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Different styles, similar problems

Mumbai-based Jiya Yadav and Nagpur-based Sanjay Kumar have very different investment strategies.Yet, their portfolios suffer from common financial flaws.

Print Edition: August 7, 2008

Jiya Yadav with family

Age: 26 years

Monthly income: Rs 27,000 (post tax)

Financial dependents: Two (wife and child)

Click here to see Jiya's complete portfolio analysis
It’s neither easy nor productive to compare the financial health and investment strategies of two individuals. After all, every person has a different income, circumstances, requirements and risk appetite. But when Nagpur-based software engineer Sanjay Kumar and Mumbai-based banking executive Jiya Yadav approached the Portfolio Doctor last fortnight, we noticed several commonalities between them. Both were 26 and in the same income bracket. So we decided to do a comparative analysis, see where the two were going wrong and how they could learn from each other’s financial mistakes.

Let’s start with Yadav, who works in the mortgage division of a large multinational bank. But if you think he has been rather conservative and prudent in his investment decisions, you’re mistaken. He has been investing in momentum stocks (RNRL and IFCI), picking up shares with a troubled past (Silverline Technologies) and packing his portfolio with obscure penny stocks (Minaxi Textiles).

Yadav has a post-tax income of Rs 27,000 a month. Almost 30% of this—or Rs 8,000—goes into household expenses. Another Rs 4,834 is deducted as a home loan EMI, leaving him with a monthly investible surplus of about Rs 14,000. This is invested in a bizarre mix of good, not-so-good and bad investment options.

First, the good part. Yadav has systematic investment plans (SIPs) in five equity mutual funds which account for a monthly outgo of Rs 3,500. But though the mode of investment is correct, Yadav’s choice of funds is not very sound. A fledgling portfolio should not have global funds, contra funds and sector funds unless there are compelling reasons to do so. However, Yadav also has good funds in his portfolio, including some taxsavers.

Then comes the not-so-good part. He has three unitlinked insurance plans and a money-back insurance policy. These plans give him a combined cover of Rs 4 lakh for a total annual cost of Rs 60,000 (Rs 5,000 a month). That’s a lot of money and too little cover for someone who has a Rs 4 lakh outstanding home loan, a homemaker wife and a newborn child. He needs a 5-6 times bigger insurance cover. The problem area in Yadav’s portfolio is his stock investments.

Learning from each other

Besides the Portfolio Doctor’s prescription, the two patients can benefit from each other. Here’s what Yadav can learn from Kumar:

Get adequate insurance: Kumar is insured for almost 6 times his annual salary.Yadav has insurance that covers just his outstanding home loan. He needs to emulate Kumar and take a low-cost term cover.

Stock investments: Kumar invests in equities through mutual funds because he is not an expert. Yadav too should get over his urge to invest directly.

And here’s how Kumar can gain from Yadav:

Equity exposure: Kumar has a very small portion of his portfolio in equities. He should take a leaf out of Yadav’s portfolio and enhance his equity exposure.

Real estate:The house Yadav purchased three years ago has almost doubled in value. It’s a pointer for Kumar how real estate can be a safe and rewarding investment option.

Goal setting: Yadav has written down his goals and chalked out investment plans to achieve them. Kumar should also follow suit.

Some very promising picks (Suzlon, Apollo Tyres) rub shoulders with momentum scrips, dubious companies and penny stocks. It’s a portfolio in search of a strategy—and desperately so. Yadav invests about Rs 3,000-4,000 in stocks every month, buying on every dip. That’s an intelligent strategy, but he still needs to pluck out the weeds and replace them with fruitful scrips. At the other end of the risk spectrum is Kumar, with a post-tax income of Rs 28,000 a month. He is a bachelor, but has three dependents—his parents and a younger brother.

His monthly expenditure is Rs 13,000, which means more than 50% of his income, or Rs 15,000, is available for investment. Unlike Yadav, who has been reckless in his investments, Kumar has put most of his savings in debtbased options such as bank deposits, PPF, PF and traditional endowment policies. Kumar says he is averse to taking risks, but doesn’t realise that his investments still carry an interest-rate risk. And in the current circumstances, when inflation is raging at over 11% and interest rates are close to 10%, that risk is at its worst. After we told him how inflation erodes the purchasing power of investments over time, he realised how his bank deposits were giving him a negative return in real terms.

Kumar began investing in equity mutual funds only this year. He put Rs 12,000 in one fund in February and started SIPs worth Rs 4,000 in three others in April. As luck would have it, the stock market crash has wiped out almost 25% of his investment value. Unfazed, he now wants to go in for tax-saving mutual funds. We suggest he take the SIP route to average out his costs.

But Kumar’s risk-averse nature has one positive spin-off. He has insured himself for Rs 20 lakh with two policies. One is a basic term policy which covers him for Rs 15 lakh at a premium of roughly Rs 4,000 a year. The other is a costly traditional endowment policy which charges almost four times the premium (Rs 14,567) and gives only one-third the cover (Rs 5 lakh) extended by the term plan. He should also consider taking accidental death and disability cover, which is cheap and infinitely useful.

Since his ageing parents and brother are dependent on him, Kumar should also consider taking health insurance for his family. There’s no need for this if his company offers the benefit to its employees and their families. (For more on Kumar’s portfolio, see box overleaf) Both Yadav and Kumar need to change their investment strategies. While Kumar needs to develop a stronger appetite for equities, Yadav needs to control his urge for risky investments.

Yadav also needs to rejig his mutual fund portfolio. Iris says he should continue, even enhance his SIPs in Fidelity Equity as well as in Fidelity Taxsaver and HDFC Taxsaver, the two tax plans in his portfolio. He should stop the SIPs in other funds and start one in the HDFC Midcap Fund. The Rs 3,000-4,000 that he invests in stocks should also be ploughed into mutual funds. Yadav should consider low-cost index or exchange traded funds.

These and several other changes are crucial if Yadav wants to achieve the huge financial goals that he has set for himself. His son’s higher education and marriage, for instance, are going to cost him Rs 8 lakh and Rs 5 lakh at today’s prices. He wants a retirement corpus of Rs 1 crore. There’s also a new house worth Rs 60 lakh on the shopping list. And the icing on the cake is a world tour for Rs 15 lakh. Assuming that he takes a loan worth 80% of the value of the house, his goals still require him to save Rs 39,166 every month. An impossible task, given his current income.

Here’s where Yadav’s most crucial investment comes into play. He is studying business management and expects his income to take a quantum leap once he completes his MBA. As this magazine has reiterated time and again, your career is one of the most stable and rewarding investment options. So, while the Rs 39,166 he needs to invest may seem impossible today, a few years down the line Yadav may actually be able to save more than this amount every month.

Insurance is another gaping hole in Yadav’s financial planning. His four policies are not giving him adequate cover. Yadav should take a term insurance cover of at least Rs 20 lakh, which will cost him about Rs 5,700 a year for 30 years. He should also consider an accidental death and disability cover, which is significantly cheaper: Rs 1,200 a year for a Rs 10 lakh cover.

Yadav also has a fixed-rate home loan which he had taken four years ago. About Rs 4 lakh is still outstanding on the loan and he is keen to prepay the amount. He plans to keep Rs 2,000 aside every month and make prepayments every six months. There’s no financial logic to this decision, just old-fashioned sentiment. “I want my property to be freed from hypothecation as soon as possible so that it can be in my name,” he says. A word of advice: after factoring in the tax benefits, his home loan is at an effective rate of only 5%. In these times of high interest rates, Yadav should invest his surplus in an FD or a fixed maturity plan than use it to prepay a low-cost loan.

When safety is a risk

Sanjay Kumar
Name: Sanjay Kumar

Age: 26 years

Monthly income: Rs 28,000 (post tax)

Financial dependents: Three (parents and brother)

At a time and age when he should be greedy, Sanjay Kumar is fearful. The 26-year-old software engineer puts a large chunk of his income in debt-based instruments. “I am a novice when it comes to stocks, so I invest in safe options,” he says. But in doing so, he has let go of an opportunity to create long-term wealth through equities

Asset allocation (%)

Financial goals 

 PresentSuggested Time horizonFuture costInvestment needed/month
Equity1080
House7 yrsRs 7 lakhRs 16,500
Debt8015Retirement24 yrsRs 2.75 crRs 13,000
Cash10
5Inflation assumed at 8% and returns on investments at 15%

Mutual funds: The SIPs are not in the best performing equity funds. Invest in diversified equity schemes and index funds for stability of returns. Choose schemes on the basis of their long-term performance.

Tax planning: Avoid investing in NSCs, PPF and insurance policies for saving tax. Instead, use ELSS schemes to achieve long-term goals as well as save tax under Section 80C. Iris says the current SIPs in SBI Magnum Comma, SBI Magnum Contra and SBI Balanced should be stopped and investments started in Templeton Taxshield, HDFC Taxsaver and ICICI Pru Tax Plan. These funds have a large cap bias and are therefore safer than most other tax plans.

Insurance: Reasonably well-insured with a cover of Rs 20 lakh. Continue with SBI Life term plan that gives an insurance cover of Rs 15 lakh for about Rs 4,000 a year. But consider turning the traditional LIC policy into a paid-up policy.This means the life cover continues but premiums stop.The company will deduct the life cover charges from the policy corpus.However, this is possible only after three years’ premium has been paid.

Retirement: Keep monitoring your retirement corpus and tweak the equity-debt ratio whenever there is a spike or a slump in the stock markets.

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