Financial planning is not a one-time exercise

Last week, we had drawn up a financial plan for the Mehta family through this column.

This exercise still continues to generate tremendous response from readers. Many have requested that a similar practical application of investment theory be reconstructed and this piece is in deference to these requests.

Therefore, this week, we shall analyse and review the finances and goals of the Shah family to see how financial planning can help them meet their objectives.

Paras Shah (name changed) is 42 years old and works as a senior manager in a pharmaceutical company. His wife is a home maker. They are the proud parents of a lovely 13-year-old daughter, who they have aptly named Suhana.

Shah’s mother lives with them. He earns Rs75,000 per month and after catering for the household and other expenses as also the EMI for their house, the family manages to save around Rs30,000 per month. Shah has Rs3 lakh in his Public Provident Fund (PPF) account, which is maturing in 2014 and the couple has, over the years, purchased shares that are currently approximately worth Rs2 lakh.

They also have around Rs1 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 Rs10,000. As far as insurance is concerned, Shah pays a premium of Rs55,000 p.a. for a cover of Rs5 lakh. Lastly, his provident fund (PF) balance is Rs5.10 lakh, with the monthly PF deduction (equally matched by the employer) being around Rs6,000 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 Rs14 lakh for Suhana’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.

Before starting, we establish that the Shahs save around Rs30,000 per month, out of which Rs10,000 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 Rs20,000 per month

1. Suhana’s Education
Suhana is currently 13 years old. Her higher education needs would arise around the age of 21 years ie eight years from now (around the year 2019).

In this regard, it is suggested that the Shahs start a recurring deposit (RD) of `6,000 per month. Part of the Rs20,000 monthly savings can be utilised for this purpose. This deposit should be opened in Shah’s mother’s name. Being a senior citizen, Shah (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.

Rs6,000 invested per month @10% p a over eight years would grow to Rs8.75 lakh.

Additionally, Shah has Rs3 lakh currently in his PPF account. It is suggested that he contributes the minimum Rs500 required to keep the account alive. The account matures in 2014. After that, it should be extended by five years such that it would mature in 2019. The maturity value of the PPF account would work out to Rs5.15 lakh.

This way, by 2019 they would have a combined amount of around Rs14 lakh (Rs8.75 lakh + Rs5.15 lakh) for meeting Suhana’s higher education needs.

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

It is suggested that Shah buys two units (equivalent to two grams) of gold per month. This can be achieved by investing in a gold ETF (exchange-traded fund).

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 Rs4,400 per month) can come out of the balance monthly savings of Rs14,000 per month (after accounting for the RD investment).

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

His current PF balance is Rs5.10 lakh with a monthly contribution of Rs6,000. At the time of retirement, sixteen years from now, the total PF balance that Shah would be entitled to will work out to around Rs68.50 lakh.

Additionally, the current investment in mutual funds is Rs1 lakh as lump sum and Rs10,000 as an SIP. It is suggested that the Shahs increase the SIP amount to Rs15,000 and shift from equity to balanced funds. At a rate of 12% p a, this amount would grow over the next 16 years to around `93 lakh.

This way, the combined retirement proceeds would work out to an astounding Rs1.61 crore!!

4. Pension
After retirement, typically one needs a monthly pension to take care of day-to-day 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 Shahs would receive a cheque of Rs1.28 lakh per month pre tax.
At 12% p a, the monthly proceeds would work out to Rs1.65 lakh per month pre tax.

Ideally, the money should be invested in a mix of risk-free deposits and mutual funds.

5. Insurance
It is found that Shah has purchased some expensive insurance policies. Also the insurance cover that these policies offer is woefully adequate for someone of Shah’s profile. It would be best if he surrenders these policies and instead buys himself adequate term as well as medical cover.

For medical insurance, a premium of Rs15,000 per annum would adequately cover the entire family.

For the life insurance, a premium of Rs45,000 would buy Shah a term cover of as much as Rs70 lakh. Note that a simple switch to a term plan buys almost 14 times more insurance cover for lesser amount of premium.

For the above medical and life insurance, Shah would need to set aside a sum of Rs5,000 per month, which is what is approximately left over out of the monthly savings after accounting for the recurring deposit (`6,000), gold ETF (Rs4,400) and the SIP (Rs15,000).

6. Contingency Fund
The Shahs currently maintain around Rs50,000 as cash in the bank. Additionally, they would receive around Rs60,000 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 Rs2 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 Rs9.18 lakh. This money can then be added to the retirement corpus to be suitably invested.

One last step
It is important to undertake periodically reviews. Planning for the future is not a one-time exercise; it’s rather 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