You may be a wizard in financial planning for your company. But have you plotted the path to a financially secure retirement? Phani Kiran Karra walks us through the intricacies of planning a secure old age.
“Time is more value than money. You can get more money, but you cannot get more time.” JIM ROHN
“If you do not find a way to make money while you sleep, you will work until you die.” WARREN BUFFETT
“If you must work for money, find a way to work and be happy. That is Financial Intelligence.” ROBERT T KIYOSAKI
Long term financial and retirement planning has become an essential requirement in everyone’s life. It has become more so with an increase in the health risk due to lifestyle disorders and environmental pollution. Technological advances in medical field are providing adequate protection and cures to new set of lifestyle diseases; however, they come at an alarming cost as well. Hence, inadequate financial resources during working life and post retirement can create havoc in one’s lives. Based on my experience and understanding, I have outlined in this article a financial and retirement roadmap that one needs to consider during their working life and it helps if one gets an early planning and investment start to leverage the power of compounding and time value of money.
Current cash flows, investments and a detailed financial analysis
• One has to understand and analyze their current income streams, expenses, investments and liabilities either on their own or with the help of a financial advisor. This is nothing but the preparation of a running cash flow statement and a balance sheet consisting of assets and liabilities.
• It is very important to understand current sources of income, which may be 100% or predominantly from salary and the saving potential possible. There are no rules to decide what saving ratio is good but generally a minimum of 25 per cent saving from the earnings is recommended, which can help in building a good long term investment portfolio.
• Current investments if any needs to be analyzed in terms of their nature, duration and how they fit in with the ideal investment portfolio more described below.
• The financial analysis of the current family situation, the financial spending habits of the family, their future requirements form an essential base for deciding the saving potential, investment options and formulating a financial planning template.
Identifying long term goals and financial requirements
• Holding a longer time-frame helps decide on the required long-term financial goals which helps in deciding on the ideal and balanced financial investment strategy.
• It helps to define short-term, medium term and long-term goals and put it on a piece of paper. Children’s education and marriage and funds needed for the same are long term and have to be planned accordingly with investments starting very early. Pilgrimage travel can be considered as medium term goal. Buying a car can be a short-term to medium term goal. Once the goals are clearly identified, it becomes easier to formulate a strategy which can help in achieving most of those goals by investing smart and early.
• On reflection, it is easier to look back and see how the years have passed, what investments were done and what opportunities were missed out. It is easier to think that had we invested INR 1-2 lacs immediately after college in real estate, in 15 years’ time, there would have been very good appreciation. It is easier to think that had our father invested in real estate in his early working days, we would have been richer by now. But, alas, are we thinking the same for our children? Are we doing the right investments for long term and are we carrying enough patience to actually invest and wait?
• Right, balanced thinking with a long horizon is the need of the hour. Whatever is one’s current situation and whatever be the stage of the career one is in, one can still apply the principles outlined in this article and match their short/medium/long term goals (which are like creating those assets) and invest accordingly for the said periods to reap maximum returns over time.
Creating an ideal investment portfolio
• Balanced Portfolio is generally considered as ideal. Balanced portfolio is a portfolio which balances both the return and risk from a long term perspective and generally can include diversified asset classes to weather all kinds of market environments spread over a long period of time. The objective of creating a long term balanced and diversified portfolio is to minimize risk and increase return. In times of market downturns, if possible, one can look at increasing the exposure to equity so that they can generate an enhanced return on those additional investments. History suggests that after land, equity as an asset class generates the next highest return over a long period of time. It means that opportunities for generating very high return exist during market downturns. If one can utilize these opportunities on an active basis while passively investing in the market through mutual fund SIP’s, the incremental return can be lot higher than the average return.
• Balanced portfolio is generally considered ideal because the investments are diversified and the inherent risk on the overall portfolio is reduced. If one asset class is not doing well, the same may be offset by another asset class doing well.
• The ideal asset classes can include bank fixed deposits, balanced mutual fund SIP’s, stocks, Jewelry, Land, Property, Insurance, PPF etc.
• Obtaining a right portfolio mix may be not be possible, but the idea is to be as diversified as possible while creating a matching balance between investment periods and time-bound goals.
Identifying gaps in relation to ideal investment portfolio
Gaps always exist between an ideal investment portfolio and the current one being followed. Gaps could be:
• Not having awareness about ideal and balanced investment portfolio.
• There is no current portfolio or what is available is randomly done without any careful thought.
• Mismatch between investment and goal durations.
• Not having a long term perspective at all.
• Blindly following someone else’s footsteps. Each person’s understanding and circumstances will be unique and most times copying someone else’s strategy can backfire badly.
• Last but not the least is investing in good products for long term but not having enough patience to hold onto the investment. Utilizing long term investment (both profits and capital) for short term uses is a cardinal sin in the investing world.
Formulating short-term and long term financial investment strategy
There can be several ways to formulate short-term and long-term investment plans. A basic understanding of the options available, their evaluation both for short-term period and long-term periods, the current allocable surplus can help in devising a bare minimum strategy to start with. There is no order to what options to choose from, how many to do. It depends on the surplus available now, recurring surplus possible year on year, risk taking ability. But, always it helps to start small with some SIP’s and build onto it year after year. Given below are few options starting with an assumption on the saving ratio.
• Keep a savings ratio and always save portion of earnings as per the decided ratio. For eg., saving a minimum of 25 per cent of monthly earnings.
• Keep minimum amount of idle cash and keep some contingency fund in short-term fixed deposit or liquid mutual fund.
• Invest in long term equity/diversified/balanced mutual fund SIP in the name of children. Different funds for studies, higher education, marriage etc.
• Invest in Recurring deposits to fund short-term goals of 1-2 years. RD’s provide a slightly higher rate of return than a normal FD.
• Utilize PPF limits to invest. This is purely for long-term.
• Park some amounts for emergency/contingency needs.
• Opt for Voluntary PF at the work place, always transfer PF post a job change. Let the corpus accumulative over time and generate a decent tax free return over a long period of time.
• Take medical insurance. One should have mediclaim, critical illness and term insurance.
• Invest in land (not apartment) at-least twice over a 20 year period to obtain the benefit of appreciation in land.
Use of debt
One always wonders whether to take debt or not for investments on house or land or car. Simple rule of debt is that one has to keep paying interest over a long period of time. Most of the current working generation is living on EMI’s only. While it is a good thing that credit is easily available these days, the burden of EMI’s over a long period of time can put oneself into an undue stress. Hence, it helps to have a clear plan of retiring the loans early. A key principle to follow is not to have too many EMI’s simultaneously and that the portion of EMI’s do not cross 50% of the net salary, leaving still some scope for other investments.
In my own experience, debt has been a great motivator to work and clear the loans faster. No debt on the personal Balance Sheet can act as a key motivator not to work and explore other things that life has to offer. It is an individual choice to make, but prudence has to be exercised in either scenario.
Dos and don’ts of financial investment
• There is no such thing as perfect time or perfect money. Now is the ideal time and even small amounts matter. One should be consistent and increase as and when their cash flows permit.
• There is plethora of information and multiple investment products available in the market. Focusing on trying to find the best product and the best return is never an optimal strategy.
• Avoid investments based on unclear assumptions and unreasonable expectations, most likely they may become counter-productive.
• Avoid hyped, over marketed and high return investment products
• Keep cool and stay put when market is in downward direction.
Some examples of bad financial strategies in general
• Keeping cash at home and idle money in bank account
• Not saving money and spending all earnings
• Not having insurance
• No investments in Land
• Excessive use of credit card and paying high interest
• Hand borrowings at high interest rates
• Pledging jewelry to borrow loans at high interest
• Hurried investing in March to save tax.
• Withdrawing PF money with every job change. Currently, withdrawals are restricted for certain purposes only. But, holding PF till retirement is the best form of investment as it generates a tax free surplus which can be considerable.
Some examples of effective long term financial investment strategies
• An investment of Rs 5,000 per month for a 20 year period in a balanced mutual fund SIP can generate a long term surplus of Rs 3.8 million based on a very conservative average equity return of 10 per cent. Long term average equity returns can generate a higher return as well.
• An investment of Rs 5,000 per month for a 20 year period in a standard Recurring Deposit (auto renewed) can generate a long term surplus of Rs 2.3 million based on a post-tax average interest rate of 6 per cent.
• A one-time investment of Rs 1 million in long term equities can generate a surplus of close to Rs 10 million based on average return of 12 per cent.
• A one-time of investment of Rs 300,000 in land in a good and developing locality can easily appreciate between 5-10 times or more over a period of 20 years.
When held for a long period of time, investment in land in a developing area can give a very high appreciation.
• Investment in PPF and utilizing yearly limit. An average tax free return of 7.5 per cent and an investment of Rs 2.25 million over 15 years can generate tax free surplus of Rs 4.2 million. If invested in spouse name also additionally will generate an overall surplus of Rs 8.4 million at the end of 15 years.
Simple yet effective strategies for implementation
• Think Long term, be patient = leverage power of compounding.
• Financial discipline = be consistent, be consistent and be consistent.
• Match short term needs to short term investments, long term needs to long term investments. Avoid asset liability mismatch.
• Start early, but it never is too late.
• Invest long term assets in the name of children.
• Minimize tax outgo. One idea is to invest in the name of both the parents where possible.
• Regularly monitor and review portfolio performance.
Conclusion & Key takeaways
Long term financial and retirement planning is an important aspect of one’s life and the same has to be given due importance and emphasis. It is imperative that one has to allocate good amount of time for this purpose, take assistance when required and ensure that their families are safeguarded by adequate financial health in their lifetime. Below is a quick summary of the key perspectives to hold and implement in action.
• Idle cash is a bane. Save and invest has to be the mantra.
• Make money work for you by being a smart and long-term investor.
• Invest in tax free products. Return may be less, but it is safe and for long term.
• Keep regularly exploring possible investments in land. Early is better, early in terms of one’s life cycle and also early in terms of the particular investment option.
• Avoid asset liability mismatch.
• Maintain financial discipline by being regular and consistent.
• Avoid taking debt for meeting expenses.
• Have adequate insurance both for self and family, be it mediclaim or term or critical illness.
• Lastly, avoid emotional decision making.
About the author:
Phani Kiran Karra is CFO at Talocity Instasolutions Pvt Ltd.