‘You should always have a strong bank balance,” is typical parental advice to a son or daughter. However, following that advice could actually hurt your finances. With the Consumer Price Index rise at 7.3 per cent in July, earning even seven per cent (the highest rate, being offered by YES Bank) means the value of your ‘strong bank balance’ is actually eroding.
Which is why Rahul Upadhyay did not take his father’s advice on how to save. “When I started working, he asked me to start investing in recurring deposits. I never followed it. I have never looked at post-office savings schemes, either,” he says.
Even the equity investment style of Udadhyay, who recently launched his own venture, seniorshelf.com, is different. While his father, a former assistant general manager with State Bank of India, believed in buying blue-chips like ITC, SBI and others for annual dividends, Upadhyay believes in investing in shares for capital gains. “I identify particular stocks which I hold for shorter periods, whereas my father still holds his blue-chips for dividends.”
His aggression in investment is a reflection of the changing times. With the vast change in lifestyles, in which watching a single movie in a mall costs at least a couple of thousand rupees for a family of four, and with the cost of education and health care rising 10-20 per cent annually, the need to save in instruments that return more and are also, most probably, riskier is growing. According to the changing times, you also need to change your financial decisions. To start with, the basics:
A strong bank balance means little: Even if there are lakhs in a bank account, it is earning a paltry rate of return – not even enough to cover for inflation. But you do need to keep some amount in the bank. Financial planners, typically, advise that you have some part of the salary – the amount you would require for monthly expenses – in the bank account. Of course, most banks have introduced a minimum balance clause that forces people to maintain it, lest there is a penalty. The advice, therefore, is to maintain the minimum balance, along with the monthly expenses, in your bank account and another 10 per cent extra. This will ensure that if there are exigencies, you don’t end up reducing the minimum balance and incur a steep penalty.
“If there is a travel or insurance premium coming up in a particular month, provision for it separately,” says Suresh Sadagopan, financial planner. Any surplus should be maintained in short-term liquid funds for less than one year. It is important not to exceed this limit because under the new debt fund guidelines, there will be a capital gains tax according to the income tax slab. These short-term funds will also provide liquidity as and when you require. “Ideally, save over time to have three to six months’ salary in these schemes as an emergency fund,” adds Sadagopan.
Shun gold jewellery as an investment product: Gold or diamond or platinum might be a girl’s best friend but it need not necessarily be a part of your financial planning. Ensure that over and above festivities like marriage or other celebrations, gold does not exceed five to 10 per cent of your portfolio. Financial planners also say gold jewellery and the like should not be considered a part of the investment portfolio, as few people sell gold to raise money. Your parents would have been prompted to buy gold during festivals. Even if you want to buy gold, use exchange-traded funds. These are more liquid and since there are no making charges, as in the case of jewellery, they provide full value for the yellow metal.
Don’t be under-insured or buy traditional plans: Did your parents ever gift you a traditional plan, which will give you a princely amount of Rs 5 lakh when you reach 40? There are many parents who put in small amounts in a traditional insurance scheme for 20-25 years for annual returns of five to six per cent – the average for most traditional plans.
Says Amit Trivedi, financial planner and director of Karmayog Knowledge Academy: “Our parents made the mistake of being under-insured or bought low-paying insurance schemes. Sadly, even now, a lot of people buy insurance schemes for tax purposes.”
If you have insurance needs, go for the term plan. And, buy a plan with a big sum assured, for instance, Rs 50 lakh or Rs 1 crore. Over the years, as dependents in the family increase, you will have to keep on adding to your insurance needs. But don’t buy a traditional or unit-linked insurance plan for this. Keep adding term plans to your kitty. With all insurers offering online term plans, the cost of buying life insurance has become even cheaper.
Use the rest of the money to invest in mutual funds or good blue-chip stocks. For instance, the annual premium of an online term plan for someone in the age group of 30-35 years with a sum assured of Rs 1 crore (for 30 years) is Rs 8,000-15,000 from private sector players. A traditional plan for a similar age group, period and sum assured will cost Rs 30,000-35,000 annually. The difference is Rs 15,000 to 20,000 a year and if you did a systematic investment plan of an equivalent Rs 1,500 a month in a good equity fund for 30 years, with a return of 15 per cent, the final corpus would be Rs 1.05 crore. Clearly, the old days of investing in several insurance schemes do not work.
Buy a house early: Property buying, in the past, was considered a significant achievement. And, most people opted to buy property only when they were well-settled, with an adequate amount in the bank. In fact, 20 years earlier, the average age of buying property was over 40 years – Upadhyay’s father bought his house at 46. This has come down sharply to the late 20s. “Young people have more leveraging power and are using it aggressively. There are several banks and non-banking financial institutions which aggressively promote home loans for young professionals,” says an official in a housing finance company.
Media professional Jahnavi Samant’s family stayed in a rented place in Dadar, Mumbai, for over 30 years. But in 2000, when she was 23, she purchased her first house, in Mira Road, for Rs 5 lakh. Six years later, she sold it at Rs 10 lakh. She had planned to purchase a flat in more central Andheri or closer with that corpus. But the rates had risen too fast by then. She settled for a 4,300 sq ft bungalow in Pune. “I paid Rs 10 lakh first and the rest through a monthly instalment of Rs 20,000. My parent never thought of purchasing a flat because we had stayed in Dadar all our lives. But I wanted to have a house of my own,” she says. Though property rates, especially in cities such as Mumbai or Delhi, have gone through the roof, financial advisors say that even if you purchase a property in a smaller city or in the outskirts in the initial years, it will appreciate in value over time and provide you with capital to make the next purchase, as it did in Samant’s case.
Go for equities early: A retirement corpus of Rs 2 crore sounds quite good now because even if it is invested in fixed deposits returning nine per cent annually, it would provide Rs 18 lakh as returns. Though the final returns will be impacted by the tax rate applicable, the returns are still not so bad.
But, you have to target a much higher rate of return. Assuming the average consumer price inflation at seven per cent yearly, the value of that Rs 2 crore would be only Rs 70-75 lakh after 15 years. Similarly, the value of a monthly income of Rs 1 lakh will be around only Rs 20,000 after 25 years. In other words, you need to save significantly more to ensure a sound corpus. Instead of Rs 2 crore, you would have to target Rs 6-7 crore. The only instrument that can ensure this is equity. As mentioned in the earlier example, even a small monthly investment of Rs 1,500, invested for 30 years at 15 per cent return, will lead to a corpus of Rs 1 crore. If you invest more aggressively, say Rs 10,000-20,000 a month, the result of compounding will ensure a healthy corpus of Rs 10-15 crore over 30 years. But this means you need to start early. The advice: Start small but early. And, increase the equity allocation over time. Important, since there is no long-term capital gains’ tax on equities, the returns will be tax-free.
However, there is one important thing to learn from your parents – budgeting. As Trivedi says: “Earlier, familes used to write down monthly expenses, which led to fewer leakages. Now, people just don’t do it because there are credit cards and loans to fund their extravaganzas like buying of white goods and the latest gadgets. This is one habit that children should learn from their parents.” Amen.