Reallocate Investments To Plan For Contingency And Retirement

Prabin Agarwal
Fortune Securities,Siliguri 

Reallocate Investments To Plan For Contingency And Retirement 

Financial planning has picked-up pace in the past few years and even people from middle-class families in Tier-2 and Tier-3 cities have realized the importance of investment and financial planning. However, most financial planning in these small towns and cities are done based on suggestions from friends and relatives and less through a proper financial planning process. Moreover, these people fail to realize that proper financial planning is incomplete without retirement planning. 

I meet a lot of clients every week and the most common thing that I notice among most of my clients in my area is that their idea of financial planning hovers around meeting children’s education and marriage expenses. As most of my clients are from business background, they feel that things like contingency planning and retirement planning are only for salaried people. 

They think that these are unwanted investments and will drain excess liquidity from their business and will hamper normal business proceedings. However, just by reallocating their current investment and savings they can even plan for contingencies and retirement. 

Let me explain this with the help of a hypothetical case study. Mr. Goyal is a 38-year-old, married for the past 10 year and has a son, aged 8, and daughter, aged 5. He owns a business, dealing in readymade garments. He has inherited a family house, currently worth Rs2 crore. His business investment is worth Rs50 lakh (including stock-in-hand and receivables). His wife is a home maker. 

Key Financials: 

His current annual income after tax is Rs15.6 lakh, i.e., Rs1.3 lakh per month. 

His monthly household expense is roughly Rs70,000 per month (i.e., Rs8.4 lakh per annum) including children’s school expenses.Travel and other healthcare expenses: Rs50,000 per annum 

He invests Rs25,000 per month in SIP since last 5 years for his children ( Rs10,000 each for son and daughter’s higher education and Rs5,000 for his daughter’s marriage expenses) 

Current SIP investment value is Rs10 lakh each of SIP’s for children’s education and Rs5 lakh of SIP linked to daughter’s marriage expenses 

He has a family medical insurance for which he pays an annual premium of Rs20,000. He also has a life insurance plan of Rs25 lakh (started 3 years ago – policy term: 30 years) each in his and his wife’s name for which he pays an annual premium of Rs150,000. His cash and bank balance(including FD) as on date is Rs 15 lakh. His annual savings is Rs2 lakh.

Goals: 

Children Education: 

1. Son’s higher education: Fund requirement Rs40 lakh (as per current cost) when he attains the age of 18
2. Daughter’s higher education: Fund requirement Rs25 lakh (as per current cost) when she attains the age of 18 

Daughter’s Marriage: 

1. Fund requirement Rs40 lakh (as per current cost) when she attains the age of 25 

Key Challenges: 

• Mr. Goyal is unaware of the need for retirement planning
• Business income might not be the same every year
• He is not fully insured 

Before approaching Mr. Goyal about the key challenges, let us check if his current investments will be able to meet his financial goals that he has prioritized. 

Top Priority: Client’s Financial Goals 

The situation in which he is right now is quite common among most investors today. Mr. Goyal has made provisions for all three financial goal priorities, but he has failed to allocate the funds properly. While he will have surplus funds from his investment after meeting his daughter’s education expenses, he will face a shortfall in meeting son’s education expenses and daughter’s marriage expenses. 

Based on our calculations and analysis, Mr. Goyal will be able to achieve his financial goals just by reallocating his investments in a more goal-oriented manner:

Just by tweaking his investment allocation, Mr. Goyal will be able to meet all his three financial goals. The total additional allocation that would be required is Rs2,000 per month (i.e., Rs24,000 per annum). 

Priority 2: Protection 

We have analyzed two major aspects: Mr. Goyal generates his income from business which can be highly volatile over the years and he is also not fully insured. To protect him from income fluctuations and to help him meet his financial goals, he should keep aside his current assets (cash, bank balance, and FD of Rs15 lakhs) for contingency purposes only.

As far as insurance is concerned, he must understand that insurance is a safeguard against a financial loss and not against an emotional loss. Life insurance should only cover the risk of life of the earning member of the family and the earning member should be fully covered. In case of any untoward event in the life of the earning member, the dependents should not suffer financial disability. In Mr. Goyal’s case, his wife and both children are dependent on him. 

So, he should take a life insurance cover of at least 10 years of his current family expenditure amount, that is, roughly Rs1 crore. The Rs1 crore policy should be a term plan as it would not be possible to pay a high premium of an endowment plan. The term plan’s annual premium would be around Rs25,000 for Rs 1 crore cover. He should discontinue the current life insurance cover that he has for himself and his wife. ' 

Priority 3: Retirement Planning: 

Most businessmen fail to realize the importance of retirement planning. While Mr. Goyal is well aware of financial planning and had somewhat set his financial goals and is investing for the same, yet he has failed to realize the importance of retirement planning. Businessmen think that retirement is only for salaried people, but is it possible for a businessman to run his business till his last breadth? 

Moreover, with Indian family value system getting westernized, it is highly appropriate to go for a retirement planning. As per our calculation, he will require Rs5.7 crore at the time of retirement at the age of 60. This amount might sound huge, but if he starts investing now, he can achieve the same by investing just Rs 25,000 per month (after utilizing Rs50 lakh business investment at retirement). We have assumed a pre-retirement period investment return of 15% as the investment will be made mostly in equity products. Post-retirement, his risk-taking ability will minimize so the retirement corpus will be switched to a debt fund that will give a moderate return of 8% per annum. 

He can easily fund the monthly investment from his current savings and the money that he will save from switching his life insurance from endowment to term plan. 

Disclaimer: The above case study is just to create awareness among investors about the importance of proper financial planning. The above case study should not be taken as a basis for making any financial investment decisions. Please contact your respective financial planner for your proper financial and investment planning.