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Posts Tagged ‘financial-goals’

uncertain inflowsI have uncertain inflows – how should I invest?

Money may not be the end in itself, but for most, it is a means to achieve many necessities as well as aspirations. Therefore it becomes important how an individual plans to use his/her hard earned money. More so when the inflows are not necessarily streamlined and consistent like that of an employee. When your personal income is linked to the performance of your firm, a well thought out plan could be all the difference between financial stability or having to make huge compromises.

Being a HR firm owner can have its ups and downs. By following certain simple financial planning steps, you can have some peace of mind with regards to your personal financial situation even though you may not have a steady income:

  1. Contingency Fund: This is a basic yet most critical part of any financial planning for a self employed individual. You never know when your next pay check may come. So it pays to prepare for the worst. Thumb rule has always been 3-6 months worth of household expenses to be kept aside in highly liquid assets as an Emergency Fund. Yet we feel that when it comes to a owner/manager, it should be at least 6-9 months worth of basic expenses!  A handy tip, do not forget to count any committed payments such as EMIs and any insurance premiums when calculating the corpus. 
  1. Risk Planning: or in lay man terms, Insurance Planning. This could be a considered an extension of contingency planning, but for very specific events. Following are the types of insurance policies one must always have at all times: 
  • Term Life Insurance Plan: The plain vanilla term plan is exactly the only kind of life insurance anyone should purchase. Handy tip, to know the amount of cover you might need, start with at least 15 times your annual revenue/income. Don’t forget, insurance should never be mistaken for an investment!
  • Individual Health Insurance: If nothing else, an individual health cover to at least cover your own standard hospitalization expenses is a must. Financial independence means you should be able to fend for yourself at the very least, even if it paying for your own recovery. 
  • Critical Illness Policy: Contracting a serious illness or undergoing a major surgery would mean a drag on your finances as well as a dent on income. Such financial risks can be mitigated by procuring a critical illness policy. Such policies usually provide for a lump sum payment to tide over the finances needed, in case of being diagnosed with a critical illness.
  • Personal Accident Policy: Another source of financial risk associated with most professionals is loss of income/job due to an accident. Similar to a Critical Illness Policy, this policy provides a supplement alternative income for certain weeks of disability depending on the terms of the policy. This can be used to either pay off medical expenses or help in taking care of household expenses during the recovery period.

While more types of insurances are available, it is essential that this set is acquired first. Having your Contingency funds and Risk Planning in place makes a strong base for you to venture into the world of investments.

  1. Planning for Retirement: Retirement, or as financial advisors put it, Financial Freedom, is something we all aspire for. The dream of not working for the sake of survival is a goal we all work towards. Yet having an uncertain income can make such a dream feel a little distant more often than not. And while retirement always seem likes a far off goal in comparison to what seem like more pressing concerns, it should ALWAYS be top priority! Underestimating your retirement financial needs can be the one of the biggest mistakes you could make and more often than not, people realize it far too late to make any significant course corrections. Even if you have to start with small amounts, it is the consistency and discipline that will ultimately help you reach your goal.
  1. Financial Goal Planning: Only after the first three steps are in place, is when you should really consider planning for the rest of the commitments/aspirations that you might have. As with any goal planning, the two critical aspects to consider are time horizon and future value of the goal, not current value. If you get these two right, the rest becomes clear.

For any individual with uncertain income flows, planning can become easier if you can channelize your savings, prioritizing in the above order! It is essentially in this area where the difference between financial planning for an owner of a firm/business versus that for an employed individual lies.

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“A dream is just a dream; a goal is a dream with a plan and a deadline.” – Harvey Mackay

Each one of us has some dreams which we want to achieve. It could be sending your child to one of the   best universities, taking a world tour, giving back to society, etc.  These will remain just wishes unless we articulate them as goals which we would like to achieve. Each of us is in different stages of our lives. Therefore goals and goal priorities will differ based on your age and circumstances. So how does one go about planning for goals?

goals

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What you need to do?

The first thing that you need to do is to know what you want to achieve. For this you need to articulate your goals well. Know your goals. Write them down. Attach time lines to each of them. Know what it will cost you today to achieve them. Apply inflation to it to know what it will cost you in the year your goal will become due.

How you will do go about doing it?

  • Priorities: Arrange your goals in the order of your priorities.

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  • Review your existing assets and allocate them to your goals: This will help you know how much more you need to invest. In the process of reviewing your existing assets you might want to do away with the assets which have not been performing or correctly understand the reasons for the same. Book losses when required so that you can start fresh new investments.
  • Before starting investment know your risk profile. Do not determine the risk appetite based on your need for higher returns. Decide based on a combination of ability and willingness to take risk. If you are an aggressive investor, do not allocate 100% into equity. Similarly, if you are a conservative investor do not just stick to fixed income investments like PPF and Bank FDs. You need to have an asset allocation in place. The basics of investment like diversification and a need for asset allocation will not change whether you are an aggressive or a conservative investor.
  • Choice of asset class: Have a mix of debt, equity, real estate and gold in your portfolio. Align your investments in line with your goals. Decide based on how far away you are from your goal. For longer term goals allocate higher proportion to equity and real estate. Having more exposure towards debt and other low risky assets could yield returns which may not be inflation beating. Include equity as it will fetch you higher returns if you stay invested for a longer term. Include fixed income as it will provide you safety. Add a small portion of gold for diversification purposes. For near term goals have higher allocation towards fixed income to avoid adding risk of volatility.
  • Choice of product: Within the asset class you can choose products based on your risk appetite and whether the nature of your product matches the nature of your goal. For example you may choose growth option in Mutual funds and cumulative option in FDs in the accumulation stage. On the other hand you may switch to dividend payout options in Mutual Funds and Interest payout options in FDs which will fetch you regular income post retirement. If any product has a lock-in period make sure you allocate money towards it in line with your goals. Keep the liquidity aspect in mind while making choice of product.

If you have not yet planned for your goals, do it now.

“The best time to start was yesterday. The next best time is now.”- Unknown.

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nri 1

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With the Reserve Bank of India (RBI) allowing non-resident Indians (NRIs) to invest in the New Pension Scheme (NPS), one more investment avenue has now opened up for NRIs keen to plan for retirement.

Ret challenges

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Challenges of retirement planning

NRIs are possibly as guilty as resident Indians of not saving and investing adequately for retirement. Some of them give priority to other goals like children’s education and marriage or infusing funds into their business, to the detriment of a crucial goal like retirement. Many are not conscious of how inflation and galloping medical expenses will cause their monthly expenses to balloon, and hence underestimate the corpus needed for retirement. With human life span increasing, the risk that one may outlive one’s retirement savings has become very real.

NRIs planning to spend their sunset years in India should also factor in the cost of buying a house here, especially of the kind that they would enjoy with respect to facilities and security. Housing prices have risen exponentially in all the major cities over the past decade. Overwhelming reliance on physical assets like gold and real estate, and aversion to equities are other obstacles that NRIs need to overcome to be able to invest effectively for retirement.

Investment options available

Since retirement would be a long term goal for younger NRIs, their investment portfolios should be tilted heavily towards growth assets like equities. Investing directly in equities may be difficult for NRIs, given the challenges of tracking stocks while living in another country. Equity mutual funds are a more suitable option for them. With India having emerged as one of the fastest growing economies in the world, NRIs can expect their equity investments to fetch them good returns.

The balance portion of an NRI portfolio should be filled with debt instruments like debt mutual funds, fixed maturity plans (FMPs), tax free bonds and bank fixed deposits. A small portion may be allocated to gold exchange traded funds (ETFs) for diversification. To this range of options, NRIs may now add NPS.

nps

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Pros and cons of NPS

What works?

The biggest advantage of NPS is its ultra-low fund management fee. By paying a very low fee, the investor gets the benefit of professional fund management. These low charges will boost the long-term returns from NPS.

The biggest advantage of NPS is its ultra-low fund management fee. By paying a very low fee,

NPS also offers equity exposure, albeit only up to 50%. Long-term returns from equities are likely to be higher than if you invest the same money in debt products, considering past data.

NPS also offers equity exposure, albeit only up to 50%.

NPS also allows investors the flexibility to change their allocation to different asset classes (equities, bonds and G-Secs) and to shift between pension fund managers, based on their track record.

NPS also allows investors the flexibility to change their allocation to different asset classes (equities, bonds and G-Secs) and to shift between pension fund managers, based on their track record.

What does not work?

NPS does come with a few drawbacks too. One, it falls under the EET regime, which means that the final corpus gets taxed at the time of withdrawal. Also, you can’t withdraw your funds before reaching 60. If you do so, you will have to use 80% of the corpus to buy an annuity. And even if you withdraw your corpus at 60, you have to compulsorily use 40% of the corpus to buy annuity. Returns from annuities tend to be lower globally.

The final corpus gets taxed at the time of withdrawal. Also, you can’t withdraw your funds before reaching 60. If you do so, you will have to use 80% of the corpus to buy an annuity. And even if you withdraw your corpus at 60, you have to compulsorily use 40% of the corpus to buy annuity.

Make informed choices

You have the choice of an active option or the auto option. Under the first, you can choose your allocation to equities, bonds and government securities, while under the second your investments are put on auto pilot. Under the auto pilot option, initially, your investment is divided in the following proportion: 50% to equities, 30% to bonds and 20% to G-Secs. This allocation remains unchanged until 35. From age 36, the allocation to equities is reduced by two percentage points every year and to bonds by one percentage points, while the exposure to government securities is increased. Thus, the allocation to safer government securities rises as you approach retirement.

You have the choice of an active option or the auto option. Under the first, you can choose your allocation to equities, bonds and government securities, while under the second your investments are put on auto pilot.

NRIs with some knowledge of investing and having a modicum of risk appetite should opt for the Active Choice option. As it is, NPS limits your exposure to equities to just 50%. By adopting the Auto Choice option, you will reduce your exposure to equities even further. Having such low exposure to equities in a long-term goal like retirement is uncalled for, and will affect the size of your final corpus adversely.

If you decide to go with the Active Choice option, the next question is how much you should allocate to equities, bonds and government securities. In our view, given the long-term investment horizon, you should invest in equities up to the maximum permissible limit of 50%. Divide the balance between bonds and government securities. Start reducing your allocation to equities about five years prior to retirement.

If you decide to go with the Active Choice option, the next question is how much you should allocate to equities, bonds and government securities. In our view, given the long-term investment horizon, you should invest in equities up to the maximum permissible limit of 50%. Divide the balance between bonds and government securities. Start reducing your allocation to equities about five years prior to retirement.

Next, how do you go about selecting the fund manager? You are permitted to select only one fund manager for managing all three assets: equities, bonds and government securities. So choose one with a reasonably good track record across all three categories, and review annually.

The opening up of NPS to NRI investment is a welcome development. NRIs should take full advantage of this product while planning their finances for retirement.

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Asset Allocation should also include global stocks and mutual funds as a diversification strategy is always better. Its always good to get the best of all global markets.

Break your home bias-page-001

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Independence Day normally involves a short holiday, hosting gatherings or planning outings with friends and family. I’m sure a lot of you are also targeting your own financial independence ? In fact, a very large number of investors whom we work with, when asked about their financial goals, indicate that they would like to achieve financial freedom. When we ask them what financial freedom means to them, their answer is: ‘When we do not have to work for the money and can actively decide how, when, and with whom we choose to associate in our professional life.’

Financial freedom can mean different things to different people. Financial planning allows them to be financially free i.e. decide how they wish to lead their lives. Over my years of running a practice, here are two examples of people we work with, who we believe financial planning has helped achieve the freedom to do what matters most to them.

Dr. Kumar (name changed) is a cardiologist and runs a hospital in suburban Mumbai. Irregular and long work hours mean that there is very little time to spend with his two young kids and his wife. What he really looks forward to, is spending time with his family and enjoying the kids’ growing up and continuing to stay connected with his wife. Booking and planning his holidays each year – one long international holiday, another week to ten day long domestic holiday and some weekend breaks are what he absolutely loves. The finances for these holidays are a part of his financial plan. Whilst there are clearly earmarked long term investment strategies for his longer term goals like retirement and education for the children, there are also separately defined strategies for shorter term holiday goals through the use of financial instruments that can give him the most optimal returns for these goals, on a post tax basis.

Sanjay and Rashmi (names changed) are currently 41 and 39 respectively and they have a young daughter. Sanjay runs a small sized family business and Rashmi works with a chartered accountancy firm. When most couples are just about beginning to save for their financial goals, and are looking to save for their retirement and childrens’ future, both Sanjay and Rashmi have already achieved their financial goals i.e. even if they do not save any monies from here onwards, and let their existing portfolio grow, they should be achieve their financial goals. This has been possible through a combination of a conservative lifestyle with controlled expenses, a savings rate in excess of 40% of total income, controlled use of leverage on a home loan that has been prepaid aggressively, and a diversified portfolio across equities, fixed income, real estate and gold, that is rebalanced regularly.

Just like India has had many historic events which finally helped us achieve freedom, your path to achieving your financial freedom will be a long-term process, wherein there will be struggles

and various factors which you will be unable to control. However, staying on the path to financial freedom for yourself and your family is the key to pursue your dreams.

Happy Independence Day!

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UTI Swatantra (99)

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Go – reach for the skies

When I was growing up, life was quite simple. Most children were bunched into three categories – aspiring doctors, aspiring engineers and others. I remember a blockbuster Bollywood movie a couple of years ago, where the father picks up his new born and gleefully says ”My son will be an engineer.” Times have changed, and as a part of building financial plans now, we meet a whole set of parents who very happily state that have no idea what their kids will be when they grow up, they will be happy with whatever they do, and they want to provide for it.

So what should be your financial plan as a parent if you really want your child to follow his or her heart? For example, if one’s child wants to do a professional education in India or overseas, how can a parent prepare himself financially to support the child’s dream without compromising on other financial goals like retirement, etc. Most parents are aware of children’s education plans, education loans, etc. However, the element of planning gets missed out very often.

 Step 1: Define the current cost:

Get a fair estimation cost for the professional program that you would like to plan for. This is hard, especially if you do not know which program to plan for as these would vary depending on choice of country, type of program, duration of program. Do remember to take all costs into consideration and not only tuition fees. You may be forced to plan for a higher amount, due to not knowing which program will finally be chosen

Step 2: Estimate the corpus required:

Considering that education inflation in both India and overseas tends to be higher than regular consumer price inflation, you would need to factor in the inflated cost of education by the time you need the corpus. To give you a perspective, a domestic education costing Rs 10 lakhs today would cost close to Rs 32 lakhs after 12 years at an inflation rate of 10% pa. Similarly, an overseas education costing USD 100000 today ie approximately 60 lakhs, would cost in excess of Rs 1.2 crores after 12 years at an inflation rate of 6%p.a..

Step 3: Systematically save monthly or annually:

Break up the target corpus into a monthly or yearly saving goal, so that it can be easily measured. For example, at a rate of return of 12% p.a., one would need to save approx Rs 10000 per month and Rs 38000 per month to achieve the goal of planning for the domestic and international corpus respectively.

Step 4: Choose the appropriate vehicle:

The vehicle to use to reach the targeted corpus would be a function of the amount of money that you can put away. For example, if you can invest only Rs 8,000 per month to save towards the domestic education goal, you will need to target a higher rate of return on the portfolio. Therefore, you will need to use products that have a large equity exposure.

Step 5: Monitor progress:

It is critical to monitor progress annually to ensure that the assumptions made and the actual output are in line, to avoid any nasty surprises at the finish line.

Help your children reach for the sky.. bit by bit.

 Vishal Dhawan is a financial planner by profession and founder of Plan Ahead Wealth Advisors Pvt. Ltd. He can be reached at vishal.dhawan@planahead.in

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