Investment guidance for management consultants

Investment guidance for management consultants

October 5th, 2007, I walked into a room full of aspirants who wanted to work for McKinsey & Company. After a rigorous and long interview process got the offer letter and I landed up spending few years in consulting before starting up.

Life at McKinsey was filled with long working hours, learning new skills and problem-solving real business issues.

The broad span of consulting work makes it an attractive career, offering a variety of projects, challenges and opportunities for personal development. This often involves working all over the world with multinational clients.

Usually, consultants are not able to allocate required time to manage their investments and here are some of the issues:

Time constraint

Consultancy requires meeting tough targets on time and consultants are often under pressure to deliver along with managing extensive travel schedule. This leaves very little time for consultants to take appropriate action for their personal investments.

Career focus

Consultancy firms often adopt “grow or go” policies. The focus remains on moving up the ladder and that leaves little scope for personal work.

Compliance

Since consultants work with corporate clients, they are not allowed to invest in client company’s stocks. This restriction includes self and family members since family members are treated as beneficiaries.

New assignments

After every few months, consultants are assigned, a new corporate client. In case they have shares of the new client, they have to sell irrespective of the price levels.

Savings growth

Consultants are paid quite well and they travel extensively. They tend to accumulate savings through salary/bonus credits. This creates a false sense of investment growth.

Few steps management consultants can take to ensure their money is working harder than they are.

Technology enabled investment management

An access that allows consultants to review and rebalance their investment portfolio remotely can ensure that they are always on top of their investments.

Review quarterly

Scheduling two hours every quarter will ensure that the investments are going in right direction and will provide psychological comfort as well.

Hire an advisor

A management consultant may hire a financial advisor to manage investment portfolio while the consultant is on the move.

Life events based investing

Buying a house, childbirth, kid’s going to college, nearing retirement etc. are all life events that have an impact on your investment portfolio. You should take time off to reflect on your investment portfolio based on your broad life ‘goals’.

A simple way to create an investment portfolio that grows peacefully is to:

Allocate 50:50 between equity and debt of your investment portfolio, irrespective of the market movement.

For simplicity, you can choose fixed deposit with a bank as a category to fill debt portion of your portfolio and index fund to fill equity portion of your portfolio. Expect 8-10% p.a. after-tax return if you follow this strategy over a period of five years or plus. You may have to annually rebalance your portfolio to go back to 50/50 allocation.

Here is even a better way to manage investments but will either require you to hire a professional or devote substantial personal time.

Allocate investments based on your investment goals and manage investments for each goal separately.

A standard 50:50 allocations may or may not make sense since each goal may have a different time horizon and psychological association.

Choose debt mutual fund or traded RBI bonds to fill debt portion of your portfolio and a combination of equity mutual funds and direct concentrated equity to fill the equity portion of your portfolio. This portfolio should generate 15-17% p.a. after-tax return.

Your money should work harder than you and provide enough financial flexibility to live a life that you love. 

How to structure your investment portfolio

How to structure your investment portfolio?

Time, energy and money are usually limited in life. Therefore, it is essential to strategize and prioritize in order to make the best utilization of them.

Just as daily tasks have allocated time slots, similarly you need to have a slot in your life to manage and grow your money. It’s easier to do this if you are aware of your portfolio.

An investment portfolio is a consolidated record of all your assets, which define your net worth. It includes stuff like stocks, bonds, real estate, gold, cash equivalents etc.

Your portfolio is not a static number – Its dynamic and changes over time as your needs vary and your assets grow.

Since each asset class has varying risks, structuring your investment portfolio with the right mix of risk-adjusted assets is central to your aim of meeting your financial goals.

How to structure your portfolio?

1.) Firstly, being aware of when and how much money you will need will help you get started.

  • Long-term focus: When you’re saving for a long-term goal, time can smoothen the returns from volatile investments. If you are investing for the long-term, you should allocate more towards equity and real estate in your portfolio.
  • Short-term focus: If you’re saving for a short-term goal, like buying a car, volatile investments may work against you, sometimes plummeting right before you need the money. Investment in fixed deposits and bonds is recommended.
  • Watch out for inflation. Retirees or anyone dependent on a fixed income needs to worry about the damage that inflation can inflict on both buying power and income (E.g. regular interest from bonds may fluctuate) Rentals from real estate as well as a healthy dose of stocks can help moderate the impact of inflation.

2.) Create a portfolio after considering your risk tolerance.

  • Investing involves risk. All investments involve some risk, even seemingly safe investments like large-cap stocks or government bonds. If you need some money for a short-term goal and you cannot afford to lose a penny of it, put it into a fixed deposit or a liquid fund.
  • No pain, no gain. Riskier assets—such as mid-cap and small-cap stocks—tend to have greater returns over time, but can also have violent swings. These investments are suitable only if you are comfortable with high short-term volatility.

Here are a few scenarios, which can help you understand how to structure your portfolio investments for specific goals and at an overall portfolio level.

Scenario 1: Planning to buy a car in two years time.

Asset category Conservative

Investor

Moderate

Investor

Aggressive

Investor

Fixed deposit 60% 50% 40%
Liquid bond 40% 40% 40%
Short-term bond 0% 10% 20%
Total Portfolio 100% 100% 100%

So if you are planning to buy a car in the next 2 years worth Rs 5 lakhs and are a conservative investor, you should put 60% or 3 lakhs in a fixed deposit and 40% or 2 lakhs in a liquid fund. 

Scenario 2: Saving for child’s college expenses (five years from now).

Asset category Conservative

Investor

Moderate

Investor

Aggressive

Investor

Short-term bond 70% 60% 50%
Medium-term

bond

20% 20% 30%
Short-term bond 10% 20% 20%
Total Portfolio 100% 100% 100%


Scenario 3: Saving for your own retirement (twenty years from now).
 

Asset category Conservative

Investor

Moderate

Investor

Aggressive

Investor

Fixed deposit 80% 60% 40%
Liquid bond 20% 30% 40%
Large-cap equity 0% 10% 20%
Total Portfolio 100% 100% 100%

These are general guidelines and will vary based on individual specifications.

Prudent investment allocation can help you ride out the ups and downs of long-term market performance. No single asset class will outperform another consistently and no single investment allocation strategy may be right for everyone. Some investments may be up while others may be down helping minimize the overall potential impact of market decline and enable you to reach your goals smoothly.

That’s why its better discuss your portfolio with a financial planner or advisor to arrive at the optimal breakup based on your individual needs and requirements.

Do you want to be rich?

Do you want to be rich?

Everybody wants to be ‘rich’ but very few take actions. However, rarely anyone would sit down and think through what he or she needs to do to achieve financial freedom.

Circumstances and needs are constantly changing. Therefore, a sound financial situation today does not necessarily foretell an equally rosy future.

  • A loss of income, even temporary can deplete your savings or leave you in debt.
  • An uninsured loss can wipe out your accumulated wealth.
  • Insufficient savings can force you into a reduced lifestyle post-retirement.
  • Frequent or unplanned borrowings can leave negative money i.e. debts for future.
  • Poor tax planning can result in higher taxes, payable separately.

All this, combined with changes in your life cycle, needs and/ or external economic changes can make you and your future generations financially vulnerable.

What do you need to do?

You need to plan and manage your current and future income to meet your current and future needs / wants. These are also known as your goals or dreams.

People who write their goals are much more likely to achieve them.

Sit down by yourself or with loved ones and try to imagine your future. Consider what drives you in your life and how that has changed over the years.

While I can’t tell you what you should want in life, the list of questions below can provide you with a fair idea of how you should start thinking about the future.

  • What milestones do you foresee in the future? – starting a family, sending kids to college, buying a new home etc.
  • When would you want to retire? And with how large a corpus?
  • What are some of the other things that you may want to do in life?

Once you have a timeline of your goals, you will need to estimate how much money will be needed to meet them.

A portion of your current savings will need to be invested appropriately so that it grows to meet your future goals’ cost.

Make a list of all key expenses you foresee in the future. This will give you an idea of how to invest your savings.

Improving your saving potential

Apart from the percentage amount saved, it is equally important to be constantly on the lookout for improving your savings potential without impacting your quality of life.

No, I am not advocating that you live a very frugal lifestyle and cut back on your consumption – after all, what’s the purpose of earning money if you can’t enjoy it. The idea is to find a right balance between savings and consumption.

If you feel you aren’t saving enough, creating an income and an expense statement as a first step will give you visibility regarding where your money is being spent.

Budgeting your expenses

It’s recommended that you create a budget for your expenses.

The first step in creating a budget is to identify the money you have coming in, i.e. your income. Keep in mind, however, that it’s easy to overestimate what you think you can afford if you think of your total salary as what you have available for spending.

Remember to subtract your employee PF contribution, employer PF contribution and income tax. Ideally, if you are assessing your monthly saving potential you should not even consider your annual bonus.

Categories of Expenses

Start by dividing your expenses into 2 broad spending categories:

1.) Fixed expenses – stuff like your house rent / EMI, monthly food expense (groceries, fruits and vegetables etc.), electricity bills, phone & internet connection expenses, school fee of your children etc. which stay more or less the same throughout the year.

2.) Variable expenses – stuff like entertainment expenses, travel, and medical expenses etc. that can change from month to month.

In each of the two categories, you will want to record details of how much you spend. This data needs to be recorded for a couple of months to arrive at your monthly average expenses.

After you’ve determined what to set aside for your fixed expenses, you can alter the amount earmarked for variable items. The variable category gives you more room in how much you decide to spend. Additionally, variable category allows you to prioritise your expenses as you deem fit. For example, you might decide you can spend less on eating out each month in order to give yourself more money to make a family trip outside India.

You may be surprised, but just knowing how much you spend under various heads will give you ideas on how to cut expenses if required.

Earlier, the better strategy

Remember, the earlier you start saving, the more you will have later in life. Here is a table that represents the growth potential of savings across income levels. 

Scenarios Individual 1 Individual 2 Individual 3 Individual 4
Monthly income Rs 50,000 Rs 1,00,000 Rs 2,00,000 Rs 5,00,000
Monthly Savings (20%) Rs 10,000 Rs 20,000 Rs 40,000 Rs 1,00,000
Value after 5 years Rs 8 lakhs Rs 16 lakhs Rs 33 lakhs Rs 82 lakhs
Value after 10 years Rs 23 lakhs Rs 46 lakhs Rs 92 lakhs Rs 2.3 crores
Value after 20 years Rs 99 lakhs Rs 1.98 crores Rs 3.95 crores Rs 9.9 crores

Assuming the savings grow at an average rate 12 % p.a.

Yes, it is possible to create a large amount of wealth over your lifetime – The key is patience and a disciplined approach to investing small amounts of money every month.

How can you plan for your retirement

There are many things you must do before your retirement. But there are few essential things that you must do before you Retire

Do not put off today what you cannot afford to do tomorrow. In India, you have to create your pension and the government has a minimal role to play in securing your retirement. Here are a few tips on things to do before you retire so that your retired life is more comfortable and enjoyable.

Payoff all your loans 

If you are taking a housing loan, personal loan, car loan or any other loan make sure that you repay them on or before your retirement. You need to choose the term of the loan in accordance with your retirement age. You can truly enjoy your retired life when you have 100 percent financial freedom, not when you have to repay your loans.

Protect your emergency fund

Emergency expenses can happen any time. But the possibility goes up as we grow older. So we need to enhance the emergency reserve year on year, based on the inflation and change in your expense levels. Also, you need to invest back in your emergency fund in case you have withdrawn out of the emergency fund to meet any other expense.

Establish a retirement budget

You need to visualize your retired life well in advance and need to create a budget for your retirement. E.g. You will not be going to an office so expenses on transport and clothes may come down. Also, you will have more time to spend. You may need to spend more on leisure travel and health care.

Examine your cash flow

Assess your cash flow situation and consider any income that will continue post your retirement such rent, interest income, etc. Will there be any unwanted outflow during your retired life? Like paying life insurance, or SIP. You must also realign your existing policy and other investments in sync with your retirement age.

Grow your retirement corpus

Most of the people start to plan for their retirement when they are close to their retirement age. Often its too late to have a structured approach to creating appropriate fund before you retire. Here is a tool that can help you understand how much you need to lead a comfortable life before you retire. A professional financial planner can help you determine the right asset allocation to achieve the required corpus.

Develop a withdrawal strategy

This is one of the toughest aspects any retiree has to deal with. When someone retires bulk of payout is made through an employer. In case you have not created a plan for withdrawal you can either commit your funds to wrong investment channels or park in an extremely safe option that does not cover your retirement life. One simple rule is to spread your retirement savings across various vehicles and then strategize with withdrawal strategy to ensure continuity, stability and tax-efficiency. 

Minimize taxes

Careful selection of investment vehicle can reduce your tax during the retired life. Investing in PF and PPF can help to grow your investments on a tax-efficient basis. However, the growth is limited to these investments. Therefore, you need to add growth assets such as equity and real estate. Until recently, equity investment was tax-free but now with the re-introduction of LTCG, you have to pay 10% on long-term capital gains. However, even considering LTCG, investing in equity is important for your portfolio to beat inflation. 

Get sufficient mediclaim coverage

The moment you retire, your employer will stop covering you under the group mediclaim. So you need to plan for your individual medical cover well in advance. At old age, the medical expenses are inevitable and will only increase. If you have not planned it properly then all your retirement plans can go haywire.

Consider inflation adjusted pension plans

The monthly income you need when you retire is not going to be the same even after 5 years of your retirement. Inflation will increase your retirement expenses year after year. Therefore, your retirement portfolio should grow more than the inflation. 

Oversee estate planning

How your fixed assets and financial assets need to be distributed to your legal heirs? Create a Will. You can avoid creating relationship problems to your next generation because of your left out wealth.

Unless you are aware of what and how much you need for your retirement goals, your current investments will probably not be enough.