Merely choosing investment products in accordance with your risk profile is not enough. Consider all your requirements before deciding where to put your money
Most people are concerned with buying the best investment products. Based on their style of investing, they categorise themselves as conservative, balanced or aggressive investors. But the problem with such a rigid classification is that investors end up looking for products to put their money, rather than taking a holistic view of their finances. This can create a rather skewed personal finance picture, and might be difficult to correct beyond a point. Let us look at two cases which can change for the better with a more comprehensive view.
Arun Deshpande wishes to invest Rs 20 lakh (Rs 2 million). He is 55 years old and has five years to retirement and would need the money then. He has been a very conservative investor and has always relied on fixed-income instruments like bank fixed deposits, postal schemes and Public Provident Fund as his main investments. He also has substantial investment in real estate.
Choose what suits you
- An all-debt portfolio may not suit everyone who is close to retirement
- Give up some assets if that can help meet other recurring needs
- Risk profile can change over time; be prepared for this
On the face of it, Deshpande's requirements look simple. Based on his risk profile, he could look at products like tax-free bonds, corporate bonds, non-convertible debentures, a mix of short and medium-term debt mutual funds, and so on. These would give him some income during the investment period in the form of dividends. At the end of five years he may get his money back with some amount of capital gains. This would fulfill his limited requirement, as he has outlined. But what about Deshpande's requirements beyond that of merely investing the money?
Deshpande's only dependant is his wife, as the couple don't have children. He owns the house they live in. Both he and his wife are currently in reasonably good health, but have had a family history of heart disease. He has a basic health insurance policy covering him and his wife for Rs 5 lakh. He also has a desire for philanthropy which would require some amount of regular income to sustain. Having worked as a consultant, he does not have retirement benefits due from any employer. Even though he has been a consultant and has no actual retirement age, he does not wish to work beyond a particular age.
The two key goals that Deshpande needs to look at are:
- Creating an income stream that can keep up with inflation and lasts for his lifetime
- Making health care provisions and meeting his philanthropic obligations
He should look at increasing this health cover or keeping a separate corpus for health care. His philanthropic goal will need additional income which he intends to continuously donate for a cause during his lifetime and beyond. For this he may need to look at setting a trust.
To create the income stream he will have to first see if his real estate holdings can generate sufficient rental income on an ongoing basis. As an alternative, he can look at a scenario of selling off the real estate holdings and investing in a mix of fixed income instruments and equity. Thinking of investing in equity might be a little difficult for him, being a conservative investor, but nonetheless the option needs to be explored in case there is a shortfall in income available.
For philanthropy, he can look at donating one of his many real estate holdings instead of looking at creating an income stream to donate a particular amount.
Besides these, there would be other issues that need to be addressed like writing a will, streamlining things so that his spouse can access and manage the wealth in his absence, and so on.
A more comprehensive investment advice for Deshpande, based on all his requirements would require investing the Rs 20 lakh corpus in equity investments as well. This will protect his wealth against erosion due to inflation and fulfill his life goals.
In the second case, 40-year-old Rajesh Kumar wants to invest an amount of Rs 30 lakh (Rs 3 million) that he has saved during his stint abroad on a project. It is currently in the form of fixed deposits in a bank and is due to mature soon. His risk profile is balanced and can even take on some amount of risk. He and his wife have steady incomes from their jobs and would not need to dip into at their investments for at least the next 12-15 years. He has purchased property as an investment, for which he has taken a home loan. The rate on the loan is 11.50 per cent and equated monthly instalment (EMI) is little more than Rs 50,000 per month. The couple is also looking to adopt a child. His wife may then take a career break to look after the child.
At first glance, it may seem that a mutual fund portfolio tilted towards equity for the Rs 30 lakh corpus, is sufficient to meet Kumar's investment needs. With both husband and wife working, the couple can take some amount of risk. But, in his case too, there are couple of more options for him to use money.
He should actually be looking at the possibility of retiring his debt. He will need to weigh in the benefits of repaying the loan and saving on the interest versus the tax saving that happens because of the loan. Another factor that needs to be considered is the opportunity cost. Will he be able to earn more than the interest that he is paying on his loan?
For instance, he would probably be better off repaying the entire loan and then looking at investing. He can invest the amount of EMI saved and also the rental income that he receives from his house. He will be debt free and would be investing for the long term at the same time.
In the scenario of his wife taking a career break, their income would go down. If Kumar's income is sufficient to cover the needs of living and investing, then probably he need not look at this option. But if there is going to be a cash-flow issue, he can look at investing this amount in tax-efficient income generating investments after taking it out from the fixed deposits.
Merely investing a particular amount according to risk profile is not the best option. Investors need to change from product-centric to and trying to get best returns to designing the life they desire. This will allow both - savings and a better risk-adjusted approach towards managing money.
Kiran Telang is Director, Dhanayush Capital Advisors
