More on investment planning

Now he has a 5 year old child. The insurance policy that he has taken will mature by the time his son is 18 years when bonus will be payable to Mr. Smith. From a standard insurance company, the average yearly bonus payable is Rs.48 per thousand sum assured. Hence, for a sum assured of Rs. 2,00,000/- Mr. Smith can expect a bonus of Rs. 9,600/- per annum which may amount to nearly 2 lakhs. ( However, this bonus is not guaranteed ). This bonus is in addition to the frequent inflows of Rs. 50,000/- (25%) on sum assured that will be paid on the 5th, 10th and 15th policy year.

In order to generate a substantial corpus for his son, Mr. Smith should invest the regular inflows from the insurance plan in an equity diversified scheme. The investment can be made either as a lump sum or through the systematic investment plan route. The investment can also be made in child funds.

Investments planning for Mr. Smith

His residential house and jewellery will not be considered as investment because they will not generate income. He needs to invest further to achieve a corpus of nearly 45 lakhs. His present savings are nearly rupees two lakh per annum and he is left with a cash of one lakh after meeting all the cash outflows. In totality, his present savings per annum are three lakhs. He will have additional savings that will become handy after the car loan is repaid (after two years). His savings will increase to Rs. 6 lakhs per annum after the repayment of loan. His housing loan will be met out of his income while he is earning as it matures at the end of nine years.

He can invest in a mix of equity and debt in such a manner that his exposure to equities is between 40% and 50% of the portfolio. He should consider safer avenues such as post office schemes that offer guaranteed returns than other avenues available.

Mr. Smith Case : Debt Front

His current outstanding liabilities amount to nearly Rs. 18,00,000/-. His annual contribution towards these EMIs constitutes nearly 45% of his monthly income.

This means that almost half of his monthly income is consumed in meeting these loan EMIs. One of the options that can be considered is the prepayment of car loan. However, it comes at a cost of penalty and therefore may not prove to be a very feasible preposition. Also, since his car loan will be repayable in the next two years it will reduce such payables and will lead to higher savings (Rs. 3,00,000/-). Once these loans are repaid, the client will be left with sufficient money to be invested.

Mr. Smith requires a corpus of nearly 20 lakhs after 20 years for his son. He also needs to build his retirement corpus or Rs. 30 lakhs in the next 10 year. He is having investments in stocks and shares,  FPF/ PPF and bank FDs worth Rs. 5 lakhs.

Mr. Smith Case : Risk Cover

Insurance needs should be constantly reviewed and monitored from time to time. If this is not done, then the investor falls prey to the risk of under insurance. This is exactly the case with Mr. Smith. He had taken a 25-year money back plan when he was 30 years for Rs, 2,00,000/-.

In addition to the money back plan, it is recommended that Mr. Smith take a term insurance plan. He can take up a cover for Rs, 30,00,000/- for a 20-year period. This amount of Rs. 30,00,000/- will not only help his family in meeting his outstanding liabilities but also in meeting expenses to some extent. The annual premium comes to Rs. 16,346/-. A suitable term plan that can be recommended is the Priceless Being. A term plan becomes important primarily because of the highly leveraged position of Mr. Smith. In case of his unfortunate death, his liabilities should not become a burden for his wife and child. Secondly, this plan can be used as a suitable supplement to the existing insurance cover. Due to its low premiums, such a plan will not cause any additional financial burden for Mr. Smith. He can also invest the proceeds from the money back plan in mutual funds, the returns from mutual fund can be used to pay the premiums for this plan.

Recommendations for Mr. Smith

The previous post highlighted the position of Mr. Smith. His main stated goals are planning for his child’s future and creating a suitable corpus for his own retirement. Considering his goals and his current financial position, it is necessary to prepare a comprehensive financial plan so that he is in a position to realize his financial goals.

Managing short-term liquidity and contingency requirements

Mr. Smith has a bank balance of only Rs. 1,00,000/-. This figure is certainly not adequate for meeting any short term contingency.

Apart from monthly EMIs totaling Rs. 60,000/-, he also needs to meet other mandatory monthly expense* of Rs. 46,671/- ( Rs.5,60,059 / 12). This position is particularly alarming because his EMI obligation and majority of investment in long-term assets. Therefore, he needs to build some short-term asset which can be accessed by him in case of any eventuality. For this purpose, he must have savings at least equivalent to his three months’ mandatory expenses, which is nearly Rs. 3,20,000/- [3*{Rs. 46,671+(Rs. 7,20,000/12)}]. He already has Rs. 1 lakh in his bank account, so he needs to increase this reserve by Rs. 2,20,000/-. He should have at least Rs. 3,20,000/- in near cash avenues such as in savings account and short-term liquid deposits.

Though the returns offered by bank deposits are very low, parking a calculated amount in such avenues is unavoidable to circumvent any unforeseen  emergency.

*Other mandatory monthly expenses include insurance premium, house maintenance and water tax, food and grocery, transportation, clothing / personal care, medical care, utilities and miscellaneous expenses.