Nirav Shah, a 29-year-old software engineer, lives in Bengaluru with wife Drashti, aged 28 and a home-maker. They are expecting their first baby in another four months and want to plan for the newest member of the family. The young couple also wants to purchase a house in Bengaluru and prepare for a dream vacation in 2020. Buying a term plan for contingencies, getting separate health insurances for self and family, and monthly investment in equity via SIP are some of the good moves they have made. But a low equity exposure, a car loan at a high interest rate and not investing for future financial goals will hurt them (see table Assets).
Generating higher returns on one's portfolio is another crucial factor when it comes to wealth creation. Returns on fixed deposits and postal schemes are subject to taxation as per Shah's tax slab, which reduces the overall amount. In fact, this disadvantage alone should keep him away from fixed deposits. Direct investment in stock markets also requires in-depth research and analysis, and it may not be possible for an individual to devote so much time and effort. So, it might be wise to stay off direct equity investment. Shah is advised to sell the same and invest in diversified equity mutual fund schemes.
The plan below assumes that the rise in expenses after the baby's birth could be met with the increase in Shah's income (see table Inflow-Outflow). He is also advised to review it and rebalance his portfolio periodically, preferably every year.
Tasks at Hand
Contingency: Shah should keep a contingency fund that will cover three months' expenses. The current balance of Rs1.8 lakh in his savings bank account has been earmarked for this. Whenever he has a salary hike, he should try and increase the corpus to cover expenses for six months. The money should be invested in ultra-short-term funds and must not be used for any other purpose.
Life insurance: Shah has already purchased a traditional plan and a term plan of Rs1 crore, paying an annual premium of Rs29,000. According to need-based theory, the couple requires an additional life cover of Rs1.5 crore. So, he should buy an additional term plan for 30 years, which will cost him around Rs18,000 per annum. As the internal rate of return of a traditional LIC plan is unlikely to beat inflation considering present surrender value, future premiums payable and expected maturity value based on current bonus rates, he is advised to surrender it. While buying an insurance policy, disclose all information, including health history, habits (if any) and existing insurance plans in the proposal form.
Health and disability insurance: The couple has a health insurance cover of Rs6.5 lakh provided by Shah's employer. They have also bought separate health cover of Rs2.5 lakh each but those have room-rent sub-limit of 1 per cent of the sum assured. Shah is advised to port the policy and buy a family floater plan of Rs10 lakh. He has bought a critical illness cover of Rs15 lakh and accidental disability insurance of Rs50 lakh, which should be retained.
If parents or parents-in-law are dependent on you, it is advisable to get adequate health cover for them. Medical costs are rising at a faster pace than consumer inflation rate. So, it makes sense to take necessary steps right now. Plus, there will be tax benefits. The premium paid up to Rs5,000 for self and family and an additional Rs30,000 paid for parents will be deducted from the total income u/s 80D of the Income Tax Act.
Future Goals
Retirement: It is a crucial goal that must be addressed to ensure a smooth financial journey. Shah is planning to retire at 60 and will require a corpus of Rs14.75 crore to take care of his retired life and that of his spouse (till she is 80). We have worked it out, assuming household expenses to be Rs70,000 per month in present term plus 7 per cent inflation.
To reach this goal, Shah should shift his direct equity investments to diversified equity mutual funds via SIP and increase the monthly investment amount from Rs12,000 to Rs15,000. He should also put in a minimum Rs1,000 in Public Provident Fund to keep it active. Future value of his current investments sums up to Rs8.9 crore. But the necessary changes will help him build the desired corpus (see table Retirement Allocations).
Child's future: The couple is expecting their first child and wants to plan for his/her higher education and marriage. To build an education fund for the child's graduation starting at the age of 18, the parents will require Rs20 lakh in today's value (future value will be Rs67.5 lakh). Shah has to start a fresh monthly SIP of Rs9,000, again in equity mutual funds. For the child's marriage at around 25, the couple will need Rs30 lakh in today's value (future value will be Rs1.75 crore). Shah must start a new monthly SIP of Rs11,000 to build this corpus. Also, a monthly SIP of Rs9,000 in an equity fund and Rs2,000 in a gold fund will help accumulate the amount.
Home purchase: Buying a home makes a lot of sense as rents are skyrocketing nowadays. The family is keen to stay in Bengaluru for a long time and wants to purchase a house that will cost Rs75 lakh in present value. Shah owns a flat in his hometown Vadodara, but he is ready to sell it to finance his new home. He should be able to sell the flat at Rs43 lakh, repay the outstanding loan of Rs25 lakh and use Rs18 lakh for down payment. For the rest, Shah will have to get a home loan for 30 years. Assuming the rate of interest at 8.5 per cent, the EMI will be around Rs49,500. His existing EMI plus savings from rent will be adequate to service his monthly EMI (see table Home Purchase). Home loans also ensure tax advantage. But one should consult a chartered accountant/tax professional for tax planning.
Dream vacation: Shah wants to go on a dream vacation with his family after two years which will cost him Rs5 lakh in present terms. As there is no surplus available to fund this goal, he should postpone it until a further rise in income.