Once bitten twice shy is how Anjali can be described as far as investing in equities goes.
After her father lost money in stocks, she has been equity averse. The belief got further strengthened when Uday tried his hand and also lost money.
Subsequently, Anjali and Uday invest only in debt with the clear notion that 'slow and steady' will win the race.
What they need to consider
1. Contingency Fund
With their monthly expense at around Rs 40,500, they should set up a contingency fund equivalent to three months' expenses. This would amount to Rs 121,500.
Around Rs 40,500 can be kept at home in cash and rest should be kept in savings bank account linked to a fixed deposit.
The Rs 50,000 currently in their fixed deposits can be utilised towards this end.
2. Health Insurance
They have not mentioned the quantum of health insurance benefit. In case there is no health insurance, either on their own or through their employer, each should obtain a health cover up to Rs 500,000.
3. Life insurance
Since there are no dependents or financial goals, the financial loss that can occur to either spouse in case of any eventuality is repayment of the outstanding home loan principal.
Both should insure themselves with a term plan to the extent of their contribution of the outstanding home loan.
Goals
1. Vacation
Their short-term goal of an annual vacation can be easily achieved with their current earnings.
2. Retirement
Though retirement is decades away, they should concentrate heavily on it, more so because they do not want to invest in equities.
This being the case, they will have to accumulate a much larger corpus than their actual need. This corpus will keep eroding due to inflation.
Debt (fixed income) products never beat inflation unless they are subsidised by the government. Government backed PPF and NSC, for example, always give higher interest rates than the prevailing market rate of other fixed deposits.
If we assume a rate of inflation of 5%, we will find that their current fixed deposit and recurring deposits are generating negative returns when compared to inflation.
Let us see how this works using the income replacement method.
When they retire, their income will have to be replaced with a corpus that will generate an income to enable them to maintain the lifestyle they want. So how much should they save to arrive at that corpus? This is referred to as the income replacement method.
Assumptions:
Anjali and Uday's age: 25 years
Average return of equity: 18% per annum
Average return of debt: 4% to 4.5% per annum
Average rate of inflation: 5% per annum
These rates may vary in the short term but over a long term, one can assume the above.
Conclusion:
Based on current income levels, they will have to save Rs 27,000 per month into an equity-based mutual fund through a Systematic Investment Plan (invest fixed amounts every month in a mutual fund) to maintain the identical lifestyle after retirement. Here we have assumed a 13% return after taking inflation into account.
However, if they want to restrict themselves only to debt, they will have to invest Rs 645,000 every month. Here we have assumed a 1% rate of return after taking inflation into account.
Wealth distribution:
There are generally two steps in wealth management.
The first is accumulation of wealth, where you are earning and adding to your savings and investments.
The second is distribution of wealth where you are no longer earning but your earnings are now used to supply you with an income. This is done during the retirement phase.
Since Anjali and Uday are decades away from retirement, strategies pertaining to wealth distribution during retirement are in the distant future.
As they have already accumulated wealth, they should make a Will and bequeath it as per their desire at the earliest.
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