Publication: DNA, Mumbai; Date: September 4, 2006; Section: Financial Planning; Page: 24
A planner understands the client, his objectives and risk tolerance before giving an appropriate advice
“I have given Rs 25 lakh to XYZ Securities to manage and they said they are doing financial planning for me”.
“I have started SIPs (strategic investment plans) and I dont need financial planning”.
These are some of the common responses that I have come across during my conversations with many executives, business owners, self-employed professionals and families.
The term financial planning seems to have created a lot of confusion. This is largely due to ignorance in general and the fact that some institutions use the term loosely.
Ajay Singh is a top-rung executive with a multinational company and draws a package of around Rs 1 crore per annum. When I mentioned financial planning to him, he said: “XYZ Bank is offering this advice and I am one of their premier clients”. Shocked by his answer, I asked him to show me the financial plan.
Ajay showed me an 8-page computerised printout with a lot of checked boxes as answers. “This is not a financial plan,” I told him.
Ajay then shared with me all the investments he had made through the bank. He also said that the relationship managers at the bank continuously kept in touch with him, talked about his childs future, rebalanced his portfolio and sold new products.
I then sat with Ajay and did some comprehensive data gathering. I then reviewed the data and, after a few days, met him again with my thoughts on his financial fitness and the gaps in his investment strategy.
The financial goals • Post-tax retirement income of Rs 1,25,000 per month in todays rupees starting in the year 2020 • A corpus of Rs 50 lakh for daughter Jahnavis US education, starting June 2007 (Jahnavi is a single mother with a daughter Poorvi)• Buy a Mercedes (costing about Rs 30 lakh) in December 2007.• Fund grand daughters education with a corpus of Rs 1 crore in the year 2022.• Form a trust and generate funds of around Rs 10 lakh per annum, starting 2015.
Current situation
A detailed assessment of the familys current cash flow and net worth statements revealed the following.• Ajay had a majority of his investments in equity (through mutual funds, unit linked insurance plans(ULIPs) and portfolio management services(PMS)). He also had some exposure to real estate and debt. He had a significant exposure to cash.• Under the garb of rebalancing, Ajays portfolio was churned consistently. This ate into his portfolio returns significantly. His mutual fund portfolio was churned 3 times in 8 months, which cost him around 2.25% (entry load), 2.4% (expense ratio) and around 2% (exit load) in some cases. Most of the churn happened when the money was moved from existing schemes to new fund offers.• Most of the investments were in new fund offers. Ajay had an uncoordinated, costly and redundant portfolio of 22 mutual funds (through his private bank) and some 35 stocks managed through the PMS.• He had around Rs 40 lakh of insurance through ULIPs (through his bank), for which he was paying a premium of Rs 10 lakh per annum. He was advised that he can pay the premium for 3 years and then stop the policy. This is a common method used in the insurance industry to sell policies. So, Ajay had paid around Rs 6.5 lakh as expenses in the first year. How can anything as atrocious as this qualify as an investment? This is one of the costliest mistakes one can make.• Ajays grand daughter had a life insurance policy in her name for which he was paying a premium of Rs 2 lakhs. I asked him “Why does your grand daughter need life insurance? Is anyone dependent on her?” To build a corpus you can use any investment or instrument — PPF (public provident fund) EPF (employee provident fund), mutual funds, stocks, real estate, Gold etc. • He had an outstanding home loan of around Rs 50 lakh.• Though Ajay was a balanced investor, a majority of his investments were in aggressive mid-cap and small-cap funds and stocks.• Though his daughters education goal is just months away, his portfolio was still equity-heavy with hardly any cash.
Solution
I told him: “Wouldnt you want a doctor who is supposed to do a bypass surgery on you to make sure that he understands critical things about you before he operates on you?” Similarly, shouldnt a wealth manager first get to understand you, your objectives, risk tolerance and then give you appropriate advice? “Why has your relationship manager advised you to opt for insurance products as investments when he/she could have told you to opt for a simple term plan to cover your home loan?” The Rs 6.5 lakh wasted in insurance policies could have yielded Rs 36 lakh (over a period of 15 years at 12 % returns).
I then showed him what a comprehensive financial plan looked like. The document is 20-40 pages long, and explains the internationally recognised financial planning process.
Risk management• Buy medical coverage for Jahnavi and Poorvi for Rs 4 lakh each.• Buy a term plan for Jahnavi for Rs 50 lakh.• Buy a declining liability home loan cover or a term plan worth Rs 50 lakh.• Take a homeowners all-risk policy for his home.• Buy a cancer insurance policy for self and wife.
Investment strategy
Ajay was around 10 years away from retirement and, based on his goals, risk tolerance, liquidity needs and tax payments, we created the above asset allocation for him.• Exited most of the ULIPs and mutual funds (worth Rs 50 lakh) and invested the proceeds in a short-term floating rate fund.• Exited the PMS and parked the money in a fixed maturity plan for 13 months. Ajay had invested at 7000 index (Sensex) levels in the PMS. Even though the Sensex had soared to 11000 levels when he exited the service, his portfolio was down by Rs 3 lakh. In the quest to earn higher returns, the broking house had just taken a very concentrated exposure in a few mid- and small-cap stocks.• Recommended maximising the PPF investment and making an additional contribution of Rs 25,000 per month as his voluntary contribution to PF.• Asked him to surrender Poorvis policy and invest the proceeds in diversified equity mutual funds. • Created a cashflow management strategy to ensure that the surplus funds are invested in appropriate investments according to the plan.• Created a portfolio of eight stocks, four diversified equity mutual funds and two balanced funds. We moved out of a lot of new fund offers keeping the exit load in mind and started SIPs and one-time investments in schemes from reputed fund managers (with lower costs and, lower volatility etc).• Created a sell strategy on how and when to exit from various investments &
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