BackMapping the future
Mapping the future
PremiumPiyush Pachauri
Peeyush Pachauri, a Bhubaneswar-based software engineer in his late twenties, is a changed man, having drastically cut down on his spending habits in the last three months. He does not eat out as frequently as he did. Parties with friends used to be lavish affairs at expensive hotels. Now he parties with just a few friends at home. Instead of flying to Jhansi to meet his parents, he now takes a train. For the first time in his life, he is keeping track of how much he spends on groceries.
The change is not just a fall-out of bad times but a conscious decision to curtail spending. “Earlier I used to spend money like anything, but I realized that the way I was going was not prudent and I needed to be smarter with my finances," says Pachauri.
He came back India three months ago, after spending around two years in the US and six months in the Asia-Pacific region on off-site assignments. He did not make any planned investments all that while, except for accumulating insurance, which his father had got for him. However, he has substantial savings, which he held on to even as the markets crashed. He knows that if invested properly, these savings can help him reach his goals.
Right now, his priority is to buy a house, a decision he has been postponing for a year as he wants to benefit from the slump. “I intend to stay in the house, but even if I move elsewhere, a house is always a great investment, especially since prices have fallen," he says. Marriage is also on the cards, as is buying a car.
Pachauri is determined to take complete charge of his finances from now on. We chalk out a plan for him.
What should his financial strategy be?
Pachauri, 27, is currently single and plans to get married later in the year. He also wants to buy a house and a car in the next few years.
Pachauri earns Rs40,000 a month and manages to save more than 70% of his earnings. His assets are mainly a healthy bank balance of Rs15 lakh, a plot acquired last year, now worth Rs9 lakh, and some financial instruments such as National Savings Certificate (NSC) and tax-saving mutual funds. He does not have any liabilities at this point. Further, Pachauri has investments in various insurance policies taken over the last few years. This year, he plans to get married and buy a house as well, which means that his current lifestyle and spending pattern will change.
Pachauri has time on his side— retirement is more than 25 years away. However, most of his savings will be used up to pay the premiums of the insurance policies he has already taken. The current surplus he has by way of bank balance will be required for his near-future goals of a house, car, holiday and education. Other accumulations will be used up for his long-term goals, such as his children’s education and marriage. Hence, there is little on which to build a retirement corpus.
Further, if an attempt is made to achieve all the goals as planned, he will not be able to honour his insurance commitments beyond a few years. Then he would lose out on the main advantage of the policies, which are equity-linked and will reap benefits for him only if he invests for the long term.
• HOUSE
His present monthly expenses are nearly Rs9,000. After marriage, we are assuming this will increase to Rs16,000. With his monthly income at Rs40,000, he should take a loan where his EMI is Rs20,000 at the most—which means a loan of about Rs20 lakh, so his cash-down amount needs to be Rs25 lakh. Assuming he sells the plot and uses up all the available bank balance, he would still be short. So this goal needs to be scaled down or postponed.
• RETIREMENT
If we assume a life expectancy of 85 years, retirement at 53 means that he would have 32 years of life left without any income other than that from his accumulated assets. Factoring in inflation and medical bills, a substantial corpus would be needed. Assuming inflation and returns at 5% and 7% a year respectively, and a monthly expense of Rs40,000, a corpus of Rs6.56 crore would be required. He falls way short of this.
• HOUSE
Pachauri should postpone this goal to 2012. If property prices are low today at the place he wants to reside in and are likely to rise in the future, he should consider a house in the range of Rs25-30 lakh. He can take a loan of Rs20 lakh and avail a lower rate of interest at 9.5% a year so that his EMI is about Rs19,000 till 2029. The remaining amount can be funded through his existing bank balance. His other short-term goals of a holiday, higher education and car can be achieved by using the remainder of the bank balance and the savings left every month after paying the premiums.
He should also keep a close watch on the plot he owns, sell it when the price peaks and invest the sum received in better avenues.
• RETIREMENT
His retirement corpus appears a difficult goal. Therefore, he should consider postponing his retirement by three-five years and reducing estimated expenses post-retirement to Rs30,000 per month. If he retires in 2038 at 56, he will just about be able to achieve the retirement corpus we mentioned earlier.
• INSURANCE
At the moment, with no liabilities or dependants, Pachauri does not need life insurance. However, with marriage and a house on the horizon, he will need insurance as a cover, not just an investment. He will need to review the situation once he gets such policies and see if they cover his loan as well. If required, he can take a term plan to cover the loan.
The annual premium outflow is Rs2.32 lakh. His annual savings, once he is married, would be about Rs2.5 lakh. So almost all his savings will go in paying premiums and very little will be left for paying EMIs or for building a retirement corpus.
In his case, it seems his unit-linked insurance policies (Ulips) have been taken to continue them after paying premiums only for three years. Many investors have been wrongly sold policies in this manner. In a Ulip, it is in the initial years that the charges deducted from the premium are the highest, leaving low amounts for investment in equities. The amount invested in equities rises as the policy runs and so does the prospect of gains from the markets. If one stops paying premiums, then the cost of keeping the policy alive with the insurance cover will be deducted from the fund itself.
• ASSET ALLOCATION
Once he takes a home loan of Rs20 lakh, he can use Rs5 lakh from his savings for the down payment for the house, leave about Rs1 lakh and invest the rest in debt and equity mutual funds in a 1:2 ratio. These investments should be made keeping in mind the insurance commitments. Proceeds from plot sale, NSC investments and insurance maturities can then be invested.
Lovaii Navlakhi is a Bangalore-based financial planner.
CONNECT
How to take advantage of the New Pension System (NPS):
Employees with no pension cover: Exhaust your PPF. Invest 30-40% of your savings for retirement in NPS. Increase the allocation subsequently, when the tax regime is simplified further and NPS costs go down. Choose “auto choice" in case you don’t want to manage your funds actively. Also look at index funds and insurance pensions plans.
Employees with pension cover: Keep contributing to your EPF account even if you job-hop and exhaust your PPF. Invest 10-20% of your savings for retirement in NPS. Invest in index funds. Remain invested in any insurance pension plans you may have.
— Deepti Bhaskaran
Some must know facts
A mutual fund account statement contains information on your investments. As soon as you invest in a scheme, the fund house sends you a statement of your holding pattern and investments. Every time you transact, the details are updated. Statements are scheme- and account-number-specific. So if you invest in two schemes, you get two separate statements. Even if your account is inactive for a year, MFs have to send you statements once a year. A good policy would be to keep the first statement of all schemes and the ones from preceding years. Others can be disposed of periodically.
— Kayezad E Adajania
Charges in Ulips: Beware
Be aware of charges to be paid in Ulips. They can take slices out of your benefits. Broadly, charges are levied under four heads:
Premium allocation charge: Upfront cost deducted as a percentage of premium for initial costs, including agent’s commission.
Fund management charge: Deducted from fund value, which comprises the premium portions invested in your chosen funds and the returns these generate.
Mortality charge: Deducted from fund value, it is the cost of providing insurance coverage.
Policy administration charge: Levied on fund value for administration of the insurance policy; it can be a flat charge or vary at a predetermined rate. You may have to pay other costs, based on when you plan to withdraw funds or how you channelize premiums.
— Deepti Bhaskaran
How much can you afford to pay for a new home?
The interest in affordable housing is apparent, according to a recent study by Edelweiss Securities, a financial services company. While the figures below are for Mumbai respondents, the preference for affordable housing is a trend seen across major markets.
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