Review on-the-theories-of-financial-planning

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International Journal of Pure andApplied Mathematics
Volume 118 No. 18 2018, 4347-4355
ISSN: 1311-8080 (printed version); ISSN: 1314-3395 (on-line version)
url: http://www.ijpam.eu
Special Issue
ijpam.eu
REVIEW ON THE THEORIES OF FINANCIAL
PLANNING
1
Biswajit Acharjya, 2
SubhashreeNatarajan
1,2
VIT Business School, VIT University, Vellore 632014, TN, India
ABSTRACT
The purpose of this paper is to review the existing theories of financial planning and to elucidate
the application of these theories in various sectors. The collation of research papers and their
findings will facilitate identifying specific areas for research in the domain of behavioural finance.
The theories reviewed in this paper, on financial planning, can be applied both by investors and
the financial advisors. This conceptual paper reviews the financial planning theories like Personal
Financial Planning theory (PFP), Family financial Planning theory(FFP), Life Cycle
Hypothesis(LCH), Modern Portfolio Theory(MPT), Capital Asset Pricing Model(CAPM), Efficient
Market Hypothesis(EMH), Behavioural Finance Theory and Prospect Theory. The manifestation
of these theories from its inception, application, critical analysis and modifications till dateare
reviewed. The context and practical implication of the theories in different fields and phases of
decision making are also included. The other extraneous factors, if any, that contributes and / or
distorts the theories are also included at relevant contexts. The main limitation of theories
reviewed are not validated with any data or is not applied in any context. The context of the
theories is subject to change as the investors behaviour changes, markets upgrade and the entire
eco-system of behaviour finance evolve with financial market and its trajectories.Detailed
framework of theories suggested by various authors is complied with its practical implication, with
an intention to broaden the financial knowledge of researcher in the field of Behavioural finance.
Keywords: Financial Planning, Financial Behaviour, Financial Theories, Behavioural Finance
1.INTRODUCTION
Financial planning, a prime fore-thought for financial well-being, is a structured, well-cultivated
habit. In many countries, financial literacy for financial independence is introduced at a very
young age. Financial planning has gained an indispensable research focus with the evolution of
financial markets and its products. Behavioural finance is a study at the grass-root level on the
individual investors. This study includes various aspects of financial decisions- inclusive of
outlining family budgets, analysing current income and expenditures, setting future financial
goals, actions, deliverables, experiences and their impact. These actions are underlined by
invisible psychological and social factors.
Behavioural finance has had been into momentous alterations and progress from the very first
step of financial planning. All entities involved directly or indirectly in financial planning have been
in muddle with regard to simple decisions like whether they should capitalize on the market
movement or should they save their hard-earned money in a tenable way, understanding which is
the best mode of investment, why and how to assess them; why would a financial tool is preferred
over the other and et al., Information plays an important role in rational financial decisions. Any
negative information on financial devastation, in any unknown part of the world, when
broadcasted affects the crowd psychology and results in distorted, loss-of-belief attitude and
action quickly than the positive news on financial prosperity.
The plethora of theories given by several researchers connecting internal and external
environment of financial planners, leading to decision making, are discussed in detail.

International Journal of Pure and AppliedMathematics Special Issue
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2.EXISTING THEORIES OF FINANCIAL PLANNING
2.1 Personal Financial Planning (PFP)
Most important theory on decision making pertaining to financial investment with respect to
Personal Financial Planning (PFP) is based on the foundations of Modigliani, Markowitz and
Becker. Gajapathy (2018) claims that personal financial planning can assist individuals
accomplish their anticipated financial goal, which includes the intention for achieving desired
future financial objective from the current financial situation. Essentially, this aids in the
achievement of financial security of an individual’s future. Dheerthan Gajapathy (2018) specified
several personal factors that helps individual attain pure apprehension to financial safety through
personal financial planning i.e. lifestyle, appetite for risk, planning horizon, level of income and
influence of knowledge. As stated, financial planning takes into account the entire picture, not just
a part of it. The major factor which decides the path your investments are going to take to take in
the future pertains to lifestyle, but there are also downsides to this where people can lose
everything they own which depends on their capacity or appetite for risks. Hence, other factor like
planning horizon serves as the time period of plan for which people plan, also has a direct relation
with one’s financial goals. Meanwhile, at all income levels, financial planning can benefit people
as well. Financial planning also offers people an edge over others by providing a better
knowledge of financial concepts which assists to achieve proper control over such investments[1].
Altfest acclaims that there should be more research on this theory, as it is a challenging task for
the financial planner, for compelling financial judgement, with the varying needs of the consumers
and fluctuating economic structure as well[2].
. Mittra et al. (2005), explained there have been
growing demand for the financial planning due to this economic instability and it‟s a
challenging task for the financial planner for taking decision[3].
PFP is the process where
individual can accomplish their anticipated goal by effective utilisation of their capitals. Harrison
(2005), states financial plan is the intentions for achieving desired future financial goal from the
current financial situation[4]
.David et al (2016), explained financial planning is not restricted to only
making pronouncement for accomplishment of money and wealth but it emphases on the
planning of various aspects like; managing cash flows, insurance, tax, estate, education planning
etc[5].
For assisting clients, Financial planner are giving tailor made solution for the financial
problems. Financial planners are specialized body those have knowledge about financial
planning, they generally guide and giving propositions to the Clint about the current market
scenario. Michel et al (2016), found seven key factors of trust i.e. feeling, honest, confidence,
curiosity, accountable and competence which should be there in between the Clint and financial
planner[6].
The author recommended, there should be trust in affiliation between the financial
planner and Clint for PFP decision. Lisha Huang (2016), specified several guidelines of financial
planning for college graduates with distinct apprehension to financial safety for prudent decision
making[7].
Earlier in some research, some author applied traditional economic approach theory for
the household financial planning. Conventional financial planning was developed in early 1970s,
and it was useful for low and middle income group people.Chieffe et. al (1999), discussedfinancial
planning is evaluated by two crucial factors i.e. one factor related to time that may be current time
and forthcoming time and another factor related tosystematic and unsystematic financial event[8].
2.2 Family Financial Planning (FFP)
GS Becker, an eminent economist, has given theories for financial planning within the family. He
stated applied economics can be used for the decision-making pertaining to financial planning
inside the family. Becker (1965), proposed changes in various household activities in relation to
the allocation of time and compared the value of time with the value of the marketable
commodities[9].
Becker (1988) consider all house hold people as both producer and consumer and
the family is like a small production firm where all inputs like raw materials, labour capitals are
processed in to useful output. In this paper, he analysed effect of time with the earning level[10].
GS Becker (1992), studied various aspects where he compared various family activities in
relation to timing. In one of his paper he compared timing given by parents for caring their infants
and infant‟s demand from parental income[11].
In another paper (Becker, 1992 a ) suggested
there should be gender based division of work load inside the family for smooth functioning by
minimising mismatch of the decision[12].
Becker et al.(1986) discussed all cultural and genetic
behaviour is transferred from parents to infants and the tendency for financial planning for
children‟s education is there in the minds of each parents[13].
Hogan et. al.(2005) stated that
people may not have knowledge of financial benefits but they should focus on financial planning
for their child‟s education and forgetting tax benefits[14].

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2.3 Life Cycle Hypothesis (LCH)
Modigliani et al (1954), have proposed a theory related to consumption and saving of the
individual called LCH which was later identified by Altfest (2004) [1].
Individual‟sexpenditure and
saving decision is not just yearly requirement it is based on their overalllifetime earnings and
spending behaviour (Modigliani et al, 1954) [15].
Kotlikoffet al (1982), have studied saving
behaviour of the individual for their old age consumption and suggested individual should start
saving from their young times by looking into their lifetime requirements[16]
. They identified Social
security is the most significant criteria for the financial welfare of elderly people and it is based on
Permanent Income Hypothesis(PIH). The PIH was postulated by Milton Friedman (1957), which
is very identical to LCH[17]
. Attanasio et al.(2003) explained about impact of pension fund
saving with personal day to day saving and find pension fund is the alternative reduction amount
of day to day savings Mittra et al. (2002) [2]
Dalton (2003)[18]
, and Dalton et al (2003,a)[19]
used
Modigilani theory of LCH and found out the amount one should invest for meeting future
retirement consumption. N Opiela (2001), suggest it is wise to save for retirement than education
and given more practical analysis by combining the thought given by the Becker‟s theory of FFP
and Modigilani‟s LCH[20]
.Lahey et al(2003), examined the situation of the individual when they
tend to move towards retirement stage and what is the impact of retirement towards the financial
wealth of that individual and found there is hardly any difference of net wealth between retired
and non-retired person, and as per financial asset concern retired person have more asset than
non-retired person. 40% of the incomes after retirement are contributed by the other household
relatives[21].
Schoeni (1997), has made an empirical analysis of family support; in this study, she
found large extent of the household income and time is transferred within their same
family[22]
Schreiber et al, (2016), explained about retirement and consumption puzzle, and life
cycle hypothesis is not holds good because of increase in leisure after retirement. As per life
cycle hypothesis, income reduction has no impact on consumption expenditure after retirement
but the author proved, there should be fall in total consumption expenditure after retirement due
to leisure endowments. So, author clarified, fall in income after retirement has adverse effect on
consumption[23]
2.4 Modern Portfolio Theory (MPT)
Markowitz (1952), proposed a fundamental theory of financial planning called MPT.MPT is the
practical extension of PFP theory. This theory states, with a given level of risk, how can a risk
averse investor optimize the expected return[24]
. Black et al. (2002), argued lack of practicality of
PFP theory. MPT is the theory where investor will invest based on the future expected return.
There should be more research on this theory as per the author suggested[25].
2.5 Capital Asset Pricing Model(CAPM)
Sharp (1964), and Tobin (1958) extended MPT and suggested a new model for financial planning
called CAPM which describes the relationship between expected rate of return and systematic
risk[26, 27]
. Unlike normative approach of modern portfolio theory, this theory gives descriptive
approach of asset equilibrium. It states, the expected return of an asset, is the sum of time value
of money and risk. Time vale of money is the risk-free rate.Generally, there are two kinds of risks
are there i.e. systematic and unsystematic risk. Systematic risk is otherwise called market risk or
un-diversifiable risk, and it is the risk occurs due to uncertainty in the market situation. It is very
difficult to control systematic risk.Un-systematic risk is the specific or diversified or residual risk
which arises inside the organisation. It is controllable; it can be controlled bymild diversification of
existing portfolio. Unsystematic risk is not considered as the real risk in the market (Sharp,
1964)[26]
, because it can be controlled.Earlier there were various assumptions of this theory, like
variance analysis for investor, no transaction and taxation cost and risk less borrowing but later
Black et al (1972) refined and states; there should not be risk less borrowing[25]
. So many authors
have already studied and refined this theoryOviatt (1989), given list of seven assumptions for this
theory[28]
. Brinson et al (1995), said extreme i.e. more than 90 of the yield of the portfolio because
of allocation of assets[29].
Markowitz (2005), clarifiedCAPM is a well-designed model with simple
assumptions. If we will replace the assumption of this model with factual domain, some basic
assumption no longer effective[30].
Pollock (2007), stated distribution of asset is the key driver of
investment decision[31].
Daryanani et al (2005), got the conclusion that this model is more suitable
for institutional portfolio than individual or family portfolio[32].
Nawrocki (1996), conferred the
restrictions of CAPM and linked with the MPT and clarified, both the theories can be considered
as the basic theory for financial planning[33].

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2.6 Efficient Market Hypothesis (EMH)
EMH, a financial planning theory, the idea advocatedby Eugena Fama in 1960s, states it is very
challenging to beat the market because share prices have previously reflected all the pertinent
information‟s. This theory suggests, stock should trade at their rational value in the stock
exchange. According to (E. Fama, 1965) efficient market is a market, where most of the cogent
profit hunters are contending with each other dynamically for envisaging the market worth of the
specific security[34].
Levich (2001), alleged if the market is efficient i.e. all the information is
accessible in the market, then investor can not able to get economic yield [35].
Shiller (2008), have
studied about EMH, discussed that the fair value of stock is similar with the current value of
discounted upcoming dividend[36].
Hence, it is realized that the price is the estimate of upcoming
dividend of the stock.Critics on market inefficiency due to stock market crash in 1987 and 2008-
09 was highlighted and questioned for its trustworthiness of EMH by Elton et. al. (2003)[37]
.
Seeking profit more than market is worthless as suggested in EMH because all the new
information is previously merged in the price structure.Campbell et. al (1997), propose it is very
hard to measure market efficiency because whole market cannot be competent and there is
possibility of getting unreal result but it is adequate to measure relative efficiency where we can
compare efficiency of two markets[38]
2.7 Random Walk Hypothesis (RWH)
In order to overcome the unreal result of EMH, one new hypothesis was developed called RWH.
This Hypothesis signifies that market prices are moving in a haphazard manner, so it is simply
irrelevant by predicting current market price by observing into past price structure. It is better to
hold the portfolio for the long time without expecting abnormal profit (Shleifer A, 2000)[39]
.
2.8 Behavioural Finance Theory
One of the judgemental decision making theory developed in 1990s in the field of financial
planning called behavioural finance theory. This theory contradicts Efficient Market Hypothesis by
giving more reliable result. This theory was developed with the assistance of ultimate theory of
human biases and cognitive error suggested by psychologist D.Kahneman and A. Tversky
(Tversky et al, (1973) and Tversky et al, (1975)) [40, 41]
. Behavioural Finance theory, can be
applied into various social science sectors i.e. psychology, sociology, neuroscience, political
science, anthropology etc.
2.9 Prospect Theory
Behavioural finance theory further improved into a new concept, which is the alternative theory of
expected utility theory of Neumann and Morgenstern, termed prospect theory. Expected utility
theory was developed in 1940s, states individuals usually contemplate about ultimate means they
will get before planning about taking decision[42]
. This theory states, the perception of gain and
loss is different for each individual and depending upon the situation the standard level of profit
andloss,is also differ. Shleifer, in 2000, described loss avers nature of human[39].
He exhibited
graph of loss function is stepper than gain function i.e. people tend to feel more hurt in case of
loss than pleasure in case of gain. Tvede (1999), described the loss avers nature of human in
share market, he explained people generally like to hold the stock at the of falling stock price but
try to sell the stock during higher stock price[43]
. One of the most important outcome given by the
two authors: A. Tversky and D. Kahneman (1979, 1992) , under prospect theory is people are
overconfident towards their ability. Due to overconfident people usually lose huge amount of fund
because they are underestimating the risk associated with the market and they were blindly
judging the current market situation by looking into past price structure[44,45].
R Shiller(2000), said
due to over confidence currently high trading in the market was observed[36]

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3.APPLICATION OF THEORY IN FINANCIAL
PLANNING
From the literature, it is found that all the above theories are applied to various sectors. Chieffe et
al(1999), categories financial planning sector into four broad types: planning for fund
management, planning for emergency, planning for meeting future expectation, estate planning[7]
.
Overton(2008), in the thesis explained, financial planning application towards various sectors i.e.
Insurance planning, planning for welfares of employees, Investment related planning, Planning
for Income tax, Planning for retirement and estate planning[46].
3.1 Planning for fund management
Planning for fund management, is the financial planning where individuals are estimating
theirfinancial consumption, spending and saving. Each individual want to capitalizetheirdeposit
effectively irrespective to the amount of fund they are investing. This kind of financial planning is
for meeting financial necessityfruitfully.
3.2 Planning for safety
An individual can satisfy unforeseen need may be by keeping safety fund separately or by
depositing regular premium for the insurance policies. Altfest (2007), Hallman et al (2003), stated
fund should keep separately apart from daily expenses for meeting surprising need[47,48].
Hallman
and Rosenbloom, in 2003, explained separate insurance premium should be given for bearing
unexpected health and property related expenses[48].
3.3 Planning for future expectation
Each individual has some sort of future expectation, to meet this expectation there should be
proper financial planning. From the literature, it is found that long term future expectations are like
purchase of asset, retirement planning, children education, pension plan etc. from the experiment
by the various standard organisation it was found that most of the people want proper financial
planning for their retirement.
3.4 Estate planning
Gitman et al. (2011), describe estate planning as planning for distribution of asset after death
consistently[49].
This financial plan is tax efficient, legally and emotionally binding plan. Estate
planning entailsapplied knowledge, tax slab,guidelines,instruction, strong determination and faith.
This planning can be used in retirement investment and life insurance investment planning. The
main focus of this planning is to rightly allocate the estate among the beneficiary so that each and
every one can able to get better wealth.
3.5 Insurance Planning
Insurance planning is one of the best way of financial planning. Generally, insurance planning is
of two types i.e. life insurance and non-life insurance. Non-life insurance is called general
insurance. By insurance planning one can transfer their risk so that they can get fund at
difficulties in future. Life cycle hypothesis can be applied in insurance planning because
insurance is giving care to client for a longer period.
3.6 Employee Benefits Planning
Employee benefits planning, is the financial planning with the help of which employee are getting
benefits, that may be from health-related compensation, tax benefits, other compensation like
flexibility in legal and other special dealings. Financial planner need to understand what kind of
benefits one client can get by availing this financial plan. Overton (2008), in the thesis report,
suggested, there should be one advanced theoretical based model, so that each and every
employee can get idea about what kind of benefits one can get by availing any specific financial
plan[46]
.
3.7 Investment Planning
Investment financial planning, is most popular financial planning for common people. Most of the
normal household prefer to invest in some financial institutions. Investment planning can be of
various types i.e. asset investment, share market investment, Tax investment etc. Torre et al
(2004), explained various kinds of techniques available to measure the risk associated with the
investments i.e. valuation of bond and stock analysis, return on investment analysis, Portfolio
diversification analysis, capital asset pricing models etc.[50]
. Samuelson (1969)[51]
, and Tobin
(1958)[27]
,explained risk taking ability of an individual is increased by experience not by age. They
challenged the normal human being thought, „young people have higher risk recovering ability
than the aged people‟ and they proved it was wrong with the help of Modern Portfolio Theory.

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Booth (2004), used Monte Carlo model of simulation for giving more probabilistic solution of the
above problem and contradict the thought suggested by Samuelson model and the rule of thumb
assumed to be right i.e. age has impact on risk recovery [52]
,Dalton (2003)[18]
and Leimberg et. al
(2002)[53]
suggest, evaluative method of solving the problem should be more applicable than
simulation technique for decision making for retirement investment. Evaluative method suggests,
by looking into various past risk and return profile evaluate the exact predictive figure for the
future. Connelly(1998), asked the reliability of the evaluative method of financial planning, he
argued, because of fluctuating economic nature of market we cannot draw a particular conclusion
by looking into past figures[54]
.Goodman (2002), explained the application of mathematical
analysis for the financial planning for retirement[55]
.
3.8 Income tax Planning
Another important type of financial planning suggested by some authors is Income Tax Planning.
For income tax planning, one should aware towards rules and regulation of Income tax, Various
tax slabs. This planning includes allocation of asset which is differed from tax rates, disposability
time of asset, Depreciation of asset etc.
3.9 Retirement Planning
Retirement financial planning is one of the important financial planning as discussed by various
authors. Various author discussed retirement financial planning using Modigliani‟s LCH. From the
various literature, it was found that people do retirement planning for various reasons like social
security, tax advantage, investment purpose, Distributing the funds purpose etc. Olsen (2006)[56]
,
Opiela (2004)[57]
and Robinson(2007)[58]
, discussed in their article about the retirement planning,
they have disused about most valid income source for the retirement fund.
4.CONCLUSION:
The paperelaborately studied the existing theories of financial planningand commendable
opportunity for identifying areas for research in the field of behavioural finance. The practical
implementation for inculcating financial literacy among young people is many (S.,Natarajan et al,
2015). The paper further extends to provide application-based information on financial and
investment planning as the paper is designed to cover the broad areas of various sectors. This
study can further be used as a foundation to define and recommend the course of action for
investment planningby the professional financial advisors to their clientele.

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