Early start to a safe future

Name: Amit Kumar (L) and Sonila Soni Age: 29 Years (Both) Monthly Income: Rs 47,000 (Post Tax) Financial Dependents: One (Child)

Click here to see portfolio analysis of Amit and Sonila

A little over a year old, Rudra has no care in the world. Two decades later, he should hopefully be as carefree—financially that is. He should have no worries about his education funding or whether he will be able to afford the latest laptop. The reason? Sound financial planning by his parents, Amit Kumar and Sonila Soni. The young doctor couple understands the benefits of an early start to building a meaty portfolio. Hence, without compromising on their lifestyle, Amit and Sonila have committed a tidy sum of their monthly income to investments.

“The idea is to fully exploit the next four to five years of our highrisk appetite,” says Kumar. The thought is bang on. However, the execution of this investing principle is a little faulty. There is scope for beefing up the couple’s investments and channelising them into better financial products.

We will identify the loopholes in their strategy a little later. First, let’s take a look at Amit and Sonila’s current financial condition.

The couple works in a government hospital and together earn Rs 47,000 a month post tax. Their expenses add up to about Rs 10,000 a month—21.2% of their combined income. This is reasonable. But as their son grows up, expenses will rise and the couple must be prepared for the cash squeeze. In July 2007, Kumar took a car loan of Rs 3.24 lakh. The interest rate is 14.45% and the EMI skims off Rs 7,724 from the couple’s income.

Keen on accelerating the growth of their portfolio, Amit and Sonila have steered clear of debt investments apart from the monthly provident fund contribution of Rs 2,500 each and Rs 1,500 each in the Public Provident Fund. Instead, they have committed Rs 8,500 in three mutual funds via systematic investment plans (SIPs). The funds are SBI Magnum Taxgain, SBI Global and SBI Contra.

In January this year, Kumar bought shares of Reliance Natural Resources worth Rs 15,000. After the market downturn, he is not even looking at the status of that investment. “I couldn’t have experimented at a worse time,” he says. But maybe it was for the best. The early knock has taught him lessons that he won’t forget easily.

Firstly, he must read up on the markets before shopping for stocks. Also, he should have a strategy for direct equity investments. And most importantly, he must brace himself for shocks. This means sticking to stocks bought with a long-term horizon despite the market free-falls like the most recent one.

After burning his fingers, Kumar has vowed to buy stocks only after equipping himself with the necessary knowledge. “I don’t want to avoid direct equities altogether,” he says. We hope that he does his homework first.

The couple plans to buy an apartment in Gurgaon in the next five years as an investment. They currently live in a government accommodation. In addition, they also own ancestral property worth nearly Rs 5 lakh.

This is a good plan. It will diversify their assets and also help them build one. To save for the down payment, we suggest that Amit and Sonila regularly invest in equity funds that we recommend. One mistake the couple has made is to not insure themselves. Two years ago they invested in two Ulips, which are pension plans. They pay Rs 10,000 annually for each of them.

Kumar is keen to start private practice after about 20 years. In a bid to ensure regular income, the couple invested in these Ulips, but as the Ulips offering pensions do not have any sum assured, the couple has zero insurance cover.

A professionally qualified working couple can skip life insurance. However, we suggest that they take some cover. They can buy a term plan of up to Rs 25 lakh each for 20 years. The annual premium for both the policies will be about Rs 14,000.

The couple’s current monthly cash flow generates an investible surplus of Rs 16,110. One way to increase it would be to prepay the car loan. Though we usually recommend closing all debts, Amit and Sonila should not attempt it. The 14.5% reducing rate of interest works out to be about 8% at a flat rate. Currently, even debt investments like fixed deposits earn about 10% interest. Hence, it is wiser to invest the money than prepay the car loan.

But the investment should certainly not be in fixed-income instruments. Equities is the way to go for the couple. We suggest that they funnel the entire surplus in large-cap funds like HDFC Equity, Franklin India Bluechip and DSP ML Top 100. Such funds are safer than those that invest in mid- and smallcap stocks.

The couple should continue with their SIP in SBI Magnum Taxgain as long as it is necessary to avail of tax deductions. In fact, they may need to increase it by Rs 5,000. Once they begin paying an EMI for a home loan, they can discontinue this SIP. We recommend that they stop the SIPs in SBI Contra and SBI Global. This is an overkill of SBI funds. Investors must try to diversify across fund houses too. Moreover, these funds are not the ideal choice to start building a corpus. Both funds bet on stocks that are out of favour and on emerging businesses. As they have a concentrated profile, these funds are riskier than the equity diversified funds. So, they should be currently avoided.

We are not suggesting any debt investments. The couple’s contribution to the provident fund and PPF is enough at this stage.

As Kumar wants some regular income when he opts for private practice, we suggest he transfer his investments from mutual funds to instruments like RBI bonds after 20 years. The strategy will allow his investments to grow at a fast pace in mutual funds before he makes the switch to low-yield investments. Also, he should not increase investments in the Ulip pension plan. Opting for mutual funds which offer pension is better as they provide greater investment flexibility. One such fund is the Templeton India Pension Plan.

Fund spread

In a bid to diversify, Amit and Sonila have chosen funds which are unsuitable for new investors. Here’s how to go about spreading fund investments.

Investing in a mutual fund is diversification and to further expand these investments is nothing short of a bonanza, provided it is done prudently. Invariably, people end up buying 20 different schemes in order to do so. But they still have all the eggs in a single basket.The reason? The funds have similar investment strategies. I remember that a lot of people invested in five different IT funds in 2000.They lost 65-75% of their investment and complained that diversification was not a sound hedge. Actually, they had not diversified their investments at all.

As the mutual fund industry evolves, it will offer more niche products. Mutual fund is the only platform that lets you invest across various asset classes.To diversify, you can select debt funds with a tenure suiting your specific needs and equity funds where the choice is much wider.You can choose from diversified, growth, value,mid-cap, small-cap, large-cap, index, infrastructure, banking , IT, healthcare funds and so on.

With gold ETFs now available, the choice has widened to include one of the favourite asset classes of investors. Soon there will be real-estate funds that will further increase the scope for diversification.

Besides asset classes, diversification includes investment in different economies. So while the Sensex gave negative returns in 2001, you could have notched 87% returns had you put your money in a fund that invested in the Russian RTX. Investing in Latin America and China is now possible through Indian funds. So for true diversification, invest in funds with different strategies and exposure to different stocks.