Prashant (33) is married and has two-year-old twin girls. He stays with his parents in a rented house, for which he pays Rs 12,000 monthly. He works as a principal analyst and has a monthly take-home salary of Rs 50,000. His wife is a home-maker.
The family's total monthly expenditure, including rent, amounts to Rs 40,000. Prashant is not keen on buying his own house, but would like to create a sufficient corpus for his retirement, daughters' higher education and their weddings. The family has been able to accumulate a corpus of Rs 23 lakh in his savings bank account and seeks our guidance in drawing up a financial road map.
An emergency corpus acts as a cushion in difficult times and should be equivalent to at least six months of expenses. Prashant should maintain an emergency corpus of Rs 2.4 lakh in a combination of sweep-in fixed deposits and liquid funds.
A sweep-in fixed deposit and liquid fund will help him earn higher returns than a savings bank account, without compromising on liquidity. Sweep-in deposits are automatically liquidated when the balance in your savings account falls below a certain threshold. For building his emergency fund, he may use a part of the corpus accumulated in his bank account.
Action: Create an emergency corpus of Rs 2.4 lakh.
The family is covered under a family-floater plan of Rs 5 lakh, provided by Prashant's employer. Prashant must buy a personal health cover in addition to the one provided by his employer, since employer-provided health cover extends to employees for only as long as they are with the organisation. It does not cover you while you transition between jobs. Also, a new employer cannot be counted on to provide you with the same benefits. In today's world where people frequently change jobs, this is more important to remember than ever.
Ideally, Prashant should buy two separate health plans, one for his parents and the other one covering his wife, daughters and himself. A floater health cover of Rs 5 lakh covering his wife and children would cost him around Rs 16,000 per annum. The health plan for his parents could be costlier because of their age.
Action: Buy a family-floater health cover independent of your employer-provided health insurance.
Prashant has bought a pure term plan of Rs 75 lakh. Term insurance is the cheapest and the best form of life insurance. It pays the nominee an amount equivalent to the life cover on the insured's demise. A life cover of Rs 75 lakh may not be sufficient to fulfil the living expenditures of Prashant's family in his absence. He should buy an additional cover of Rs 50 lakh. It would cost him around Rs 6,000 per annum.
Action: Buy an additional life cover of Rs 50 lakh.
Daughters' weddings and education
Prashant wants to spend Rs 1 crore and Rs 80 lakh on his daughters' higher education and weddings in today's value. Considering an inflation rate of 8 per cent, this amount would swell to Rs 3.17 crore and Rs 4.70 crore by the time these goals fall due. Prashant estimates these goals to be 15 and 23 years away.
Over such long periods, equity mutual funds work best. Equity has the potential to give inflation-beating returns. The accumulated corpus would fetch him Rs 1.19 crore in 15 years if he invests in equity, assuming a 12 per cent return. Prashant should not be disheartened that he will not be able to reach the goal amounts. Generally, there are many conditionals in financial planning and what you will eventually need may be altogether very different from your estimates. Things will get clearer with time. He should focus on saving and investing as much as possible. And with every rise in his income, he should try to invest even more.
Action: Don't get disheartened by the goal amount. Just focus on saving and investing.
Based on his current lifestyle, Prashant will require a retirement corpus of around Rs 8.60 crore. This requires him to do monthly SIPs of Rs 17,500, growing at 10 per cent per annum. Currently, he doesn't have the required surplus. Hopefully, his income will increase in the coming years and he will be able to invest more. Until then he should focus on saving and investing as much as he can.
Action: Allocate money to investments as and when your income increases.
Prashant would be left with about Rs 20.60 lakh in his savings bank account after creating an emergency corpus. This amount should be invested in equity funds as his goals are at least 15 years away. Pure equity mutual funds are an ideal instrument for investments with such a long horizon.
However, since Prashant has never invested in any market-linked investment product before, he should start with aggressive hybrid funds. Aggressive hybrid funds invest 65-80 per cent of the amount in equity and the rest in debt. The debt exposure cushions the downside risk, making the investment less volatile and therefore suitable for new investors. On the other hand, the equity component helps to earn higher returns.
Prashant should not invest this amount as a lump sum, but over a period of 18 months through an SIP. By investing a lump sum in equity, you always run the risk of investing at a market peak, and in doing so suffering a loss that it may take quite long to recover from. Spreading the investment over a period of time also averages the purchase cost and reduces risk. He may choose to park these funds in a liquid fund and set up a systematic transfer plan (STP) in two-three aggressive hybrid funds to transfer the amount over the next 18 months into a hybrid fund.
He can invest the monthly surplus left after buying the additional insurance in a tax-saving mutual fund. Tax-saving mutual funds are pure equity funds with an additional benefit of tax deduction under Section 80C. While they have a lock-in period of three years, they help save on taxes. In his financial plan, Prashant may link this fund to long term goals such as retirement, or his daughters' education/ weddings. This way the lock-in period will not be a problem.
Action: Invest the accumulated corpus in aggressive hybrid funds over a period of 18 months. Invest your monthly surplus in an ELSS fund.
Keep in mind
- Park your emergency corpus in sweep-in FDs and liquid funds. It should be equal to six months of expenses.
- Even if you have employer-provided health cover, buy additional health insurance.
- Term insurance is the best form of life insurance.
- If your goal amounts seem overwhelming, don't be discouraged. Keep saving and investing as much as you can anyway.
- Start with aggressive hybrid funds if you are new to equity.
- ELSS is the best tax-saving tool. Link it to a long-term goal to get the full benefit from it.