Dear all,

Please find below a good article as appeared in Advisor Khoj for your reading:

Common retirement planning mistakes one should avoid

Retirement planning is one of the most ignored aspects of financial planning in India. But with changing socio economic conditions in our country, retirement planning now is more important than ever before. In this blog we will discuss 6 common retirement planning mistakes that individuals must avoid, in order to achieve financial independence and be free from financial stress during their retirement years.

• Not starting retirement planning early enough: Most individuals do not think about retirement planning early in their careers, but start to worry about it only when they are nearing retirement. Starting to invest for your retirement from early age has great benefits. The earlier you start the better are the chances for creating wealth as you get more return for more time on your investments. Many investors are not aware of the power of compounding. If an investor wants to set a goal of creating a retirement corpus of र 1 crore at age 60, he or she can achieve it with a much smaller amount simply by starting earlier, as shown in the chart below.
  
  
  
  
  
  
  We can see from the chart above that starting early has major benefits. Starting too late, on the other hand, will put your retirement planning at serious risk.


• Ignoring the impact of inflation in retirement planning: Another common mistake is to ignore or even underestimate the impact of inflation on expenses. Inflation cannot be wished away as it reduces the value of savings. The chart below shows the annual (December to December) CPI inflation rates in India from 1984 to 2014.
  
  
  
  
  
  
  The chart above shows that except for a 5 – 6 years period from 2000 to 2006, the annual inflation rate in India has been mostly above 6%. The geometric mean annual inflation rate over the last 3 decades has been 7.8%. This means than an expense of र 1,000 in 1984 would be nearlyर 10,000 today. Now, if we extrapolate this 20 years forward, an expense of र 10,000 today, would be nearly र 45,000 20 years from now. Even if we expect inflation to moderate in the long term to an average of 5 – 6%, living expenses will be at least 3 to 5 times higher 20 or 30 years later. In other words, if you are 30 years old and your monthly expense is र 20,000, you should expect your monthly expense at the same lifestyle to be over र 1 lac by the time you retire. When you set a retirement goal for yourself, you should always factor in the effect of inflation.


• Misconception with regards to risk in retirement planning: Most investors believe that investing in risk free or low risk investment options is the best retirement planning strategy. Accordingly, they opt for investment options like PPF, VPF, NSC and life insurance endowment plans. Investing in low risk investment options can actually result in taking a risk with your retirement plan. Risk free or low risk investment options often fail to beat inflation, which leaves the investor short of his retirement needs. Let us take for example life insurance endowment plans. Historically, returns of life insurance endowment plans have been around 6%, which is well below the average historical inflation rate discussed above. Post tax returns of other risk free investment options have also struggled to beat inflation. Equity as an asset class has historically been able to beat inflation in the long term and create wealth for the investor. The chart below shows the Sensex returns and the annual inflation rates from 1999 to 2014.
  
  
  
  
  
  
  We can see from the chart above, that while Sensex returns have been volatile, it has managed to beat inflation. The compounded annual growth rate of the Sensex from 1999 to the end 2014 is around 16%, while the geometric mean average inflation rate during this period was 6.5%. Long term investors must not equate volatility with risk. Investors should understand that volatility is a short term phenomenon and does not impact the long term objectives. For long term investors, not meeting the financial goal is the real risk. It is essential that equities form a significant portion of your investment portfolio to help you meet your retirement goals.


• Not having enough health insurance: Healthcare costs in India are increasing at a distressing rate. Based on some estimates, the annual healthcare inflation is in the range of 15 – 25%. A hospitalization for a serious illness can cost र 5 lacs or above. While health insurance or Mediclaim is essential for all, it is even more relevant for senior citizens, because health risks increase substantially with advancing age. In the absence of Mediclaim, a serious illness in your family can cause financial distress at a time when you least expect it. While many companies offer group health insurance cover for their employees, there are companies which do not. Even if employees are covered under the group insurance plan of their employers, they should check what kind of benefits their employer’s group health insurance policy offers, total amount of cover, and nature of illnesses covered. Employees who are covered under their company’s group health insurance policy lose their health cover on retirement. This puts them and their dependents at serious risk. IRDA's portability guidelines cover policy transfers from group to retail, allowing retiring employees to switch to the retail policy of the insurer offering the group insurance plan to their former employer. However, the premiums and the policy terms may change once you switch to the retail plan. Alternatively senior citizens can consider buying an individual or family floater Mediclaim from an insurer of his or her choice.


• Not being debt free early enough: We should understand that, debt in any form has a cost associated with it. Home loans, vehicle loans, credit card loans etc, have interest cost which comes out of our savings. For unsecured debt, like credit card loans the interest cost can be quite high. Many investors over extend themselves buying a house and the home loan EMIs constitute a large chunk of their incomes. Interest costs comprise the major part of the home loan EMIs in the early and mid part of the home loan term. The higher the interest and the longer we pay it, the more we put our long term financial goals at risk. We should strive to be debt free early in life, so that we can free up our savings to work towards our retirement planning.


• Completely avoiding risk after retirement: While the conventional financial wisdom dictated that we avoid risks after retirement and allocate our accumulated corpus to safe investments like fixed income, longer life span and high inflation necessitates a rethink of this approach. Retired lives can now easily 25 years or even more. On account of high inflation and increased longevity, you can run out of your funds if they are deployed in low yielding assets. Let us try to understand with the help of a couple of examples. Suppose you have accumulated a retirement corpus of र 50 lacs. After retirement you deploy your funds in risk free assets like fixed deposits giving you post tax return of 7%. Let us assume your monthly expense is र 50,000 and the inflation rate is around 7%. You will run out of your funds in only 8 years. Even if you accumulate a corpus of र 1 crore and deploy it in risk free assets with a post tax yield of 7%, with a monthly expense of र 50,000 and inflation of 7%, you will run out of your funds in 16 years. If you live till 85 to 90, you will have to financially dependent on someone else for the last 10 to 15 years of your life. Now let us see what if you deploy 25% of your corpus in high yielding assets like equity and the balance in low risk debt investment. Assuming you get 20% return on your equity investment, a र 1 crore can last more than 23 years. Therefore, it is prudent not to completely avoid equity after retirement. You should set your asset allocation depending upon your financial situation.

Conclusion

In this article, we have discussed some common retirement planning mistakes that we should avoid. Retirement planning is a very important part of financial planning. We should take retirement planning seriously from an early stage of our careers, so that we can have a happy and fulfilling retirement.

https://www.advisorkhoj.com/company/ICICI-Prudential-Mutual-Fund/articles/6-common-retirement-planning-mistakes-one-should-avoid#.VOq9YPmUdJc

regards

Dear All,

Please find below a good article as appeared in Morning Star for your reading:

How important is liquidity in a portfolio?

What is liquidity and how important is it in a portfolio?

Let’s play out a scenario.

One Sunday you sit to chalk out your net worth and come away fairly impressed.

For one, you own an apartment which you give out on lease. The rent from the latter gives you a fairly steady income (in addition to your own monthly salary) and the property only grows in value over time.

A beautiful masterpiece by a world-renown artist adorns your wall. You might have paid a tidy sum to own it and then spent more to insure it. You won't get a steady stream of income by way of dividends or rent. But you are certain that this painting will fetch you a jaw-dropping price when you decide to sell it.

Soon an unfortunate financial emergency befalls you and you need cash urgently. You will immediately realise that you cannot sell the painting so easily. Apparently half the market is traded privately. Also appraisals must be made and buyers must be approached and courted. This will take time and you don’t have time. But you would have gained an instant understanding on why art is an illiquid investment.

Liquidity refers to how easily an asset can be sold for cash without the sale affecting its price.

So let’s say you decide instead to sell the apartment. To get the price you are asking, you may have to wait for weeks and months before the right buyer comes to your doorstep. Sure, you can sell it quite quickly if you lower the price sufficiently. But if you have to knock off a substantial amount off your desired asking price just to get traffic in the door, then that does not make it a liquid asset either. It is not just how easily it can be sold, but how much a quick sale will affect its price. The more you have to lower the price, the less liquid the asset really is. Real estate too is not a very liquid asset.

For this reason, at least some portion of your portfolio must be liquid. It is what financial planners refer to as an emergency fund. Money here will be kept in a savings account or a liquid fund or a bank fixed deposit.

Every investment you make requires you juggle between risk, return and liquidity.

In the case of the emergency fund, you would look for high liquidity and low risk. Of course the trade-off will also be a lower return.

On the other hand, when you buy property, you are looking at low risk and a fairly high return – by way of rentals and appreciation. You will have to compromise on liquidity though, as the above example exemplifies.

If you are investing for the long term, you want a higher return and so are willing to go with stocks or equity mutual funds. They are liquid too but you take on more risk.

One component of liquidity is the speed at which you can perform a transaction—the time elapsed between when you put up the asset as a seller and when you find a buyer. In this sense, stocks are very liquid investments as they can be traded on any working day on the stock exchange. Millions of transactions take place daily and the market activity on the stock exchange sets the price for the stock.

The other component of liquidity is the ability not to take a price hit. Here, stocks could falter. After all, if you are selling when the market is in the doldrums, you will get your money quickly but not at the rate you would have desired. Or, it could be that the market is on a roll but you are selling small cap stocks which are not in demand at that point in time. In that sense, blue chips are more liquid than small caps.

A liquid investment is easy to cash up; an illiquid investment is difficult to sell without taking a price hit. It’s not at all wrong to have illiquid assets. But they are worth it if you don’t need to sell them to bail you out of an emergency. Such investments are great if you can hold on to them till the opportune moment when they have appreciated in value.

It’s just as vital to have some wealth in assets that you can sell quickly if needed. So should a medical emergency come up, or should you lose your job, the liquid portion of your portfolio can help you sustain that period and you need not derail your entire investment plan.

Liquidity, unfortunately, is an investment attribute that slips below the radar for many investors, only to be sharply reminded of its importance during an emergency.

http://www.morningstar.in/posts/31439/how-important-is-liquidity-in-a-portfolio.aspx?utm_campaign=shortanswer&utm_medium=email&utm_source=morningstar

regards

‘Wish I’d known’ lessons from finance gurus

Dear All,

Please find below a good news article as appeared in Live Mint for your reading:

‘Wish I’d known’ lessons from finance gurus 

Starting early is the easiest and smartest financial lesson. Even leaders of the industry agree 

Anyone who has just joined the workforce for the first time has a list of things to spend on—from clothes to gadgets, and more. Saving and investment rarely feature in this list. This may sound boring and even unimportant, but if you don’t want to be financially lost, you must plan your finances. Here are a few things you can do with your income in the early stages of your career. 

Start early 

When it comes to growing your money, the earlier you start saving and investing, the easier it will be to build a corpus. “You should understand the power of compounding. Unfortunately, people don’t understand it and how starting early will enable lower investment savings,” said Dilshad Billimoria, director, Dilzer Consultants Pvt. Ltd.

Say, you are 25 years old and plan to retire at 60. If your current annual expense is Rs.10 lakh, the expenses in your first year of retirement would be Rs.77 lakh, assuming annual inflation of 6%. So, you will need a corpus of Rs.10.7 crore at age 60, for which you need to invest Rs.28,000 per month till retirement age and earn return of 10% on it. If you delay and start investing only when you turn 30, you would need to save Rs.35,365 per month. So, the later you start, the more you need to save. 

Identify goals later 

You may be wondering, why invest when you don’t have goals. Imagining about retirement or any other kind of long-term goal is difficult when you are in your 20s. “Many financial commitments come in the form of events. The older you get, the more difficult it gets to catch up to the expenses. People don’t think about this in their 20s,” said Leo Puri, managing director, UTI Asset Management Co. Ltd. 

How does one overcome this difficulty? 

“It is a simple thing. Generally, your financial goals will include retirement, buying a house, marriage, children, their higher education and marriage, your higher education, travel and spending on gadgets or white goods. Even if none of these make into your list right now, they will soon creep in,” said Suresh Sadagopan, a Mumbai-based financial planner. Even if you don’t have a goal, keep a part of your salary aside to be used for future needs. 

Insure yourself

Once you have decided to save a certain portion of your income, the next step you may assume is to invest. It’s not. the next step should be buying health insurance so that medical liabilities are taken care of. “Life insurance can wait. But you should take medical insurance immediately. You may think that your employer will take care of it. But health issues can occur any time, say, when you are in between jobs. Consider taking health cover of at least Rs.3 lakh, which will cost you under Rs.4,000 per annum,” said Sadagopan. You don’t want to dip into your savings or investments when you have an option to hedge. 

Understand products 

After health insurance comes investing. You must remember that over time, money loses value due to inflation and taxes. So, leaving all your money in a savings account is not prudent. Of course, that doesn’t mean that you invest in any product that gives you higher returns than a savings deposit. You should calculate the returns you get after factoring in inflation and tax. “People don’t understand the difference between real return and nominal return. They misunderstand nominal return to be the real return. Always remember to factor in inflation when you are investing,” said Vivek Dehejia, professor of Economics at Carleton University in Ottawa, Canada. 

So, which product to choose? Since you have time on your side, you are in a better position to take risk. 

“Equity-oriented products are a good option. But you should invest at least 40% of your money in lock-in products such as Public Provident Fund as it will help you build financial discipline,” said Sadagopan. 

You can create a corpus by investing in short-term products such as debt funds or even bank fixed deposits. This will help build financial discipline. 

Though you should save and invest regular, it doesn’t mean that you can’t indulge. “You can buy a new gadget or go for a vacation, but it doesn’t mean that you go overboard with you credit card and spend more than you can afford,” said Sadagopan. 

If you have basic understanding of financial products and how they work, you will be able to make the right decisions about your money life. Doing so will earn healthy returns.
Read more at: http://www.livemint.com/Money/NBuCcrV9IT3E65yN6eBH3L/Wish-Id-known-lessons-from-finance-gurus.html?utm_source=copy

regards