Cash flow planning is key to a good financial plan

Many of my readers keep asking me as to why I do not have different portfolios allocated to different goals of mine. I have explained this in other posts so will not repeat the basic arguments here. Suffice it to say, multiple portfolios will most likely lead to sub-optimal returns and I do not look upon it as smart financial planning at all. In fact if you really look at how you go about your life and the finances you need ta take care of your plans, the most important aspect is really cash flows.

While cash flows are kind of implicit in goal based planning – we are asked to redeem our financial investments to cater for the expenses linked to a goal – it is important to understand the true nature of it. In a recent discussion with a friend it struck me that most people do not have a clear idea about it at all and do not understand how to go about it. When I was thinking of how to explain this to my readers, I thought of how we use water in our daily lives. This is an analogy I have used in one of my earlier posts and can be used well here.

Let us assume a normal middle class household in India where we have different types of expenses such as listed below:-

  • Regular monthly expenses such as food, groceries, utility bills, transportation etc.
  • Quarterly or biannual expenses such as school or college fees.
  • Annual expenses such as Insurance premiums, TV subscription etc.
  • Irregular expenses such as clothing, purchases of personal discretion.
  • Large expenses such as White goods, Vacations abroad etc
  • Goals such as College admission, marriages etc.

To personalise this example let me relate it to you as a reader. For the next 12 months, list out all possible cash needs you have out of these categories. For example you may have something looking like this:-

  • Monthly household expenses @ 40000, Annual costs = 4.8 lacs
  • School fees @ 10000, Annual costs = 1.2 lacs
  • Insurance premiums, TV service etc, Annual costs = 1 lac
  • Vacations, White goods, Annual costs = 1 lac
  • No large goals in next 12 months.

What does this really mean? In cash flow terms, your outflow will be to the tune of 8 lacs. So if you have got 8 lacs and more from your salary or business you are fine, right? This is unfortunately not true at all – understand that your outflows on large goals are not there now but they will occur at some point in time. When it does you have to spend and that amount may not be possible from your normal cash inflow. Let us say your son will go to a college that costs 5 lacs a year for 4 years. If this amount can be catered for through your active income, you are home and dry. If not then you must invest in the years before he gets to college so that when the time comes you have access to the money. Similarly you need to plan for your retirement – at that time you have no active income but your household expenses remain there. So, you must have some alternate source of cash inflow so that you are able to sustain your expenses.

Where does cash inflow come from? Well, there can be several sources, but some of the more common ones are as follows:-

  • Salary from your job
  • Income from business or profession
  • Income from hobbies or other interests ( blogging etc)
  • Interest income, dividends
  • Rental income
  • Capital gains from selling an asset
  • Redeeming financial instruments

Where does the water analogy come in? Well, you can think of regular cash flows as the water that is supplied to your house every day by the City corporation. Most of your needs are met by that. However, you also store some water for an emergency that may occur. In case you are planning to clean your house thoroughly, you will plan to arrange for availability of water etc. What happens if you are having a big function at your house and you need to have a lot of water? Well, in case you have stored it in a tank etc you can use that. Alternately you can get some water tankers to get water for you. This is similar to redeeming financial instruments for a large goal. You can also stretch the thought process to look at these tankers as a loan – in that case you have to pay back the water just as you pay back through EMI for the loans.

The bottom line is this – your cash inflows either in term of current income or income from past investments or loans must match your cash outflow needs at all points in time. With the water analogy we have to look at running water, water stored earlier or water obtained from external sources such as tankers to take care of our needed consumption.

Pretty simple really, if you think of it a little and then the entire financial planning just becomes an exercise in cash flow management. How do we factor in investments into this? Well, I will cover that in another post as this one has already got quite long.

A life plan must precede a financial plan

With the increasing readership of my blog, I get a lot of requests to either make financial plans for people or to review an existing financial plan that was made by someone for them. What strikes me as amazing is that people by and large focus greatly on their financial goals and almost take their life goals for granted. This flies in the face of the obvious reality – your finances are there to support your life goals and therefore must come after you have thought through your life goals.

The first thing which surprises me is that people project their lives for the next 30 years or so without having the ambition to do more with it. Let us say you have passed out of college and got a job. While it may be a job which you like, you may still look at ways and means of improving it. An IT person who started his career just 5 years back may already be finding himself in the cross roads. There is no guarantee that your current job will last for 10 years, let alone 30. It is therefore imperative that you fix your life goals based on your current skills, future skills you may need to acquire and the kind of work you want to do. It may be necessary for you to take up your first job for many reasons, but there will be equally good reasons as to why you may want to do other things.

The same goes for people who are in their mid career with a family. Yes, changing your life direction may be more difficult now but it is not impossible by any means. I had a friend who was a hotel manager for 10 years, worked in Rediff for another 10 years, went on to do an MBA abroad and is now a professor in an US Business school. Note that the latter career moves were all done when he had a family. Another friend of mine who is from an IIT and an IIM, went to the US recently to pursue a second MBA as he was not happy with how his career was shaping up. In his case too he took his wife and a young daughter to the US. There is no doubt that these people had to go through a lot of tough times but they were clear as to what they wanted to achieve.

Changing careers are getting much more common nowadays than ever before. I just came to know of a Doctor, who practised for 7 years after his MBBS and has now got into IIM Ahmedabad for their one year Executive program. He wants to be associated with Health care but not as a practising Doctor and felt that an Executive MBA will give him the opportunities that he is seeking out.

The problem with financial plans is that they are done assuming people will proceed in their lives linearly. They will start with a job, increase their salaries every year, get married, invest and increase their investments, plan their finances, home buying and have other goals such as children’s education, marriage and retirement. This does not at all cater to real life and real people. For example, I started working at 24 and always wanted to retire at 45, or at least be financially independent by then. If I had been to a financial planner, he would probably have told me that I needed to work for 35 years and early retirement was just not possible in India.

The logic can get extended to any particular passion you have in life. Earlier it was difficult to take up your passion due to lack of resources and opportunity. However, many people nowadays want to take up their passion after they have fulfilled most of their responsibilities. I know of people who have taken up travel, reading, teaching and several other interest areas at a relatively late stage in life and have done very well in them.

So the point is your life plan must be dynamic in nature to fulfil the aspirations you have. We will not meet all our aspirations but there should be a clear and concerted attempt to do so. The financial plan must adapt to your life journey not the other way round. You need a financial planner who understands this.

How does one go about doing this? Let that be the subject of another post.

IndiGrid InvIT Fund IPO – should you invest ?

In the investment world we are all looking at newer ways to invest, always hoping that the next product coming across will hopefully give us better returns than our earlier ones. In this context the Infrastructure Investment trust bond issue from IRB Infra generated a lot of interest in the market and was oversubscribed 8.6 times, despite the high ticket size of 10 lacs. Close on it’s heels we have the IndiGrid InvIT fund IPO, open from 17th to 19th of this month.

To begin with, Infrastructure projects such as ports, roads, power projects and other kinds of construction are normally on a massive scale and need a lot of funding. These are also long gestation projects where the returns will only come after a certain number of years. If you look at NHAI for example, the several companies started by it for the different projects are all technically running at a loss, due to the high interest rates and depreciation that they have to deal with. Their loans are huge and though the marginal profits on EBITDA are very good, progress in some of these projects have been slow due to the adequate availability of cash at the right times.

The idea of an Infrastructure Investment Trust ( InvIT ) is to restructure these loans by paying it off with the investment they will get in the trust. The Trust will then have an arrangement with these companies to get returns from them through the profits generated. Investors in InvIT will get their returns through dividends, buyback etc. As all these companies are having pretty much assured revenue over a period of time, the returns are likely to be good.

The below information about the IndiGrid InvIT Fund IPo, is taken from the website http://www.chittorgarh.com and a few other sources of publicly available information:-

Incorporated in 2016, IndiGrid InvIT Fund is an infrastructure investment trust (“InvIT”) established to own inter-state power transmission assets in India. They are focused on providing stable and sustainable distributions to their Unitholders.

Sterlite Power Grid Ventures Ltd, sponsor of IndiGrid InvIT Fund is one of the leading independent power transmission companies operating in the private sector, with extensive experience in bidding, designing, financing, constructing and maintaining power transmission projects across India.

Company’s sponsor owns 11 inter-state power transmission projects with a total network of 30 power transmission lines of approximately 7,733 ckms and nine substations having 13,890 MVA of transformation capacity. Some of these projects have been fully commissioned, while others are at different stages of development. They recently won bids for two transmission projects in Brazil,

Of the 11 inter-state power transmission projects owned by the Sponsor, they will initially acquire two projects with a total network of eight power transmission lines of 1,936 ckms and two substations having 6,000 MVA of transformation capacity across four states (the “Initial Portfolio Assets”).

Objects of the Issue:

The object of the issue are to:

1. providing loan to BDTCL and JTCL for repayment or pre-payment of debt (including any accrued interest and any applicable penalties) of banks, financial institutions, SGL1, SGL2;
2. repayment of any other long term and short term liabilities and capital expenditure creditors.

Comparision of InvITs

Comparision of InvITs (IRB InvITs & IndiGrid InvIT)
Particulars IRB InvITs IndiGrid InvIT
Price band Rs. 100-102 Rs. 98-100
Issur Size Rs. 5921 cr. Rs. 2250 cr.
Sector Toll Road constructions Power Transmission
Likely yield 8 to 12% 10 to 15%
Entry Level At a Premium At par value
Tenure 16 years 35 years
Corporate Ratings AAA/Stable AAA/Stable
Proportionate Allotment 75% of the issue (i.e. except retail) 75% of the issue (i.e. except retail)
Risk Factors Inflation, Traffic Volume, Govt. policies Load Availability, Market trends
Market perception Bearing Risk as above Considered as Safe asset class Globally
Promoter IRB Group Sterlie Group

Should you be applying to this issue? Well, if you have not got an allotment in the IRB InvIT IPO then you should definitely look at it. The one thing which may be a spoiler here is that the yields are primarily going to be in terms of interest and this will be taxable in the hands of the investor.

In case you are not yet fully invested in equities through MF and stocks, you may want to delay investment in InvIT’s for now. Focus on building your equity investments and you can then look at future InvIT issues. There will surely be many more soon.

 

A case study from recent AIFW post

It always surprises me a little to see the reactions of people in Facebook groups when a group member asks a simple query. Some members assume that the questioner needs to get knowledge by reading blog posts of some other members first, others advise him to go to a fee only financial planner and even give him a list, yet others tell him that one should just keep working and not think of retiring.

To come back to the recent query, here are the salient facts shared by the person who wanted advice on whether he will be able to gain Financial independence in 6 years:-

  • He has 1.2 crores in FD and another 30 lacs in equity etc
  • Can invest 20000 per month for next 6 years
  • Has a child in class 7, who should be going to college in 6 years
  • Has his own house and loans will be paid for by the time he is 50.
  • Current costs are 1 lac per month, 15000 for child and includes loan repayments.

Let me come to the question as to whether he will be able to be financially independent by the time he is 50. For this we will calculate his Financial Independence Number (FIN) in the following manner.

  • His base cost at 50 will be lower than 1 lac as child cost will be gone and so will the loan repayment. However, let us take it at 1 lac to take care of inflation etc.
  • For retirement of 30 years his cost will be 3.6 crores at zero real rate of return
  • For child higher education we can take 20 lacs
  • For asset replacement etc we can take 20 lacs
  • Total FIN therefore comes to 4 crores.

Fortunately, in real life we do not need to go with financial planner and/or calculators blindly and can use some experience and common sense. It is difficult to tell others what to do as they will have their own goals and ways. However, if I were in his place, I would be doing the following:-

  • As his child’s college education is 6 years away, I will put 10 lacs in an Aggressive Balanced fund like HDFC Prudence. This amount will take care of the 20 lacs that will be required for the child’s graduation.
  • I will redeploy the 1.1 crore left in FD to different types of Debt funds. Assuming a CAGR of 8 % this will grow to an amount of 1.75 crores.
  • His current equity investment will grow to 60 lacs if we take 12 % CAGR over 6 years.
  • 20000 SIP @ 12 % returns will grow to about 21 lacs in 6 years.
  • So at 50 years he will have 1.75 crores in Debt and 81 lacs in equity

Let us now look at deployment of corpus. In the first 10 years of retirement, his strategy can be the following:-

  • Interest from Debt portion will be to the tune of 14 lacs @ 8 % returns. This is definitely possible if he is into good quality Debt instruments.
  • As his child is in college and he is still relatively young, I will not reinvest this 2 lacs but spend it in discretionary expenditure such as travel or asset replacement.
  • At the end of 10 years, he will be 60 so the activities will reduce and on the balance his medical expenses may grow. I think an annual expense of 18 lacs will be enough. There is no need to calculate this by inflation formula – makes no sense at all to do so.
  • Assuming a 12 % return on equity his equity corpus will be 2.51 crores.

In the next decade his deployment can be as follows:-

  • Keep using the interest from Debt instruments and take out the remaining required amount from redeeming the principal.
  • Even after you finish the decade you will have some amount left in Debt instruments. I suggest you donate it to a charity of your choice.
  • Your equity investments would have grown to more than 7 crores by now and will be more than enough to last your life as well as live a legacy.

So to come back to the basic query – will you have enough to retire at 50? You bet you will. Now just shut out all the negative people with negative comments from your mind and go ahead with the plan. Honestly, if you are able to get the selection of instruments done on your own, you do not even need a Financial planner.

Will be happy to receive comments, feedback and criticism on the post.

A contrarian case study on retirement

I have been writing this blog for more than a month now and have come across many individuals, with different and unique financial situations. I also get pulled in for advice on how to deal with several financial issues. I think it will be a good idea to share some real life situations with my readers so that it helps them in their financial journey.

The first one that comes to mind is of a recently retired person who was introduced to me by a friend. For the purposes of this discussion we will call him Aloke. Some background of Aloke will be in order before we get to the case itself.

  • Aloke is an Engineer by profession and has worked in different manufacturing companies for about 35 years before retiring last year.
  • His wife is a homemaker and he has one son who is a CA, working now in a reputed audit firm in Mumbai.
  • Aloke has a 3 BHK apartment in West Hyderabad and wants to settle there.
  • He has never been in equity, most of his investments were in PF and PPF. All expenses except the apartment was always from his active income or from FD / RD which he had set up for larger expenses.
  • His current expenses are 5 lacs a year and he thinks if that is adjusted for inflation he will be pretty ok with it.
  • He got his PF in 2013 which amounted to about 1 crore. He had put all of it into Tax free bonds that were giving an interest of 9 % then.
  • His PPF is presently having 45 lacs.

Aloke came to me as he was confused with all kinds of strategies that were being told to him by financial planners. Many wanted him to sell his funds in the secondary market and put the money into different buckets etc. This is an amazingly bad idea as he is getting a tax free income of 9 lacs and will be getting it for the next 17 years !!

Here is what I suggested to him.

  • Continue with the current situation till the tenure of the tax free bonds run out. By that time he will be 80 years old.
  • For the surplus each year, put 1.5 lacs into PPF and the rest in a multi cap mutual fund such as ICICI Value Discovery or SBI Emerging Blue Chip.
  • Assuming 6 % annual inflation, Aloke will be able to carry on the MF investment till year 6 by which his investment will be about 9 lacs.
  • PPF can be carried out till year 9 when his expenses will get to 9 lacs a year.
  • From the years 10 through 17 he will need to withdraw from his MF fully and PPF partially to fund extra 32 lacs of expenses.
  • At the end of 17 years, when Aloke is 80, he  will have 1.5 crores in PPF and 1 crore from redemption of tax free bonds.
  • Even with annual expenses of 20 lacs then, this will definitely last him comfortably till the rest of his lifetime.

Understand that the plan is specific to Aloke who does not really want any risks, does not want to worry about taxes and is comfortable with his present lifestyle. It is not always important to have 5 crores or chase equity returns. There is a financial plan present for each person and situation, you just need to use some knowledge to get there.

Innovative use of Education loan

As all my readers will know, I am not fond of loans by a long stretch of imagination. In general, I believe that loans should not be used for consumption and, even in a crisis situation, they should really be the last resort. If a loan is needed to acquire a high value asset like a home, my preference is to pay it off as soon as you can. However, there can be some specific situations where an Education loan can be used in an innovative manner.

Before getting into the how and why of it, let us take a look at how we normally plan for the graduation expenses for our children. Typically, this will be done over a period of 15 years or so through some equity instrument such as Mutual funds through regular SIP or other mode of investment. If you have assumed a 12 % return over a reasonably long period it is likely that you will achieve your goal targets. To be on the safe side you may want to follow something like the plan below:-

  • Let us say, your estimate of your child starting his college education is in 2020 and the amount estimated over 4 years from 2020 is 12 lacs.
  • Your SIP corpus has reached a level of 11 lacs now, after the current market run up.
  • You can redeem your corpus in MF, put it into a safer debt fund and be quite certain that you will have the 12 lacs needed in 2020 when it is needed.

While the above is a perfectly acceptable way of doing things, it does have certain basic deficiencies which you may want to look at:-

  • You are redeeming your portfolio 3 years early, to be on the safe side. This may seriously hamper the growth opportunities.
  • You do not need all of 12 lacs in 2020, the requirement is over a 4 year period. It is therefore inefficient use of resources to block it in a low return debt fund etc.
  • As you are not aware of what exactly your child will land up for graduation, your need for money may be more or less than the plan you have made.

One way to look at this issue afresh is to consider Education loans from Public Sector banks. Now, the earlier rates of loans were in the range of 13% and more as it was not perceived to be a safe loan by the banks. At these prices, it does not make sense to take a loan. However, there is a class of loans nowadays, which are restricted to some listed Educational institutions, where the lending rates are way lower. At the present point of time the rates are in the range of 9.5%. With this option being available to you, the plan can be sufficiently tweaked as follows:-

  • Focus on the preparation of your child for competitive exams, so that he is likely to get into one of the listed colleges.
  • If you think it is needed for your child, have a goal amounting to 3 lacs or so when he starts in class 11, for the expenses related to coaching for competitive exams.
  • You may have earmarked an investment for your child’s graduation, but simply let it grow without getting into unproductive mechanisms of redeeming it and then putting the amount in debt instruments etc.
  • At the point of time you get admission for your child, take a sanction for the full expenses through an Education loan from a PSU bank, SBI or otherwise. Make sure it is a loan where there are no pre-payment penalties.
  • As far as payment goes. it will normally be every 6 months or so. As far as possible try to pay it from your active income if you are in a job or profession. If not look at whether it makes sense to redeem your equity investment to the extent of the installment of fees. The final option will be to get the Education loan disbursed for this part.
  • Whenever the market goes up substantially, redeem part of your equity holdings and try to pre-pay part of the loan already disbursed.
  • Over a 7 year period ( 3 years before the course and 4 years of the college), it is very likely that the markets will do well in a few years.
  • In the worst case, just keep holding equity and use the Education loan to the full extent. Start paying the EMI and when the opportunity presents itself, repay as much of the loan as you can.

Of course, there will also be situations where you have not invested adequately for your child’s education. In such cases the Education loan is a boon as it will still enable your child to study in the course and college of his choice. Once he/she passes out the loan can be paid off over a period of time.

I will encourage all of you to look at this strategy. It will ensure that your investments are being used productively and you do not need to redeem them at an inopportune time.

My investment audit in July

In the last post I had written about my financial audit in July, where the focus was mainly to look at my revenues, expenses and consequently the cash flows. In the current post I will look at the investment audit which I had carried out simultaneously for the same period, that is the first 4 months of the financial year.

As my regular readers will probably recall, I had the following investment plan for the current year:-

  • Investment of 3 lacs in the PPF account of my wife and me.
  • Investment in equity MF to the extent of 5 lacs in the year. For this purpose I am looking at the calendar year 2016 rather than the financial year.
  • Stock portfolio investment, mainly by my wife, to the extent of 1 lac.
  • Reinvest of the principal amount from FMP redemption proceeds into appropriate debt or hybrid instruments.

In my audit of investments, I had the following observations:-

  • Contribution of 3 lacs was made to the PPF account of Lipi and me in the beginning of April. The next contributions will be in April 2017.
  • Equity MF purchases were done in the January to March period mostly. I have so far invested 2.5 lacs out of the yearly planned 5 lacs. I have plans to buy MF again when the Nifty is close to the 8000 figure. I feel it eill happen by October or so, but even if it does not, I can always buy at a later point.
  • As the stock buying opportunities were good, we ended up moving about 1.5 lacs fresh money into Lipi’s portfolio. This was helped by the maturity proceeds of an FD that she had.
  • FMP investments worth 7 lacs at cost value matured in this period. I have taken the LTCG as revenue for myself and reinvested the 7 lacs. Based on my thought process about FMP not being a good choice right now these have been invested in Gilt funds, Equity Savings funds, Monthly Income Plans and Arbitrage funds.
  • I also redeemed one of my debt funds from Franklin Templeton as it was not doing well. Again, the proceeds were invested in the instruments mentioned in the earlier point.

In the August to November period there are some key investment decisions that I need to make:-

  1. Decide on an appropriate time for additional MF purchases.
  2. Reinvest FMP maturity proceeds into appropriate investments.
  3. Decide on how much money should be made available for Lipi’s stock portfolio.

Overall, the investment plan seems to be going fine and I am feeling quite good about it.