Sunil took a loan and bought an under-construction house. But his builder abandoned the project. Now, Sunil wants to take another loan for a new house.
12-Jan-2022 •Research Desk
Sunil (48) works as a manager with a private company. His take-home salary is Rs 1.42 lakh. He has a daughter and a son, aged 12 and 2.5 years, respectively. Sunil's wife, Sujata (39), is a home-maker. The family lives in a rented house. It has a monthly expenditure of about Rs 81,000. This includes Sunil's term-insurance premium and an EMI of Rs 30,000, which goes towards the loan repayment for an under-construction flat. Sunil has accumulated more than Rs 75 lakh, which is spread across various financial assets. Besides these, he also has a plot of residential land worth Rs 40 lakh. Sunil wants us to draw a financial road map for him.
Sunil has around Rs 3.46 lakh in a combination of a fixed deposit and savings account as the emergency corpus. The major part of his emergency fund is in a savings bank account. An emergency corpus should be sufficient to take care of at least six months of your expenses, including EMIs. For Sunil, this amount works out to Rs 4.86 lakh. He should maintain it in a combination of sweep-in fixed deposits and liquid funds. This will help him earn higher returns, without compromising on liquidity.
Action: Maintain an emergency corpus of Rs 4.86 lakh in a combination of a sweep-in fixed deposit and a liquid funds.
Sunil doesn't have health insurance. He should buy a floater plan of at least Rs 5 lakh, covering all his family members. It should cost him around Rs 25,000 per annum. Though Sunil has opted for a critical-illness rider with his term insurance, it does not cover the treatment cost of diseases other than the ones termed 'critical' by the insurer.
Action: Buy a health cover of at least Rs 5 lakh, covering all your family members.
Sunil has a pure term plan providing a life cover of Rs 1.2 crore. In addition, he has also invested in a couple of endowment plans and ULIPs, the value of which is about Rs 7 lakh. Insurance and investments should be kept separate. Hybrid products, such as ULIPs and endowment insurance, provide neither good returns nor sufficient life cover. Sunil should consider surrendering these plans. A part of the proceeds can be used to meet the shortfall in his emergency corpus. Further, he may consider increasing the life cover by another Rs 50 lakh through a pure term plan.
Action: Consider surrendering your investment in ULIPs and endowment plans.
Children's education and weddings
Sunil would like to spend Rs 40 lakh, in today's terms, on the higher education of his children. This amount is likely to be required in about six and 14 years from now. Earmarking Rs 14.4 lakh from his equity corpus of Rs 25.2 lakh would solve the need for the funds required for the higher education of Sunil's daughter (assuming a return of 12 per cent and an inflation rate of 6 per cent). For his son's higher education, he should opt for a Systematic Investment Plan (SIP) of Rs 9,500 in a flexi-cap fund and raise the contribution by 10 per cent every year.
Sunil wants to spend a total of Rs 30 lakh, in today's terms, on the weddings of his children. For this, an SIP of Rs 7,000 in a flexi-cap fund is required (assuming a rate of return of 12 per cent). This contribution should also be increased by 10 per cent every year.
It is important to note that while the higher education of Sunil's son will likely begin only in about 14 years, Sunil would be able to actively contribute to this goal only for the next 10 years, that is, his working life. This fact stands true for all other goals, too.
Action: Earmark Rs 14.4 lakh for your daughter's higher education and start an SIP of Rs 16,500 in pure equity funds.
Sunil will likely retire at 58 and has only 10 years of his active work life remaining. His current accumulation in the NPS, PPF and EPF, along with his provident fund, would fetch him around Rs 90.28 lakh over the next 10 years. An SIP of Rs 20,000 in a good flexi-cap fund would fetch him another Rs 61.5 lakh by the time he retires, provided he increases the contribution every year by 10 per cent. This will accumulate to Rs 1.50 crore. Assuming a conservative annual withdrawal of 6 per cent, this amount should be more or less sufficient to maintain the same standard of living during his sunset years.
Action: Start an SIP of Rs 20,000 in a good equity fund.
There are two more goals on Sunil's wish list. One is to buy or construct a house. Sunil purchased an under-construction flat around four years ago with a home loan, but the builder ran out of money and stopped the project midway. Though he has taken legal action against the builder, Sunil has little hope of getting the delivery of the house. Unfortunately, he cannot escape the home-loan liability and will have to service the remaining EMIs.
Sunil now wants to buy another house or construct one of his own. He estimates the cost to be Rs 80 lakh. Sunil holds a piece of residential land worth Rs 40 lakh. Sunil can either sell this land to partially fund the new house or build a house on the same piece of land. However, due to limited resources and the existing EMI of Rs 30,000, Sunil should try to keep the total cost of the new house to Rs 60-65 lakh. An additional loan of Rs 20 lakh would mean an EMI of Rs 25,000 throughout his remaining working life. Paying a higher EMI may mean a subsequent compromise in the standard of living during his post-retirement years. Once he takes up the additional home loan, he should accordingly factor this in his emergency corpus and life insurance.
The second goal in Sunil's wish list is to buy a new car. As mentioned earlier, Sunil has some investments in ULIPs, which he should surrender. After meeting the shortfall in the emergency corpus, the balance of the proceeds can be used for buying a new car. He may club this with his annual bonus of Rs 1.5 lakh, which is expected in a few months.
Action: Reconsider the value of the new house you plan to buy.
Out of Sunil's current equity corpus of Rs 25.2 lakh, a small portion is invested in stocks. You should invest directly in stocks only if you have the required time and skills to do the required research. Otherwise, you should opt for equity funds. Sunil's mutual fund investments are spread over 17 schemes in different categories. Investing in too many schemes only results in duplication of holdings and hassles of monitoring. It may also impact returns over the long term.
Sunil should consolidate his portfolio to just four to five good mutual fund schemes. He should systematically withdraw the required amount over a period of 12 to 18 months before his long-term goals fall due and transfer it to an ultra-short-duration debt fund. This will help him reduce the risk of exiting the market at a low. For tax saving, he should invest in one or two good tax-saving funds, which may be linked to any of his long-term goals. Being in the highest tax bracket, he should continue to invest in the NPS only for the purpose of getting an additional tax benefit.
Action: Consolidate your mutual fund portfolio to four to five schemes, including a tax-saving fund.
Despite suffering a loss on the first house he tried to buy, by following the above plan, Sunil may achieve all his financial goals and meet his EMI commitments, though he may have to compromise on the value of the new house he buys.