a benefit to their employees. Employers may make contributions to
the employee's pension plan on their behalf, and employees may also
contribute.

2. Tax Benefits: Contributions to pension plans are typically tax-
deductible, which means that contributions are made with pre-tax
dollars. Furthermore, any earnings on the pension investments are tax-munotes.in

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78 deferred, which means that the earnings are not taxed until the funds
are withdrawn.

3. Defined benefit vs. defined contribution pension plans: There are two
types of pension plans: defined benefit and defined contribution.
Defined benefit plans pay a set amount to the employee upon
retirement, whereas defined contribution plans allow employees to
contribute to their own retirement savings while also allowing the
employer to contribute.
4. Vesting: The period of time an employee must work for an employer
before becoming eligible for pension plan benefits is referred to as
vesting. Vesting periods differ depending on the plan and the
employer.

5. Retirement age: Employees typically become eligible for benefits at a
set retirement age under most pension plans. Depending on the plan,
this age could be earlier or later than the standard retirement age of 65.

6. Payout options: Employees who retire may be able to receive their
pension benefits in a variety of ways, such as a lump sum payment or a
regular stream of income.

7. Portability: Employees may be able to take their pension benefits with
them if they leave their employer before retirement age in some cases.
This is dependent on the specific plan and may be subject to additional
rules and restrictions.
Pensions offer several key benefits to individuals who participate in
them, including:
1. Retirement income: Pensions are intended to provide a source of
income during retirement, allowing people to maintain their standard
of living and cover expenses when they are no longer employed.

2. Tax advantages: Contributions to pension plans are frequently tax-
deductible, which can help reduce a person's taxable income.
Furthermore, any earnings on pension investments are tax-deferred,
which means they are not taxed until the funds are withdrawn.

3. Employer contributions: Many pension plans are sponsored by
employers, and employers may contribute to the plan on the
employee's behalf. This allows employees to save for retirement while
not contributing as much of their own money.

4. Professional management: Professional investment managers typically
manage pension funds, ensuring that the funds are invested in a diverse
portfolio of assets to maximise returns and minimise risk.
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79 5. Guaranteed income: Defined benefit pension plans provide a
guaranteed income stream in retirement, which can provide retirees
with peace of mind and financial stability.

6. Automatic savings: Employees can contribute a portion of their salary
to defined contribution pension plans, on a regular basis, allowing
them to save for retirement without having to think about it.

7. Potential for growth: Pension investments have the potential to grow
over time, allowing employees to build a larger nest egg for
retirement.
Overall, pensions can be a useful tool for individuals looking to save for
retirement and provide financial security in their golden years.
Tax Benefits in Pension:
Uncommuted Pension: The term "uncommuted pension" refers to a
pension that is received on a regular basis. Both government and non-
government employees are fully taxed on it.
Commuted Pension: A commuted pension is a lump sum amount
obtained by commuting the entire or a portion of the pension. Many
people convert their future right to a pension into an immediate lump sum
payment.
Exemption in respect of Commuted Pension [Section 10(10A)]
Employees of the Central Government/ local authorities/ Statutory
Corporation/ members of the Civil Services/ Defence Services: Any
commuted pension received is fully exempt from tax.
Other Employees: Any commuted pension received is exempt from tax in
the following manner:
If the employee is in receipt of gratuity,
Exemption =
of the amount of pension which he would have received had
he commuted the whole of the pension.
If the employee does not receive any gratuity
Exemption =
of the amount of pension which he would have received
had he commuted the whole of the pension.
Illustration 06:
Mr. Mahadev retired on 01.10.2022and was receiving ` 10,000 p.m. as
pension starting from 31.10.2022. On 01.02.2023, he commuted 60% of
his pension and received ` 9,00,000 as commuted pension. You are
required to compute his taxable pension assuming:
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80 1. He is a government employee.
2. He is a private sector employee, receiving gratuity of 5,00,000 at the
time of retirement.
3. He is a private sector employee and is not in receipt of gratuity at the
time of retirement.

Solution:
Case I: Government Employee
Particulars Amount Amount
Pension
Uncommuted
From Oct to Jan (10,000 x 4m) 40,000
From Feb to Mar (10,000 x 40% x
2m) (WN. 1) 8,000
48,000
Commuted
Received 3,00,000
Less: Exempt (WN. 2) (3,00,000) - Taxable Pension
48,000

Case II: Non-Government Employee (Gratuity is received)
Particulars Amount Amount
Pension
Uncommuted
From Oct to Jan (10,000 x 4m) 40,000
From Feb to Mar (10,000 x 40% x 2m)(WN. 1) 8,000 48,000
Commuted
Received 9,00,000
Less: Exempt (WN. 3) (5,00,000) 4,00,000
Taxable Pension 4,48,000

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81 Case III: Non-Government Employee (Gratuity is not received)
Particulars Amount Amount
Pension
Uncommuted
From Oct to Jan (10,000 x 4m) 40,000
From Feb to Mar (10,000 x 40% x 2m)(WN. 1) 8,000 48,000
Commuted
Received 9,00,000
Less: Exempt (WN. 4) (7,50,000) 1,50,000
Taxable Pension 1,98,000

WN. 1
Since the Pension is commuted for 60%, after 01.02.2023 only 40% of
uncommuted pension will be received by the Assessee in the future.
WN. 2
Commuted Pension received by the government employee is fully
exempted.
WN. 3 Exemption is calculated as below when gratuity is received:
1/3 x (Amount of Commutation/% of Commutation)
= 1/3 x 900000 ÷ 60%
= 1/3 x 15,00,000
= 5,00,000
WN. 4 Exemption is calculated as below:
= 1/2 x (Amount of Commutation/% of Commutation)
=1/2 x 9,00,000 ÷ 60%
= 1/2 x 15,00,000
= 7,50,000
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82
3.5.6 Post Retirement Counselling
Post-retirement counselling is a type of counselling that assists people in
preparing for and transition into retirement. This type of counselling is
intended to assist retirees in adjusting to the changes and challenges that
come with retirement and making the most of their retirement years.
Post-retirement counselling may cover a wide range of topics, including:
1. Financial planning: It includes information on how to manage
retirement savings, budgeting, and managing expenses in retirement.

2. Healthcare: Post-retirement counselling may provide information on
healthcare options such as Medicare, long-term care insurance, and
other services that retirees may require.

3. Lifestyle planning: It includes information on staying active and
engaged in retirement, developing new hobbies and interests, and
staying connected with family and friends.

4. Housing options: Retirees may benefit from post-retirement
counselling to learn about housing options such as downsizing to a
smaller home, moving to a retirement community, or staying in their
current home.
Pension
Commuted
Government Employee
Fully ExemptNon Government
Employee
Gratuity is Received
1/3 x (commuted
pension received ÷
commutation %) x
100, would be exempt
u/s 10(10A)(ii)(a)Gratuity Not Received
1/2 x (commuted
pension received ÷
commutation %) x
100, would be exempt
u/s 10(10A)(ii)(a)Uncommuted
Fully Taxable
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83 5. Legal planning: It includes estate planning, wills, and other legal
issues that retirees may require.
Financial planners, retirement counsellors, and social workers are among
the professionals who can provide post-retirement counselling. It can be
delivered one-on-one or as part of a group programme. Post-retirement
counselling can assist retirees in navigating the many changes and
challenges that come with retirement and maximising their retirement
years.
Key Features of Post Retirement Counselling:
1. Individualized: Post-retirement counselling is frequently tailored to the
specific needs and goals of the individual. The retiree will work with
the counsellor to identify their concerns and provide personalised
advice and guidance.

2. Comprehensive: Financial planning, healthcare, lifestyle planning,
housing options, legal planning, and other issues that may be relevant to
retirees are common topics covered in post-retirement counselling.

3. Experienced Counsellors: Post-retirement counsellors are typically
experienced professionals with expertise in retirement planning,
financial management, and related areas.

4. Confidentiality: Post-retirement counselling is typically provided in a
private setting, allowing retirees to openly discuss their concerns and
goals without fear of judgement or disclosure.

5. One-on-one or Group Sessions: Depending on the individual's needs
and preferences, post-retirement counselling can be provided one-on-
one or as part of a group programme.

6. Holistic Approach: Post-retirement counselling is frequently holistic,
addressing the physical, emotional, and social aspects of retirement.
Counsellors can assist retirees in discovering new hobbies and interests,
connecting with others, and finding ways to stay active and engaged in
retirement.

7. Focus on positive transition: The goal of post-retirement counselling is
to assist retirees in making a positive and productive transition into
retirement. Counsellors can assist retirees in setting goals, developing
plans, and identifying resources to help them achieve their goals and
live a fulfilling retirement life.
Overall, retirees can benefit from post-retirement counselling as they
navigate the many changes and challenges that come with retirement.


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84 3.6 EXERCISE
A. Choose the most appropriate alternative:
1. Which of the following is not a tool for retirment planning?
a. Contribution to Provident Fund
b. Contribution to pension funds
c. Contribution to Public Provident fund
d. Contribution to political party fund
2. Partial withdrawal from PPF is allowed after __________ years.
a. 3 b. 4 c. 5 d. 6
3. Maximum tax benefit under EPF is _________.
a. 1,00,000 b. 1,50,000 c. 2,00,000 d. 2,50,000
4. In case of recognised provident fund, interest credited in excess of
_________ is taxable.
a. 8% b. 9.5 c. 10% d. 12%
5. For the purpose of employee covered by Payment of Gratuity Act,
1972, no. of days in the month is considered as:
a. 25 days b. 26 days c. 30 days d. 31 days
B. True or False
1. Retirement planning can be done at young age.
2. Withdrawal from RPF is not taxable.
3. Only government employee can contribute towards the PPF
4. The company can contribute maximum of 10% of employee's base
salary and dearness allowance for superannuation.
5. Gratuity received by government employee is fully exempt from tax.
1. True; 2. False; 3. False; 4. False; 5. True
C. Answer in Brief
1. What are the needs for retirement planning?
2. What are the different types of pension plans?
3. What is post retirement counselling? State the key features of it.
4. What are the benefits of superannuation funds?
D. Short Notes
1. Process of development of retirement plan.
2. Sources of retirement planning.
3. Benefits of EPF
4. key features of the PPF scheme
5. Key features of pension fund.

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85 4
INVESTMENT PLANNING
Unit Structure
4.0 Objective
4.1 Meaning of Risk
4.3 Risk Return Analysis
4.4 Investment Planning
4.5 Asset Allocation Investment Strategies
4.6 Portfolio Construction and management process
4.0 OBJECTIVE
After studying this unit, you will be able:
 To identifying the various types of risks associated with a person;
 To comprehend the various methods for measuring and managing
risks;
 To become acquainted with risk management;
 To examine the role and significance of financial statement s in
financial planning.
 To define the term "investment" and define the various types of
investments;
 To introduce the concept of risk and return;
 To determine an asset's expected return and describe risk -free and
risky assets.
4.1 MEANING OF RISK:
Risk c an be defined as the potential for loss or harm resulting from
uncertainty or variability in financial, economic, or other circumstances.
Types of Risks:
Systematic risk and unsystematic risk are two different types of risks that
investors face when invest ing in financial markets.
A. Systematic Risks: Systematic risk, also known as market risk, is a risk
that affects the entire market or economy. It is not unique to any one
company or investment, but rather to the market as a whole. Changes in
interest rate s, political instability, natural disasters, and recessions are all
examples of systematic risk.

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86 Different types systematic risk:
1. Interest rate risk: This type of risk arises when interest rates change,
which can impact the prices of bonds and other fixe d-income securities.
For example, as interest rates rise, bond prices fall, and vice versa.

2. Market risk: It is inherent in the stock market and occurs as a result
of factors such as economic growth, inflation, and geopolitical events. For
example, a sudde n increase in oil prices due to geopolitical tensions can
cause the stock market to fall.

3. Currency risk: It arises when an investor owns foreign assets or
makes investments denominated in a foreign currency. Currency
fluctuations can have an impact on the value of these investments. For
example, suppose an investor owns stock.
B. Unsystematic risk : It is also referred to as specific risk because it
refers to the risks that affect a specific company or investment. It is
company - or industry -specific, and it can be mitigated by investing in a
portfolio of different companies or assets. Management changes, labour
strikes, lawsuits, and supply chain disruptions are all examples of
unsystematic risk.
1. Business risk: This type of risk arises from a company's speci fic
operations and performance. Risks include changes in demand, production
issues, and management issues. A company that relies heavily on a single
product line, for example, is vulnerable to business risk if demand for that
product falls.

2. Financial risk : It arises as a result of a company's financial structure
and performance. Risks include high debt levels, low liquidity, and poor
credit ratings. A company with a high debt -to-equity ratio, for example,
may face financial risk if interest rates rise and the cost of servicing that
debt rises.

3. Regulatory risk: This type of risk arises from changes in laws or
regulations that affect a specific industry or company. For example, a
pharmaceutical company may face regulatory risk if the government
imposes new r egulations restricting the sale or use of certain drugs.
As a conclusion, systematic risk affects the entire market or economy and
cannot be mitigated, whereas unsystematic risk is specific to a single
company or investment and can be mitigated by investin g in a diverse
portfolio of assets.
Risk Measurement:
The process of quantifying or estimating the level of risk associated with a
specific activity or investment is referred to as risk measurement.
Assessing the likelihood and potential impact of potenti al risks, as well as
the effectiveness of risk management strategies in reducing or mitigating
those risks, is part of this process. Risk measurement is an important munotes.in

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87 component of risk management because it enables individuals and
organisations to identify and assess potential risks, as well as develop
appropriate risk mitigation or risk management strategies. Organizations
can make informed decisions and take action to minimise potential losses
and improve overall performance by measuring and analysing risk s.
1. Standard deviation (
): It is a measure of how much the values in a
set of data deviate from the mean value. It is calculated by taking the
square root of the variance. A higher standard deviation indicates greater
variability in the data. M athematically it can be represented as
OR


2. Variance: Variance (V) is a measure of how spread out a set of data
is. It is calculated as the average of the squared differences of each value
from the mean. A higher variance indica tes greater variability in the data.
Mathematically it can be represented as
Variance =
OR


3. Coefficient of variation (CV) is a measure of relative variability that
is used to compare the standard deviation of one data set to it s mean. It is
calculated as the ratio of the standard deviation to the mean. A higher CV
indicates greater relative variability in the data. Mathematically it can be
represented as:

4. The Certainty Equivalent Quotient (CEQ) is a measure used in
decision -making under uncertainty that assesses an individual's risk
preference. It represents the amount of money that an individual is willing
to accept with certainty in place of a risky prospect with a given expected
value and variance. More specifically, the CEQ is defined as the ratio of
the expected value of a risky prospect to the amount of money that the
individual would accept with certainty, which provides the same level of
utility as the risky prospect. In other words, the CEQ is the amount of
certain mone y that an individual would be willing to trade for a risky
prospect.

5. Probability analysis: Probability analysis involves using statistical
methods to estimate the likelihood of a specific risk event occurring. This
may involve analyzing historical data, c onducting surveys, or using
mathematical models to estimate the probability of various outcomes.

6. Scenario analysis: Scenario analysis involves evaluating the
potential impact of different scenarios on the activity or investment being
evaluated. This may i nvolve creating and analysing different scenarios,
such as best -case, worst -case, or most -likely scenarios, to estimate the
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88 7. Sensitivity analysis: Sensitivity analysis involves assessing the
potential impact of chang es in key variables or assumptions on the overall
risk of an activity or investment. This may involve conducting a "what -if"
analysis to evaluate the impact of changes in interest rates, market
conditions, or other factors on the overall risk level.

8. Stres s testing: Stress testing involves simulating extreme or
unexpected scenarios to evaluate the resilience of an activity or investment
to various risks. This may involve testing the impact of severe market
downturns, unexpected events, or other extreme scen arios to assess the
potential risks and identify potential mitigating actions.

9. Value at Risk (VaR): VaR is a statistical measure that estimates the
potential loss that could occur within a specific time horizon and at a
certain confidence level. It is com monly used in financial risk
management to estimate the potential losses associated with market
fluctuations, credit risk, or other financial risks.

10. Risk rating models: Risk rating models involve assigning a
numerical score or rating to various risks base d on their severity,
probability, or other factors. This may involve developing a scoring
system or using existing risk rating models to evaluate and compare
different risks.
By using these tools and techniques, organizations and individuals can
better und erstand and quantify the potential risks associated with various
activities and investments, and develop strategies to mitigate those risks
and minimize potential losses.
Illustration 01: Standard Deviation without Probability
Ms. Prachi Surve an investor is planning to invest her savings in the shares
of Satyam Ltd.
Solution 01:
Year Return Deviation Squared
Deviation
x x – x ` (x - x `)2
2019 10,000 3,600 1,29,60,000
2020 5,000 (1,400) 19,60,000
2021 (3,000) (9,400) 8,83,60,000
2022 12,000 5,600 3,13,60,000
2023 8,000 1,600 25,60,000
32,000 13,72,00,000
x ` = 32,000/5
x ` = 6,400
Variance 2,74,40,000 munotes.in

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89




steps:
1. Calculate the average return: To calculate the average return, we add up
all the retur ns and divide by the number of years. In this case, the average
return is:
Average Return = (10,000+5,000+(3,000)+12,000+8,000)/5 = 6,400
2. Calculate the deviation of each return from the average return: To
calculate the deviation of each return from the average return, we subtract
the average return from each return.
Deviation = Return - Average Return (x - x `)
3. Square the deviations: To calculate the variance, we need to square the
deviations.
Squared Deviation = Deviation^2
4. Calculate the variance : To calculate the variance, we add up the squared
deviations and divide by the number of years.
5. Calculate the standard deviation: To calculate the standard deviation,
we take the square root of the variance.
Illustration 02: From the given data of Redd y Ltd.
a. Variance
b. Standard deviation and
c. Coefficient of variation for X.
Cash Flow (X) Probability 10,000 0.20 20,000 0.30 60,000 0.10 80,000 0.20 20,000 0.20 munotes.in

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90 Solution:
Project X
A B C = A x B D = x ` -
A E = D^2 F = B x E
Cash Flow Probability Expected
Cash
Inflows x - x ` (x - x `)2 P.(x - x `)2
10,000 0.20 2,000 (24,000) 57,60,00,000 11,52,00,000
20,000 0.30 6,000 (14,000) 19,60,00,000 5,88,00,000
60,000 0.10 6,000 26,000 67,60,00,000 6,76,00,000
80,000 0.20 16,000 46,000 2,11,60,00,000 42,32,00,000
20,000 0.20 4,000 (14,000) 19,60,00,000 3,92,00,000
1.00 x ` =
34,000 70,40,00,000

Variance
=70,40,000
Standard Deviation =

=

= 26,533.00
Coefficient of Variation =

=
= 0.78
Illustration 03: The following details are provided by the investment
scheme of Prashant Ltd.
Year Cash Fl ow Certainty Equivalent Quotient 1 2,00,000 0.75
2 1,40,000 0.70
3 1,30,000 0.65
4 1,20,000 0.60
5 80,000 0.65
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91 The investment scheme requires immediate invested of ` 3,00,000.
Kindly Suggest to Mr. Dubey, the investor, whether t he investment
scheme is worth investing of not? Assume discounting factor to be 15%.
Solution:
A B C D E = C x D F = B x E
Year Discounting
Factor @
15% Cash
Flow Certainity
Equivalent
Quotient Certainity
Equivalent
Cashflow Cumulative
Discounted
Cash
Inflow
1 0.870 2,00,000 0.75 1,50,000 1,30,500
2 0.756 1,80,000 0.70 1,26,000 95,256
3 0.658 1,50,000 0.65 97,500 64,155
4 0.572 1,20,000 0.60 72,000 41,184
5 0.497 90,000 0.65 58,500 29,075
Present Val ue of Cash Inflow 3,60,170
Present Value of Cash Outflow (3,00,000)
Net Present Value 60,170
Since the net present value is positive, Mr. Dubey should invest in the
scheme.
Illustration 04:
Rajesh Ltd. is considering launching a new product lin e, and they have
estimated the probabilities of three possible outcomes: success, moderate
success, and failure. The following table shows the estimated probabilities
and the corresponding payoff for each outcome:
Outcome Probability Payoff (in `)
Succes s 0.4 100,000
Moderate Success 0.3 50,000
Failure 0.3 -20,000

You are required to calculate the expected value of the new product line,
we can use the following formula:
Expected value = (Probability of success x Payoff for success) +
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92 Expected value = (0.4 x 100,000) + (0.3 x 50,000) + (0.3 x -20,000)
Expected value = 40,000 + 15,000 - 6,000
Expected value = 49,000
Therefore, the expected valu e of the new product line is ` 49,000. This
means that, on average, the company can expect to earn ` 49,000 in profit
from the new product line.
OR
A B C D = B x C
Outcome Probability Payoff (in `)
Success 0.4 1,00,000 40,000
Moderate Success 0.3 50,000 15,000
Failure 0.3 (20,000) (6,000)
49,000

4.3 RISK RETURN ANALYSIS:
Risk-return analysis is a process used by investors and financial analysts
to evaluate investments based on their p otential returns and the level of
risk involved. It involves assessing the potential return on an investment
against the likelihood of losing some or all of the investment due to risk
factors.
The basic steps involved in risk -return analysis are:
1. Determine the potential returns: Investors begin by determining the
potential returns they anticipate from the investment. This can be
based on past performance or future projections.

2. Identify the risks: Investors must then identify the risks associated with
the i nvestment, which may include market risk, credit risk, liquidity
risk, and operational risk.

3. Assess the level of risk: Investors then assess the level of risk
associated with the investment by employing techniques such as
probability analysis, scenario an alysis, and stress testing.

4. Evaluate the risk -return tradeoff: Based on the level of risk associated
with the investment, investors determine whether the potential return is
sufficient to justify the level of risk.

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93 5. Make an investment decision: Finally, investors make an informed
investment decision based on the risk -return analysis, taking into
account both the potential return and the level of risk associated with
the investment.
Overall, risk -return analysis is an important tool for investors to use wh en
evaluating investments and making informed decisions that balance
potential returns with risk. It assists investors in identifying investments
with the potential for higher returns while managing risk in order to
achieve their financial goals.
4.4 INVES TMENT PLANNING
Personal financial planning must include investment planning (PFP).
Investment planning entails identifying investment options that correspond
to a person's investment objectives, risk tolerance, and financial situation.
Here are some of the investment options that may be included in
investment planning for PFP:Let’s study all this Investment plans in
details:
4.4.1 Investing in Stock:
1. Company fundamentals: Before investing in a stock, it's important to
analyse the company's financial statements, m anagement, competitive
position, and growth prospects. This includes factors such as revenue
growth, profitability, debt levels, and market share.

2. Industry trends: Understanding the broader trends and dynamics within
the industry in which the company oper ates can provide valuable
insights into the company's future prospects.

3. Market conditions: It's important to analyze the broader market
conditions, including economic indicators, interest rates, and inflation
levels. This can help identify potential risks and opportunities for
stocks.

4. Valuation: A stock's valuation, or its price relative to its earnings, is an
important factor to consider. Stocks that are overvalued may be at risk
of a price correction, while undervalued stocks may represent a buying
oppo rtunity.

5. Dividend yield: The dividend yield of a stock, or the percentage of its
price paid out in dividends, can be an important factor for income -
oriented investors.

6. Risk tolerance: Understanding your own risk tolerance, or the level of
risk you are co mfortable taking on, is important when investing in
stocks. Stocks can be more volatile than other types of investments,
and may experience significant price fluctuations.

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94 7. Diversification: Investing in a mix of stocks from different sectors and
industrie s can help reduce risk and exposure to any one company or
sector.
By considering these factors, investors can make informed decisions about
investing in stocks that align with their risk tolerance, investment goals,
and financial situation.
Investing in st ocks can offer both advantages and disadvantages. Here are
some of the key pros and cons to consider:
Advantages:
1. High potential returns: Investing in stocks has the potential for high
long-term returns, especially if you invest in companies with strong
growth prospects or pay dividends. Stocks have historically outperformed
other asset classes such as bonds and cash over the long term.
2. Liquidity: Because stocks can be bought and sold easily, they are a
relatively liquid investment. If you need to acc ess your money quickly,
you can usually sell your shares quickly.
3. Diversification: By investing in stocks, you can diversify your portfolio
and reduce risk. You can spread your investment risk and potentially
improve your returns by owning shares in a v ariety of companies across
different industries and regions.
4. Ownership: When you buy stocks, you become a part -owner of the
company. This gives you a say in company decisions as well as the
opportunity to profit from its profits.
Disadvantages:
1. Volat ility: Stock prices can fluctuate quickly due to a variety of factors
such as economic conditions, political events, and company performance.
This can make predicting your returns and timing your trades difficult.
2. Risk: Investing in stocks is risky beca use there is always the possibility
of losing some or all of your money. Stock prices can be influenced by a
number of factors, including market conditions, economic recessions, and
company -specific risks.
3. Difficulty: Investing in stocks can be difficul t, particularly if you are
unfamiliar with financial markets or accounting principles. It can be
difficult to determine which companies are likely to perform well, and
research and analysis can take time.
4. Fees and taxes: When investing in stocks, you ma y be required to pay
brokerage fees, capital gains taxes, and dividend taxes. These costs can eat
into your returns and reduce your investment's overall profitability.
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95 Overall, investing in stocks can be a good long -term way to grow your
wealth, but it's critical to understand the risks and potential drawbacks
before you invest. If you're new to investing or have questions about your
investment strategy, it's also a good idea to seek the advice of a financial
professional.
4.4.2 Investment in Bonds:
There are several key factors, advantages, and disadvantages to consider
when investing in bonds as part of your personal financial plan (PFP).
Here are a few of the most important:
Key factors:
1. Credit quality: A bond issuer's credit quality is an important f actor to
consider. Bonds issued by companies with high credit ratings are generally
regarded as safer investments, whereas bonds issued by companies with
lower credit ratings carry a higher risk of default.
2. Interest rate risk: Bonds are subject to inter est rate risk, which means
that their prices can fluctuate as interest rates change. When interest rates
rise, the value of existing bonds falls, and vice versa.
3. Yield: The yield on a bond is the expected rate of return on the
investment. Bonds with hig her yields generally provide higher returns but
may also carry higher risks.
4. Maturity: The length of time it takes for a bond to reach its face value or
principal. Longer -term bonds typically offer higher yields but may be
more sensitive to changes in i nterest rates.
Advantages:
1. Income: Bonds can provide a consistent stream of income in the form of
interest payments, which can be particularly appealing to investors seeking
a source of passive income.
2. Diversification: Bonds can help diversify your p ortfolio, reducing risk.
When stocks and bonds are combined in a portfolio, the bond investments
can help offset stock losses.
3. Capital preservation: Bonds are generally regarded as less risky than
stocks, and they can aid in capital preservation during market downturns.
4. Protection against inflation: Some bonds, such as Treasury Inflation -
Protected Securities (TIPS), are designed to provide inflation protection by
adjusting their principal value in response to changes in the consumer
price index.
Disad vantages:
1. Low returns: Bonds typically provide lower long -term returns than
stocks, which can be a disadvantage for investors looking to maximise
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96 2. Interest rate risk: As previously stated, bonds are vulnerable to interest
rate risk, whi ch can lead to losses if interest rates rise.
3. Credit risk: Bonds issued by lower -rated companies are more likely to
default, resulting in investor losses.
4. Inflation risk: Bonds are subject to inflation risk if the rate of inflation
exceeds the bond's interest rate, which can erode the investment's
purchasing power over time.
Overall, investing in bonds can be a good way to diversify your portfolio
and generate income, but before you invest, you should carefully consider
the key factors, advantages, an d disadvantages. A financial advisor can
assist you in determining whether bonds are a good fit for your personal
financial plan and can recommend specific bond investments that
correspond to your goals and risk tolerance.
4.4.3 Investment in Mutual funds:
Investing in mutual funds can be an effective way to grow your wealth and
achieve your financial goals as part of your personal financial plan (PFP).
Here is some key information on mutual funds, including their meaning,
key factors to consider, and their advantages and disadvantages.
Meaning:
A mutual fund is a type of investment vehicle that pools money from
multiple investors in order to buy a diverse portfolio of stocks, bonds, or
other assets. A professional investment manager manages the fund,
decidi ng which assets to buy and sell in order to meet the fund's
investment objectives.
1. Investment objectives: Different mutual funds have varying investment
objectives, such as income generation, capital appreciation, or a
combination of the two. It is crit ical to select a mutual fund that aligns
with your own investment objectives.
2. Fees: Mutual funds charge management and administration fees, which
vary greatly between funds. These fees can reduce your returns, so it's
critical to understand and compare the fees of various funds.
3. Performance history: When selecting an investment, the performance of
a mutual fund can be an important factor to consider. To evaluate the
fund's performance, examine its historical returns over various time
periods and compa re them to benchmarks.
4. Risk level: The risk level of mutual funds varies depending on the assets
they invest in and their investment objectives. It is critical to select a
mutual fund that matches your risk tolerance.
5. Fund manager: The fund manager i s in charge of making investment
decisions for the fund. When selecting a mutual fund, it is critical to
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97 Advantages:
1. Diversification: When you invest in mutual funds, you can diversify
your portfo lio across a wide range of assets, which can help reduce risk.
2. Professional management: Mutual funds are managed by experienced
investment professionals with the knowledge and expertise to make sound
investment decisions on the fund's behalf.
3. Liquidi ty: Because mutual funds are easily bought and sold, they are a
relatively liquid investment.
4. Availability: Because mutual funds are widely available and can be
purchased through most brokerage accounts, they are a viable investment
option for individua l investors.
Disadvantages:
1. Management and administration fees: Mutual funds charge management
and administration fees, which can eat into your returns and reduce the
overall profitability of your investment.
2. Limited control: When you invest in a mut ual fund, you are entrusting
the fund manager with your investment decisions. This can make it
difficult to make individual investment decisions.
3. Lack of transparency: Mutual funds can be complex investment
vehicles, making it difficult to understand ho w your money is being
invested.
4. Market risk: Mutual funds, like all investments, are subject to market
risk, which means that their returns can be influenced by economic
conditions, political events, and other factors beyond your control.
Overall, inves ting in mutual funds as part of your personal financial plan
can be a good way to achieve your financial goals. However, before
investing in any particular fund, it's critical to carefully consider the key
factors, benefits, and drawbacks, and to seek the advice of a financial
professional if you're new to investing or unsure about your investment
strategy.
4.4.4 Derivatives: Meaning:
Financial instruments that derive their value from an underlying asset,
such as stocks, bonds, commodities, or currencies, a re known as
derivatives. Derivatives can be used for a variety of purposes, including
risk hedging, price movement speculation, and gaining exposure to
specific markets or assets.
Derivatives contracts are classified as follows:
1. Futures contracts: Futur es contracts are agreements to buy or sell an
underlying asset at a future date and price. They are commonly used to munotes.in

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98 hedge against future price movements or to speculate on underlying asset
price movements.
2. Options: Options contracts grant the buyer the right, but not the
obligation, to buy or sell an underlying asset at a future date and price.
They are frequently used for hedging.
3. Swaps: Swaps are contracts between two parties in which cash flows
are exchanged based on the performance of an underlyi ng asset or
benchmark. They are frequently used to manage interest rate, currency,
and credit risk.
Overall, as part of a personal financial plan, derivatives can be an effective
way to manage risk, gain exposure to different markets, and generate
income. They do, however, carry a high level of risk and complexity, and
it is critical to carefully consider the key factors, benefits, and drawbacks
before investing in any particular derivatives contract.
Important considerations:
1. Risk tolerance: Derivatives are complex financial instruments with high
risk. Before investing in derivatives, you should think about your risk
tolerance and investment objectives.
2. Market understanding: Derivatives necessitate a thorough understanding
of the underlying assets as well as market dynamics. Before investing in
derivatives, it is critical to have a thorough understanding of the markets
in which you intend to invest.
3. Volatility: Derivatives are frequently used to manage risk and volatility,
but they can also be volat ile themselves. Before investing in derivatives, it
is critical to understand the potential volatility of the underlying assets and
markets.
4. Margin requirements: Derivatives trading frequently necessitates
margin, which is money that the investor must p ut up as collateral. It's
critical to understand the margin requirements and how they might affect
your investment returns.
5. Counterparty risk: Derivatives contracts involve two parties, and there
is always the possibility that one of them will fail to m eet their obligations.
When investing in derivatives, it is critical to select reputable
counterparties and understand counterparty risk.
Advantages:
1. Risk management: Derivatives can be used in a portfolio to manage risk
and volatility by providing a wa y to hedge against price movements in
underlying assets.
2. Leverage: Derivatives can offer leverage, allowing investors to gain
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99 3. Diversification: Derivatives can be used to gain exposure to a wide
range of markets and assets, allowing for diversification.
4. Income generation: Through option writing and other strategies,
derivatives can be used to generate income.
1. High risk: Derivatives are complex financial instruments with a high
degree of risk. Investing in derivatives can lead to substantial losses.
2. Complexity: Derivatives are sophisticated financial instruments that
necessitate a thorough understanding of the underlying assets as well as
market dynamics. For inexperienced investors, they can be difficult to
grasp.
3. Margin requirements: Margin is frequently required in derivatives
trading, which can result in additional costs and increase the risk of loss.
4. Counterparty risk: Derivatives contracts involve two parties, and there
is always the possibility that one of them will fail to meet their obligations.
This can lead to substantial losses for investors.
5. Lack of transparency: Derivatives markets can be opaque and opaque,
making it difficult for investors to determine the true value of their
investments.
Overall, as part of a personal financial plan, derivatives can be an effective
way to manage risk, gain exposure to different markets, and generate
income. They do, however, carry a high level of risk and complexity, and
it is c ritical to carefully consider the key factors, benefits, and drawbacks
before investing in any particular derivatives contract.
4.4.5. Real estate investing: Meaning:
Real estate is property that includes land and buildings, as well as natural
resources su ch as crops, minerals, and water. Real estate investing entails
purchasing and owning property with the intention of generating income,
either through rental income or capital appreciation.
Key factors:
1. Location: A property's location is an important fa ctor in determining its
value and potential for income generation. When evaluating a property, it
is critical to consider factors such as proximity to amenities,
transportation, and schools.
2. Property type: The potential for income generation and appreci ation
varies depending on the type of property, such as single -family homes,
multi -family properties, and commercial properties.
3. Financing: Real estate investments frequently necessitate large sums of
money, and financing options such as mortgages and l oans can have an
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100 4. Property management: Managing a property, which includes finding
tenants, handling maintenance, and collecting rent, can be time -consuming
and necessitates specialised skills and knowledge.
5. Market trends: Real estate markets can be cyclical, so it's critical to stay
current on local market conditions and trends when investing in real estate.
Advantages:
1. Income generation: Rental income from real estate investments can
provide a consistent source of passive income.
2. Capital appreciation: The value of real estate can increase over time,
providing the opportunity for capital gains when the property is sold.
3. Inflation hedge: Because rental income and property values can rise in
lockstep w ith inflation, real estate can be used as an inflation hedge.
4. Tax advantages: Real estate investors can take advantage of tax breaks
such as mortgage interest and depreciation.
5. Tangible asset: Real estate investments provide a tangible asset that can
be seen and touched, thereby providing security and stability.
Disadvantages:
1. Capital requirements: Real estate investments frequently necessitate
large sums of money, which can make them inaccessible to some
investors.
2. Market volatility: Real estat e markets can be subject to cyclical trends,
which can affect a property's value and income potential.
3. Property management: Managing a property takes time and requires
specific skills and knowledge, which can be difficult for some investors.
4. Liquidit y: Real estate investments can be illiquid, which means they can
be difficult to convert into cash quickly.
5. Risk: There is inherent risk in real estate investments, including the
possibility of tenant vacancies, property damage, and legal liabilities.
Overall, as part of a personal financial plan, investing in real estate can
provide a source of consistent income as well as the potential for capital
appreciation. However, before making a real estate investment, it is
critical to carefully consider the ke y factors, advantages, and
disadvantages, as the capital requirements and potential risks can be
significant.
4.5 ASSET ALLOCATION INVESTMENT
STRATEGIES
Asset allocation is a financial strategy that attempts to balance risk and
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101 tolerance, and investment horizon. Because stocks, bonds, and cash and
equivalents all have different levels of risk and return, they will behave
differently over time. There is no simple formula for determini ng the
optimal asset allocation for each individual. However, most financial
professionals agree that asset allocation is one of the most important
decisions that investors make. In other words, the allocation of assets in
stocks, bonds, and cash and equiv alents, rather than the selection of
specific products, will be the primary determinants of your investing
success. Investors can use various asset allocations to achieve various
goals.For example, someone saving for a new car in the coming year
might inve st in a highly conservative mix of cash, certificates of deposit
(CDs), and short -term bonds. Risk tolerance is also an important factor to
consider. Even if they have a long -term investment plan, someone who is
hesitant to invest in equities may choose a more conservative allocation.
Stocks are generally recommended for holding periods of five years or
longer. Cash and money market accounts are appropriate for short -term
goals of less than a year. Bonds are located somewhere in the middle.
Previously, fina ncial experts advised dividing an investor's age by 100 to
calculate how much to invest in stocks. Asset allocation is an important
part of creating and balancing your financial strategy. After all, it is one of
the most important factors influencing your o verall returns, even more so
than stock selection. Developing an appropriate asset mix in your portfolio
of stocks, bonds, cash, and real estate is a continuous process. As a result,
your asset mix should always correspond to your objectives.
In PFP, the f ollowing are some popular asset allocation investment
strategies:
1. Strategic Asset Allocation: This approach entails constructing a
diversified portfolio comprised of a mix of asset classes that corresponds
to the investor's risk tolerance and investment objectives. It is typically
based on long -term projections of expected returns, and the asset
allocation is rebalanced on a regular basis to maintain the desired asset
mix.
2. Tactical Asset Allocation: In this strategy, asset allocation is actively
adjus ted in response to changing market conditions and economic trends.
For example, if an investor believes that stocks are currently overvalued,
he or she may reduce their allocation to stocks while increasing their
allocation to bonds or cash.
3. Dynamic Ass et Allocation: This approach is similar to tactical asset
allocation, but it is based on a quantitative model that uses market data to
adjust asset allocation. For example, the model may allocate more to
stocks during periods of economic growth and less to stocks during
periods of economic decline.
4. Core -Satellite Asset Allocation: This strategy combines a diversified
core portfolio with a smaller group of targeted investments, or "satellites,"
that can provide additional diversification or specialised ex posure. For
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102 as the core, but then add satellite investments in commodities or real
estate.
5. Life Cycle Asset Allocation: Adjusting asset allocation based on the
investor's age, ris k tolerance, and investment time horizon is a component
of this strategy. Younger investors with a longer time horizon may favour
stocks, whereas older investors approaching retirement may prefer a more
conservative portfolio with a higher allocation to bo nds.
6. Risk Parity Asset Allocation: Rather than relying on traditional market
capitalization weighting, this strategy seeks to balance risk across asset
classes. The goal is to create a more balanced portfolio with less reliance
on any one asset class.
These are only a few of the numerous asset allocation strategies employed
in personal financial planning. The best approach will be determined by
the investor's unique circumstances, such as risk tolerance, investment
goals, and time horizon. To determine t he best asset allocation strategy for
your specific needs, consult with a financial advisor.
4.6 PORTFOLIO CONSTRUCTION AND
MANAGEMENT PROCESS
Few things are more important or difficult than developing a long -term
investing strategy that allows a person to invest with confidence and
clarity about their future. Building an investing portfolio necessitates a
thorough and precise portfolio -planning approach comprised of five
critical elements.
1. Assess the situation - For future planning, an investor must hav e a
thorough understanding of their current situation in relation to where they
want to be. This necessitates a thorough examination of current assets,
liabilities, cash flow, and investments in relation to the investor's primary
goals. Goals must be clear ly defined and quantifiable for the evaluation to
identify any gaps between the current investment plan and the stated goals.
This process should begin with an open discussion about the investor's
values, beliefs, and priorities, which will lay the groundw ork for
developing an investment strategy.
2. Establish Investment Goals - Establishing investment goals is centred
on determining the investor's risk -return profile. Determining how much
risk an investor is willing and able to accept, as well as how much
volatility the investor can tolerate, is critical in developing a portfolio
strategy that can generate the desired returns while remaining risk -
adequate. After defining an acceptable risk -return profile, benchmarks for
tracking the portfolio's performance can be established. Tracking portfolio
performance against benchmarks allows for incremental changes to be
made along the way.
3. Develop an asset allocation strategy - Using the risk -return profile, an
investor can develop an asset allocation strategy. By selecting from
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103 assets in a way that provides optimal diversity while achieving the
expected returns. The investor can also assign percentages to various asset
classes such as stocks, bonds, cash, and alternative assets based on an
acceptable range of volatility for the portfolio. The asset allocation plan is
based on the investor's current situation and goals, and it is typically
revised as life changes. For example, as an investor nea rs retirement, their
allocation may shift to reflect a lower tolerance for volatility and risk.
4. Choose your investments - Individual investments are chosen based on
the parameters of the asset allocation strategy. The exact investment type
selected is l argely determined by the investor's preference for active or
passive management. Individual stocks and bonds may be included in an
actively managed portfolio if there are sufficient assets to ensure optimal
diversification, which is typically more than $1 million. Smaller portfolios
can benefit from professionally managed funds, such as mutual funds or
exchange -traded funds. A passively managed portfolio could be
constructed by an investor using index funds from various asset classes
and economic sectors.
5. Monitoring and rebalancing - Following the implementation of a
portfolio plan, the management process begins. This includes monitoring
investments and comparing portfolio performance to benchmarks. The
performance of investments must be reported on a reg ular basis, usually
quarterly, and the portfolio plan must be reviewed annually. Once a year,
the investor's situation and goals are reviewed to see if there have been
any significant changes. The portfolio review then determines whether the
allocation is still on track to reflect the investor's risk -reward profile. If
not, rebalance the portfolio by selling shares that have met their targets
and buying equities with greater upside potential.
1. Explain the nature of risk return tradeoff
2. Explain the impo rtance of understanding risk return tradeoff
3. What are the different investment avenues available to an investor?
4. Briefly explain the importance of effective asset allocation.
5. What is portfolio construction and explain the process of portfolio
construction.

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