Focus on variables to plan finances better

If you are a do-it-yourself (DIY) investor, planning for financial goals could be cumbersome. You will need to assume a few things, such as inflation, return on investments and annual growth in your income.

Based on your assumptions, a lot could change. Suppose you are targeting a corpus of ₹1 crore after 15 years, and assume 10% rate of return from a systematic investment plan (SIP) in equity mutual funds, you will need to invest ₹24,000 a month. But if you assume 15% rate of return, you can accumulate the required funds by investing ₹15,000 a month.

Being conservative or aggressive even with one data point can make a drastic change to your financial plan. How do you then ensure that different numbers you assume are optimum?

“A financial plan is never accurate. You must keep making changes to it regularly—at least once every three years—as economic and investment trends change,” said Suresh Sadagopan, founder, Ladder7 Financial Advisories and a Sebi-registered investment adviser (Sebi-RIA).

We spoke to investment advisers and mutual fund distributors, who were making financial plans before the Securities and Exchange Board of India (Sebi) introduced new regulations segregating advisers form distributors, on assumptions they would use to help client reach their goals.

Inflation: Investment advisers assume different inflation rates depending on the goal. If an investor wants to save for a child’s education, many advisers assume 8-10% inflation, as the cost of education has been rising by that rate every year. The same holds if an investor wants to have a fund for medical expenses in the future.

For retirement, they use 6-7% as the annual inflation rate. “For near-term goals, in some cases, there could be no need to even account for inflation. For example, someone is saving to travel within a year or buy a property in the next two years,” said Deepesh Raghaw, founder, PersonalFinancePlan, a Sebi-RIA.

Some suggest that investors should look at their lifestyle to determine the inflation rate. “For this, you should calculate spends on travel, leisure activities, high-end gadgets, designer clothes and merchandise, etc., and see how the expense has grown in the last two-three years,” said Arvind Rao, a chartered accountant and founder of Arvind Rao & Associates.

Rate of return: Investors, typically, use a combination of equity and debt to reach their financial goals. Most advisers assume a 10-12% return from equity. “If you are conservative, you can keep rate of returns from equities at 9% as there’s long-term capital gains tax. Also, as you reach closer to the goal, your equity allocation must go down,” said Melvin Joseph, managing partner, Finvin Financial Planners, a Sebi-RIA.

Advisers point out that the average long-term equity returns have been falling. “In the 2001-2010 decade, most planners considered average return from equity at 15-18% based on the historical data,” said Malhar Majumder, a Kolkata-based mutual fund distributor and partner, Positive Vibes.

Debt investment includes different mutual fund categories, fixed deposit and provident fund. In the current interest rate environment, most planners assume returns of 6% form overall debt portfolio.

Life expectancy: This is crucial when planning for retirement. The longer you assume you will live, the higher corpus you will need for retirement.

“According to census data, the life expectancy in India is around 69. But it’s an average of rural and urban data. Most people in metros have access to medical infrastructure. That’s why we assume a life expectancy of at least 85 years,” said Joseph.

Advisers prefer to use 85-90 years as life expectancy so that the retirees are able to live off the corpus they have accumulated.

Rate of income growth: Even for advisers, this can be tricky. It’s difficult to assume at what rate the income of the client will grow every year, as it varies from one industry to another. It also depends on the job function and seniority.

Each expert assumes a number based on their experiences. Most advisers say that it’s more important to focus on making a plan and executing it.

It doesn’t matter if your assumptions are off the mark. With experience, you will be able to optimize them.