Planning for financial requirements provides direction and meaning to your financial decisions. It allows you to understand how each financial decision you make affects other areas of your finances. For example, buying a particular investment product might help you pay off your loan faster or it might delay your retirement significantly.

>By viewing each financial decision as part of the whole, you can consider its short and long-term effects on your life goals. You can also adapt more easily to life changes and feel more secure that your goals are on track. Financial Planning is akin to driving a car. Like a car's four tyres, we also have four financial components in our life- income, expense, investments and liabilities. It is about synchronizing these four that makes all the difference.

For example let's take the case of Mr. Anil Kumar. Mr. Kumar is recently retired. He has been steadfastly saving for retirement. He has frugal habits and his savings rate has been very high. However, when he sat down and worked with real numbers, it became very clear that he would have to scale down his post-retirement expenses. This was because though he saved most of his salary, he put them in traditional saving products such as PPF and fixed deposits, resulting in a corpus that hadn't grown much. In addition, as Mr. Kumar had not worked on real numbers like inflation and rate of return earlier, he had no real idea about how much money would he need on retirement. Hence, while he had planned his income and expenses well; he had failed to identify his liabilities and the requisite investment he would need to make.

The risk-return profile is the relationship between the risk that an asset class is exposed to and the returns it generates. Generally, higher the risk involved in an asset class, higher is the return associated with it. For example, equity has the potential to generate higher returns than debt, but at a higher risk. Cash on the other hand, though the safest asset class, generates the lowest returns.

What is an asset class ?

An asset class is a set of securities/ investment instruments that show similar characteristics and behavior in the market. The group of securities in an asset class is also governed by the same rules and regulations. For example, shares, property, cash, fixed interest assets etc.

Asset classes can be broadly classified into two types, namely defensive and growth oriented. Defensive asset classes comprise assets that generate safe and consistent returns. They are suitable for investors who are not willing to take high risks. Growth oriented asset classes match the profile of long term investors who do not fear risks. Their aim is to generate higher returns.

How do I decide on the right asset allocation for me ?

Asset allocation is the process of balancing risk and reward by dividing assets according to an your individual goals, risk appetite and investment horizon. By spreading your investment across different asset classes, you create a diversified portfolio where the loss that you may make on a certain asset class can be compensated by the profits that you make on another. Thus, you reduce the overall risk of your investments.

There is no simple formula that can find the right asset allocation for every individual. Asset allocation is however one of the most important decisions that investors make. In other words, your selection of individual securities is secondary to the way you allocate your investment in stocks, property, and cash and other investments, which will be the principal determinants of your investment results.

Your risk appetite, investment objective and investment horizon will determine your asset allocation.