Going wrong with fundamentals

Click here to Enlarge Name: Saibal and Sumana Sinha with their child and Saibal’s parents

Age: 35 Years (Saibal) Monthly Income: RS 98,500 (post tax) Financial Dependents: One (child)

When you find that a couple with a monthly post-tax income of Rs 98,500 has so far invested only Rs 80,000 in equities and about Rs 41,600 in debt instruments, you know that there is a problem—a huge one. Are they spending all the money, all the time?

The routine monthly expenses are approximately Rs 13,500. So does the home loan EMI swallow the surplus? No. The EMI is Rs 15,487. The down payment of the house was funded by a personal loan, for which the EMI is Rs 15,289. After subtracting the insurance premiums, the investible surplus should be a chunky Rs 40,644 a month. The couple ought to have built their current portfolio in just three months.

This could have also been explained if the couple had just started their careers. But 35-year-old Saibal Sinha, area business head for an IT company, has been working for 12 years. His wife, Sumana, has been a lecturer since 2004. Saibal’s income is Rs 85,000 and Sumana earns Rs 13,500. The doctor was, of course, intrigued, but managed to crack the whodunit. It turns out that the culprit is unaccounted expenses.

To explain this, consider the financial details for the past four months that the couple sent us. According to these, the duo should have spent about Rs 54,000. Their surplus ought to have been around Rs 1.6 lakh, possibly parked in a savings account. When we rechecked with Saibal, he told us that the total money in their bank accounts was about half that amount. Where did the rest of the money go?

It was spent on electronic goods. As this is not a recurring expense, Saibal did not include it in the figures sent to us. If we average out this expenditure, it adds Rs 20,000 to “routine” monthly expenses.

The problem might seem like the proverbial needle in a hay stack, but it is a dangerous practice. If you don’t average out oneoff expenses, you are slipping up on the first step of financial planning—budgeting. Saibal’s answer explains his cash flow for the past four months. However, we don’t know if this holds true for the rest of the year as well.

Opportunity lost The Sinhas let Rs 1.5 lakh erode in value by choosing the wrong investment strategy. They have Rs 1 lakh in savings deposit and Rs 50,000 in a Savings Assurance Plan. Here’s their opportunity cost: • In 10 years, Rs 1.5 lakh invested in equity funds would have increased to Rs 6 lakh. • In 10 years, Rs 1.5 lakh invested in a bank fixed deposit would have increased to Rs 3.6 lakh. • If this was used to partially prepay their personal loan, the EMIs would have dropped by 30% (tenure remaining the same). • If they had bought a term insurance of Rs 20 lakh for 20 years, it would have paid premium for 21years. Annualised returns from equity fund assumed to be 15%; Fixed deposit returns assumed to be 9%

This means we don’t know about the couple’s actual monthly surplus. So we cannot accurately predict whether Saibal and Sumana are on track to meet their financial goals.

Saibal admits to having been a careless spender through most of his working life. He had taken a personal loan of Rs 2 lakh to fund the down payment of his home, but he topped it up a few times to repay credit card debts. Currently, the outstanding balance on the loan is about Rs 5 lakh.

The Sinhas have learnt the lesson of thrift and have tried to reduce regular expenses, but are yet to realise that random expenses can also be routine and that they too eat into the monthly surplus.

To construct a financial plan with a realistic cash flow, we have assumed that the expense pattern of the last few months holds true throughout. So our first advice to the Sinhas is that they drastically cut down on these deceptively innocuous random expenses. They should maintain a written record of the smallest expenditure—this is the easiest and most effective way to spot the leaks. Most importantly, use plastic with care. Think of it as a way to shop with convenience, not with credit.

Prepaying the personal loan should be the first priority. At 14.75% interest, the loan is very expensive. We will tell the Sinhas where to invest their surplus, but they should begin by doing away with the loan.

The couple’s only wise financial move has been to invest in real estate. In 2004, they bought an apartment in Kolkata for Rs 21 lakh. The value of the property has risen to Rs 38 lakh—an increase of 80% in four years. In 2006, they bought a plot of land worth Rs 75,000, which is currently valued at Rs 4 lakh, over 400% of the purchase price.

Saibal and Sumana began investing in equities last year. This is a very late start. They are now at the end of the golden period of compounding, but their risk-taking capacity is still high. Therefore, their entire monthly surplus should be poured into equities to maximise the returns potential.

This does not mean that they should take hasty decisions. The couple has invested in eight mutual funds. There is no overall strategy for the fund portfolio as a whole or any specific criterion for selecting each fund.

Luckily, there aren’t too many duds in the collection. Apart from two funds (Tata Indo Global Infrastructure and UTI Energy), Iris suggests that they continue investing in the others. These two funds have a narrow focus and are meant for sophisticated investors who understand and can capitalise on high-risk, high-return sector funds.

However, Iris suggests retaining UTI Infrastructure, a sector fund, as it has been performing well. Moreover, it improves diversification without diverting from our strategy. The couple should note that Iris suggests holding this fund, not investing in it any more.

Besides, Saibal and Sumana should not opt for a new fund unless it adds another dimension to their portfolio, such as exposure to a unique set of companies. Iris advises that they build a fund portfolio around large-cap funds as they are the safest. It is good to steer clear of direct equity as neither spouse has the requisite expertise for stock picking.

For insurance, the couple has invested in a Ulip, a pension plan, four endowment policies and a savings assurance plan. The annual premiums amount to about Rs 1.6 lakh. Saibal is covered for about Rs 37 lakh and Sumana for Rs 1.4 lakh. This is adequate as they are a working couple. The cover is also split proportionally to each spouse’s income. If Saibal wants to increase his cover, he should opt for a term policy as it is the cheapest form of pure life insurance.

No matter what the name of a Ulip, it is not the best investment for the specific purpose of securing your child’s education. Nevertheless, we suggest that the Sinhas continue to invest in the HDFC Unit Linked Young Star PLus II. It pays the sum assured and the premiums for the entire tenure in case the investor dies before the policy expires. The premium for the policy is higher than usual Ulips, but this facility justifies the extra cost.

One policy that Iris is sure the couple must exit immediately is the HDFC Savings Assurance Plan. It is a traditional endowment policy that underperforms even the RBI bonds. Saibal has paid a premium of Rs 50,000. He has not only taken an expensive personal loan from the HDFC Bank at 14.75% interest, but has also been sold a product that will earn barely 6%—less than half the interest rate of the loan. Saibal could have used this money more profitably (see “Opportunity Lost”).

Such blunders are a result of ignoring the big picture while constructing a financial plan. There is also an important lesson for our readers: don’t depend on your banker or broker without checking the facts yourself.

How to fill the form The Portfolio Doctor is flooded with requests for financial health check-ups. While we thank our readers for their interest and trust, we are unable to process several requests because the online forms are not filled adequately. Circled below are the fields that are not filled properly most of the time—along with instructions to do so correctly.

Name: Age: Gender: Marital status: Phone number: Residential address: Financial dependents: Include parents if they are retired and don’t have a pension INCOME Monthly income: Spouse income: Other income: Include rent, interest income or any windfall income EXPENSES Monthly expense: Include average of random expenses House loan: Give EMIs, total loan amount, rate of interest and tenure of loan Car loan: Personal loan: Owner: Properties: Include your house, inheritance, plot of land or commercial property INVESTMENTS Balance in PF: Give the monthly contribution if you don’t know the total amount PPF and NSC: Bonds and FD: Jewellery: Mutual funds: Give names of funds and amount invested. Specify if they are SIPs Shares: Current value of your property: FINANCIAL GOALS WITH CURRENT VALUE Short term (6-18 months) Current value: Specify why and how much money you need Medium term (5-6 years) Current value: Long term (over 10 years) Current value: RETIREMENT The age you plan to retire at: How much monthly income would you require post retirement: INSURANCE Type of policy: List all policies Sum assured: Premium: Tenure: Specify the tenure for each policy Maturity: It’s not the same as sum assured. It’s the money you get when the policy matures