Financial planning: How to invest to optimise your returns

In the first of this four-part series N R Ramakrishnan demystified the tedious process of financial planning. While the second installment explained how the power of compounding helps you achieve financial goals, the third part of this series explained the basis for choosing your investment options so that you achieve your long-term financial goals.

Today, the concluding part of this series tells you how Ajit Manohar, 35, with wife Swarna, 33, and two children Swarit (son), 10, and Aparna (daughter), 7, through disciplined financial planning, managed to achieve his long term goals.

People are generally concerned about growing their net worth (asses net off liabilities) to enable them to have sufficient resources to meet their goals, while simultaneously protecting their existing wealth against erosion. The protection of wealth may be achieved either through transferring risks or opting to keep the assets in safe avenues.

Some will be concerned with management of their liabilities by reducing the interest/principal outflows to achieve a positive cash flow position.

Some may be concerned with the problem of saving for meeting their children's education cost, maximising the tax benefits available to them, saving for their retirement, or maximising what their heirs will inherit.

We can therefore say that the three objectives of financial planning are:

• Estimating the right amount required to be saved and for the right length of time based on the requirements worked for the financial goals
• Depending on the risk taking ability and the risk reward relationship of the investment option choosing the right mix of instruments or vehicle so that the investments are optimally managed
• Appropriate matching of the future inflow from investments with the expected outflow from assessed needs so that the investments mature at the same time in future as the resource requirement of the financial need has been estimated

We will now look at the strategy of savings adopted in Ajit's case and see whether the objectives are met or not. This we propose to do by measuring Ajit's net worth at the end of each event. The test for objective achievement being whether the right amount has been invested in the right instrument and the same is available for use at the right time.

The author is head of knowledge management at Money Bee Institute Pvt Ltd., Nagpur. Money Bee is a corporate training firm associated with NIFM (Ministry of Finance, GoI), SEBI, NSE, BSE, SBI and leading mutual funds in India. He can be reached at ramkiraj@hotmail.com.

The genesis of the plan for achieving the life goal event is the current surplus for which it is necessary to see that Ajit continues to earn. In his absence the entire plan will fail. It is therefore important for Ajit to get himself insured for an amount, which when invested in risk free securities, should replace 70 per cent of his income.

Assuming a post tax return of 6 per cent the amount required would be Rs 83 lakh. Ajit already has investments of Rs 23 lakh & insurance of Rs 30 lakh. Additional insurance of Rs 30 lakh may have to be taken. This will entail shelling out of Rs 9,000 per annum towards risk cover.

We know that Ajit has a surplus of Rs 30,000 currently and his income is likely to increase by 10 per cent and expenses by 8 per cent of income and his surplus is likely to increase at the rate of two per cent. We have already seen the cost of each goal which has been separately worked out and the relevant cost met.

Only at the stage of the house purchase did we use up the savings towards meeting margin money requirement.

The returns we have assumed can be further optimised by allocating more amounts to risky assets but as we see that for each goal we have assumed certain allocation to the broad category of assets and we have been able to accumulate wealth as needed.

The broad allocation suggested by experts at the conservative level is a 50-50 allocation to risky & non-risky assets.

A slight variation of the same is to allocate to non-risky assets weightage equivalent to one's age and the rest to risky assets, in line with our assumption.

We will now draw out Ajit's net worth position to test whether the movements in net worth are consistent with his objectives.

As we have assumed that specific investments will be made for specific goals like annual tour, car, education expenses & marriage expenses, the same is being ignored in the position of net worth below.

However we will see how the net worth position is affected with residual amounts directed towards other goals and build up other assets (Table II). Before that let us recapitulate the assumptions made in the form of a table I below.

Table I: Showing allocation of monthly surplus as earlier decided

From 60-240 months surplus of Rs 16,200 will be used for repayment of loan

Table II: Statement of Ajit's net worth

** The figures include retirement savings

Assuming the couple maintains the current standard of living, they will require an amount of Rs 1.29 lakh per month 25 years from now and increasing by 6 per cent every year. Similarly we have assumed that the funds will be invested in assets that will fetch an annual yield of 8 per cent. In such a case the couple will require a sum of Rs 224.84 lakh to meet their requirements for a period 17 years after retirement.

The actual amount available is Rs 247.73 lakh. We can say that the objective of financial plan worked out for Ajit as he has been able to meet all his goals.

In conclusion we can say that a planned investment strategy with proper asset allocation may enable an investor to harness and optimise returns on his investment and by and large remains on course to meet his goals. Additionally, the strategy of periodical and early savings helps one to enhance the yields and firmly puts one on course to meet the goals.

Desires lead to goals; goals lead to plan; a good plan with proper implementation enables a person to reach her/his goals; and achievement leads one to taste success.