Your money my money
Jan 18 2013 , Mumbai
Planning where to put your cash in these distressing times is key to your future security
— H Jackson Brown Jr
Before everything else, getting ready is the secret to success
— Henry Ford
The last few years have been hard for most of us, with incomes mostly static, and raises, if they came at all, were miserly. You couldn’t switch jobs: with very few companies hiring, switching jobs was not an option. Making matters worse were the ever-rising EMIs, eating up a greater share of income. If the present is bad, think what the future could be. Are you ready for the future?
It is never too late to make a New Year resolution and start afresh on planning for the future, have financial goals and work towards them. There is no bigger guarantee of an assured future than planning for it now.
Professional financial planners say eight out of 10 Indians have no financial plan for the future. That means they have no financial goals. Only when faced with a crisis, they think of financial planning. And many go wrong, because of the abysmal rate of financial literacy. For most of those who think of financial planning think short-term: a financial return and/or a tax-saving benefit or two.
So here we are to help you set your goals with a roadmap:
1) Identify your financial goals: A goal is not a wish. Thinking of getting rich enough to own a private jet on Rs 6 lakh annual household income is a wish. Judiciously using that Rs 6 lakh to be able to maintain your lifestyle 25 years later is a financial goal.
For most Indians, goals revolve around the family; such as owning a house, not being indebted, taking an occasional vacation, giving the kids the best of education, seeing them married and settled, and then saving for retirement.
A goal has to be realistic, measurable and achievable within a specific timeframe. Wanting to be ‘comfortable’ after retirement is not a goal, unless you can quantify ‘comfort’.
2) Decide the timeframe: Break down each financial goal into several short-term (less than one year), medium-term (one to five years) and long-term (five to 30 years) goals. The last set of goals takes the longest time and more money to attain. Give yourself a reasonable amount of time. Rank your goals in order of priority. If long-term goals are more important, compromise on less important goals, like buying a car or vacationing in an exotic location. You could, for example, give top priority to your kids’ education now, relegating comfortable retirement to the second place.
3) Estimate the cost: Try and arrive at an estimated cost to achieve a specific goal. For example, if the goal is to save for your children’s education and marriage, you need to first get a fix on the future date when you will need the money and the amount. Find out the cost of education for a specific degree and of marriage now? If you want your kid to go for an MBA, find out the cost today and then estimate the cost say 10 years hence when he will be in a B-school. For this, you have to consider inflation (say, an average rate of 6-7.5 per cent for 10 years). If the course cost is Rs 6 lakh today, inflation of 6 per cent alone will take the cost to Rs 10.74 lakh in 2022 and Rs 19.24 lakh in 2032. Likewise for other degrees.
If you want to plan for retirement, decide at what age you want to retire. Keep tabs on you present monthly expenditure. Ask yourself if you want to maintain the same lifestyle or could do with less in retirement. In the latter case, clearly, you could do with a lower income. Adjust the money required for funding your retirement with an annual inflation of 6-7.5 per cent till you retire. This will give you an idea of the monthly income you will need then.
4) Budgeting for the future: Those who budget usually are able to attain goals at the right time. Budgeting tells you your surplus after meeting all monthly needs now. Map this surplus with your financial goals. Does it seem possible within a given timeframe; or is it like wishing for a private jet? If the latter get back to the drawing board and rework your goals.
Jaideep Lunial, a certified financial planner suggests: “Put all your expenses into different categories such as basic expense, discretionary expense, capital expense and investment. Basic expenses are your grocery bills, medicines, rent, maid’s salary, school fees, electricity and phone bills. Discretionary expenses are vacationing, shopping, watching movies or eating out. Capital expenses are debt-driven like EMIs on a home loan, car loan or personal loan.”
Try to be faithful to your budget. If basic expenses seem to top the budget, be skimpy on discretionary expenses.
5) Invest in the future: How much you invest, where and for how long depend on your age, risks and the timeframe for attaining goals. There are many instruments to invest in, such as mutual funds, shares, bonds, public provident fund, national savings certificates, post office monthly income scheme, insurance policies, bank and corporate fixed deposits, foreign currency, gold and jewellery, real estate and tax-free infrastructure bonds. Each instrument has its own characteristic of liquidity, safety, capital appreciation, tax benefits and returns. Money market instruments give you liquidity and protect your principal, but returns are usually the lowest. Bonds give income with a moderate risk to the principal. Stocks provide quick growth, but also carry high risk. Can you afford to take the risk? Ask yourself.
Equity gives inflation-adjusted returns if held for a long-term. But if you are ignorant of the stock market, but willing to take high or moderate risk, systematic investment plans (SIPs) of mutual fund schemes is the way.
PPF and employee provident fund are the safest and give tax-free income of 8.6-8.8 per cent. Anyone can open a PPF account and put anything between Rs 500 and Rs 1 lakh a year. Try not to withdraw money early. PPF works best because of its 15-year lock-in and pays a tax-free interest of 8.8 per cent (the rate now, but it can change). EPF offers 8.6 per cent and comes with no risk.
The new pension scheme is another avenue. It calls for a minimum investment of Rs 6,000. You can invest a maximum 50 per cent of your portfolio in equities. You can join the scheme at a branch of any bank authorised by the Pension Fund Regulatory & Development Authority. The list authorised banks is available on the authority’s website. NPS has fixed the retirement age (60 years). Once you reach that age NPS allows you to withdraw 60 per cent of the accumulated money; you get the remaining 40 per cent in the form of annuities.
Tax-free bonds are infrastructure bonds with returns this year ranging from 7.64 to above 8 per cent. They are low risk, long term and best suited to people in the highest tax bracket. Fixed deposits with banks, the most common and easiest form of saving, offer 8.5-9 per cent for maturities of three to five years. But the interest is taxable; thus the post tax return on an FD for those in 30.9 per cent tax bracket is 5.87 per cent, way below the 7.64-8.01 per cent from tax-free bonds.
Accounting for the tax-savings, the actual yield on a tax-free bond for the highest tax bracket works out to 11.17 per cent and 11.4 per cent for 10 years and 15 years, respectively. For those in the 20 per cent tax bracket, the pre-tax yield is 9.72-9.92 per cent and for those in the lowest tax bracket it is 8.61-8.78 per cent. So the returns from a fixed deposit are better for those in the lower tax bracket.
Harsh Roongta, CEO of Apnapaisa.com, said: “If a person has a goal, say 15-20 years away he should invest 90 per cent of his money in equities through SIP and the rest money in PPF. This is because equities perform the best over a long term.”
If you are not willing to take even that risk, you best bet is investing in a balanced fund and a small portion in PPF. Similarly, your goal is to get your child married some 15-20 years from now you can consider investing 90 per cent of your investment money in equities through SIP and the remaining in gold ETFs or a regular gold fund, says Roongta.
In retirement planning, and when retirement is just five years away it is a good idea to transfer all your investments from equities to debt funds, according to Lunial.
6) Buy adequate insurance: It is very important to have a term insurance policy, health insurance, accidental disability insurance and critical illness insurance. God forbid, if you get inflicted by a dreaded disease not only your health, but also your ability to work will be impaired. If your income stops flowing, no amount of budgeting or fixing financial goals will help.
Avoid traditional insurance plans and unit-linked insurance plans (Ulips) as they give lower returns and come with high costs compared with mutual funds.
7) Widen your basket: Asset allocation is about investing money systematically in a basket of assets to ensure that in case of loss in one asset it is made good with the returns from other assets. Asset allocation minimises risks. A very frequent mistake committed by several investors is over-investing in a particular asset class. In recent times when gold prices were going above Rs 30,000 for 10 gm, many investors believe that this was the best asset class and bought gold in the hope that prices could only go further up. Research by Apnapaisa.com shows that gold gave double-digit returns only in the last five years, over the past 10 years the returns were in single digits.
Similarly, a very conservative investor who chooses to invest only in debt instruments will not have enough money invested that will give his the targeted returns he expects. For example, if a person needs Rs 10 lakh for his child’s education 10 years from now, but invests only Rs 5 lakh in a 10-year government bond giving 6.53 per cent, he will end up with only Rs 8.3 lakh.
One also must diversify within each asset class. For example, in stocks money should be put in large, mid, and small caps.
8) Shuffling the portfolio: There are investors who do not review their investments in stocks and miss the opportunity to profit from selling off at the right moment. Some keep holding on to them in the hope a recovery. They burn their fingers when the market drops further. Holdings should be reviewed on a dynamic basis, say every month, quarter or any other chosen frequency. If the holdings do not enable satisfactory progress towards a particular goal, the process of attaining it should be changed. Big changes in life like switching jobs, career or even marriage should take into account the likely changes in the estimated cost of achieving a goal.
9) Make a will: With the nuclear family becoming the norm, involving one’s spouse and making a will is a key rule of financial planning. This helps the spouse to carry on with life more easily and even retain the original goals for children in event of your death. Ideally, you should make your spouse a nominee or the second holder (marked as either or survivor) in all investments. If you don’t have a spouse you should keep a relative/trusted friend informed of your investments.
10) Managing debt: Your total monthly outgo on contracted debt (for example, EMIs on a home loan, car loan, personal loan, credit card bills) should not exceed 30-40 per cent of your take-home pay. Many use credit cards recklessly and foolishly and have problems in paying dues on time. Credit cards are the most expensive loans with an interest rate of 36-48 per cent. You have to bear additional interest charges for not settling your dues in full every month. By paying anywhere between 5 per cent to 9.99 per cent of the total dues, every new purchase you make will be without the benefit of the free credit period (ranging between 18 and 40 days) and get added to your outstanding balance from the date of purchase. This means the interest clock starts ticking from the date of purchase itself.
Worse, if you default on your credit card payment even once you spoil your prospects of getting a loan in future. Repay all credit card dues even if that means liquidating your fixed deposits, selling your gold or any other investments. If it comes to that take a personal loan (interest rate 14-28 per cent) and pay your credit card dues.