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For over two years now, I have been sharing with readers various concepts and principles of tax and money management through this column. The basic idea is that while a major part of our life is devoted to earning a living, prudent financial planning will ensure that the money earned is appropriately conserved, earmarked and spread over the time span of one’s needs.

To some, financial planning may sound esoteric. However, it is nothing but arranging your finances in the light of your future goals. A goal-oriented approach almost certainly ensures that you achieve your objectives without having to compromise on your standard of living or in the worst case, some of the goals themselves. Therefore, the thing to do is to put everything down on paper, in terms of cold numbers. This way, you have graduated from having a hazy idea about your requirement to being fully seized with at least a broad ballpark figure. Also, quantifying helps make the picture clearer by removing any subjectivity.

Let’s take the example of a typical family to see how financial planning can help them meet their objectives.

Helping the Mehtas do better
Let us take the case of the Mehta family. Mr Mehta is 42 years old and works as a senior manager in a pharmaceutical company. His wife is a homemaker. They are the proud parents of a lovely 13-year-old daughter who they have aptly named Khushi. Mr Mehta’s mother lives with them. He earns Rs 75,000 per month and after catering for household and other expenses as also the EMI for their house, the family manages to save around Rs 30,000 per month. Mr Mehta has Rs 3 lakh in his Public Provident Fund (PPF) account, which is maturing in 2011 and the couple have over time purchased shares that are currently approximately worth Rs 2 lakh. They also have around Rs 1 lakh invested in mutual funds as a lump sum and out of their savings, they are about to start a systematic investment plan (SIP) of Rs 10,000. As for insurance cover, Mr Mehta pays a premium of Rs 55,000 p.a. for a cover of Rs 5 lakh. Lastly, his provident fund (PF) balance is Rs 5.10 lakh with the monthly PF deduction (equally matched by the employer) being around Rs 6,000 per month. Given this background, their key goals are to provide for the education and marriage of their daughter. They estimate that they would like to keep aside over Rs 14 lakh for Khushi’s higher education. They are also concerned about the requirement of gold for her wedding. Of course, last but not the least, on the agenda is providing for retirement.

Read the Mehta family’s profile once again if you must for we are about to wear the hat of a financial planner and help them provide for their stated goals.

Before starting, we establish that the Mehtas save around Rs 30,000 per month out of which Rs 10,000 is already being applied for the SIP. We have to see how best they can put to use their existing investments as also the balance savings of Rs 20,000 per month.

1. Khushi’s education
Khushi is currently 13 years old. Her higher education needs would arise around the age of 21 years, i.e. eight years from now (around 2016).

In this regard, it is suggested that the Mehtas start a recurring deposit of Rs 6,000 per month. Part of the Rs 20,000 (after deducting the SIP amount of Rs 10,000 p.m.) monthly savings can be utilised for this purpose. This deposit should be opened in Mr Mehta’s mother’s name. Being a senior citizen, Mrs Mehta (Sr) would earn a higher interest of 10% p.a., which would be anyway completely tax-free taking into consideration the fact that she has no other income.

This investment of Rs 6,000 per month @10% p.a. over eight years would grow to Rs 8.75 lakh.

Additionally, Mr Mehta currently has Rs 3 lakh in his PPF account. It is suggested that he contribute the minimum amount of Rs 500 required to keep the account alive. The account matures in 2011. After that, it should be extended by five years such that it would mature in 2016. The maturity value of the PPF account would thus work out to Rs 5.15 lakh.

This way, by 2016, they would have a combined amount of around Rs 14 lakh (Rs 8.75 lakh + Rs 5.15 lakh) for meeting Khushi’s higher education needs.

2. Gold for Khushi’s marriage
Here, it is assumed that Khushi would be married at the age of 26 years. This means, there are 13 years to go for her marriage.

It is suggested that Mr Mehta buy 2 units (equivalent to 2 grams) of gold per month by investing in a gold exchange traded fund (ETF). Space constraints preclude a detailed discussion on ETFs but suffice it to say that it is one of the most efficient methods of buying gold whereby not only is the investor assured of the quality of the metal but also does not have to worry about storage and the risk of theft.

Two units per month over 156 months (13 years) works out to 312 grams or approximately 31 tolas.

The funds required for this (approximately Rs 3,000 per month) can come out of the balance monthly savings of Rs 14,000 per month (after accounting for the RD investment).

3. Retirement
It is Mr Mehta’s desire to work till the age of 58. This means that he has 16 years left for retirement.

His current PF balance is Rs 5.10 lakh with a monthly contribution of Rs 6,000. At the time of retirement, 16 years from now, the total PF balance that Mr Mehta would be entitled to will work out to around Rs 68.50 lakh.

Additionally, the current investment in mutual funds is Rs 1 lakh as lump sum and Rs 10,000 as an SIP. It is suggested that the Mehtas increase the SIP amount to Rs 15,000 and shift from equity to balanced funds. At a conservative rate of 12% p.a., this amount would grow over the next 16 years to around Rs 93 lakh.

This way, the combined retirement proceeds would work out to an astounding Rs 1.61 crore.

4. Pension
After retirement, one typically needs a monthly pension to take care of his needs.
The above retirement fund may be invested either at the rate of risk-free 9% p.a. or in mutual funds @12% p.a.

At the risk-free rate of 9% p.a. (say in a bank fixed deposit), the Mehtas would receive a cheque of Rs 1.28 lakh per month pre-tax.

At 12% p.a., the monthly proceeds would work out to Rs 1.65 lakh per month pre-tax.
Ideally, the money should be invested in a mix of risk-free deposits and mutual funds.

5. Insurance
Mr Mehta has purchased some expensive insurance policies. Also, the insurance cover that these policies offer is woefully inadequate for someone of Mr Mehta’s profile. It is best that he surrender these policies and instead buy himself adequate term as well as medical cover.

For medical insurance, a premium of Rs 15,000 per annum would adequately cover the entire family.

For life insurance, a premium of Rs 51,000 would buy Mr Mehta a term cover of as much as Rs 70 lakh. Note that a simple switch to a term plan buys almost 14 times more insurance cover for a similar amount of premium.

For the above medical and life insurance, Mr Mehta would need to set aside a sum of Rs 5,500 per month, which is what is approximately left over out of the monthly savings after accounting for the recurring deposit (Rs 6,000), gold ETF (Rs 3,000) and the SIP (Rs 15,000).

6. Contingency fund
The Mehtas have around Rs 50,000 as cash in the bank. Additionally, they would receive around Rs 60,000 as surrender proceeds of the insurance policies. This would cover around two months of regular monthly expense.

Additionally, the current value of their investment in shares is around Rs 2 lakh. This should also be maintained (of course after streamlining the same) as an emergency fund but one that can keep growing till needed. Assuming that they don’t need the same till retirement, at a very conservative rate of 10%, this fund would grow to around Rs 9.18 lakh. This money can then be added to the retirement corpus to be suitably invested.

One last step
It is important to undertake periodic reviews. Planning for the future is not a one-time exercise, but a constant, continuous process of knowing where you stand and what you have to do if you have strayed from the demarcated trail. If necessary, take the help of a professional financial planner. However, it is never a good idea to depend entirely upon someone else. Start drawing your own map, and go to the professional only for the fine-tuning.

The writer is director, Wonderland Consultants, a tax and financial planning firm. He may be contacted at sandeep.shanbhag@gmail.com.