Ahmedabad-based Alok Kumar saves intelligently but must leverage the advantage of being an early investor to maximise returns.
If money could talk, Alok Kumar’s finances would plead—Invest Me! Saving a whopping 83% of his income, Kumar has an investible surplus of nearly Rs 2.3 lakh every year. So when it comes to expense planning, he has obviously got it right. But what does he do with this cache? “Usually the money lies in my savings account but I sometimes give it to my parents,” says this 24-yearold assistant manager from Ahmedabad.
And that is where he has blundered. After factoring in inflation, funds parked in a savings account actually erode by at least 2%. So while Kumar is saving intelligently, there is much to learn on the investing front.
An annual income of Rs 3.6 lakh, no dependents and a career on an upswing; Kumar has an enviably high-risk appetite. An advantage he has just begun to build upon.
This year Kumar has been on an investment binge. He purchased two insurance policies; an endowment assurance plan in January with sum assured of Rs 5 lakh and a Ulip in March with similar cover. The Ulip also provides him with a health insurance of Rs 5 lakh. Total premium outgo for these policies is a hefty Rs 70,000 annually.
Between January and March, Kumar invested Rs 30,000 in four mutual funds—UTI Long-Term Advantage, PNB Long- Term Equity Fund, Kotak Emerging Fund and Birla Sun Life 96 Tax Relief. Cairn India is the solitary direct holding in his equity basket.
Currently sharing an apartment with friends, he has no investments in real estate, though there are plans to buy some property in Ahmedabad or his hometown Lucknow. But he isn’t very keen on adding to his empty debt portfolio.
Kumar’s exemplary saving habits and eagerness to participate in the equity markets is the correct approach to financial management. The fact that he has started investing early in his career is a huge plus point. Through the power of compounding this advantage can be leveraged to build a sizeable nest egg. For that Kumar must plan his investments according to his short-term and long-term needs.
At his age, an aggressive exposure to equities is a must. That portion of his investible surplus which will not be required for at least the next five to seven years should be allocated to equity funds. Though Kumar has invested in some, the fund selection is not very prudent. Three of the four funds are relatively new and should have been avoided. However, he should not exit them hastily.
Profits on equity mutual funds sold within a year of purchase are considered to be short term gains and taxed at 10%. To save himself from this tax burden as well as the exit load of the funds, we recommend that Kumar holds on to them for at least a year. If the funds perform well, he may retain them in his portfolio or sell after a year.
Funds which have performed well consistently in the long term are the safest bet for all investors. Kumar should invest about Rs 1.5 lakh of his surplus in equity diversified funds. He can refer to the Mutual Fund Monitor in the MONEY TODAY Insight section of this magazine for details on the best performers.
New players of the markets like Kumar should invest through systematic investment plans (SIPs). Investors who put in large sums at one go have often suffered when markets suddenly dip. By averaging out the cost, SIPs help tide over such volatility.
Having made these investments, Kumar should review his mutual fund portfolio on a yearly basis. Subsequently the better performing funds can be rewarded by increasing investments in them.
The loss-making Cairn India stocks must be sold off immediately. There is no need for Kumar to dabble with direct holdings if he is unable to understand the dynamics of stock markets. Mutual funds are a safe and smart way to milk maximum returns while minimising the risk inherent to equities.
While debt instruments offer lesser returns than equity they are not entirely dispensable from the financial portfolio of even young investors. Besides adding stability to the portfolio such investments are especially handy to foot foreseeable short-term expenses. Kumar wishes to save about Rs 4 lakh for his sister’s marriage, due in the next two years. For this, he can invest Rs 60,000 from his surplus in either fixed deposits or fixed maturity plans (FMPs).
Currently both these instruments are giving returns of 9-10% a year. But between the two, FMPs make better investment sense simply because they are tax efficient. Their income is treated as capital gains and enjoys indexation benefits. This mix of debt and equity investments should be enough to meet his short-term requirements.
Kumar can remain invested in the two insurance policies he bought this year. Though much has been said against Ulips, they can be very rewarding for long-term investors of the stock markets. The medical insurance is also a wise decision as it is very cheap at such a young age. However, Kumar’s total life cover is too low. A term plan of Rs 30 lakh with a tenure of 40 years will remedy this flaw.
Tax planning is integral to financial management. While making his investments, Kumar must ensure that he exhausts the Rs 1 lakh limit provided under Section 80C of the Income Tax Act. Apart from equity linked savings schemes, he can invest in Public Provident Fund, Ulips and fixed deposits with a lockin period of five years.
As for his plans to invest in real estate, it may be better to wait a while. Analysts predict a fall in the home loan rates and correction in property prices in the next few months.
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