Frittering away potential

Pune-based Dhembares have the resources to build a large portfolio, but they must not be complacent and should take calculated risks to accelerate wealth creation.

Kamya Jaiswal | Print Edition: January 22, 2009

The Dhembare Family
Name: Paresh and Mitali Dhembare
Age: 35 and 29 years
Monthly income: Rs 67,000 (post tax)
Financial dependents: Two (son and Paresh's mother)

What can be wrong about using your past savings to finance the down payment of a home loan? If you want the correct answer to this question, don't approach Paresh and Mitali Dhembare.

Six years ago, the couple wiped out its investments to cough up Rs 3 lakh for the down payment of a Rs 10-lakh home loan for a two-bedroom apartment in Pune. Today, they seem none the worse for it. They have built a portfolio worth about Rs 5.2 lakh, which is not a bad start. Paresh (35) and Mitali (29) have age on their side. With disciplined investment, they should be able to reach their financial goals comfortably.

But what if things had not been so hunky dory? What if one spouse hadn't been able to work for a year due to an illness or an accident? Or if one spouse had lost his/her job? The couple had worked out the viability of the EMI of Rs 7,175 on the basis of their combined income. In the event of any such mishap, they would have been stranded with a cash flow that generated no or very little surplus and with no savings as a back-up. Worse, they might have been forced to a take a personal loan and found themselves in a debt trap.

A sound financial plan must have enough cushions for such unexpected, but not improbable, events. This is why, despite the happy ending, we think that the Dhembare couple was wrong in depleting its savings completely to buy an asset which is very illiquid. They ought to have preserved a reservoir of at least one year's expenses to fund any exigency.

That's not the only mistake in their financial books; their cash flow also exhibits a similar complacency. Paresh, an area sales manager with a private bank brings home Rs 30,000 a month. He has taken an advance of Rs 5 lakh from his employer to buy a car. So Rs 4,000 is deducted every month from his salary. Mitali is a recruitment manager and has a monthly income of Rs 37,000. The couple spends a reasonable 21% of its income, Rs 14,000, every month.

Taking Loans: Dos and Don'ts
The Dhembares took a high risk for their home loan. Consider these factors to ensure you do not make the same mistake:
Purpose of loan: Ideally, you should not take a huge loan for buying a car or a consumer durable. But if you must, maximise the down payment.
Down payment: Do not use all your savings for this. You must have a reserve equivalent to one year's expenses to meet any exigencies.
Total EMIs: Your EMIs should not constrict your investible surplus to such an extent that you are unable to invest the amount that you planned.
Loan tenure: Try not to have a mortgage during periods of no income, say, after retirement or during a pre-planned sabbatical.
Loan rate: Compare the loan rates of different banks on the Web. If you plan to prepay the loan, look for banks that levy no or minimum penalty.

After deducting the EMI for their home loan, systematic investment plans (SIPs) of Rs 7,000, and the average insurance premium of Rs 3,375, the cash flow generates a monthly surplus of Rs 31,450. Where does this money go? Nowhere, as it rots away in the couple's bank accounts. With the inflation (CPI-UNME) for October 2008 at 10.4%, the money is actually eroding in value by 6.9%. This negates the good work of investing Rs 7,000 in equities.

Unfortunately, financial planning never works piece meal. All mini-plans must blend into one big strategy for you to reap the dividends. So our first advice to Paresh and Mitali is to be hands-on about their finances. They must invest their savings.

If they are still feeling lazy, the two should go through the facing page—they need to invest Rs 27,313 a month to ensure that their goals are fulfilled, excluding investment for the car and the house. Currently, they are short by over Rs 20,000.

With time, this gap will widen.

To make their money work harder, the two must focus on investing in equities. The couple has an average risk appetite and can go full steam with equity mutual funds.

Iris has consolidated Paresh's current basket of 13 funds (see Aiming for More). DWS Investment Opportunity, Kotak Opportunities and Sundaram BNP Paribas Select Focus have been shown the door as they have a narrow focus and invest in a limited set of companies. This increases their risk profile. So why has SBI Bluechip, which, as the name suggests, invests in blue-chip companies, also been booted out? Because compared with its peers such as the HDFC Top 200, the performance of this fund has been poor.

Instead of these four, Iris suggests that Paresh and Mitali invest their surplus in HDFC Top 200, DSP Black Rock 100, HDFC Capital Builder and ICICI Discovery fund. The first two funds are equity diversified funds which have been consistent performers and could form the couple's core fund investments. HDFC Capital Builder is a first-timer in the recommendation list and has won a place for being a good mid-cap fund. It will add some variety to the Dhembare's portfolio and has the potential to ratchet up returns when the good times roll. ICICI Discovery, another new entrant, finds favour with Iris as it invests in value stocks, which is a good strategy for markets that are going down or have stabilised.

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