Do you have a financial plan?

Irrespective of how much time you spend on your personal finances, or how much you earn or spend or save .. you should have a financial plan as soon as you get independent and start earning. Or at-least when you start a family.

I have seen people worrying much about small things, while not giving adequate attention to the long term goals. I remember discussing with a colleague who keeps tracking each and every penny that he spends on what ever he does. I don't say it's completely waste, but does it really have ROI? beyond some analytics on top of that data and an exact total you spend every month - what else does an individual get?

I would rather suggest to worry about bigger things like

• how much money do you need to retire?
• when do you actually want to retire?
• what are your recurring goals?
• do you need a term insurance?
• does your family needs a health cover?
• what are the key skills you have and how you can leverage them?
• and so on .. 

Beleive me smaller financial things in life would automatically fall in place. If you don't do it already, start thinking now about the buckets of investment. Allocate a specific amount to your monthly expense bucket and use whatever it has to do whatever you want. Rest all goes towards building corpus for your goals.

There are always two ways you can approach your investments

• Income - expense = savings 
• Income - savings = expense 

And second is the approach you should be really following. If you really want to meet your goals and want to measure if you can actually be there in time with right amount of money, I would suggest you start with following simple exercise

• Make some assumptions about the following - your date of retirement, the amount you want to retire with, rate of inflation, %age return on your savings. etc. 
• Start with your Networth
• And then cashflow statement 
• Determine your goals, how much you need by when for what?  
• And start measuring, do you save and invest enough to take you there?

Here is an excel that can help you with this basic exercise. 

Are you holding endowment policies or ULIPs?

Are you holding any of the endowment policies or ULIPS? If yes, then you should be definitely reading this one.

I have never help ULIPS and had an endowment policy once. I did not buy it for myself, however when i started earning, my dad gifted this to me. This was based on the traditional wisom, most of the people from his generation would know this. Anyways, I was very happy then that I was saving tax, completely ignorant on the personal finance topic.

This endowment policy from LIC was bought in July 2006, was of 25 years term and insured me for 10 lakhs and was costing me around 37,600 per year. Historically, when such a policy is redeemed it would have given me around 20 lakhs plus.

In the year 2012, when I was also learning the concepts of future value and how to compare value of annuities etc.during my MBA, I decided to analyze this one as I always had a feeling that this is not something that is right for me.

What I observed:

• If I receive 20 lakhs at the end of 25 years, for an annual investment of 37,600 for 25 years, the pre-tax rate of return comes out to meagre 6%, even a PPF has much higher, at-least then. 
• The insurance of 10 lakhs is nothing for the kind of cover I needed. I was looking at a cover of at-least 1 crore to cover the liabilities I had then. 
• Disclaimer: I did not consider the 80C benefits from the policy, as I was paying a home loan and principal payment and PPF easily covered much more than allower limit. 

What I realized

• To get a tax free return after 25 years, I could have simply put that money in PPF or even in equity funds 
• In PPF at the rate of 8% I would have needed 28,000 annually to generate similar returns. 
• In equities at the rate of 14% I would have needed just 11,500 annualy. 
• I could easily buy a term insurance of 1 Crore for life (endowment insured for 25 years only for one-tenth amount) at cost of 12,500 annually
• Now, considering the term was 25 years, I would have gone for equities mostly, and would have had a much better deal in 34,000 (11,500 + 12,500) annually, with a flexibility to tweak my equity invesments whenever I like. 

I had to convince my dad that it makes sense to surrender the policy, the concept of sunk cost is very useful while making such decisions. And i did surrender the policy, even after I had paid the installements for 8 years.

Similarly, ULIPS also are mixed products - providing equity investments and insurance together. And if you analyze them then you are easily better off by having more insurance and better returns when you buy these separately.

Hence, I would recommend to anyone

• If you don't have it, don't bother you don't need them anyways 
• if you have it, then get out of them as soon as possible (in most cases, except the ones when you are very near to endowment policy maturity)

Feel free to reach out, if you want more details on the subject.

Happy to help.

Equity as your child

I remember reading this perspective from someone recently, and I kind of liked the way the author put this forward. Let me re-iterate what I read.

If you have two kids, as a parent you would try to make sure that you provide for the need of both your kids in most fair manner. Now consider equity as your third child, and make sure that all the expenses that you make for your kids are simply divided by 3 and the third poriton goes to equity. Note that you must treat this as expense and not investment.

Now, when you are 60 and your children are busy with their families and may and may not have time and willingness to provide you support, your third child will always be by your side and if you have been fair to him, he would have more than enough to provide for later years.

Isn't this an interesting analogy to bring home the necessity of retirement goal.

An individual may have many goals in life, however the top priority and number one goal in everyone's list should be retirement goal. This is the only mandatory goal one should have, others are really optional. And the key idea behind it is that if you don't provide for yourself who else will.

Ponder upon, if you havn't so far. 

Should I invest in NPS?

NPS or National Pension Scheme is a voluntary scheme, where one should be contributing to build the retirement corpus until the age of 60 and beyond that derives pension from the acculmulated corpus. Hence, it's fundamentally a retirement product.

During the accumulation phase, an individual keeps investing till the age of 60. At the age of 60 when he/she retires, then he is elligible for withdraw upto 60% from the corpus as lumpsum. For the balance corpus which is at-least 40%, he must buy an annuity that comes to him as monthly pension.

Now, the question comes whether I should start putting my money in NPS or not? Well, I will try to answer that question, but a little later in the post. Before that let's list down what are the pros and cons of investing in NPS.

Pros

• This is one product that has least cost of maintenance/management amongst all the equity products available (MFs, ULIPs etc.). Just 100 would be charged as management fees for managing a fund of 10 lakhs. 
• If you want to save for retirement and do not want to bother with balancing of your asset allocation over the years, then this is the product for you. Life stage option in NPS automatically moves your assets from equity to debt as you start aging. 
• Tax benefit 
• While contributing, the contribution in excess of 1.5 lakhs can be claimed as deduction against section 80CCD(1B)
• At retirement, the 40% of the accumulated retirement corpus will be completely exempted from Tax

Cons

• The funds get locked till the day you retire, which is the age of 60. You might be in your early twenties or thirties and all your money gets blocked till you are 60. 
• The max investment in equity is only 50% of the total contribution. Considering retirement for many would be the long term goal well over 10 years for many. There need to be an option to invest almost 100% in equity. That's where the investing directly in equity funds for retirement would be better. 
• At the age of retirement you must buy annuity for atleast 40% pf the corpus. That may not be the most efficient investment from return perspective at that point in time, but you have no choice. Also the pension from annuity is taxable in your hands for that year. A systematic withdrawal plan from an equity fund would be much better in that case, and note these withdrawals from equity funds are tax free as they are coming from equity funds after 1 year of investment. 

Hence, my take here would be, you would be better off investing directly in equity funds via SIP approach. When you are nearing 60s, 

• you should start systematic transfer plans from these equity funds into aggressive/conservative debt oriented funds. 
• And start a systematic withdrawal plan from these debt funds

What do you think? Do you see anymore advantages of NPS? Do you think you would still want to buy an NPS?

PS: There are chances that govt may start taxing the returns from equity funds which today are completely tax free after 1 year. If that happens we may have to review the attractiveness of the NPS with new scheme of things. However, till then i would say avoid NPS. 

Are you investing without having goals?

I developed a habbit of saving since the year I start my Job. However, i used to simply created fixed deposits or recurring deposits with whatever I felt like I won't need during that month.

That approach worked well for me to some extent as I was at-least saving, however today when I look back I would not advice that approach to any young earner. I call it dangling investments.

I say this as now I beleive in the following principal 

"If you don't know where you want to go then any road can take you there"

This simply means if you are putting money into some investment avenues and you don't know what are you gonna use it for the following is going wrong 

• You don't know when you will need that money - short term, medium term or long term. And hence you might have made a choice of investment that is possibly not giving you right returns for the time it would have been invested. Putting money in FDs for say over 5 years is a financial sin you must not commit unless you have really strong reasons to do so.
• You don't know whether you are over investing or under investing - you may be saving some 25k everymonth. Now, how would you know if that would be enough to meet your future needs in case of emergencies or your live events. Unless you know what you are investing for and the time horizon, your quantum could be completely wrong. 
• You don't know how much you can pull out from investments - Suppose you have been saving and have 50 lakhs in your investments. Now, you feel need of buying that awesome car, and you pull out 20 lakhs from your investments. Is it what you should be doing? No, right this one unknown bucket investments has money for your retirement, your kids education, buying a house and buying the car should be least of your priority against most these goals

Hence, its always prudent to decide your goals (the detination) and the time horizon when you want to reach there. This clarity will even help in your day to day decisions that you take, you will always we clear whether you have enough to splurge on your daily whims and desires. 

And once you have your goals figured out, you need to definitely put down a plan that you should be reviewing every few months to have a pulse check. A plan is very important as a goal without a real plan is just another dream. I hope i made my point. 

Diversification of portfolio

Anyone who has been investing would know what a portfolio means and what are the typical assets an individual would have. He would also know that diversification of the portfolio is important, however I am writing this one to re-iterate the fact that diversification is important, but over diversification is not.

Let's first understand the aspects of assests that need to be understood well, which are liquidity, return and risk. 

Liquidity: Normally there are following types of assests: fixed assets like property or land and liquid assets like cash or savings account and finally equities/funds etc. which fall in between the spectrum of these two extreems. 

Return: Return is typically measured as the Annual rate of return for the given asset. For instance cash has 4% return, FDs have 7% returns, Debt funds offer mostly a little better and equities even better for longer horizon and then properties some time provide staggering returns for investors. However, no one should ever consider only return for an asset alone. I say this because typically the moment the potential for the return increases it does come along with increased risk and volatility. 

Risk: Definition of risk is basically the volatility of returns for an asset, and this volatility sometime ends up eating from your principal as well. Its not always feasible to measure the risk for the investment. You should have a mitigation plan for this aspect, and one of the mitigation approach is Diversification. 

Note that some structured investments like mutual funds and equities do have alpha values, that help you determine the risk adjusted returns from these investments. But then there are property investments which are very local to the nature, location and type of property and cannot be so generalised.

So, in summary diversification of portfolio helps us average out excessive volatility in any given asset and help provide stability to the whole portfolio. 

However, over diversification simply adds up to the hassles of maintenance of the assets rather than helping a lot.

 A typical example would be of an individual investing in top 5 mutual funds of say mid-cap category. Now, each of those funds are by nature diversified and they all end-up investing in same universe of equities and hence there is no much sense behind holding more than 1-2 funds of a specific category. 

Another would be holding too many properties, property consumes a huge quantum of your money and hence more than one would really skew your portfolio towards a particular type of asset. And then you would take years to balance, or you may never be able to balance the risk and volatility that might come from this kind of asset. 

I think with all this I have made my point on Diversification

• The need of diversification
• And how not to overdo it 

So, the golden rule is "too much of anything is bad", you have not heard it first time :)

Buckets of Money

Ideally, each one of us who is above 18 and earning should start thinking about finance .. a little bit of it is not that bad. Wait .. to all the people just out of their teens, I am not asking you to start planning your retirement now, chill .... you have lots of time, or do you??? he he ...

See the golden rule I beleive in is

"Do not sacrifice enjoying your present for the future, however do not splurge in your present so that you can have a future"

Now, having set some context, I beleive that each individual should have three buckets of money for him/family

The Emergency Bucket
This should typically be the 6-12 times of your monthly expenses (including EMIs). I say 6-12 times, as it depends on the nature of your Job, size of your family, health of your family members and so on .. So, you decide your number. I prefer it above 9.

Typically, for this fund 25% should easily sit in your bank accounts as Fixed deposits and rest 75% should be working hard in liquid funds (of course for better returns).

The 0-5 Year Bucket
This money bucket is for your goals that are pretty near from today. For some its marriage (yes, its a huge affair in India), for others it could be education, car or even a house (you can't really save to buy a house, but at-least for the lumpsum contribution that bank needs on your part for giving a home loan).

Typically, if its 0-3 years i would recommend you to stick to carefully chosen debt and liquid funds, with slight exposure to equity funds. However, if it's 3-5 years then, make it more spicy having a higher quantum of equity. But don't go overboard, you should not have more than 25% of equity exposure for this whole bucket.

The 5 and Beyond Bucket
This money bucket is for your goals that are pretty distant, retirement, kids education/marriage could be the goals that fit here. They are so far in life, that you can safely put your money in equity and forget it till the time you are nearing your goal date.

Typically, this money would go in balanced funds or complete equity funds. You may try hands on with direct equity exposure, however this requires lots of tracking and no one is paying you for that. Plus you will never get the enough diversification you need to reduce the risk. Hence, recommendation is to go with mutual funds only. 80%+ equity exposure should help you save enough for your goals, the return you can expect easily is 12% (always make conservative estimates).

So, you have your bucket's sorted out now, or not?

How to reach your Retirement Goal

You have understood your Networth and your cashflow statement by now, and you have also gone to the future date and really understood how much money that you would possibly want when you retire. [if not, read earlier blogs]

• What's your Networth
• What's your cashflow statement
• Fast Forward to your retirement

Now, that you are done with where you stand and where you want to go, let's figure out what do you need to do to reach your destination in time and with right quantum on money.

In simple terms your retirement corpus is the Future Value of your Investments today, which typically are: PPF, EPF, Properties, Land Holdings, Fixed Deposits, Mutual Funds, Equity Holdings, Graturity, Annuity, NPS savings etc.

Let's say you had invested in PPF, and you have it for self, your spouse and kid. And here are the holdings

Similarly, you have Mutual Fund Investments - In the form of emergency liquid funds, your current equity holdings and your planned SIPs. Say they value as follows

And you do have say two properties as well, which value something like below. I am assuming really a low rate of return on properties of around 3-4%. Also, i am assuming you stay with your family in one and have lent out the other one which gives you a rental income  of say 30k per month as on today (grows 5% per year)

And say you both work and your EPF lumpsums today and future earnings on EPF would be increasing 5% per year. 

With all these you would end up having a retirement corpus of 8.8 Cr (but observe that you have also taken immovable assets like properties in to account, which needs to be liquidated if you need their woth to be in banks and withdrawable for usage)

I am repeating, but i am never tired of stating this "Always make conservative estimates for the benefits and generous estimates of your liabilities"

Fast Forward to your Retirement

You have understood your Networth and your cashflow statement by now [if not, read earlier blogs]

• What's your Networth
• What's your cashflow statement

Now that you are done,

Let's make few assumptions as on today 

• You are at the Age of 35
• You wish to retire when you are 50
• Your monthly expenses today is around 75,000
• You assume to have an annual inflation of around 6%
• You assume to build a retirement corpus of around say 7 Crore (Big Number, or is it?

Let's fast forward now to the date of your retirement. 

• You are 50 now
• Your monthly expenses are 1,79,741 (Future value of 50000 considering inflation)
• You have 7 Crores 
• Now you expect to earn 5% post tax return on 7 Crore (beleive me it's an optimistic number as after retirement you would only be putting most of your money in FDs)

Given the facts above, now let's assume you start withdrawing your expenses (growing at 6% each year coz of inflation) from this retirement corpus (grows at 5% each year), your whole 7 Crores would be exhauseted by 2066 when you are 83. 

Now, ofcourse there are lots of variables and factors that I have used to arrive at this number. However, this is just to illustrate some facts and give you an idea there is a way to put numbers for your retirement corpus. 

I would suggest you to sit down and start making your own assumptions about the variables mentioned above and get your retirement corpus you are comfortable with.  

The calculations for the above assumptions are as follows 

Cashflow statament, Income equals savings plus emi plus expenses

Well, keep in mind that retirement goal is typically one of your goals, but is the most important goal that you should save for, why? coz no one else will do that for you. 

And again, remember the golden rule, while making assumptions in finance "Always make conservative estimates of figures that benefits you, and generous estimates of figures that are basically against you". This will avoid you from boundary conditions :)

What's your Cashflow Statement?

You have understood your Networth by now

[if not, read earlier blog  What's your Networth]

Do you know what is Cashflow statement?
In simple terms a cashflow statement will help you determine all the incoming and outgoing flows of money for a period. In this case, for personal finance perspective, i would rather like to define this time period as month. And this simplifies it further:

Typical inflows:
Salary Income, Rental Income, Business Income, Interest Income, Dividend Income etc.

Typical Outflows:
All the different EMIs for loans, your expenses, be it travel, food, entertainment, utilities, addictions etc. and Savings.

Balance:
Whatever is left in the pond, I mean this is inflows - outflows.

Now, typically your outflows should never be more than your inflows, else you are progressing towards the bigger mess with each passing hour.

Also, note that you should not really have too much left in the pond, that's waste of money .. as cash holdings are the most in-efficient way to use money.

Let's cut short the talk and let me come back to cash flow statement. Here is a sample one

Cashflow statament, Income equals savings plus emi plus expenses

This kind of monthly cashflow statement will immediately tell you what percentage of your income is going in EMIs and Expenses (divide your annual expenses by 12), what you are typically saving and what's sitting idle in your bank accounts. 

A further note, while filling out the items above do not forget the golden rule "Always make conservative estimates of your inflows and Generous estimate of your outflows", and this is obviously when you don't know the exacts. 

And you are half way done.

What's your Networth?

Do you know what's networth? 

Well, networth is delta between your assets and liabilities. 

Do you know what's your networth? 

Well if not, then that's the question you should be answering in the first place even before you get into any other personal finance topics. This gives you a reference point in your financial life, where you stand. If you don't know that, there's no point knowing the destination you want to arrive, right?

What are the typical things that you would count as your assets and liabilities ?

Well, before i put down the sample matrix for your assests and liabilites, would like to point out the ultimate rule that you should follow: "Always make conservative estimates of your assets and Generous estimate of your liabilities", beleive me this will go long way. 

Now, here are the typical Assets & Liabilities 

(have put some sample data, don't worry that's not mine :))

Networth equals assets minus liabilities

Prepare an above mentioned matrix and this will help you get your networth. Also, you may further classify this what are your assets based on liquidity potential, for instance properties and land holdings are most illiquid assets and bank balance is most liquid. 

If you are wondering, the networth of the fictious person above is 

27,797,000