ULIP #3 -How to use it for goals

I had started writing a series on ULIP but it had got interrupted as I thought some other posts will be more relevant. Readers who are interested in the previous posts can read them to get an idea of why the older ULIP’s were a bad idea and how the different charges connected with them work.

As ULIP is an unique product it can be used in a very innovative way, by taking advantage of insurance and market linked growth combination. Let me give you an example below in order to demonstrate how it can be used:-

  • Suppose you are planning for your child’s education in college which is 15 years away. Normally you will do some SIP in MF to achieve this goal.
  • The risk in above is something unfortunate happening to you, in which case the SIP may stop. This can be taken care of through insurances that you will have. However, as the insurance is not linked to the specific goal, someone will still need to manage the process of continuing the investment on your behalf.
  • An alternative can be to use ULIP. If your goal is 20 lacs in current money terms, take a policy with an equivalent life cover. Keep paying the regular premium.
  • If at all, something untoward happens the amount received can be simply put in a debt fund so that it grows to a reasonable level by the time the goal comes.
  • If you go for an online ULIP then the policy allocation charges are quite low. This will ensure that the overall cost structure of the ULIP is low.
  • Note that ULIP and MF both invest in the same underlying asset class. As such there is really no reason why an ULIP will under perform an MF. The real problem is with the charges and that has got addressed to a large degree now.

I am not saying that you should or should not look at ULIP as an investment product. However, in the changed form it does offer you a lot of flexibility and benefits. In order to convince yourself, look at the performance of some of the recent ULIP for yourself, both in terms of the returns as well as the charges.

You may then well start wondering as to why you have not thought of it earlier !!

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Goal based planning – how it can go wrong

I have never done any goal based planning in financial terms myself, even though I agree with the general principles. My belief has been that you need to be clear about your life goals and invest in the 3 portfolios of debt, MF and stocks as much and as well as you can. In my interaction with my blog readers I often come across examples where some goal based planning has been done in a very sub-optimal manner.

Let me share a scenario with you that I encountered in the last week only:-

  • Ajay is 44 years old and his son Raja is 10 years. Ajay wants to have 40 lacs at current prices for his son’s graduation and PG education.
  • As Raja will go to college in 8 years, the financial planner wanted to put the entire amount in debt, so that the money will be available risk free.
  • As Ajay wanted 40 lacs in current prices this meant putting 50 lacs in debt funds. As you can imagine most of his current assets were now locked in debt funds.
  • The other goal Ajay has is retirement in about 12 years which can be met through his PF, Superannuation, LIC policies and SIP of 30000 every month.

Now you are probably thinking why am I not in agreement with the financial planner here. The reason is a lack of understanding of the goal itself. Let us now take a look at things in a more detailed manner, like what the financial planner should have done.

  • Assuming that Graduation and Post graduation require equal money, Ajay needs 20 lacs in 8 years and another 20 lacs in 12 years.
  • Even in Graduation it will be 5 lacs each year and not 20 lacs in the first year.
  • Therefore keeping 40 lacs in debt when you have 12 years is really not making sense.
  • Ajay should simply put 10 lacs in debt funds and put the rest in equity MF over a period of time. If he wants to be more conservative he can look at Debt funds for graduation and Equity MF for post graduation.
  • This will free up some of his current resources. He will need to do a SIP of about 20000 as opposed to putting 20 lacs in debt funds.

Goal based investing cannot just be a mathematical exercise of applying the formulae and calculators. It needs some knowledge about real life scenario and application of that knowledge in meeting your investment goals.

I hope you would have taken care of these things while planning your goals.

Your MF investments – understand the impact

I had wanted to follow up the post of yesterday by outlining some practical strategies that investors might follow in order to mitigate the risks associated with MF investments through SIP in a highly volatile market over years. However, on seeing a few posts in Facebook groups which are clearing misleading people, it seemed to me that it will be worthwhile to spend some time in giving a concrete example.

Before I do that, let me state the surmise of the arguments presented by people who want others to continue doing SIP as if nothing has happened. Firstly, it is said that over the long term the market volatility will cease to matter. For example, if you look at an MF performance for the last 20 years or so, this can be demonstrated. As an academic exercise this is intellectually flawed as it takes only one set of data point available for the Indian markets. As a practical advise, it is useless for doing the same thing when situations have changed dramatically, without any reassessment of the situation, is hopelessly inadequate. Secondly, the crux of the argument is equities are still the best bet, even if the XIRR of your investments done through SIP is in deep red. This seems completely lopsided to me. Simple reason is this – money does not have a different class based on the asset class it is invested in, you need to base your investment decisions on a clear basis of asset class relative returns, not on some romantic notions propounded by blog writers.

So let me take an example in the real world to show you how there is an impact. We will take a situation where a person starts investing in 2008, so that his money has had the best chance to grow through SIP. The following is the example background:-

  • In 2008 Ravi wanted to invest in MF through SIP for his son Ajay who was 3 years old at that time. Ravi estimated he would need the money in 15 years, which was sufficiently long term for equity returns to do well.
  • Estimated costs in 2008 for an Engineering course in a private college was 5 lacs. Ravi took 12 % educational inflation and arrived at a cost of 27.36 lacs in 2023, when he would need the money for Ajay.
  • His planner told him that with a 12 % XIRR, he would need to invest 5478 Rs per month in order to reach his goal.
  • Ravi started his investment in mid 2008 by doing an SIP of 5500 Rs in a popular diversified equity fund, which seemingly had the least volatility when compared to it’s peers.

Most of us know what happened to the markets from 2008 till today so I will not get into details regarding those. For much of the time Ravi had concerns about getting a 12 % XIRR but his worries were allayed greatly in 2014 when the spectacular rise in the markets made him think that he will achieve his targets 2-3 years earlier.

Cut to the present – let us see how things stand now and how will it affect the future. 

  • From 2008 till now, the XIRR of his fund has been a mere 7 % and this may actually get worse in the coming months.
  • His investment value is currently pegged at 6.52 lacs, assuming 71/2 years of investment time.
  • If we take his son’s age to be 10 1/2 years now and start with a base figure of 6.52 lacs, how much will Ravi need to invest if he has to reach the goal of 27.36 lacs in the next 7 1/2 years?
  • If Ravi still assumes a growth of 12 % his monthly SIP will be 8362 Rs.
  • If he is more conservative now and wants to take 10 % XIRR for the current value growth and future SIP then he will need to put in 10538 Rs every month.

This is the impact in real financial terms, never mind what people tell you otherwise. You need to do this exercise for yourself in order to understand how you have been impacted and how your investment needs to change in future for achieving your goals.

In the next post I will get back to what can possibly be done for existing investors.

Do you have a financial goal in next 3 years?

The current state of the markets will have all kinds of investors worried as the cuts to their portfolios have been rather brutal. It also does not look like abating soon as the conditions both global and local, do not present a pretty picture for the next 2-3 months. The investors who are the worst affected are, of course, people who were hoping to redeem from their equity portfolio in this year or the next 2 years.

OK so let us assume you are in a situation where you had pretty much achieved your target figure for a goal like your child’s college education by end 2015. Based on your financial planner’s recommendation you had thought of shifting some amount from equity to debt over the next 3 months or so. This would have ensured that the amount would be largely safe and available when the goal came around in 2017 or 2018. But as they say, “man proposes God disposes”, and in the case of investors the market certainly did not let your plan come to fruition. So what is to be done now?

Let us make the example a little more specific, so that all of us can understand it better. Assume that the money was planned for an Engineering college starting July 2017. You had planned for 20 lacs overall and your portfolio had reached close to that level by 2015 October. Thereafter things went really wrong and you are now having only 13 lacs in your portfolio with more downside quite a possibility. In order to tackle this situation, you will first need to understand the cash flows in question and then look at possible strategies.

The cash flows then – even though the course fees and associated expenses may cost 20 lacs over 4 years, you do not need to have this cash at one go. This is something very fundamental but most people do not understand it. Breaking down the cash flow by semester and assuming there is a 10 % cost escalation every year ( take 15 % if it is BITS ), the cash outflow plan that you need to manage will look like this:-

  • 2.5 lacs in July and December 2017.
  • 2.75 lacs in July and December 2018
  • 3 lacs in July and December 2019
  • 3.3 lacs in July and December 2020
  • Total expenditure for the course including inflation within it is 23.1 lacs

The deployment of cash from your resources seems much simpler now. You only need to arrange for 2.5 lacs in July 2017. If you are working in a job or business, it should be possible to save up this much money over the next 18 months. Even if you are not working, you will have the option of redeeming some of your debt instruments to get this done, under the assumption that equity markets have still not recovered by then.

What about December 2017 and thereafter? Well, you can continue in exactly the same manner. There is nothing like paying for the goals from your active income. Believe me, I have done it for my children so far and that is the best way. I am not saying that you should not invest for your children’s education or other goals, just that there are other ways of achieving that objective also.

What you must not do is panic and shift to debt by selling at a wrong time in the market. That will destroy your wealth like nothing else will. Your portfolio may be down 40 % today but the loss is really a notional one, it is only when you convert it into an actual loss by selling you have made sure that no recovery is any more possible.

I hope this has given some peace and succor to all of you who have been worrying about the imminent financial goals. At a broader level, forget this whole silly business of having different portfolios for different goals and shifting from debt to equity 3 years before the goal etc. These are completely senseless ideas which sensible people must avoid.

If you want to know more about it, just read through the posts in my blog on the 3 portfolio strategy.

A real life financial planning case study

From the time i have started the blog, several readers have interacted with me with a variety of requests. Some want me to review their existing portfolio, others want me to suggest what MF they should be buying and a few want me to advise them on whether their overall financial plan is on track. While I normally respond to all requests, it is the last one which is of more interest to me as I get to learn a lot from it. Last week, I got to review a financial plan which I wanted to make into a case study as it will be of use to all readers of my blog.

To begin with here was the background information that was supplied to me by Ravi :-

  • Ravi is 33 and works in a Financial company in Bangalore, where he stays with his wife and 3 year old son. He was in Pune earlier, where he owns an apartment. His current apartment in Bangalore is rented.
  • Rental from Pune is 18000 and he pays a similar rent in Bangalore. His household expenditure including the schooling of his child is about 25000 per month.
  • His financial assets are as follows:
    • PF / PPF of 6 lacs in all.
    • 3 lacs FD and 3 lacs of RD.
    • 30 lacs worth of stock portfolio.
  • His home loan for the Pune apartment has been paid off aggressively and has only 3 lacs to go now.
  • He has an insurance policy from LIC of 12 lacs.
  • Current cash flow is 1 lac from salary and 18000 from Pune apartment rental.
  • Goals for Ravi are mainly son’s higher education and own retirement.

My observations on what Ravi has done well and what he has not were as follows:-

  • His insurance is clearly inadequate and must be at least 1 crore preferably more.
  • Aggressive pre-payment of home loan has been a good achievement.
  • It is great that he has built up a substantial stock portfolio in limited time.
  • Not having any MF investments is not a good idea, he needs to have a MF portfolio apart from stocks.

Based on these I suggested the following action plan to Ravi:-

  • Take a term plan of 1 crore immediately and bump it up to 2 crores when he reaches 40 years.
  • Start SIP with MF and put 20000 Rs per month into 4 funds as per my MF portfolio structure. This will be enough to take care of his son’s graduation needs that will be there in 15 years. Ravi can increase this SIP amount later on.
  • He is looking to buy a house in Bangalore. Ideally, he should do it by selling the Pune apartment. If he does not want to do so then he has to make a down payment of at least 20 % of the Bangalore apartment price. Also his loan EMI along with the rent he gets from Pune apartment should not exceed 50000 Rs per month. In other words EMI should not be more than 32000 Rs.
  • He needs to maximize his PF and PPF for the debt portfolio. No other debt products are needed.
  • He should continue to put all surplus money in his stock portfolio, where he is already doing very well. Over the period of the next 25 years this can easily grow to 5 crores and more.
  • Without any real need to do the calculations, it is easy to see that Ravi will be able to retire comfortably in 25 years with his PF/PPF account amount and stock portfolio value.
  • Even if he wants to do something different earlier to retirement, he will have the option of selling off his Pune apartment to fund the same.

I hope this has been an useful read for most people and would have helped them relate to their own financial situation. If any of you want me to take a look at your financial plan, reach out to me through Facebook and I will interact with you.

Children’s college education – how should you plan?

As all of us will probably agree, the college education of our children is next only to retirement in our priority of goals. The way things are in our country right now, a good college education is not only desirable but also imperative to deal with the kind of competitive environment that exists. In a previous post, I had given some idea about the different options available in the Engineering education and some ball park costs regarding these. In this post, I will try to outline a case study showing how much you may actually need in monetary terms and how should you plan for it.

To begin with, here are the set of assumptions that I am making for the case study in this post:-

  • Ravi and Madhuri have a 3 year old son Ankit for whom they want to plan. They are looking at a good government or private college for Engineering education in about 15 years time.
  • Current costs of fees, hostel and other related expenditure comes to about 3 lacs per year. This has been growing at 12 to 15 % every year and the trend is likely to continue.
  • Though the couple realize IIT etc are less expensive today they want to plan for the higher figure as admissions to government colleges are tough and even there, subsidies may well be withdrawn after a few years.

The financial planner that Ravi goes to gives him the following plan:-

  • Total cost of the course today will be 12 lacs. Projected cost after 15 years assuming an inflation of 12 % is 66 lacs and with an inflation of 15 % the cost comes to 97 lacs. They decide to work with the higher figure.
  • At an assumed XIRR of 12 % over a 15 year period, Ravi will need to invest 20000 Rs per month.
  • This looks fine by itself but there are a few critical issues to consider.
    • What happens if they have another child and need to invest the same amount?
    • If you take overall SIP for retirement, children education, marriage then the total SIP needed will be in the region of 75000 per month.
    • Ravi already has an EMI of 50000 Rs for the home loan, so even with a take home salary of 1.5 lacs per month he will be struggling to get all these done.
    • What happens if the markets crash 2-3 years prior to the college going goal? Ravi can cover this by investing in debt products but he is already short of his overall investment needs.

Note that the above situation arises because of faulty planning and over reliance on Maths and calculators instead of common sense. The first thing to understand is that Ravi will still be working, or at least earning active income, when his son goes to college. Now if his take home salary is 1.5 lacs today then even at a conservative estimate of 7 % annual increase, it will become 4.14 lacs per month when Ankit goes to college. Surely he can fund part of the college fees from his active income at that point? 

The problem lies in the completely wrong and rigid way financial planning is done in our country today. The whole idea of having separate portfolios for separate goals and therefore, running multiple SIP in equity and also possibly debt funds is completely illogical and benefits only the Fund houses. The other problem is that people who have been converted into this band wagon of goal based investing and mindless SIP, become ardent supporters of it and start hammering it into the consciousness of all future investors that this is the only way to do it. They may have good intentions but then they are so completely wrong that you should not touch their advise with the longest of barge poles.

OK, all that being fine what should Ravi be really doing then?

  • Understand that even if the education cost comes to 97 lacs overall, he will really be needing 24 lacs every year. More accurately he will need 12 lacs every semester as all Engineering colleges operate in that mode.
  • If he is investing in PPF and maximizing his contribution for 20 years, he will have enough money to cover for a large part of the expenses for Ankit.
  • He should invest in MF, maybe even through SIP but have only 1 MF portfolio. The initial amount of investment is immaterial, he can invest whatever he has surplus without compromising on his lifestyle.
  • Attempt should be to pay off the housing loan quickly so that the EMI can be channeled to investments.
  • As his salary increases and he is able to pay off the home loan, more funds will be automatically available for his investments. So even if he can invest 30000 to 40000 in MF today instead of the 75000 that his planner is saying it is absolutely fine.
  • He should focus on leading a good life and not worry about keeping on hammering away at all calculators, imagining what all can go wrong.

How do I know this will work? Precisely because, I have gone through this myself and know that it works. In the next post I will outline my experiences so that the message is driven home in a clearer manner.

The best way to meet financial goals

In my discussions with people about their financial goals, I have often been surprised to note that many of them want to put even short term events or regular ones as a goal and want advice on how to invest for these. Now, I can understand if you want to take a family vacation to Europe in 5 years and plan to spend 6 lacs for it. That will definitely qualify as a goal and you may want to specifically invest for it. However, if you are going for an annual vacation every year and spend 50000 on it then having it as a goal for investment is really going overboard. Similarly there are people who want to put their children’s regular school expenses as a goal to be invested for, which makes no sense at all.

Now do not get me wrong – some of these can be fairly high and definitely need to be planned for. However, when you confuse it with short term or long term investments then things can get very convoluted. Cash flow management is very different from investment and these need to be kept separate. All your regular expenditure must be met from your active and passive income that you generate monthly or in different periods. In order to meet these expenditures you may plan your cash management but that is different from investment. Let us see a few examples:-

  1. You plan to go for a vacation every year and this costs you 50000 Rs on an average. Ideally you should be able to meet it from your funds in the SB account. Even if this expenditure is higher, say 1 lac or so putting aside some money every 1-2 months will get this to happen.
  2. Your children’s school fees are 20000 Rs every month. This is something you will need to pay out of your salary or business income in a regular manner. Yes, if the fees are taken quarterly then you may need to accumulate it over a period of a few months.
  3. You are planning to replace your furniture and it will cost you 1 lac in the next 6 months. Here again you put aside some money every month and reach the figure at the desired time.

Which brings me to the real point of this post. Make sure that the real financial goals you need to invest for are both some time away and also significant in terms of the money amount. If your normal lifestyle expenditure is not being met through your regular earning then there is a fundamental problem you need to address. The only two ways there is to either increase your earning capacity or reconcile to a lifestyle that you can afford. 

Having said that the best way to meet your goals are not from investments but from your regular income, be it active income or passive income. Let us say that your child is studying in college and you need to pay 2 lacs every 6 months for the fees and other expenses. Most of us would have planned it as a goal and will take money out of earlier investments to meet the goal. While there is nothing wrong in it, a much better way will be to meet it from your regular earning. My daughter is in the final year of her college now and I have paid the fees for her 7 semesters in exactly this way. Now I may have been able to do this due to my income levels etc but even if they were lower, I could have done the same with some planned cash flow management.

What are the advantages of this approach? There are many but a couple of them are significant. Firstly, it creates a match between your current lifestyle and earning so you know where you are financially in terms of your bandwidth. Secondly, it lets your investments grow to the maximum extent possible through having the benefit of real long term. In fact, I am of the opinion that retirement is the only real goal that you need to invest for. Maybe one can add children’s marriage to it but my views on an ostentatious marriage has always been rather lukewarm.

Action points – look at your goals and check if you can meet them through your regular income when the time comes. You may be surprised to see how easy it really is. For example, I have always been able to meet all of my goals through the income that I have generated in the relevant year. The only exception was buying the apartment for which I took a loan. I have never redeemed my investments for meeting a goal so far and hopefully will not need to till I retire.

I am happy to see many people have got started out here. Also, become a part of my Facebook group Market Musings where a lot more is discussed on the general market situation and also individual stocks.

Interested readers may pls follow my blog on email by clicking on the relevant button on the right hand panel. I will shortly be stopping the practice of posting the links in different Facebook groups. Following the blog will ensure you get intimated whenever there is a new post.