Plan To Diversify

A smart businessman, who had most of his investments only in business, realises the benefits of diversification

Deepak Shah, a business owner in his early forties, lives in Mumbai with his wife Radha and two daughters Rekha and Jyoti (both 12 years). He was absolutely focused on his business and had most of his savings tied to it. His business had grown well within a short period and like most owners, he invested most of the funds into business.

He always believed that his business was earning good returns and that there was no need to diversify. However, a sharp downturn and losses made him rethink on a strategy.
When we started the discussion, he felt that he was in control of doing things because he was a prominent client of a couple of multinational banks and had done a few insurance policies and investments (in an ad hoc manner). But as we progressed, he started to realise the risks that he was exposed to. Some of the observations that I had were:

Almost 90% of his net worth was tied to the business. His family was exposed to the biggest risk that all business owners face today—risk of concentration. Almost all their investments and assets were concentrated on their business. There was minimal diversification. There was no will of inheritance prepared by him or his parents. The women in the family had no clue about the investments or what the family actually owned.
He was paying several lakh rupees as life insurance premium but had a very low cover. At the same time, there were some liabilities to be covered. His investments were hodgepodge and accumulated over a period.
At times, his current account and savings account had lots of funds earning zero to nominal returns.

There was no track of many investments and he was not even sure where the papers were.
When I explained these points to him, Deepak understood the situation and seemed a little worried.

Challenges faced by most business owners  

Loss of business due to changes in economic climate, consumer preferences and typical business risks can have a significant impact on the income and career prospects.

There is a very thin line between business and personal funds. Also,
there are no separate personal investments. There is a constant need of capital for business expansion.

However, it is very important that one understands the difference between personal financial goals and business related ones and the need to keep them separate.

Deepak’s simple goals 

To maintain a lifestyle by having a post tax retirement income of Rs 2.5 lakh per month in today’s value. Provide Rs 1 crore for daughters’ US education. Involving his wife in the business and updating her about the same—this was more of an objective. Diversifying investments from the current business and making a sound portfolio of debt, equity, real estate, private equity and gold.

Do a thorough estate planning exercise for his parents and himself.
A detailed assessment of Deepak’s goals, cash flow and net worth statements, insurance policies, investments and tax returns revealed the following:

Deepak’s savings were good but most of it was going into costly and low-return endowment policies from LIC and ULIPs. He was paying around 29% of his net income for insurance policies. Lifestyle expenses took around 43% of his net income. He was getting a paltry 4-5% on the traditional policies and some of his recent ULIPs were deep in the red and they will surely take several years to break even. Also, he had taken a few policies in his children’s name—something which was not needed as children have no dependents and are not the breadwinners in a family.

Also, the cover he had from the LIC policies was on the lower side at around Rs 90 lakh.
Majority of his net worth was tied to his residence and business. His investments were very nominal as compared to his overall financial and business situation. Adequate diversification was missing in his plan.
The only beneficial plans were his PPF contribution and exposure to certain blue chip stocks and mutual funds.

We created a comprehensive financial strategy for him, parts of which are reproduced below.

Strategy  

We created a detailed cash flow statement and ensured that all weekly and monthly inflows get parked in liquid plus funds instead of the current account. This ensured that he earned decent returns of around 6% post tax instead of 0% in his current account and negligible returns in his savings account. We also parked funds that were not needed for more than three months in quarterly fixed maturity plans.

We then surrendered some of the new life insurance policies taken a couple of years back and brought the premiums down to Rs 8 lakh (term plan premium included). At the same time, we raised his cover to Rs 4 crore.

We renegotiated some of the business loans and paid off those where the interest rates were too high. We also decided on cutting the losses in a certain business venture that was taking a toll on his core business.

We started monthly systematic investments in mutual funds and stocks which we identified and decided to add to our existing positions on every 5-7% fall in the market. This ensured that the surplus cash flow did not lie idle and was deployed productively when available.

As Deepak was in the highest tax bracket, any investment in debt should either be tax-free or tax advantaged, else returns would be very low post tax. Hence, tax-free investments such as PPF and tax advantaged investments such as fixed maturity plans were used.

We prepared a legal will and ensured that all bank accounts and investments had his wife as joint holders.

We decided to review the plan every six months so that any changes in the external and internal environment could be taken care of.

Most business owners, after an initial success, are clear about the nuances of their business and devote more and more money into their business (which is good).

However, at times there is very little diversification that they manage to achieve and hence it leaves them exposed to the risk of putting all eggs in one basket. But for making prudent financial decisions, taking a holistic view of their overall finances is a necessity.

A comprehensive strategy that will look at every aspect of personal finance—from cash flow and debt management, loans, all risks that a business owner faces, how best to address these risks, investments, retirement and estate planning is paramount for the success.
Amar Pandit is a Certified Financial
Planner and Director, My Financial Advisor

MEET THE FAMILY 

Deepak Shah, a smart business owner in his early forties, lives in Mumbai. His wife Radha (38) is a homemaker. They have two daughters Rekha and Jyoti (both 12 years) who study in a private school