The retirement question
39-year-old Rohan must either increase his SIP investments or sell his land in order to have enough for retirement
By Research Desk | May 9, 2019
Rohan (39) is employed with a private sector company. He is married and has two daughters. His wife is a homemaker. Rohan's parents depend on him financially. He earns Rs 1.3 lakh per month. He has an outstanding home loan of Rs 28 lakh, for which he pays an EMI of Rs 40,000. This is the same house where the family lives. He wants to create a sufficient corpus for his retirement and for his daughters' education and weddings.
An emergency fund is absolutely necessary to provide for any unforeseen expenses. As a general principle, the emergency fund should be equal to six months' expenses.
Rohan's monthly expenses (including the home-loan EMI) adds up to Rs 80,000. He already has an emergency corpus of Rs 4 lakh, which is kept in a savings account and in a fixed deposit. Since Rohan should ideally have an emergency corpus of Rs 4.8lakh, he should work on growing this amount by around a lakh. Further, he should keep this in a combination of sweep-in fixed deposits and short-term debt funds. This will ensure both liquidity and better returns as compared to a savings account.
Rohan may pick two short-term debt funds from the funds rated four to five star by Value Research. Generally speaking, one should look for a low expense ratio and high assets while picking debt funds.
Action: Increase your emergency corpus by Rs 1 lakh. Keep it in a mix of sweep-in fixed deposits and short-term funds.
Rohan has a term plan of Rs 1 crore. In addition, he has a life cover of Rs 50 lakh from his employer. Since Rohan is the sole breadwinner, Rs1.5 crore might not be sufficient to take care of the inflation-adjusted expenses of his family, which also include home loan repayment. He should consider increasing his life cover by Rs 50 lakh. This will cost him around Rs 10,000 per annum. As a general rule, don't just look at the premium while buying a term cover, but also check the claims settlement ratio.
Action: Increase your life cover by Rs 50 lakh.
Rohan is completely dependent on the Rs10-lakh health insurance provided by his employer, which also covers his wife and children. For his parents, he has a separate Rs 4-lakh cover provided by his employer.
Employer-provided insurance covers you only as long as you are working for that employer. It ceases to exist once you leave your job. Further, there is no guarantee that your new employer will provide similar benefits. Rohan should therefore buy a separate family floater plan of around Rs 5 lakh which should also cover his wife and children. This would cost him around Rs 24,000 per annum. Similarly, he should buy a senior citizen health insurance policy for his parents.
With changing lifestyles, it has become imperative to look beyond basic health insurance. Rohan might also explore personal accident and critical illness insurance.
Action: Buy health insurance for both yourself and your parents.
Based on his current expenditure, Rohan would need around Rs 6.18 crore to maintain the same lifestyle during his post retirement years. We have assumed an inflation rate of 8 per cent and a return of 9 per cent during his post retirement years. Life expectancy has been assumed to be 85. His current investments in equity mutual funds, the EPF and the PPF would fetch him around Rs 1.91 crore. Ongoing SIPs of Rs 17,000 in equity mutual funds would fetch him another Rs 1.94 crore. While this may seem impressive, there will be a shortfall of Rs 2.34 crore.
There are two alternatives to meet this deficit. One, he can sell his land which has a market price of Rs 25 lakh, and invest the proceeds in equity mutual funds. Assuming a 12 per cent return, it would fetch him Rs 2.7 crore by the time he retires. Alternatively, he can increase his current SIP contributions to Rs 21,000 and further increase this amount by 10 per cent every year when he receives his annual salary increment.
As an investment class, real estate carries a high maintenance cost and may yield lower returns than equity. However, if Rohan is emotionally attached to the land or has strong expectations of higher returns than equity, he may retain the land.
Action: Increase your SIP contributions to Rs 21,000.
Children's education and weddings
Rohan's two daughters are one year old and nine years old. He plans to spend Rs 36 lakh in today's rupees on the higher education and weddings of his daughters. At an inflation of 8 per cent, this amount would swell to Rs 1.37 crore when he needs it. His daughters' higher education and wedding goals are 10 to 25 years from now. For these, he can start an SIP of Rs 14,000 in multi-cap funds (with four to five star rating). Further, this contribution should be increased by 10 per cent every year. Rohan has a sufficient surplus to start investing towards these goals.
Action: Start an SIP of Rs 14,000 in multi-cap equity funds.
Broadly, Rohan's mutual fund portfolio is 40 per cent large-cap funds, 40 per cent mid-cap funds and 15 per cent small-cap funds. A small amount is in balanced funds.
It might not be a good idea for a retail investor, who has limited time and knowledge, to allocate his portfolio between large, mid and small caps on his own. Instead, two to three good multi-cap schemes should be chosen for long-term goals.
Rohan should limit his investment in the PPF to the minimum (so that the PPF account remains active) and invest in a (four to five-star) tax-saving equity fund. Tax-saving mutual funds, also called equity-linked savings schemes (ELSS), yield higher returns than the PPF.
Further, he should continue with his investments in direct equity only if he can thoroughly research companies on his own and pick good ones. If not, he should move to equity mutual funds.
Action: Switch to multi-cap funds and a tax-saver mutual fund.
Keep in mind
- Maintain an emergency corpus equal to six months' expenses.
- Buy adequate term insurance. Do not mix insurance and investment.
- A sufficient health cover is a must. Do not rely only on employer-provided health insurance.
- The earlier you start contributing towards your retirement, the more conveniently you can accumulate the desired amount. Do not forget to increase your contributions every year.
- Three to four good equity funds are all you need to build your portfolio and achieve optimum diversification. The funds should be from different fund houses.
- Among the various types of equity funds, multi-cap funds are the best as they can invest across companies of all sizes. Avoid sectoral and thematic funds as they provide limited diversification.
- For tax saving, tax-saving mutual funds score over traditional instruments like the PPF.