Publication: DNA, Mumbai; Date: July 9, 2007; Section: Personal Finance; Page: 6
Thats the prescription for DNA Money reader Rahul Shah
I have done things in an ad hoc fashion and I am not sure if I have done the right thing,” Rahul Shah rued. A 37-year-old corporate executive, he lives in Mumbai with his wife Seema and 2 children, Ananya and Ashish.
“I just want to secure my future,” he told me. “I want to ensure that I am able to provide my children with the best possible education, provide for their marriage, buy a house and ensure a sound retirement. In case something happens to me, I would still want to ensure that all these goals are addressed in my absence.”
We discussed his financial details and goals.
Stated financial goals• Rs 25 lakh for Ananyas marriage at 25 years• Rs 25 lakh for Ashishs marriage at 25 years• Rs 10 lakh for Ananyas education in 2017• Rs 10 lakh for Ashishs education in 2022• Retirement income of Rs 1 lakh per month starting 2024 (Rs 2 crore after 55 years of age)
Current situation
The Shahs have invested in two properties. One is in Gurgaon, which they want to sell off, and the other is in Mumbai, which would be ready in 2008. Right now, the family resides in a rented apartment.
Diagnosis
A detailed assessment of the Shahs objectives, risk tolerance, investments, insurance policies and net worth statement threw up the following points: • Their monthly expense was around Rs 1,00,000 including the home loan EMIs. However, they just have around Rs 1.25 lakh in a combination of fixed deposits and savings account. Contingency fund was very low and at the same time net monthly cashflow was around Rs 10,000 (Rs 1.5 lakh annually after some reimbursements were made). The contingency fund needs to be enhanced to at least Rs 4 lakh and a major part of this can be in fixed deposits since an overdraft can be taken against them in case of a contingency. At the same time, around Rs 1.5 lakh can be parked in short-term floating rate funds.• Though cashflow seems stretched now, things will ease next year when they move into their apartment and dont need to pay rent, though maintenance expenses will come up as well as the cost of furnishing the apartment. The first step is to improve cashflows from Rs 1.5 lakh to at least Rs 4 lakh per annum.• Personal expenses are not very high. However, at the same time, if we remove taxes and bonus, which come at the end of the year, net income is around Rs 17 lakh. EMIs take away around 51% of Rahuls income and if we exclude reimbursements, EMIs take away at least 54% of his income. Insurance payments and rent take away an additional 20%. • As far as insurance goes, Rahul has 8 LIC policies, a Birla term plan and an ICICI Prudential Life Time plan. Seema has a HDFC insurance plan. The combined premium is around Rs 1.28 lakh annually. Except for the term plan and a couple of old LIC policies, most of the insurance plans, which have completed 3 years or have just completed 1 year, can be surrendered and terminated, respectively. This will save at least Rs 80,000 per year. However, given his liabilities, goals and future family income, Rahul is short by Rs 2 crore. He can start off with a cover of at least Rs 75 lakh, which can be increased through a term plan for which an additional premium of Rs 26,500 would be payable. Thus, cashflow saved is around Rs 54,000 and his net cashflow per year can be taken to around Rs 2.06 lakh.• The rental expense will stop next year and at the same time, the Gurgaon property can be rented for around Rs 35,000 per month or be sold off on completion of 3 years. The proceeds can be used to part-prepay the residence loan so as to reduce the EMI and interest cost. This will again increase the cashflows to above Rs 4 lakh comfortably.
The key is to tide over the next 12 months, which seems doable.• Though most of Rahuls goals are long-term in nature (at least 10 years time horizon), exposure to equities is very low at about 19% (around Rs 8 lakh with Rs 4 lakh spread across 11 stocks and Rs 4 lakh in 37 mutual fund schemes). At the same time, debt exposure is also very low at 5% of the portfolio. Though he has been contributing Rs 70,000 to PPF every year and also contributing to EPF (which is also a decent number), the corpus seems to be very low (Check with the HR department for the exact EPF figures). Ad hoc purchases based on new product launches and sales pitches seem to be the preferred route.• Investment portfolio is heavily skewed towards real estate and he is underweight in cash, debt and equity, in that order. Being a balanced investor, Rahul needs to maintain an asset allocation that is in alignment with his risk tolerance, goals , time horizon and liquidity needs.
Recommendations• Improve cashflow as given above and create a contingency fund. Park most of it in fixed deposits and around a third in floating rate funds.• Scale up medical insurance to at least Rs 3 lakh per person in the family. You can buy a medical cover of Rs 1 lakh from a general insurance company.• Review the cover offered through the Bajaj Allianz and New India Insurance policy and understand exactly whats on offer. Tata-AIG General Insurances Secured Future Plus, which will provide an income of Rs 35,000 per month up to 20 years in case of contingencies like paralysis, total disability and accidental death, may also be looked at. • Buy a term plan for Rs 75 lakh and then surrender a few LIC, ICICI Prudential and HDFC policies.• Buy a Cancer Insurance Policy from the Cancer Patients Aid Association for himself and his wife for the maximum amount. CPAA introduced the Cancer Insurance Policy in 1994 in collaboration with New India Assurance Company. The policy is available to healthy individuals who have not suffered from cancer in the past. An individual wishing to take this policy must first undergo a mandatory free check up at one of the CPAAs cancer detection centres. The policy takes effect 30 days from the date of the medical check up.
Achieving financial goals• To achieve his childrens education and marriage goals, Rahul needs to save around Rs 18,800 per month (Rs 2.25 lakh) per annum and invest for a return of 12%. This return can be accomplished with a split of 60-80% in equity and 20-40% in debt, respectively. This is over and above his current equity investments of Rs 8 lakh in stocks and mutual funds. • An important factor for his retirement income goal is life expectancy. If he retires at 55, he should consider an expectancy of 35 years, till 90. For this, he would need to have a corpus of Rs 11.2 crore by the age of 56 (with a 6% return on the portfolio). A retirement income of Rs 12 lakh per annum today (indexed at 5% annually) is the equivalent of Rs 30,32,340 in 19 years, at age 56. This is the most difficult goal to achieve and hence we would need to relook at this goal next year after the Gurgaon property is sold, or post a substantial increase in his income. He will need to either scale down the goals, increase his income and cashflows substantially, retire beyond 60 or plan income till the age of 75 instead of 90, which may be a dangerous thing to do.• Restructure the equity portfolio. There is no need to have an army of mutual funds and stocks. Considering the current size, 3-4 funds and 5 stocks should be adequate. Having several funds and stocks is defeating the very purpose of diversification. He seems to have subscribed to all the NFOs in the last 2-3 years and would do well to sell most of these funds where he has completed 1 year and park the proceeds in good diversified equity funds with solid track records. Out of the 11 stocks, he has to restructure the portfolio around 4-5 good quality stocks, some of which are already there in the portfolio.• Create a detailed Will. It is necessary to make wills to avoid the problems of dying intestate. Rahul should state how he wishes his your assets to be distributed. This may include naming not only the one who he would like to receive all or part of his estate when he dies, but also who benefits if the first choice beneficiary (or second or third) predeceases him. This is very important especially in case of the children who are minors.
The author is a practising certified financial planner. The plan is based on the data made available to the planner. The views expressed are those of the author and do not necessarily represent those of FPSB India. Readers are advised to take their own informed decisions in all such aspects. Feedback may be mailed to myplan@fpsbindia.org
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