The ‘I’in investment

Publication: The Times Of India Mumbai; Date: Nov 20, 2007;    Section: Your Money;   Page: 40

Your role in planning your money doesn’t end with becoming a bank’s ‘gold’ client. Only you know your goals, liquidity needs, and risk profileLIFE has been good to Ravi Subramanian, 39, and his wife Meena, 37. They are flying high in their careers, they have a charming daughter, a lovely home, and no liabilities. Money is not in short supply in the Subramanians’ lives, but there’s just one little problem: it needs to be managed rather differently to meet the family’s goals.

When I first met Ravi and Meena, I learned they were “gold” clients in a couple of private banks. With simple faith in the terms banks use to describe their service, the Subramanians for long believed they were being offered comprehensive wealth management services. But then Ravi called me a few months ago, to make an appointment and review his and Meena’s finances.
We met, and were going over their finances, when Meena asked me about a particular insurance plan, “What do you feel about this policy?” I asked her how
much cover the policy would provide, and she had no clue. So I asked her the reasons for choosing such a product. Meena said, “I was initially told that this policy will deliver fantastic returns. But now our relationship manager says that since the investments were in debt and not equity, returns will be much lower.” I gently said that the product was essentially a debt product, and that the returns the couple had been promised were impossible in the first place. Further, it was an endowment plan, and there was no way to switch to equity.
Sensing a larger issue was at work here, I asked the couple a simple question: “How do you make decisions in personal finance matters? Are they based on one simple thing called returns?” Meena answered in the affirmative.
N ow, there’s no onesize-fits-all formula in personal finance; returns are only one part of the puzzle. I told the Subramanians that people often mistakenly assume information and knowledge are the same thing, and underscored the importance of taking into consideration other imperatives: liquidity needs, product suitability, asset allocation, risk tolerance, one’s overall situation, and, of course, good old peace of mind.
We then discussed the Subramanians’ goals. Firstly, they wanted to ensure a posttax retirement income of Rs 75,000 per month in today’s rupees. Secondly, theywanted to provide Rs 50 lakh for the education of their daughter, Reena. Thirdly, they wanted to ensure a corpus of around Rs 1 crore to enable Meena to launch her own venture. And they wanted to fund the education of five underprivileged children every year.
Financial assessment
We made a detailed assessment of the Subramanians’ cash flow and net worth (see tables), including insurance policies, investments, and tax returns. We found they had a solid cash flow, and it hadn’t taken them long to pay off their home loan—just eight years. Although they had got a good rate on their home loan, Ravi was uncomfortable with living in debt. The couple were saving almost 54% of their gross income, but not in the most productive of investments. They tended to accumulate huge sums and then pick financial products in an ad hoc fashion, based on what was new on the market at that point in time. Most of the Subramanians’ investments were in fixed deposits and insurance policies. They had also put some money in mutual funds and stocks, and a little in the Public Provident Fund (PPF). Their Employee Provident Fund (EPF) account had recently started up, since they had encashed their EPF after a job change, to pay for renovations on their home and an overseas vacation.
PPF bias
For some strange reason, Meena and Ravi believed the Public Provident Fund was a useless investment, because it gave just 8% returns. They felt insurance policies were better, because they not only saved tax, but also yielded higher returns.
I pointed out to them that PPF was, in fact, one of the best instruments available to people in the highest tax bracket in the debt space. I suggested they each make the maximum possible contributions to PPF at the start of every year. Returns there are compounded, while an endowment policy only yields simple interest on the face value of the policy.
There’s no way their endowment policies would yield higher returns than a PPF, unless the rate of return on PPF were to suddenly drop to around 3-4%, for some reason.
Risk and reality
The couple had several fixed deposits in the portfolio, which were earning 7% interest and were, in effect, losing money. Besides, they had around 20 stocks and 16 mutual fund schemes, with about Rs 20,000 in each. Ravi and Meena both were growth-oriented investors and their objective, besides the specific goals discussed above, was to grow their wealth so that they could actively support and participate in philanthropic activities.
Their overall portfolio was in complete contrast to their risk behavior and
capacity. It appeared as though nobody had advised them on these areas, except to sell them a few irrelevant and expensive insurance policies, nor had they themselves taken the initiative to think things through. Their focus had been single-minded: returns.
The Subramanians had good medical insurance cover from their employers, in addition to some cover they themselves had bought some years ago.
Investment strategy
We drew up a comprehensive investment strategy, of which the highlights are below. Considering the stability of their income and strong cash flows, we set aside around three months’ expenses as a contingency fund. Besides, we kept around Rs 10 lakh as opportunistic cash.
We then trimmed the equity portfolio to around eight stocks and eight mutual funds, with a bit of shuffling to make each investment more meaningful. The couple had good blue-chip stocks such as L&T and Reliance, so we increased exposure in those. We also added six new stocks and mutual fund schemes. We invested in a staggered fashion, and were able to take advantage of the fall in the market.
We started monthly and quarterly Systematic Investment Plans (SIPs) in the mutual funds and stocks that we identified, and decided to build on our existing positions at every 5% fall in the market. This would ensure that the surplus cashflow would not just lie idle, but would be deployed productively when opportunities became available.
In terms of life insurance cover, our assessment was that Ravi and Meena did not need much, considering they had accumulated sizeable assets, had no liabilities, and each would additionally be inheriting property from their parents. So we advised them to consider encashing some of their non-performing and irrelevant policies.
We then consulted with an estate planning attorney, and discussed whether Meena and Ravi should set up a trust for their philanthropic aspirations, and create a will for the distribution of their assets. I then left them with a thought of the great philosopher Confucius: “If a little money does not go out, great money will not come in.” Ravi thought about this and seemed to appreciate the message: that when you make a mistake and lose money in the process, it is important to correct your course and go down the right path.
Amar Pandit is a Certified Financial Planner and
Director, My Financial Advisor

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