Navsari-based assistant manager Hemant Chauhan needs to leverage his high risk-taking capability and invest aggressively in equity and debt markets to build a sizeable financial portfolio that would focus on asset accumulation.
The main claim to fame of Hemant Chauhan’s hometown of Navsari is as the birthplace of Jamsethji N. Tata, the first and perhaps the greatest of all Indian entrepreneurs. JNT went on to found the Tata group taking calculated risks to set up businesses, which have since become household names.
|Name: Hemant Chauhan with wife |
Monthly income: Rs 25,000
Financial dependent: One
Given that he’s young, has a high savings rate and only one dependent, one might have expected Chauhan to have tried to expand his net worth exponentially through heavy investments in equity. But he hasn’t done that
In fact both asset classes, equity and debt, are missing from his portfolio save one solitary investment in UTI Balanced Fund, that is presently worth Rs 59,000. He has also accumulated jewellery worth about Rs 1.5 lakh.
The rest of his savings are parked in various term and endowment policies, which require Chauhan to shell out annual premiums of about Rs 45,000. In addition, he holds an LIC pension plan. The total cover is Rs 11 lakh, which is inadequate for protecting his assets and insuring his family and health.
The first step would be to build a well-diversified financial portfolio. Apart from reallocating his substantial monthly surplus, he can also rejig his insurance policies to create some additional surplus that may be invested in equity.
Insurance should be ideally viewed only as a tool to hedge the risk of loss of life, while the remaining savings should be held in a combination of faster-growth assets such as equities, debt or even liquid cash. The underlying principle is that insurance and investment should never be combined.
Chauhan needs to look at pure insurance plans like term cover for protection. It may be expected that his dependents will grow. For an adequate cover of about Rs 20 lakh, the annual premium for the term plan would be about Rs 7,500. Thus not only will he get better protection, a switch from endowment policies will generate a surplus of Rs 17,500 in terms of saved annual premiums. As we show in Premium Patterns, that surplus could easily be grown to a return of Rs 8 lakh even if it simply earns 8% return in fixed deposit accounts.
A pension plan early in life is a wise decision as it will help him build a significant nest egg by the power of compounding.
Since Chauhan is still very young and already earning enough to save and invest a tidy sum, he has a good opportunity of increasing his net worth through disciplined and systematic investments. At his stage of life, asset allocations should be skewed in the ratio of between 3:1 and 4:1 in favour of equity investments against debt.
He has good frugal habits in that he saves over two-thirds of his earnings. The next step would be putting the money in the right options. Chauhan does not hold any direct stock investments which is fine. It’s much better to avoid investing directly in stocks if you don’t understand them well and also lack the time to create and monitor an equity portfolio.
The best way of milking good returns from the markets without taking too much risk is by allocating a part of the savings to equitydiversified mutual funds on a monthly basis, that is, through systematic investment plans.
In specifics, we suggest that he pick any three diversified equity funds from a selection such as Franklin Prima Plus, HDFC Sensex Plus, HDFC Growth, Birla Mid Cap, PruICICI Dynamic and Reliance Growth. These are all highly rated schemes with long track records, which have tended to outperform the market indices.
Among index funds, PruICICI Spice and Tata Nifty are both highly rated with acceptable expense ratios. Going by historical data, even average index funds can offer long-term returns that are far in excess of endowment plans.
We believe that if he implements an SIP with a perspective of several years, Chauhan’s net worth will grow much quicker than through other means. He can also go in for ELSS to ensure that he exhausts the Rs 1 lakh available as a tax-shelter under Section 80C.
It is clear that Chauhan is riskaverse. So, he should also allocate a certain proportion of savings in debt or balanced schemes as well. Debt offers stability as well as returns that beat endowment plans hollow. He could consider parking up to 35% of his assets in debt—this is higher than the normally recommended 25% for a person with his age and earning profile.
For example, he may increase his exposure to UTI Balanced Fund where he already holds a position. He can also consider floating rate schemes such as PruICICI’s Floating Rate Plan—floaters provide a hedge against rising rates.
Currently, fixed income instruments are offering good returns and Chauhan could consider fixed maturity plans if he is looking for tax-efficient returns in the next 1-2 years. If he has a longer time horizon, he could seek FDs with a three-year lock-in period. In any event, he has to take exposure to both equity and debt instruments in order to maximise returns.
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