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Juvenile investing

Our portfolio experts suggest that Gurgaon-based Bhanu Sharma must plan his investments and increase equity exposure. Read on to know all about Sharma's portfolio.

Print Edition: April 3, 2008

Bhanu Sharma with family
Bhanu Sharma with family
Age: 29 years
Monthly income: Rs 59,300 (post-tax)
Financial dependents: Four

Click here to see Sharma's portfolio analysis

Come 23rd or 24th of every month and I have hardly any money left in my bank account,” says 29-year-old associate general manager Bhanu Sharma. Not that he doesn’t earn well. Sharma has a monthly income of Rs 59,500 post-tax. He just doesn’t plan well. Admits Sharma: “I spend more than I should.” Routine expenses and his car loan EMI gobble up nearly 70% of his income. Indisciplined spending apart, Sharma is also a bad investor. He has been working for four years. But he started investing only in 2007. We have often explained how the power of compounding can multiply savings. Sharma lost out on three precious years of wealth creation.

Though hardly worth emulating, Sharma’s financial habits and approach to investing would strike a chord with several Indians who unlike him are good savers, but like him are bad investors. Read on for more dos and don’ts from this financial health check-up. Sharma’s choice of investments do not align with his financial goals (see table on following page). He has bought a bunch of Ulips to save tax. But these investments have a three-year lock-in period and won’t be of much use when he goes about buying a house in the next two years. The Ulips give him an insurance cover of Rs 22 lakh—not enough for this sole bread winner of a family with four dependents. His only mutual fund investment— Rs 30,000—are in two ELSS funds.

Sharma has recently started dabbling in stocks. He has invested Rs 70,000 in four stocks including, Larsen & Toubro and Infosys. “The markets were down and I thought it was a good time to buy,” he says. Though the rationale is correct, a novice like Sharma should not take such risks. The only other investment is in jewellery worth about Rs 2 lakh.

Don’t just save, invest

Sharma wants to build a bank balance of Rs 10 lakh in the long term. He would earn more if he keeps the target at Rs 1 lakh and invests the rest in mutual funds. Here’s how:

• Monthly investment required to build corpus of Rs 10 lakh in 10 years at 3.5% returns: Rs 7,500

• Emergency fund required: Rs 1 lakh (equal to nearly three months’ expenses)

• Time required to build emergency fund by investing Rs 7,500 every month: 1 year

• Rs 7,500 invested every month for 9 years in a mutual fund that earns 15% annualised returns earns: Rs 16 lakh

• Total corpus in 10 years: Rs 17 lakh

• This is Rs 7 lakh more than what Sharma has intended to accumulate in the same time period

Sharma’s financial goals are an extension of his naïve investing strategy. In the short term he wants to build a bank balance of Rs 1 lakh. He also intends to prepay the Rs 4.67 lakh car loan. His long-term goal is to stash away Rs 10 lakh in his bank account. The logic: “Cash gives me security. I know I can withdraw money any time I need it,” says Sharma. A debt-free house is also on his radar. Given Sharma’s approach to finances, our prescription is a preliminary one, aimed at brining in some discpline and consolidation.

We would be happy to do a thorough financial health check for him six months after he implements our suggestions. He must change his plans of building a corpus of Rs 10 lakh in cash. Money idling in bank accounts earns only 3.5% interest, while consumer price inflation is running at over 5%. An emergency fund equal to three months’ expenses combined with liquid investments such as mutual funds is an ideal strategy.

Though his approach to finances is deeply flawed, there is one positive sign—Sharma knows he is going wrong. His investing strategy needs to be completely overhauled. There are tough decisions to be taken. But we think they will be beneficial in the long run.

The first step of financial planning is budgeting. Without disciplined expenditure it is impossible to generate a reasonable surplus on a sustained basis. Other than his rent and car loan EMI, Sharma spends about Rs 27,000 every month.

Sharma must cut back on discretionary expenditure now to increase his investible surplus. He should also consider stopping further investments in at least three of his four Ulips after three years. The corpus should be enough to give insurance cover for some years.
This would free Rs 5,750 every month in addition to his current surplus of Rs 9,450. Sharma can continue with the HDFC Unit Linked Young Star Suvidha policy. After a few more payments, in case of his untimely death, the company will invest on his behalf to fund his child’s education. We suggest Sharma invest his entire surplus in equity diversified and balanced mutual funds. If he is not keen to take on too much risks, Sharma could also consider investing in debt funds which give higher returns, are more liquid and attract lower tax than fixed income options such as fixed deposits and bonds.

Among equity diversified funds, Value Research suggests he choses from Reliance Vision and HDFC Equity. Some good balanced funds are HDFC Prudence and DSPML Balanced. He should invest in ELSS funds with a good track record such as Magnum Taxgain. To ensure that his fund investment do not suffer due to his splurging habits, Sharma can opt for systematic investment plans (SIPs).

In the next two-three years, Sharma plans to buy a house worth about Rs 50 lakh. But currently he does not have the funds even for the down payment of a home loan. He should postpone this goal by another five to six years. To increase his insurance cover, we suggest Sharma buy a term plan of Rs 30 lakh for 25 years. The annual premium would be about Rs 11,000. He should also buy a family floater health insurance policy of at least Rs 5 lakh.

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