29 July, 2015

Buying pension plans is not retirement planning!

At a certain point in life we do get jittery about the years we spend in retirement. For most people, that point comes somewhere in forties. For some of us the realization hits us in our fifties. We then hit the panic button.

All of us realize that we need a good corpus in retirement. But most of us underestimate how much we need.

And there comes along an insurance agent, who converts the butterflies in our stomach to cash in bank – for him – by selling pension plans as the panacea for a well-funded retirement!

Pension plans mean retirement

Pension plans are directly connected to retirement. It seems natural to plan for retirement through pension plans. That seeming connection has been wonderfully exploited by insurance companies to sell huge pension policies to those who are in the panic mode. Holding one’s head high in retirement & living with dignity is a theme that has gone down well with this crowd.

People feel safe after doing these pension policies and heave a sigh of relief after they have half a dozen policy documents in their hands. Have they really done the right thing? One needs to know a bit more about pension plans…

Knowing about pension plans

Pension plans have an accumulation phase when one needs to contribute regularly towards building the corpus. Around the time one retires, the corpus accumulated would be used to pay a regular income called Annuity. The annuity is typically the interest income being distributed back to the policy holder. But the distribution is low – just 5-6% on an average. In some cases, it goes to 7% or more.

The problem with a pension plan is that in the accumulation phase, the corpus grows only by 4-6%, ensuring that the final corpus is rather puny. This is what happens in the traditional pension policies.

There are unit linked pension policies where the corpus growth can be faster, but is subject to the vagaries of the market. The policy holder is going to bear the market risk here. Potentially, these policies accumulate to a much bigger corpus and hence the annuities can be better.

Also, the pension policy premiums are eligible for tax deductions under Section 80C, which is a talking point and a prime selling point for the agents.
Sounds fine to you? Wait till you hear about the taxation…

 The taxing issue

Unlike all other insurance products, pension products accruals are not tax free. This is a vexing problem regarding pension products. Due to the income tax, the actual returns will be very low indeed, as the gross returns itself would be 5-6%. After tax, it will be even lower and will fare poorly in comparison to the other investment options.

There have been representations on this to the government and it is being considered. But, when it will see the light of the day is an open question. Hence, the current situation is that the pension income is taxable.

Now what…

If pension plans don’t appear that great any longer and you are again panicking, help is on the way. Stay with me…

The fundamental thing is that you need not plan retirement through pension policies. In fact, it is quite an inefficient way of planning for retirement – so much so that, you are sure to be underfunded if the main or the only way by which retirement planning is done is through pension plans.

The main thing in retirement is sustained income. That can be set up if there is a good sized corpus there, in the first place. There are several accumulation methods during one’s earning phase – investing in direct equity / equity oriented mutual funds in a regular, sustained manner would help in corpus accumulation at a faster clip. PPF is another good tool to accumulate for retirement.

Employee PF & other retiral benefits are not to be used and should be kept aside exclusively for use in retirement.

Sustained income can be setup using tax free bonds and systematic withdrawal from debt mutual fund schemes. These two are very tax efficient. Systematic withdrawal from debt funds is completely flexible & lends itself to increased or decreased withdrawals, in times to come.
There are other traditional investment options like bank FDs, Post Office MIS, Senior Citizen Savings Scheme etc., which would also offer interest income & may still work reasonably well for those in the lower tax brackets or nil tax bracket.

Some people also depend on rental income. But administering a property in retirement is not the best way to have a peaceful retirement – with all the headaches surrounding it. Also, the rental yield in India is about 2%, on an average. A person in retirement is hence well advised to cash out the property and invest in a financial asset from which to earn income in a hassle free manner and at a much higher level.

We can hold our head high in retirement only if we plan well. Else, it will be a retirement where we need to cut corners, depend on others & generally feel miserable. We don’t want to be there, do we?

Article is published on Moneycontrol.com on 29th Jul-15

27 July, 2015

Do I need Financial Planning?

Most people face this dilemma – do I need a financial planner?. Lot of them tend to think that they do not make enough money to hire the services of a financial planner. People have this impression that financial planning is for the rich & well endowed. The other opinion that is widely prevalent is that financial planners are wildly expensive and hence are not affordable.
Though these are widely held opinions almost bordering on being articles of faith through constant reinforcement, we need to examine how much of these are true.
A much abused term
Image courtesy of Stuart Miles at FreeDigitalPhotos.net

There are myths & misconceptions surrounding financial planning. Many people today claim to do financial planning – insurance agents, distributors, banks – everyone!  So people have got this idea that if someone suggests a product that is suited for their goal, it is financial planning! That is at best proper need-satisfaction selling – a simplistic matching of needs to a product.
The problem with this is that any product can be twisted enough to make it appear suitable for a goal. For instance, a multitude of endowment plans maturing every year in retirement, is touted to be retirement planning! This is what lots of insurance agents have done.
Also Read: Saving alone is not enough; link it to your financial goals

The snag here is that the product is inefficient in that, the returns are low and the product has been somehow used to mimic a regular return product. In comparison to the premiums, the final payouts that come to the policy holder are low, when it could have been a lot better if more thought were given to retirement planning & how to achieve that goal optimally.
This is the problem with agents & distributors. They will coax & twist the product they have in their armory to suit any and every goal one may have.
To a person with a hammer, everything looks like a nail!
That brings us to the important question…
What is Financial Planning ?

Financial Planning is a process where the client goals are kept in focus & a blueprint is created after taking into account their current financial situations & various factors impacting them so that the salient goals are achieved in the time frames needed. This calls for analysis of the client situation, evaluation of alternatives, strategies needed to achieve desired outcomes and finally coming up with appropriate recommendations to put the plan in action.
In the financial planning process, products come at the end as recommendation – as a byproduct of all the planning & deliberations. Along with it will also be recommendations about what to do about loans, properties, liquidity & contingency to be maintained, risk mitigation through appropriate insurances and risk tolerance based asset allocation suggestions of where to invest. The focus here will be on efficient management of resources at the client’s disposal and optimize it based on the client’s specific needs. That means choosing the right vehicles for the right purposes, ensuring tax efficient investments, meshing the investments with the overall requirements on risk-return, tenure etc.
Financial planning is hence an ongoing engagement which starts with a plan and continues to engage clients & offers appropriate advice going forward.

Who is a financial planner/ advisor?

Customers have a problem in understanding who is a financial planner/ advisor. Most who just sell products hold out as planners and advisors which confuse customers.

There is a huge confusion in their minds as to who is an advisor and what to expect from them.

We have just seen what is financial planning. A person who provides that kind of service is a true financial planner. Some advisors may not get into this level of detail and may look at the person’s situation and offer advice after broadly understanding their needs. Customers may need to understand what they want and accordingly engage with an advisor/ planner.

What should I pay?

The fee to be paid will also vary accordingly. Overall, Financial Planners/ Advisors will help in ensuring that wrong decisions are not taken by the client and the decisions taken are aligned with the goals and future needs.  Also, they would help in optimizing the tax savings and money management itself. Mostly the fees to the planner/ advisor would be justified by the savings and efficiencies that one can derive from all these. And most importantly, there will be a blueprint to follow and there should be clarity & peace of mind.
Typically the fees will be a factor of the experience/ expertise of the planner, the amount of work that is involved, the depth of their plan / advice, their setup and their reputation. Still, one needs to take the call on who the planner will be. It will depend on what one is looking for.  Fee alone cannot be the criterion.

You go to the best surgeon for an operation – not the cheapest one. The same holds for financial advice.

Is Financial Planning the preserve of the rich?

Financial Planning is needed by everyone. It is more needed by those who are moderately endowed than the rich – for the margin of error in the latter is much smaller. Hence, financial planning is needed more by those on a tight leash than those who are rolling in money.

Whether one wants to do it oneself or would like to hire the services of a professional financial planner is left to their evaluation of their personal needs and what would suit them.

Rich need very different products…

This is a myth perpetrated by those in financial services to be able to distinguish themselves from other product sellers and at the same time sell products that are costly, though they offer no real differentiation. This is used to massage the egos of the rich by offering products that are suitable for “Wealthy” or HNIs only.
Most Portfolio Management Services ( PMS ) products are simply MF schemes in another form. Some are somewhat different, but the final payoff after all expenses & fees is not anything which other products cannot offer. Then there are structured products which offer a reward structure based on the happening of a future event or reaching or not reaching a target. They are simply speculative & are of not much real value to the investor. Looking at it another way, the same can very easily be achieved by a combination of simple equity & debt products, at lower expense.
The latest is Venture Capital ( VC ) funding options put before the rich. How many people understand the skyhigh risks in VC funding is an open question.
IA Regulations to regulate Advisors

To ensure good quality advice, Securities & Exchange Board of India ( SEBI ) has come out with an Investment Adviser Regulation 2013, where anyone professing to offer advice in the financial area should be registered with them.

IA Regulation enforces a higher level of standards, compliance, education & certification norms and avoidance of conflict of interest. Those registered as Investment Advisers ( RIA ) need to derive income only in the form of fees from their clients and not in the form of commissions/ incentives from product distribution. Hence RIAs are fee-only advisers, who also accept a fiduciary responsibility.

Fiduciaries are those who put their client’s interest above everything else, including their own. That is the guarantee to the customer that their interest will be served when they approach an adviser. Distributors follow the suitability standard.

Also look at –  
 http://goo.gl/fsgDEA to know about Fiduciary responsibilities.

So are all Advisers/ Planners registered as RIAs?

No. There are very few who have registered. The number across India after over two and half years is less than 300 !

So, most who profess to offer advice are not interested in submitting themselves to scrutiny and the compliances that this regulation calls for. Most do not want to be fee-only advisers. They want to distribute products and incidentally want to offer advice as well. This brings in conflict of interest, which is what the regulation seeks to avoid.
Hence, it is in the best interest of customers to seek out those who are RIAs for getting advice. After the advice, one can go to a distributor and purchase the products.

Is it necessary to always go to a financial planner/ adviser?

If one has the necessary knowledge, interest, skills & the time to understand one’s requirements and evaluate options, an advisor may not be necessary. There are people like this who can do it themselves. But they are not the majority.

For most people, it would be advisable that they approach a financial planner to seek correct advice. This is just like going to a lawyer, doctor or an architect to get appropriate advice in their area. When choosing an adviser exercise caution. See whether the adviser/ planner is a RIA with SEBI, their credentials, experience etc.

Half the battle is won, if you choose the right advisor. With someone posing a one, you’re sunk.

To know more about choosing the right advisor for you also go through this -   

In summary

Clarify for yourself what you need & then go about planning. Whether you choose a planner for the purpose or you do it yourself, it’s a matter of choice and requirement. But planning for the future, needs to be done anyway. That’s something you cannot do without!

The article was published in Linkedin on 25th July’15
Also Read-  Financial Planning simplified!

18 July, 2015

Are you rich or poor?

Your financial adviser may differ with your perspective.

Someone who has over Rs 5 crores of investments can be called rich. That’s my opinion. A wealth manager may disagree and believe the individual is mass-affluent, not rich. According to some of them, the rich category starts at Rs 25 crores or somewhere in that vicinity. The “really rich fold” would have salted away Rs 100 crores or more. The super-rich club would start somewhere at Rs 1,000 crores or so.

If you were to ask the man on the street – the aam aadmi (not to be confused with the party that professes to represent him), he would probably call most of us rich. Why?

Simply because we have our dwellings, gad around in our vehicles, send our children to decent enough schools, take vacations… to them, it seems like we are living it up!

Now ask yourself: Are you rich?

The most common reply would be: Not me; no way! I’m just a middle class guy.

Also Read: Lifestyle expenses can wreck important goals

This middle class, however, is a super-elastic bracket which takes within its ambit someone who earns Rs 15,000 to Rs 1 crore a month! Hence we have terms like lower-middle class, middle-middle class, upper-middle class and upper class! People want to believe they are in upper-middle class or at least middle-middle class – else they will feel miserable and poor!

If you were to ask our government, they would call everyone earning more than Rs 30 a day as middle class.  If you are paying taxes, you must be rich – that’s why they are taxing you, remember?

You would then agree that defining who is rich is really confounding, right? It is. But we have come up with a different methodology for identifying the rich. In our methodology, even how much one earns or has does not matter. What matters is the staying power. I might have confused more than I have clarified, but stay with me.

As financial planners/ advisers we come across people from various walks of life, earning piffling sums to the motherlode pay cheque. Spends are different too – for some they are modest and for others it reaches the stratosphere!  When there is so much variance, how can we come up with a reasonable definition of who can be classified as rich?

Let’s first understand what does not classify a person as rich.

For starters, multiple cars, a home with all the trappings of luxury and the latest gadgets, children enrolled in expensive private schools, regular family vacations, and high-paying jobs do not mark out a person as rich. Even multiple properties and a seemingly good cash-stash does not.

There are a few markers which would help us separate the ones with pelf from others who have small change, in a manner of speaking.

  • Spend ratio
If someone is spending over 70% of their income, they may be spending too much. This would be true for virtually any income band. Would be truer for those who do not have too many years to retirement. They should be saving more, in fact.

For instance, a person at 50 would potentially have another 10 years to retirement. His income would be pretty good, at that point. Expenses should have plateaued. If loans are still there, the EMIs as a percentage of earnings should be a meager number. College education may be underway for the children – but money for that would have been squirrelled away separately. So, they should be saving at least 40-50% of their income, if not more.

This is going to mark out the rich from the poor. Those saving too little during their earning years are setting themselves up for penury, in the years ahead – however grand their present looks!

  • Expenses
It is rarely the grocery or regular home expense that spells trouble for most. It is the discretionary lifestyle expense that breaks the piggy bank. Many of them have a busload of goals that guzzle cash –second homes, foreign vacations, multiple cars with frequent changes, child’s education abroad, etc.  This ensures that much of their earning goes towards servicing loans over a long period.

A very high watermark for expenses is a red flag. Family members get comfortable with a high-flying lifestyle. And they keep upgrading it. Expenses hence tend to be high throughout and savings commensurately lower.

The corpus would hence be small at retirement. With expense high and a low corpus, they could support themselves only for a few years after retirement.  They may have to cut their lifestyle drastically, just to survive, making them decidedly poor.

  • Big corpus myth
Many clients think that they have a big enough corpus and will be able to sail through retirement, easily enough. A seemingly big corpus is no guarantee for a fully funded, comfortable retirement. Inflation and medical expense nibble away at the corpus. Also, increased longevity can deplete even a gargantuan corpus.

Penny pinching – a preserve of the poor – will then have to take centrestage.

  • Cash flow
A good salary and strong cash flow in the bank lulls people into a false sense of security. People tend to take it for granted that life will always be like that – getting their jolt when the pay cheque stops. That is when they start experiencing the privations of the poor!

So when is a person rich?

To summarise, one’s earnings or corpus does not make a person rich. A blizzard of expenses and a false sense of security can actually make one poor.

A person is rich when there is enough money for various needs – now and in future, and when one does not need more nor is craving for more. They are the ones who can be at peace and live a contented life. Sounds philosophical, but true. The rest are poor and they need to think hard about it – for their own good!

The article was published in Morningstar.in on 2nd July’15

Have you taken retirement planning seriously yet?

Retirement is something that’s a long way off…so long that most of us don’t give a thought to it. But, this is the single biggest goal that we all have. Yet we neglect it and make it subservient to the flimsiest of desires, like going for a vacation or buying a fancy gaming laptop etc.

Himalayan numbers - We would probably not do that if we understand the enormity of the goal. This goal is really big.

Let’s take a case to illustrate. Ram is 35 and spends Rs.40,000 per month on regular expenses and another Rs.2.5 lakh on annual expenses. There is another Rs.1.25 lakh premium he pays towards his various insurance plans. Approximations indicate that his expenses would be about 70% of today’s expenses in the first year of retirement. Taking into account 7% inflation in this period, the monthly expenses in the first year of retirement is expected to be Rs.2.4 Lakhs! If the survival period is 25 years and he needs a corpus (which also grows at 7%) which will meet his needs in this period, the amount is Rs.3.4 crore!!!

Don’t get deflated… diligence & regularity will help you scale this summit too!

Saving for retirement – Let us look at how to achieve such astronomical numbers. It becomes a lot easier when one starts saving early in life for retirement. That also presents an opportunity to invest in assets like equity, which can offer best long term returns, though they may be volatile in the short term. The earlier one starts investing for retirement, better is the benefit of compounding and higher the possibility of reaching desired corpus.

Here is an example – Ashok (25) starts Rs.2,000 per month SIP and keeps it at the same level till 29. At 30, he increases it to Rs.5,000 per month. Every five years he increases by Rs. 5,000 per month till age 55 and he contributes at this level till 60 years. Sound unremarkable right? But this would swell to Rs.2.16 crore (assuming 8% returns ) at his retirement, when he is 60 years!

Now, let’s say Ashok missed investing from age 25-34 and spends the amount of Rs.4.2 lakh, which he would have otherwise invested in this period. But from age 35 onwards he invests as in the previous example. The corpus at the end would be lower by Rs.45 Lakhs!

If Ashok realizes later in life and wants to start saving only from 45 for retirement (as many do), the amount to be invested to reach Rs.2.16 crore would be about Rs 56,000 per month!

Compounding was called the eighth wonder of the world. Allow it to work for you.

Never touch this corpus – Since retirement is seen as something far into the future, most people withdraw money from their retirement fund. They dip into it for celebrating anniversaries, vacations, children’s education, home renovation, loaning to relatives etc. The result is that retirement corpus at the end of the period tends to be a rather small number, which would mean a life of penury, in the golden years.
About 80% of employee provident fund corpus at retirement has Rs.20,000 or less.

It’s difficult to mend it later – In case of most goals, you can rework it or even drop it. Education goal can be scaled down and the child can borrow money. Foreign vacation can be dropped, if warranted. The type of car going to be bought can be brought in line with one’s cashflows.

But, in case of the retirement goal, it obviously cannot be dropped. Some amount of scaling down & adjustments can at best be done. Beyond that – nothing.

Hence, retirement planning needs to be approached with all the respect and caution it deserves!

Also Read: Never dip into retirement funds for other needs

No loans for this goal - Think about it… this is probably the only goal for which you cannot borrow your way out of the problem. For a home, car, education etc., one can always borrow and pay later.

So, this is a goal which calls for a big corpus & something for which you cannot borrow too. That makes saving from the beginning for this goal, important.
Some people nonchalantly think that their kids might take care of them in their old age, since they have invested so much in them. But that can be a serious mistake as how the future will pan out is not known. Things have changed substantially from the time when this was entrenched thinking. Now, we should all be prepared for fending for ourselves. That makes this goal a really unique and a very important one and we need to give it mind share!

You cannot borrow for sure. Begging & stealing is not what I would suggest, to make ends meet!

Living too long – Paradoxically, this is going to be a major problem for many. The survival period is going to be in decades and not just a few years. The longevity is not in one’s hand. People tend to joke that they may live for 10-15 years.
How long we live is in God’s hands, we say. But we can hardly persuade God for a communion after 10 or 15 years, can we?

What do you do if you have insufficient funds at retirement? – There are some small ways in which one can make amends.

Seek employment - At least for some time, maybe as a consultant. This may not be easy to land & may not be feasible for many, given the health condition at that age. Others can look at internet based jobs which does not require them to travel.

Relocate – One can always consider relocating to another town to bring down costs. Selling off properties in big towns/ cities may release some money, even after buying a home in the smaller town. Also the cost of living could be lower in a smaller town, which can help. But here, one may have to leave behind a known place & friends – which is a difficult decision to make.

Cut down on expenses – One can cut down on expenses by scaling down one’s requirements. This may mean a comedown in terms of life style. This may be an option where none other exists.

Reverse mortgage – There are many senior citizens who are asset rich, but cash poor. For these people, their home is their biggest asset. Such people can borrow against their home equity. An annuity can be setup for upto 15 years, which can help greatly. Also, they can continue to live in their homes for as long as they live.
Let’s hope we don’t have to resort to any of these. Let’s give fiscal prudence the pride of place in our lives and avoid Grecian tragedies!

Where do you invest for retirement planning? Investments for retirement are equated with pension plans. Retirement planning is important; but doing it through pension plans is inefficient. For one, pension annuities are taxable. Also, if one goes for a traditional pension plan the corpus grows at a measly 5-6% rate, ensuring a small corpus buildup. Commutation of pension is possible between 25% - 33%, without tax. Beyond this it has to be converted to annuities, which are taxable.

so, if one goes for a traditional pension plan the corpus grows at a measly 5-6% rate, ensuring a small corpus buildup. Commutation of pension is possible between 25% - 33%, without tax. Beyond this it has to be converted to annuities, which are taxable.

Also, it may be a much better idea having a bouquet of products, all of which together help in achieving the desired corpus at retirement. This may be desirable as asset allocation needs changes over time which can be easily accommodated if one is investing in a bouquet of products.

Retirement planning done mainly with pension plans is bound to give a lifetime of tension!

A secure retirement - One needs to have a good health insurance in place. Many have group medical insurances till, they are employed. They should take adequate cover a few years before retirement so that any pre-existing illnesses too will get covered from the time they retire.

The other important thing to keep in mind is the requirement of a good medical contingency fund, which could come in handy if the medical insurance were inadequate or does not cover certain portions of the expenses.

The other fund to be kept aside would be a liquidity fund which one may use for any spikes in expenses or other unplanned expenses. Expenses themselves should be kept in check, the portfolio reviewed from time to time & any adjustments made in the asset allocation, if necessary.

With this knowledge half the battle is won. The balance half is putting this advice to action. The ball is in your court now!

The article was published in MoneyControl.com on 7th July’15