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How to plan your finances through life
Archana Rai, Outlook Money | July 19, 2006
You see them everywhere. In malls, multiplexes and restaurants in every city. Demanding the latest gizmos, the most expensive wines, the most fashionable accessories... They belong to the 300-million-strong mass affluent population, and their motto seems to be 'have money, will spend.'
And that's visible in the record growth in the country's economic indices. It's visible in the fact that 47 commercial banks recorded an increase in retail lending from around 13 per cent in 2001 to almost 41 per cent in 2005. In fact, retail loans account for some 70 per cent of ICICI Bank's portfolio. Over the same period, SBI has reported a two per cent drop in corporate loans.
This is not something confined to the metros; according to RBI estimates, consumer durable loans in rural areas went up from 19 per cent in 2001 to 27 per cent in 2005. All of which points to the fact that across the country, the newly minted mass affluent class is earning enough to borrow and spend on what were hitherto considered luxury goods.
But simply because you are earning a lot and are in a position to spend does not mean you should ignore financial planning. Outlook Money examines the money imperatives at three points of an individual's lifecycle to develop a financial strategy in a time of affluence. This can serve as a roadmap to managing your money in these exuberant times.
Starting out single
This is the stage when you've started earning and are also spending recklessly. Typically, this group consists of 21-29-year-olds. Says certified financial planner Gaurav Mashruwala: "It is crucial in this stage to strike the right balance between spending on current pleasure and saving for future costs." While spending is not barred, this is the time when cash in hand must translate into a solid financial foundation. Money earned should be channelled into building a long-term corpus.
Create an education fund. It's your first job and you simply must have that swanky new mobile phone. And the latest iPod. And... Before you start splurging on gadgets and gizmos, keep some of your money aside to fund further education.
Because there's a very real possibility of being left behind in a knowledge-based economy if you don't constantly upgrade your skill sets. As this money is for short-term expenditure, ensure that you manage risk adroitly.
For instance, if your horizon is two-three years, invest in a debt:equity ratio of 75:25. Park this crucial corpus in a fixed monthly plan that currently yields 8-9 per cent return. If you have a five-year horizon, increase equity to 50 per cent.
Rein in spending. Remember to spend from profits from investments, not income. Typically, living a credit-fuelled life means you are leveraging your future income. Once that leveraging extends beyond the classic rule of thumb that EMI (equated monthly instalments on loans) must be below 30 per cent of your net take-home salary, it's time to cut down spending.
Build real assets. You've got your study corpus going, you've allocated a certain amount for non-discretionary spending, and you're paying all your regular expenses. If you have an investible surplus after this, take a home loan.
You not only buy a tangible asset, you get an extended window of up to 30 years to clear the loan, while, ideally, you should be retiring the loan earlier. And set aside some money for your retirement plan. Adds certified financial planner Lovaii Navlakhi: "It's not too early to start saving for retirement even at 25."
Insurance. If you don't have financial dependants and if your liabilities will not devolve on others, you really don't need insurance now. Ideally, wait till you're married before you take life insurance. However, medical insurance is essential at all stages of life. Says Navlakhi: "If you want to invest any surplus funds in a long-term product, you could pick a whole life policy or pure term loans for specific liabilities."
Expenses are high, matched by the outflow of investments. Though your income could be healthy, this is the time that your portfolio requires careful handling. Says Srikanth Bhagavat, CEO of Hexagon, a wealth management company: "This is a time when, if the roadmap is drawn, it takes execution for the rewards to come in."
Insurance. Protection, protection, protection. This should be your mantra at this point in life. Your insurance cover should be large enough to enable your family to live comfortably off the interest on the corpus amount in the event of an unforeseen occurrence.
Financial planners say if you earn Rs 10 lakh (Rs 1 million) a year, buy an insurance cover of Rs 1 crore (Rs 10 million). But remember, you need to have bought insurance by the time you turn 40 if you want to build a cost-effective risk cover.
Financial planning. Writing down your goals in consultation with your partner and then adopting a structured method to reach them is vital in the mid-career stage when expenses shoot up.
Says Navlakhi: "If you have articulated your money plan, then it is easy to prioritise." Once you bring in some method to money management and once you identify your goals, it becomes far easier not to splurge on a fancy plasma TV and to save for your child's college education, instead.
Asset allocation. Fine-tuning your portfolio is vital at this stage. This is the time when you need to constantly track the impact of external environment changes on your money. For instance, if profits of Rs 200,000 are shaved off from your corpus of Rs 10 lakh (Rs 1million) due to a market slump, you must examine your equity-debt allocation. Says Bhagavat: "As long-term goals are crucial at this stage, diversifying across asset classes is important."
Alter and adapt. Financial planning requires agility. For instance, parents typically keep a goal of setting aside Rs 3-7 lakh (Rs 300,000 to 700,000) for a child's education. But if you consider the effect of inflation and erosion in rupee value over the next 10 years, the real cost of funding Junior's education can shoot up.
Make room for changed scenarios in your financial plan. Adds Mashruwala: "The government controls the fees at top colleges at present, but costs may go up in the future if caps on college fees go."
Spending control. Says Bhagavat: "Don't stint on pleasure but make your profits pay for it, not your retirement corpus." That's sage advice.
This is also the time to make your children financially literate. Postponing spending decisions in a time-bound manner can teach them to handle money responsibly. Show them how profits on investments in a two-year time frame can fund a holiday abroad.
Bhagavat, for instance, told his children that they would have to wait a while to get a Basset Hound pup. The pup was bought finally from the profit he booked by selling an IT stock at a high value a week after buying it during a market slump.
These are often called the golden years, and so they will be if you've planned well and wisely. There are, of course, specific aspects of money that must engage you, including your tax plan, your health cover and income protection.
Growth-oriented portfolio. Bhagavat says, "Inflation is the real threat for senior citizens today." The challenge is to stretch income enough to provide for extended life spans. As equity protects against inflation, ensure that you have at least 30 per cent equity exposure in your portfolio by the time you are 55-60. Trim equity down to 20 per cent by the second decade of retirement and 10 per cent in the third decade.
Realign real assets. Mashruwala says, "Senior citizens will have to ensure that their net worth is not locked up in real estate." Investments in real estate in this stage should be geared to future needs. There is no point in building a four-bedroom house that lies empty in your later years and does not fetch you any returns.
Plan your taxes. Manage your maturing investments outflow by placing it in instruments like the Senior Citizens Savings Scheme and post office deposits. Says Navlakhi: "Even an increased outflow of Rs 20,000 in taxes in the retired years can mean a huge hit on income."
Healthcare. The focus on health cover should ideally begin early enough for you to be in fine form in later years. Says Mashruwala: "Pick up mediclaims for yourself and your spouse at least five years before retirement." More importantly, don't forget to pay the premium on time. A simple memory lapse can cost you your health cover in your later years, as companies can refuse to renew a policy.
Estate planning. Financial planners caution against bequeathing assets while you are alive. The idea is to chart out a legally foolproof will that will allow your inheritors to enjoy the proceeds once you are gone.
It sounds like a lot of hard work, but financial planning is actually easy. Just think of a future without all the luxuries you take for granted today, and you may find it easier to salt away some money regularly instead of splurging all of it. Spend, but remember to plan for the future as well.
Rekha Bagry 32
Ragasyama 35 & Srikanth Bhagavat 39
Kavita 62 & Vinod Nagpal 67