Living it up that was Pramod Sharma’s philosophy for the first three years of his career. The software engineer had a great job, good money and no responsibilities.
He could find new ways to blow up his salary every month. Then marriage happened, and Sharma woke up to the concept of saving and investment.
Says the 27-year-old who started investing only in April this year: “I never gave financial planning a thought before. I was living from one pay cheque to the next.” But now that he has started saving, he is bang on target.
His wife, Anshul, a lecturer, is equally keen on building a sizeable corpus. With a heavy bias towards equities, the couple’s approach to wealth creation is correct.
But their portfolio has potential for lot more. Before we find out how to exploit it, let’s do a quick inventory of what the Sharmas have managed to do in the past eight months.
Together, the young couple earns Rs 49,000 (post tax), half of which is gobbled up by routine expenses. They aren’t very credit savvy, so no loans yet. The couple has invested Rs 15,000 in Public Provident Fund (PPF). Pramod’s monthly contribution to provident fund is about Rs 5,000. Equity exposure is through four systematic investment plans (SIPs) chiefly in tax saving mutual funds. Total incremental savings in equities is Rs 5,000 a month.
Pramod has also picked up a term insurance cover of Rs 25 lakh for 30 years. A wise move indeed, as at his age life insurance is relatively cheap. For health insurance, the Sharmas rely solely on the insurance provided by their employers. Though Pramod and Anshul are saving nearly 50% of their income, investments constitute only 20% of total savings. So the disciplined spending does not accomplish much, as most of their savings Rs 19,000 a month is idling in savings bank accounts. The modest 3.5% interest is not enough to beat inflation. Forget about earning returns, the money is actually depleting in value.
So our first recommendation don’t just save, invest. And with such a high risk-appetite, the focus should be only on equities. Pramod’s monthly provident fund contribution and their investments in PPF are enough to build a reasonable cushion. The couple should avoid further investment in debt instruments. This is important to maintain the thrust on equities.
The Sharmas are planning a holiday in the Maldives early next year. Total cost of the vacation is estimated to be about Rs 80,000. They can withdraw this amount from their mutual fund investments. In another three years, the couple wants to buy their dream apartment. This would cost approximately Rs 40 lakh. For a down payment of about Rs 8.5 lakh, their savings of Rs 19,000 must generate at least 15% returns annually. Just one asset class that can do this equities.
Already, the couple has a good collection of tax planning funds. It would be ideal if they could simply increase their SIPs in them. But these funds have a lock-in period of three years. This means that further investments in them cannot be redeemed in time for the down payment.
We suggest that the Sharmas invest in a couple of good balanced funds like HDFC Prudence and DSPML Balanced to meet this goal. The best part of this strategy is that it does not stray from their longterm planning. After liquidating investments for the down payment, the couple should continue investing in these funds for building a corpus. Fixing an approximate amount for their retirement corpus is important. This will give better direction to their investments and help evaluate their progress.
However, we suggest that they avoid investing in any instrument which locks in investments for five years or more. Once the Sharmas buy a house and have children, their financial goals will change drastically. They can then make long-term commitments according to the time horizon of the new goals.
Pramod is also keen to invest in direct equities. “I want to book profits in six to eight month intervals for personal consumption,” he says. While equities can generate good returns in such a short period, he must understand that they give maximum benefit in the long run only.
Regarding insurance, Pramod has got everything right. But his life cover will have to be increased after three years at the time of buying the house. They should buy a term plan for Anshul too, with a sum assured of about Rs 5 lakh.
