Boost cash in hand, have contingency fund ready

Rohit needs to prioritise and time his goals to meet them without putting too much stress on his present earnings

 Projected cash flow(Rs) FY 08-09 FY 09-10 __ FY 13-14
 Cash in hand/bank 50,000 40,866 — 92,470
 Inflows 3,40,000 3,74,000 — 4,97,794
 Application of fund     —   
 House exp.* 96,000 1,01,760 — 1,21,198
 Clothing and accessories* 8,000 8,480 — 10,100
 Yearly travelling exp.* 10,000 10,600 — 12,625
 Ins. premium endowment 30,000 30,000 — 30,000
 Ins. premium bike 2,000 1,800 — 1,312
 SIP 36,000 36,000 — 36,000
 PPF 13,200 13,200 — 13,200
 Additional required investments (pa) 1,48,584 1,33,500 — 48,000 
 Additional premium for ins. (pa) 9,350 9,350 — 16,814
 House EMI @ 9% 0 0 — 2,15,940
 Car EMI @ 12% 0 0 — 1,26,372
 Net surplus/deficit pa 40,866 73,445 — 14,101
 Net surplus/deficit pm 3,406 6,120 — 1,175

There are three sources of income: people at work, money at work or charity. If a person is not at work, he should have enough money to work for him or he has to depend on charity.

Rohit Agarwal (27) has understood the importance of financial planning at an early stage. He has done his MCA and is working as a software engineer in Pune for 2 years. He hails from Sehore, Madhya Pradesh. His net annual income is Rs 3.40 lakh per annum (pa).

His father MP Agarwal (56) is a businessman and mother Shyama Agarwal (50). His parents have many real estate properties in Sehore. They have done enough savings to spend their retirement years without any contribution from Rohit.

Financial goals:
Marry in 2009 and spend Rs 10 lakh.
Buy a house worth Rs 40 lakh by 2011. 
Buy a car worth Rs 5 lakh in 2012.
Start his own business in 2013 and needs Rs 20 lakh.
Provide education to his kid/s and would like to spend Rs 10 lakh each till 2029 and 2032.
Would like to create corpus for the marriage of his kid/s and intends to spend Rs 20 lakh each in the year 2036 and 2039.
Would like to create a retirement corpus of Rs 1 crore, assumed at the age
of 60, to spend retirement years in Sehore.
The entire amount outlined above is the present value. Inflation has not been factored in.

Quick observation:
He has many goals and the timeline given to achieve them is  not sufficient. This is an example displaying lack of clarity and ability to time the goals appropriately, crowding them over short duration, ignoring present earnings. He needs to prioritising and time his goals over a longer tenure without putting too much stress on his present earnings.

Current savings:
His current savings are as below:
Cash in hand/bank: Rs 50,000
PPF: Rs 15,000
PF: Rs 15,000
Mutual fund (equity): Rs 36,000

Expenses:
Rohit’s regular expenses are Rs 8,000 per month (pm). He spends Rs 8,000 pa and Rs 10,000 pa on clothing and travelling respectively.

Other information:
He has taken an endowment policy of Rs 6 lakh sum assured maturing in the year 2028 and paying Rs 30,000 premium every year.

He has been investing Rs 3,000 pm in equity fund for last one year and intends to continue this for long term. He has been contributing Rs 1,100 pm in PPF account since 2007 besides regular contribution in his company PF. He intends to continue his contribution in PPF till he turns 50.

Recommendation:
Rohit has cash in hand/bank of Rs 50,000, which is not sufficient for his 6 month expenses. It is advisable to keep contingency corpus of 5-6 months expenses. 
His total average expense of Rs 9,667 pm and investment of Rs 5,500 leaves him with Rs 13,166 pm for further investment.

Insurance planning:
He is in his early working years and has less liabilities. He is in the process of saving for his goals and asset acquisition. This would lead to leveraged earnings (liabilities) as he gets into the next phase of life (post marriage). He is advised to take 25 years’ term-insurance of Rs 36 lakh (12.5 times of current earnings and based on capital replacement method without taking income growth into consideration) to provide risk cover to his present income.

It is advisable to continue revising the risk cover in future. An accident cover is also recommended. He should take a floater mediclaim policy for himself.  The maturity proceeds of his existing endowment policy might coincide with the requirement of the fund for his kid’s education and partly finance that goal.

Assumptions:
Equity fund generates 15% return pa in long term.
Balance fund and MIP generate 12% pa and 10% return pa in long term.
The debt and debt oriented MF generates 8% pa return over mid to long term.
Inflation is assumed at 6% pa.
Rate of interest is 8% pa for less than 5 years and 10% pa for more than 5 years tenure.
Income is assumed to be growing at 10% pa.

Planning for self marriage: Rohit is planning to get married this year. It is assumed that the amount of Rs 10 lakh that he intends to spend on marriage would come from his parents because his current savings do not permit such spend, and also go for a honeymoon trip.

The corpus required could be accumulated by investing Rs 4,250 pm in appropriate money market mutual fund assuming Rs 50,000 spend on honeymoon. The surplus post this planning could be diverted to the other goals subsequently.

Planning for home: The desired amount to buy a house is Rs 40 lakh today, which would grow to Rs 47.64 lakh by the year 2012. A 10% growth in income would qualify him for a home loan of about Rs 20 lakh. Therefore, he has to either revise his expectation downward or take some monetary help from his parents to arrange for the difference of Rs 27.64 lakh.

Assuming he revises the amount for home loan downward to Rs 20 lakh and contributes 15% towards down payment, he can buy a house worth Rs 23.50 lakh. He could accumulate corpus for his down payment by investing Rs 8,125 pm in appropriate MIP/balance fund till 2011.

He should also take mortgage term insurance to cover his home loan amount.
Planning for car: Rohit is planning to buy a car in the year 2012 costing Rs 5 lakh today. The amount required would grow to Rs 6.31 lakh. It is assumed that he takes loan for 75% of car cost and contributes 25% down payment (DP) from own source.

The amount required for DP could be accumulated by investing Rs 3,000 pm this year and Rs 4,000 pm in the year 2010 and 2011 respectively in appropriate balance/MIP fund.

Planning for business: The planning for house and car is leaving Rohit with no significant surplus. He should either delay the plan to start his own business until some of the liabilities, such as car loan, are repaid and income increases.

Alternatively, he could postpone buying a house by a few years and start the business with the money accumulated for the home’s down payment.  He would need a business loan instead of a home loan. However, the surplus amount post expenses and investment from this year onwards could be appropriately invested to build corpus for the business.

Planning for kid/s education and marriage: Planning for children’s education and marriage could wait for some time until they are actually born, as his  current income does not leave reasonable resources for any meaningful saving for these goals. However, the maturity proceeds of endowment policy could coincide with one of these goals.

Planning for retirement corpus: If the current investment of Rs 3,000 pm in equity scheme is continued till retirement years (60), it could create a corpus of Rs 3.26 crore. This amount would not be sufficient to take care of the retirement years. The corpus so accumulated reduces to just Rs 47.68 lakh when discounted in today’s term. This is much less than Rs 1 crore that he needs in today’s term for his retirement years.

The amount accumulated in PPF would also help in retirement corpus. He is advised to continue contribution in PPF till his retirement. If he continues with his monthly contribution of Rs 1,100 pm for next 33 year (i.e. continues for first 15 years of PPF term and extend it for 4 blocks of 5 years each) the amount could grow to Rs 21.27 lakh on his retirement.

Despite the present SIP investment and PPF contribution, he needs to invest more to meet his goal for retirement corpus.

With the growth in income every year and after repayment of car loan, he is
advised to start savings for the other goals.

It’s expected that his retirement corpus could have some contribution from his parents’ estate. However, he should consult his financial planner and lawyer when he gets details on the estate and take advice on deploying them efficiently to create a robust corpus.

Review: It’s advised that he reviews the plan every 6 month.

The writer holds certified financial planner certification, which is awarded by FPSB India. FPSB India relies on its members’ prudence, competence and ethical standards to have submitted this write-up in good faith in their personal respective capacity. The article and the views are those of the writer and do not represent those of FPSB India. Readers are advised to consult their professional financial planners for advice.