# Misled by mis-calculation

September 19, 2008
 Name: M.K.Ganapathy and Sheeca GanapathyAge: 41 and 34 YearsMonthly Income: Rs 1,01,000 (Post Tax)Financial Dependents: Two

If Rs 20,000 invested every month grows at 15% annually, how much will you have saved in 15 years? M.K. Ganapathy says about Rs 3.5 crore. The right answer: Rs 1.34 crore.

Obviously, Ganapathy’s solution is way off the mark. But what’s in a calculation? Actually, quite a lot. For, on it rides this 41-year-old realty developer’s entire financial plan.

Ganapathy wants to retire early, as do most of us. The difference between him and the majority of people is that he has planned his finances to make this dream a reality. Therefore, he funnels Rs 20,500 every month in equity mutual funds in the hope of hanging his boots at 55 or 56 years with a nest egg of about Rs 3.5 crore.

But as we have already caluculated, he will not cross even the halfway mark with this strategy.

Worse, this is not Ganapathy’s only calculation error. He and his event manager wife, Sheeca, earn Rs 73,000 and Rs 28,000 a month, respectively. According to the figures he has sent us, the family’s monthly expenses are Rs 45,000. Another Rs 50,428 is devoured by the EMIs of a home loan and two car loans. If we add the couple’s systematic investment plans (SIPs) in mutual funds and the monthly average of their insurance premiums, the couple uses up Rs 1,17,179. This is Rs 16,179 more than their monthly income.

Bad arithmetic again? Yes, partly. The rest is sheer carelessness. When we rechecked with the couple, Ganapathy couldn’t identify the problem in their cash flow accurately. So he concluded that the family had spent less than he had reported.

We think the Ganapathys went wrong in averaging out their irregular expenses. These can be highly illusionary—you think they are too high or too low until you put them down in black and white.

One wrong calculation can change an entire financial plan. If Ganapathy insists on retiring as planned, he will not only fall short of his targeted nest egg, but will also be unable to meet other important financial goals, which can otherwise be within reach (see “Early Bird Disadvantage”).

Our first suggestion for him is to postpone his retirement. Even after incorporating a healthy increment in pay cheques, the family cannot afford the chief breadwinner to stop working after 15 years. This is heartbreaking news for Ganapathy, but it is better than finding out at 65 years that his corpus won’t support him any longer.

In January 2003, Ganapathy bought a two-bedroom apartment for Rs 19 lakh. The down payment of Rs 5 lakh was met by Ganapathy’s provident fund savings and stock investments. To fund the balance amount, he took a home loan of about Rs 10 lakh. The EMI works out to Rs 26,447. Ganapathy has also taken two car loans totalling Rs 10.07 lakh. One car loan and the home loan tenure will be over next year. This will free Rs 36,165 every month.

The Ganapathys are in a dilemma over how to use this money efficiently. As their children are growing, they feel the need to shift to a bigger house. Ganapathy does not want to sell the apartment that they currently occupy. So, should the couple invest in another apartment and use this money to pay its EMI? Or is it better to wait and invest the money in mutual funds?

Iris favours the latter strategy. The logic is simple: when they need to buy another house, the couple can withdraw the money from their corpus. An investment in real estate is not as liquid as in funds or stocks. Moreover, equities are likely to give higher returns than the rent generated by the first apartment in the period that Ganapathy uses this money to pay the EMIs of the home loan.

 MUST-KNOW CALCULATIONS To ensure you don’t slip up like Ganapathy, here are two calculations integral to a financial plan.Future cost of goals: This is how you calculate if you want to know the price of a Rs 5 lakh car after three years. Inflation assumed to be 6%.Future cost = Current cost (1+rate of interest)n= 5 lakh (1 + 6)3= Rs 5.95 lakh approxWhere n is number of years(You will need a calculator to do this)Returns on stocks: If you bought one share of a company in 2000 for Rs 25, and on 31 December 2007, you sold it at Rs 190, these are your returns:Absolute returns = Sale price minus Cost price/Cost price X 100= 190-25/25 X 100= 660%
The Ganapathys have a very aggressive asset allocation: about 93% of their financial assets are in mutual funds and stocks. Iris suggests that they continue with this investment spread for at least five more years. The couple’s provident fund contribution and the premiums of three endowment policies are adequate debt exposure.

If they decide to surrender the endowment policies as they are inefficient insurance schemes, investment in other debt instruments like fixed deposits and fixed maturity plans should be considered.

Ganapathy admits to repetition in stock exposure through the 14 mutual funds in his basket. This is a common mistake made by people who want to diversify fund investments. To remedy this flaw, Iris has pruned the collection to six funds. Fewer funds are easier to track and manage than a bloated portfolio. Ganapathy wants to add DSPML T.I.G.E.R to his collection. This is a good fund, but the final six that Iris has chosen gives him a similar stock exposure. Hence, he should avoid it.

Keen on direct equity, Ganapathy has invested about Rs 1.8 lakh (23.4% of his total equity portfolio) in shares of NTPC , Reliance Petroleum and Suzlon Energy. The problem is obvious: all three companies belong to the energy sector. If this industry takes a hit, Ganapathy’s stock portfolio will sink.

As he did not consider the conspicuously high concentration of stocks in one sector, we can safely assume that Ganapathy is not wellversed with market dynamics. He wants to distribute half his equity investments in funds and the other half in stocks. We do not think this strategy is sound. As we said earlier, his age does not permit him to experiment with his money to learn the tricks of stock-picking. So it is best for him to avoid the temptation to invest directly in stocks, and instead, choose mutual funds.

Insurance is another worrisome aspect of the Ganapathys’ plan. They have only three endowment policies that provide a cover of Rs 5 lakh for Ganapathy and Rs 50,000 for Sheeca. This is a dangerously low insurance cover. We suggest that Ganapathy immediately buy a term plan of Rs 75 lakh for 20 years. The annual premium will be Rs 40,350. If he delays this investment, the cost of insuring himself will steadily increase as he grows older. Also, with age, the couple’s medical expenses will shoot up. Therefore, they should buy a family floater health insurance policy for about Rs 5 lakh to reduce the burden on their savings.

Finally, about the asset that is Ganapathy’s ace—two plots of land in Mysore worth about Rs 1 crore that he will eventually inherit. This definitely reduces the pressure on his retirement corpus, but it isn’t enough to meet all his goals.

REVISITING PAST PATIENTS

 Sunil Kumar Dhavala, 36Financial dependents: Two

We do a quick check-up to monitor the health of our past patients’ portfolios

What we diagnosed
• Portfolio distributed well across all asset classes
• Bloated mutual fund portfolio
• Concentration of IT stocks

What we prescribed
• Rejig mutual fund portfolio
• Exit some IT stocks
• Spread emergency fund across savings and sweep-in accounts

What he did
• Exited Kotak Mid Cap fund and Magnum Multi-cap
• Sold stocks of Infosys and TCS
• Parks surplus in a sweep-in account to earn more than a savings account

What he didn’t
• Exit Franklin Prima Plus and DSPML T.I.G.E.R fund

Dhavala’s was one of the portfolios that was given a good rating by the doctor. By incorporating a majority of our suggestions, he has strengthened his strategy, and it should give him good returns in the long term.

"The advice helped me to cut losses as I exited information technology stocks just before the sector started its downslide."