Investing Jargon

Bottom Line    Bottom line is the slang which is used for net income or profit.      

Bottom Up Investing     An investment approach that de-emphasizes the significance of economic and market cycles. This approach focuses on the analysis of individual stock.        

Bull & Bear    A bull refers to an investor who thinks the market, a specific security, or an industry will rise. While, a bear is an investor who thinks the market, a specific security, or an industry will fall.        

Dividends  Dividends refer to the cash payment from profits of the company that is announced by the Company’s Boards of Directors to be distributed among the stockholders.      

Panic Buying    The term refers to high volume buying brought about by sharp price increases. This happens mainly due to some news which is spread in the market.        

Panic Selling    The term refers to high volume selling brought about by sharp price decline. It happens when the market collides.

Tax planning and Conclusion to Mr. Smith Case

In order to plan for his taxes it is important that Mr. Smith should be aware of the tax implications of the various investment avenues. Before discussing the tax implications, itt is important to understand the all pervading standard section of the income tax act, which provides a deduction under that section, upto Rs. 1,00,000/-. The earlier rebate under section 88 has been replaced with section 80C. Mr. Smith should understand the following aspects while planning for his taxes:

►  Tuition fees paid for his child is eligible for a deduction under section 80C

►  Premium paid on insurance policies

►  Contribution towards national savings certificate and public provident funds are also eligible for a deduction

Conclusion

Normally any personal financial planning is a highly comprehensive exercise involving close interaction with the clients. It covers a number of dimensions and involves studying the needs and requirements of the client closely. This case just touched the tip of the ice berg and aimed at bringing light on the basic elements of financial planning when planning for the children’s expenses.

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.

Investment details and analysis of Mr. Richard Smith's case

Investment details of Mr. Smith

The investment portfolio of Mr Smith covers the following avenues:

►  Investment in bank FDs – Rs. 1,00,000/-

►  Investment in stock and shares – Rs. 2,00,000/-

►  Investment in post office savings schemes EPF / PPF / NSC totaling Rs. 1,82,000/-

Asset classification of Mr. Smith

Mr. Smith’s asset portfolio includes :

►  A residential house property costing Rs. 26,00,000/-

►  Purchase of a car whose current market value Rs. 7,00,000/-

►  Jewellery for his wife costing Rs. 2,50,000/-

►  He is maintaining a bank balance of nearly Rs. 1,00,000/- in his account. The collective outstanding liability on his car loan and housing loan is Rs. 18,00,000/-

Insurance details of Mr Smith

►  He had taken an Insurance plan with a 20 year money back plan worth Rs. 2,00,000/- when he was 30 years. The annual premium is Rs. 18,059/-

Analysis of Mr. Smith’s position

►  Mr. Smith’s annual expenses are Rs. 14,30,059/- and after meeting his annual savings Rs. 2 lakhs, he is left with a cash of Rs. 1,19,941/- per annum. 

[Rs. 17,50,000 – (Rs. 14,30,059/ +Rs. 2,00,000/-)]

►  Mr Smith pays Rs. 60,000/- per month as EMI towards his loans. Hence, his current liquidity position is not in a very good shape as any event that temporarily hampers his monthly earnings can prove disastrous.

►  Though he has invested in many long term assets, he is having only Rs. 1,00,000/- as balance in his bank account.

►  He has only taken an insurance policy for Rs. 2,00,000/-. Under the present circumstances he is underinsured and needs to revise his insurance plan.


Recommendations for him follows here.

Investment Case Study

Mr. Richard Smith (36 years) is working with a multinational company for the last 6 years. His family includes his wife - Mrs. Annie Smith and son ( Justin ) aged 3 years. He has approached a financial planner for comprehensive financial planning assistance so that he is able to achieve his financial goals.

The client's stated financial goals :

•  To have adequate savings worth Rs. 20 lakhs for building his son's career after approximately 20 years.
•  To accumulate Rs. 30 lakhs ( approximately ) to maintain decent lifestyle after retirement. He wants to retire after 12-15 years when he would have attained an age of 50 years nearly.

Client's Information  : 

Mr. Smith's annual income is :Rs. 17.5 lakhs. A statement of his annual cash outflows is given below :

Details	Amt ( Rs. )
Mortgage payments ( EMI )	4,20,000
Car loan payments ( EMI )	3,00,000
Insurance Premium	18,059
House maintenance and water	18,000
Tax	1,50,000
Food & Grocery	30,000
Transportation ( 2 cars )	1,50,000
Clothing / Personal care	50,000
Medical / Dental Care	30,000
Utilities ( telephone + electricity )	78,000
Misc. (maids etc.)	36,000
Entertainment / Gift	50,000
Vacation	1,00,000
Total	14,30,059

In addition to the above expenses, he also contributes nearly Rs. 2,00,000 towards his savings in provident funds and fixed deposits annually.

His investment details and analysis of his case follows here.