Essential things to do before you retire

Mr Sanjeev Sharma, 50, is working as head of operations in a leading auto ancillary company. Sanjeev has been a conservative investor but most of his savings were consumed either in down payment of the house or for daughter’s wedding.

Sanjeev’s take-home salary is Rs 30 lakhs and his annual expense includes Rs 12 lakhs living expense and Rs 9.25 lakhs home EMI. The EMIs will continue for another ten years and the current home loan outstanding is Rs 58 lakhs. Other than employer’s health coverage, Sanjeev also maintains a personal health plan for his family.

Although Sanjeev expects to receive Rs 2.5 crores from the provident fund at the time of retirement but he is worried, whether that is enough funds to retire at 60.

Just like Sanjeev, if you are also worried about your retirement, you can do a few things so that your retired life is more comfortable and enjoyable.

Protect your emergency fund

Emergency expenses can happen any time. However, the possibility goes up, as you grow older. The emergency reserve must increase year on year, based on the inflation and change in your expense levels. Sanjeev must always maintain six months of his living expenses for the emergency.

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 per cent financial freedom, not when you have to repay your loans.

Sanjeev has an outstanding home loan of Rs 58 lakhs. The home loan will be paid off before he retires but in case he has additional income say an annual bonus, he can partially reduce the home loan.

Understand your retirement needs

You need to visualize your retired life well in advance and need to create a budget for your retirement. Most of the people start to plan for their retirement when they are close to their retirement age. Often it is too late to have a structured approach to creating appropriate fund before you retire.

You can always consult a professional financial advisor who can set realistic expectations and create a right asset allocation for your retirement fund. However, here is a simple formula to know your retirement corpus.

Current annual living expenses X years of retirement.

Assuming, Sanjeev’s life expectancy to be 85 years, retirement corpus at 60 would be Rs 12 lakhs X (85-60) = Rs 3 crores.

Rs 2.5 crores will be available through the provident fund and that will leave a deficit of Rs 50 lakhs. Sanjeev maybe required to invest Rs 3 lakh annually for the next ten years to cover the deficit.

Examine your cash flow

Assess your cash flow situation and consider any income that will continue post your retirement such rent, interest income, etc. You must realign your existing policy and other investments in sync with your retirement age.

Sanjeev has a cash surplus of Rs 5.75 lakhs after meeting living expenses, home EMI and retirement savings. An additional saving of this amount can create further retirement cushion.

Consider inflation withdrawal strategy

When someone retires, the 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.

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.

Sanjeev expects Rs 2.5 crores from his employer’s provident fund in ten years. Careful due-diligence of investment vehicle well in advance can reduce Sanjeev’s tax during his retired life.

Get sufficient healthcare coverage

The moment you retire, your employer will stop covering you under the group medi-claim. Therefore, you need to plan for your individual medical cover. If you have not planned it properly then all your retirement plans can go haywire.

Sanjeev must continue to maintain his personal healthcare plan and if required, evaluate super top-up plan to increase coverage.

Appropriate action by Sanjeev can ensure his peaceful retirement.

Do not put off today what you cannot afford to do tomorrow. Understand your retirement goals and structure your current investments so that you can retire comfortably.

Why you should have a financial adviser ?

Why you should have a financial adviser ?

In India, working with a financial adviser is still not a preferred way to manage personal finances. We get informal advice from mutual fund or insurance agents on various products. We rely on these agents because we do not want to pay for financial advice. We invest in the products and later regret our financial decisions. Bad financial investment decision often leads to dis-interest in financial markets. Then, we tend to prefer keeping money in just fixed deposits. 

A pleasant experience of financial market is critical to growing your wealth. You need to acknowledge the difference between an agent and a financial adviser. There are various ways you can deal with financial services providers:

Brokerage firms

Generally these companies offer mutual funds, PMS and direct equity. The primary reason these companies exist and grow is brokerage through distribution of products. 

Wealth Management Firms

There are numerous wealth management firms that operate in India primarily focused on clients who can invest more than Rs 2 crores. These companies primarily offer mutual funds and PMS. These firms also earn through brokerage.

Banks

Banks are major distributors of financial products. In fact any financial product manufacturer would first reach out to banks for pushing the sales of new offering. Most of the banks offer mutual funds and insurance products. However, banks also earn only through brokerage.

Mutual Fund/Insurance Agents

There are thousands of these agents selling financial products especially MFs, insurance policies, LIC etc. Again these agents also earn through brokerage. 

Financial Advisory Firms

As per the guideline of SEBI, any firm or individual who claim to be financial adviser, have to register with SEBI and get investment adviser license. These firms or individuals are regulated by SEBI and have regular audits. Additionally, these firms or individuals cannot make money from commissions, hence avoid conflict of interest with the client. 

Most of the brokerage houses, banks and wealth management companies present themselves to be advisors but they aren’t. Brokerage houses, banks and wealth management companies push financial products to earn brokerage and have no interest in client’s objective. These firms do not care about quality of clients but just care about ‘quantum of clients’. On the other hand, mutual fund agents and insurance agents cannot afford to be selective because of ruthless competition and hardly any differentiation. 

Select a financial adviser after thorough understanding of their processes and approach. Make sure that you get unbiased advice from the financial adviser. This is possible only when the source of revenue for the adviser is not linked with the financial product.

Investing in Real Estate

Investing in Real Estate

Have you heard this piece of advice before, “Buy land. It’s the only thing which God or man is not making any more, hence its supply will diminish over time as the population rises and hence increase in value”.

If only things were that simple.

Real estate is a great asset class. It has delivered great returns for astute and early investors. Any Indian who wants to grow their money, cannot ignore real estate as an asset class. Indian real estate history is often used as a proof to demonstrate phenomenal returns that real estate can offer. However, like any other growth asset, real estate investment should not be made to meet short-term goals.

People often carry this notion that real estate prices cannot fall. This is a myth as real estate prices also fluctuate and the decline is usually gradual. Therefore real estate should be considered at par with any other growth asset class. Typically should not be more than 20% of your investment portfolio.

Risks associated with real estate as an investment option.

Economic Downturn

Real estate growth is aligned to economic cycles. As it has a high dependence on money supply and credit availability. Over valuation in bullish markets is a common feature as prices rise rapidly in a bull run and hence, is a big risk. Therefore, the sector tends to suffer steep corrections when the bubble bursts.

If the economy is not doing well and companies are laying off people, they will require lesser office space, which in turn will further drive down rentals and capital values of commercial properties.

This, in turn, will impact the residential market as lesser employees mean lesser demand for rental residential properties thereby driving down rents.

Interest cost

This applies to under-construction property. Project delays are a reality and very few projects are completed as promised on schedule. Most people look at the per sq. ft. rate and forget to factor in the cost of money that is required to hold that property while construction is going on.

To put it simply, if you have bought a property on loan while it is undergoing construction, your EMIs will primarily consist of interest repayments, which add to the total price of the property.

Liquidity

A lot of people end up buying real estate as an investment. However, if you have ever bought or sold real estate, you will have realized that it’s far easier to buy real estate than to sell it.

That’s because you would like to sell it at a particular value, which maybe higher than the market value. Apart from this, finding the right buyer and closing negotiations can sometimes take a couple of months.

Another constraint is that you cannot use a part of your real estate investment to fund a goal.

E.g. Let’s assume that you bought a house for Rs 1 crore which has grown in value to 5 crores after 20 years. Your child is now ready to go to college abroad for which Rs 1 crore is needed.

If you don’t have liquid savings, it will be very difficult to monetize your real estate, as you cannot sell a part of the house to raise Rs 1 crore.

One idea, which is slowly gaining ground in India for investments in real estate, is REITs.

Instead of investing a large amount into a real estate project, a better way of getting real estate exposure is through a Real Estate Investment Trust (REIT).

REITs are entities that buy and manage rent-producing assets such as offices and retail outlets. Professional managers handle operational issues such as building maintenance and managing tenants. Property held by REITs may also be sold and reinvested in other assets.

If you are a safe player, REITs — with their diversified portfolio — can fit your bill better than land or mega-projects. Recently, Government of India has provided tax benefits to boost real estate investment trusts (REITs).

Once REITs become a reality in India, they can be used as an option for those who want to diversify their portfolios to include real estate as an asset class.

How to prioritize your financial goals?

How to prioritize your financial goals?

Some financial goals will continually collide with one another.

E.g. paying for a child’s school fee may reduce the money that would otherwise go into their higher education fund. Or save effectively for your child’s higher education can reduce a part of the contribution for your own retirement fund.

That’s why to get what you want most, you should try doing the following:

Decide which goals will take priority first.

This can get slightly tricky as most people get serious about financial planning only when they hit a milestone in life e.g. getting married, having a baby etc.

In India, it’s a cultural thing to prioritize your children’s needs over everything else in life. Making sure they get the best schooling, saving enough for their higher education, then setting them up in business if possible, paying for their marriage, gifting them your house etc.

Times are changing and kids are more independent these days and will get more self-reliant in the future.

Your first priority goal should be your own financial security.

Listed below are some recommended goals, which you should start saving for immediately if you haven’t already started doing so.

Your Retirement Fund

You need to have a sufficiently large retirement fund so that you can lead a financially secure life with self-respect during your golden years and without being dependent on anyone else for your financial needs. Plus your kids will automatically inherit your assets (if you wish so!) so they will also be taken care off after you leave for your next journey.

Buying a Home

Your first home is not an investment. It’s an expense till you can afford to buy a second one. That’s because you will always need a place to live. You should start planning to buy a house from the day you start earning. Unless of course your parents own a home and you will continue to live in it. In that case, you can look at alternate real estate investments as a diversification option after you have a significant financial portfolio.

Emergency Fund

You should have a liquid emergency fund equivalent to approximately 3 to 6 months of your living expenses. These funds you can access immediately for any unforeseen or unplanned expenses. This will not only give you peace of mind but will also allow you the freedom from taking on an expensive debt in an emergency situation.

Being Debt Free

We live in the age of excessive consumption with multiple EMI’s. You should try and reduce as many EMI’s as possible. Not all EMI’s are made equal. An EMI for a house loan is not really an expense as it goes towards building an asset. However, an EMI for a high-end smartphone is an expense because your iPhone will start losing value the moment it’s bought – and continue to do so till it becomes worthless after a few years.

Are You an Exception to the Rule?

While these are broad guidelines that will apply to most people, every individual has specific requirements, which means you should allocate money based on your personal requirements and priorities.

Why should you invest in Direct Mutual funds?

Why should you invest in Direct Mutual funds?

A lot of first-time investors think that a regular mutual fund is better because of the name ‘regular’. And when the advisor mentions about ‘direct’ mutual fund, the first-time investor often attaches negative view on ‘direct’ word.

Let’s understand the difference between a regular mutual fund and a direct mutual fund

Each mutual fund scheme — be it equity or debt — has two plans to offer, regular and direct.

The direct plan cost is lower than the regular plan to the extent of commissions paid to distributors.

In both the cases, you are buying into the same portfolio but at different costs.

Why is the expense ratio lower in case of a direct mutual fund?

In simple terms, because you do not pay any commission or brokerage to the agent in case of a direct mutual fund.

Let’s understand how mutual funds make money: through an expense ratio or management fees.

The expense ratio is the cost expressed as a percentage of assets that would be deducted from mutual funds. The ratio is an annual figure but gets reflected in the daily net asset value of a scheme.

Expense ratio matters as it takes away from your overall return. The higher the expense ratio, the lower will be your net return. Cost isn’t the primary factor for investing in an equity fund, but it matters.

In case of mutual funds, the impact is higher as costs can vary (subject to an upper limit) among different schemes.

Who defines the expense ratio?

Mutual fund schemes charge expenses in a tiered structure, as per guidelines prescribed by the Securities and Exchange Board of India (Sebi). As more assets get added, the incremental expense ratio is lowered. Ideally, a scheme which is growing in size should see lower not higher expenses.

For equity funds, the maximum expense ratio chargeable is 2.5%, plus 20bps can be charged in lieu of exit load and another 30bps can be charged for inflows garnered from B15 locations, taking the upper limit to 3%.

Direct mutual fund expense ratio will be lower than a regular mutual of the same scheme. The difference in case of an equity mutual fund is ~0.7%-1% and debt mutual fund is ~0.3%-0.5%.

How does the expense ratio impact your portfolio?

For long-term investors, just as returns compound, annual costs also compound. This is the advantage of well-priced direct plans—they give self-guided investors a return boost.

Who should invest in a direct mutual fund?

Direct mutual fund plans aren’t meant for all investors. Don’t simply jump after low cost.

If you were to pick a direct mutual fund, you have to directly deal with a mutual fund company. An agent will not have an incentive to serve you. However, SEBI has allowed investment advisers who are registered with SEBI to offer direct mutual fund.

It is better to work with an investment adviser who can understand your needs and create an asset allocation. An adviser can offer conflict-free advice and manage your investment portfolio in direct mutual funds.

There are a few online platforms that offer direct mutual funds but you need to know how to manage your portfolio. Direct plans may also not be the best option for investors who don’t have the time to manage a mutual fund portfolio.

If you are a seasoned investor who has found the right platform to access direct plans, keep in mind that expense ratios are dynamic and it is prudent to add it to the tracking list along with performance and risk parameters.