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Saving for multiple goals?

Devang Shah | November 21, 2005

Got a question about your money? What you should or should not do with it?

Our expert Devang Shah has the answers.

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I am 28 year-old IT professional.

Monthly income
Rs 29,000, expecting a 20% hike per annum.

Investments
Insured for Rs 8,00,000 and paying Rs 48,000 per annum. They are for two LIC endowment policies for 20 years.

I am also planning to save Rs 15,000 every year in my Public Provident Fund account.

Expenses
I service a company loan at Rs 7,500 every month. This will end in March 2006.

I have to pay Rs 2,00,000 which was incurred as debt of the family business.

I have to help my parents and my three siblings who are studying. This sets me back by around Rs 12,000 every month.

Besides, I also have two children of my own, aged four and less than a year.

1) Should I take one personal loan of Rs 3,00,000 for five years and repay all my debt?

2) How must I invest for my children's future?

3) I would like to retire from my job at the age 42 year and start my own business. How should I plan for this?

- Mike A

Hi Mike!

Consolidating your loans

Are you able to take the personal loan at a lower rate of interest compared to your current debts?

If yes, then by refinancing your debt (taking the personal loan to settle all the other loans) you will reduce your interest burden.

If not, which is more likely to be the case, then you are unnecessarily increasing your total interest outflow.

If you want to take one single loan to consolidate your loans or reduce your monthly outgo on loans (by spreading it over a longer period), it might not be a good idea for many reasons. The most important being that you are the sole breadwinner in your family. It is financially more sensible for you to have less loans.

However age is on your side, which is a positive.

Read Get out of debt, NOW! to figure out how to prioritise your loans

Investing for your children

Since your children are very young, and you probably need to save up mainly for their higher education, you could actively consider using equity oriented mutual funds to start saving for them.

A couple of points on that front:

1. I like the children's plans that HDFC and Prudential ICICI mutual funds have. Do take a look at them.

2. I often find that, like most other investment plans from insurance companies, children related investment products from insurance companies can be expensive. So before buying one, I would strongly recommend getting independent, competent, fee-only, advice on that.

3. We do not have gift tax and estate taxes in India. So, it might work well for you to save up and invest in your name and transfer it to your children at an appropriate time.

4. At the current stock market levels use broad diversified funds, Equity Linked Saving Schemes of mutual funds, value funds and even some debt floating rate funds to manage your risk better over a period of time.

Broad diversified funds are those that invest in the shares of various companies across various sectors. ELSS are mutual funds that give you the tax benefit under Section 80C.

Value funds are those in which the fund manager looks at the fundamentals of stocks and invests in them, irrespective of whether or not other fund stock market players are bullish on them. Theoretically, the fund manager would not mind picking up a stock that the market hates, if he finds value in it. Similarly, the fund manager would not touch a hot favourite of the stock traders if they do not believe it is a good value proposition.

Templeton India Growth Fund and Prudential ICICI Discovery Fund are supposed to be value funds. Value funds, due to their structure, are expected to be less volatile than other equity funds.

Debt floating rate funds are those that invest in fixed-return investments which have a floating interest rate and not a fixed interest rate.

Plan your expenses to be able to set up your business

Here again you have a reasonable time horizon to be able to plan for raising the capital needed to fund your business as well as your personal expenses during the time that your business might not generate profits (gestation period).

Some of the avenues suggested above would remain applicable here too.

I sense that there are two areas of concern from a financial strength point of view:

Retirement planning

Most people think of that as too far an event to plan for. Others mistakenly give it a low priority.

Retirement funding is an important goal which only you will provide for (unlike, for instance, children's higher education which could be funded by the children themselves). Also planning for it early on makes it that much more easier to accomplish.

Insurance

You have too many people dependent on your earning ability. You need to buy an adequate term insurance cover. You will be surprised with how cheap it can be and how much of a protection it can offer in an eventuality.

It is also very important to view the interrelatedness of all the above. Your retirement, your entrepreneurial plans, your children's future and your debt are all interrelated for the simple reason that your money has to be allocated to all of these. That means trade offs.

What you need to do is the following:

1. Put down on paper how much money you will need for each of these in today's prices

2. Prioritise these goals in terms of importance of achieving them.

3. Calculate the inflated amount of how much money you will actually need when these events happen. Let's say you need to save Rs 2,00,000 to set up your business 14 years later and you take inflation at 5% per annum. Inflating Rs 2 lakh by 5% per annum will mean about Rs 4,00,000.

4. For events that are going to happen more than 7 to 10 years later, you can use equity related, diversified portfolio. Investing for events which need to be funded in the next 5 years need a derisked portfolio largely consisting of debt oriented investments.

5. Calculate how much you need to save and invest at a reasonable rate of return, to achieve these goals.

6. In case the goals look tough to achieve, then consider what changes you can make in terms of the timing of these goals or amount of funding required to make them more achievable.

Hope that helps.

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Illustration: Dominic Xavier

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