Certified financial planner and wealth advisor Gaurav Mashruwala comments on Prashant's financial situation.
Prashant is a middle class boy, very much grounded in traditional family values. While he has just one stated goal, that of buying a home, my recommendation to him is to consider saving/ investing for his retirement, which will happen many years from now.
The twenties and thirties are the golden saving years in any individual's life because family responsibilities during these decades are the least.
Once we are in our 40s and 50s, expenses of children's higher education, retired parents and children's marriage start showing up. Ironically, retirement, which is much closer at this stage, usually takes a back seat. Then, we suddenly realise we are just few years away from retirement without sufficient funds.
Here is my recommendation to Prashant.
Saving and investment
Every month, Prashant deposits Rs 500 in a post office recurring deposit. Till date, he has an accumulated balance of Rs 8,000.
Prashant's investments need a more focused approach.
His only investment is in a debt-based instrument; he has no equity exposure whatsoever. Neither is there any systematic approach towards tax planning. He has no insurance and huge amounts in his savings account.
Contingency reserve
Every month, he has surplus cash of Rs 14,000 (Rs 21000 -- Rs 7000).
There are huge amount of funds available in his savings account.
Currently, he has Rs 57,000, which is equivalent to around eight months of mandatory expenses.
I suggest he only keep aside approximately Rs 25,000 for contingencies in his savings bank account. The rest should be deployed towards his other financial goals.
Insurance
His company covers him for health related expenses. But I recommend he reads and understands the details about the cover carefully. He must be aware of what is and what is not covered.
Prashant has no life insurance cover and I recommend he gets one. He must opt for a cover of at least Rs 20 lakh (Rs 2 million). I suggest a term plan which is the purest and cheapest form of life insurance. Should something happen to him, his family will get this money.
This insurance is necessary because his family is dependent on him and he is considering opting for a home loan too.
Buying a home
At an annual salary of Rs 2,52,000 a year, Prashant will be entitled to a Rs 8,00,000 to 10 lakh (Rs 1 million) loan.
Given his salary and expenses, he will also be able to pay his Equated Monthly Installment of around Rs 10,000 per month comfortably.
However, if he opts for such a large amount of loan, his ratio of liability (outstanding loan) to assets (his investments) will be adverse.
Usually it is recommended that total outstanding liability should be just 50% of total assets.
For instance:
He buys a property = Rs 10,00,000
+
His investments = Rs 65,000
Total assets = Rs 10,65,000
In such a scenario, his total outstanding loan amount should not be more than Rs 5,32,500.
The reason this is recommended is that -- though he will be entitled to a loan based on his salary and though he will be able to pay the EMI -- in the event of a job loss, due to any reason, he will not have sufficient assets to repay the loan and make his house debt free.
Therefore, I advise him to delay the purchase of his house till he can fund at least 50% of the amount.
For the next three years, he should keep investing surplus cash of Rs 14,000 every month in a mutual fund. He can pick up a fund that invests around 20%-25% of its total investments in equity and rest in debt.
Once he can contribute about 50% of the value of house, he can opt for a loan for the balance amount needed to purchase the house.
Retirement
Apart from saving for the house, Prashant should also consider investing funds for his retirement.
All his bonuses (if any) and future increments should go towards this goal. This investment should ideally be in equity-based products.
Also, he needs to ensure the investment is liquid. Since his major investment -- his house -- will be an illiquid investment, all his other investments must be liquid.
Prashant has a lot going for him: Decent surplus funds every month, a simple lifestyle and age on his side. If he plans his finances well, he will be able to create substantial wealth.
