Publication: The Times Of India Mumbai; Date: Aug 28, 2007; Section: Your Money; Page: 38
So what exactly is financial planning and wealth management, Rakesh Jha was curious to know. This 45-year-old businessman was in my office because he wanted to plan his family finances. My reply was straightforward: comprehensive financial planning is the process of allocating financial resources in the best way to achieve your financial goals. A financial plan addresses four important areas:risk management, wealth creation, wealth preservation and wealth transfer.
“Wealth management” and “financial planning” both serve the same purpose. The difference between the two lies in the wealth of the client and the products and services offered, from budgeting, risk management, investment advisory, limited tax advisory and estate planning services. A typical process consists of the following stages: data gathering, diagnosis of your current situation, preparing the plan, presenting it, and reviewing it at regular intervals. The output of this process is a Financial Plan, which is a 25-40 page document. A certified financial planner or advisor with the right education, expertise, ethics, and intent, can draw one up for you.
Financial goalsWe discussed the family’s financial goals, and did a data gathering session. The Jhas’ first financial goal was to build a corpus of Rs 10 crore to fund startups beginning in 2020. The second goal was to ensure a post-tax retirement income of Rs 1.5 lakh per month from 2025. And lastly, they wanted to build a school with a corpus of Rs 10 crore, as a philanthropic endeavour. Next, we considered the Jhas’ financial situation. After cash flow assessment, a net worth statement (see tables), and a review of insurance, investments, and tax returns, it was our turn to ask questions.
How’s your health—and health insurance?
We found the Jhas had 24 insurance policies of various tenures for Rakesh, Prerna and the children. They were paying Rs 12 lakh a year in premiums, and had all the best-selling plans. They had been sold a certain unit-linked insurance plan (ULIP) as a financial planning tool. Rakesh showed me an article in a distributor’s newsletter, titled “Make this ULIP your Financial Planner”.
Rakesh’s life insurance cover was low. In fact, wife Prerna and daughter Niharika had a higher cover than he did, although they have no income and no dependents. And although Niharika will start earning an income next year, she will still not need life insurance until she has dependents. The ULIP was pitched to Rakesh as requiring premiums to be paid for only three years. Now, despite Tuhin Chakraborty premiums all paid up and a roaring bull market, the planis only breaking even. The endowment and money-back policies have severely curbed liquidity, as surrender charges are steep—it takes great conviction to exit such policies, accept one’s mistake, and take a short-term hit.
Although the risk of heart attacks looms large in his family, Rakesh had a cover of only Rs 50 lakh. This was risky, especially considering he had a home loan liability of around Rs 1 crore.
I said, “If you really financial planning, you would not be underinsured despite having many insurance policies and paying huge premiums. Why do your children and wife have more insurance than you, although they do not need any insurance?”
Why all the hopping around?The Jhas had around 28 mutual fund schemes, 30 stocks each through two portfolio management schemes (PMS), and 18 other stocks. Most of their direct stock investments were in penny and smallcap stocks, bought with the aim of doubling or trebling their money in a few months. Their mutual fund portfolio was churned by exiting from some investments to put money into others. The portfolio management service provider repeatedly bought and sold stocks like Tech Mahindra, Larsen & Toubro, and Siemens, booking profits at every 3-4%, but also repeatedly incurring costs for taxes, brokerage, and entry at higher levels. We inundated Rakesh with questions: Why do you have an unwieldy and poorly managed portfolio? Why are you getting out of some investments in order to buy others? Why have two of your portfolio managers bought you the same funds—SBI One India Fund, Reliance Equity Advantage, and UTI Lifestyle Fund—in different quantities by selling existing funds such as Reliance Growth and SBI Contra? Why do you have stocks like Solar Explosives, Lok Housing and IKF Technologies, when you could have built a solid portfolio of large- and mid-caps?
Just pointing to the broker is no good. His recommendations may have been based on several parameters, but they obviously didn’t include your goals, risk tolerance, and return expectations.
Setting the house in order
We drew up a comprehensive financial plan, and here’s what we recommended. The first aspect to address was risk management. We advised Rakesh to buy a term insurance plan for himself for Rs 2 crore. We suggested he cancel 12 insurance policies that started in 2006, for which only one premium was paid. For a few other policies, we suggested he pay premiums for another year, and then consider surrendering them. We also advised Rakesh and Prerna to buy a cancer insurance policy for themselves. We suggested they protect their valuable possessions with a homeowners “All Risk” policy. And we advised them to buy medical insurance for their parents, and increase the cover for their daughter.
The second knot to untangle was the Jhas’ investment strategy. Their portfolio was skewed towards real estate, which accounted for about 60 % of the total allocation. Debt accounted for 18%, equity for 12%, and cash for 10%. We scaled up the equity and debt components by taking Rs 30 lakh out of savings and fixed deposits (FDs). The FDs were earning 8% pretax (5.36 % post tax), so we moved around Rs 15 lakh to 13-month fixed maturity plans (FMPs) which yield 9.0% post tax. The cancelled insurance policies made Rs 4 lakh available for investments. Rakesh had invested around Rs 20,000 annually in the Public Provident Fund (PPF). We recommended he max out his PPF investments, and invest in debt throughFixed Maturity Plans.
Additionally, he gifted Rs 15 lakh to his father, who invested it in the senior citizens’ scheme at 9% per year. The interest of this is gifted back to the Jhas, who then put it in a diversified equity fund through a systematic investment plan. We also drew up an investment policy that tightly defined when and what to buy and sell. Non-performing funds, stocks and PMS schemes were booted out of the portfolio. We created a cashflow management strategy to ensure surplus funds were appropriately invested according to plan and not in an ad hoc manner. The Jhas’ portfolio now has PPF, FMPs, 10 stocks, five diversified equity mutual funds, a balanced fund, a start-up investment, and some art.
Not the end
The Jhas’ financial planning does not end here. If anything, the family is starting out on a journey. We will meet up with them again in January to follow up. Perhaps the biggest risk investors face today is buying into illusions. It’s not hard to do, when the tantalising promises of dazzling returns abound, and that too, under such cool-sounding banners as “Financial Planning” and “Wealth Management”. The next time you hear those terms, be alert and make sure what what’s on offer is a real financial plan, and not just a mirage of one.
MEET THE FAMILY
Rakesh Jha is a 45-year-old businessman who sells computer hardware. His wife Prerna, aged 43, is a homemaker. Their 22-year-old daughter Niharika will soon return from the US with a degree in fashion design, to start a career in advertising. Amar Pandit is a certified financial planner, and director, My Financial Advisor.
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