This article shows how a very typical salaried couple with one child can invest for future goals using the Arthgyaan goal-based investing tool.
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Introducing the investors
Personal details
Krish and Megha, husband and wife, age 33 and 32, respectively residing in a major metropolitan city in India
One child Akshay, age 2, boy
Income: 4L/month, post-tax in-hand combined from salary
EPF: 40,000/month combined for them and is included in the amount above
Monthly expense: ā¹1.63L/month (including EMI)
Loans: one home loan, EMI: 48,000/month plus 27,000/month prepayment (~42L outstanding @ ~9.55%)
Krish and Megha are joint homeowners. They stay in this house
Credit card dues: none
No education or personal loans
Existing assets and investments
EPF: ā¹23L in EPF
PPF: ā¹3L in PPF
Banks: ā¹2L in FD, 23L in savings account
stocks: ā¹2L (mostly Indian blue chips)
MF: ā¹26L in equity MF
Insurance policies: LIC investment policy for ā¹4L
Ancestral assets: Krishās parents own a ā¹30 lakhs house in his ancestral city
The total market value of these assets:
equity assets: ā¹31L
debt assets: ā¹23L
cash assets: ā¹25L
total asset value is ā¹79 lakhs (the market value of their primary residence is excluded from this total)
Pre-requisites before you start investing
To build a house, you need to first build a strong foundation
Goal-based investing requires completing some steps to ensure that the investment plan is seamlessly executed without breaks due to unforeseen circumstances. We will follow the steps described here: I have heard of goal-based investing. What now?
Risk profiling
Risk profiling is a mandatory step that should be completed before investing in goals. A portfolio created for a goal has one purpose: to meet the goal. Therefore, we need to balance risky assets that generally appreciate fast (like equity) and slow-growing assets that provide stability (like debt). The tool that is used to determine this mix of investments is risk profiling. Risk profiling, if not done, leads to a high chance of missing the goal. Being invested in the wrong asset class in the wrong proportion (either equity or debt) can lead to either high risk or poor returns or worse both.
A minimum of 6 times total monthly expenses and EMI, which is ā¹1.63L x 6 = ten lakhs. They should keep ideally this amount in a joint bank account with sweep FD. Both spouses should have debit cards and net banking access to this bank account to get immediate access in terms of need.
However, in this case, they have ~ā¹23 lakhs parked in savings accounts. This amount together with high-value credit cards will easily cover standard emergencies.
As expenses increase or the emergency fund is used up, the current monthās investments should be diverted until the fund is rebuilt.
Given that this value of cash in savings account is very high, we will explore how to deploy the amount based on goals in the following sections.
Term insurance
Krish has only a corporate group cover of ā¹50 lakhs as term insurance.
As we will see below, this coverage amount is not enough considering their goals. Given the value of their goals today, they need at least ā¹6 crores of insurance between them. Two additional life insurance policies of ā¹3 crores per head, given their age and 20-year coverage, should cost a total of around ā¹70,000/year. Any existing medical conditions must be declared at the time of taking the policies and there must be a physical medical test.
There should generally be the following policies that a family should have at a minimum:
corporate group insurance for salaried employees covering all family members
personal family floater of ā¹20 lakhs covering self, spouse and childĀ Ā» they already have a ā¹20L family floater policy
separate policy covering elderly parents. Since a policyās premium depends on the highest age of the members, parents must be covered separately. Here Krishās parents have a ā¹7.5 lakhs policy for both. Megha should cover her parents with a similar policy
The family needs to immediately take a ā¹1 crore super-top-up health insurance policy to cover treatments that cost much more than the family floater. This policy is for extreme cases, and the premium amount, ~ā¹5k/year, is a small price to pay for insuring against a significant risk
The purpose of the personal accident (PA) insurance policy is to provide a replacement for your income if you have an accident and cannot work after that. Unlike term insurance, where claims are paid on death, a PA cover is applicable when one of the following is the result of an accident:
accidental death
temporary or permanent partial disability
temporary or permanent total disability
The family should therefore take ā¹1-2 crore personal accident insurance each for Krish and Megha with a total premium of around ā¹17,000-35,000.
Pay off high-interest loans
Fortunately, the family has no high-interest loans like credit cards or personal loans.
Paying off the home loans
The family is currently having home loan with a moderate outstanding amount. As a family, they are currently paying an EMI of ā¹48k/month plus a large amount of ā¹25k/month as prepayment. The loan is insured up to ā¹50 lakhs.
Here is something that the family should consider:
take the term insurance and personal accident insurance to protect their incomes
stop prepayment of the loan even though interest rates have gone up recently
feel secure due to the fact that they have an adequate emergency fund
divert the prepayment amount to goals as per the model output
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To know how much you can invest for goals (the investible surplus), you need to classify and figure out approximately the major monthly expense heads under the three main buckets below:
mandatory: rent/EMI, food, school fees, electricity/mobile bills etc.
save-to-spend: these are used for the sinking fund that is used to pay for hefty annual expenses like insurance premiums, festival gifts and travel by saving for them every month
Given that they have a 2-year old baby, their expenses will likely shoot up once the child starts going to school. The current expenses do not consider this point.
Setting financial goals
Having clear financial goals is the first and vital step before investing. We will use the SMART framework to write down goals:
Specific: Why do you need the money?
Measurable: How much money do you need?
Achievable: Can you do it? Do you need help?
Realistic: Can you reach this target based on where you are?
Time-bound: When do you need the money? Is the timing flexible?
We will assume that the family can increase its investments by 7% every year via upskilling and improving their human capital: Your human capital, not investment returns, is your biggest wealth creator. Given the importance of human capital, the family should allocate an upskilling line item in the monthly budget. The family can use this for courses, books and other related purposes.
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Retirement (normal and early)
The SMART framework is applied like this:
Specific: To retire from active service for both spouses. In retirement, the lifestyle required is expected to cost ā¹9.6L in todayās money. We assume 7% inflation both in the pre and post-retirement phase. At this inflation level, expenses double in 10 years
Measurable: The target corpus is ā¹18 crores which is what should be accumulated by the point retirement starts
Realistic: The SIP amount per month for retirement is something the family can invest, given their income and expense levels
Time-bound: The plan is to reach early retirement (RE in FIRE) in 15 years when Krish is 50 years old. Megha plans to retire at the same time
Child goals: education, marriage, and house purchase
Childrenās goals are very precious for a family. However, given the much shorter horizon for purposes like an UG degree, the monthly investment amount can be surprisingly higher.
Specific: Akshayās school admission, school excursion, UG and PG degrees, marriage, and down-payment for his first house
Measurable: In todayās money, these goals add up to more than ā¹1.5 crore
Realistic: The modelās output for this goal is fairly low on a monthly investment basis since most of this goal is already funded. We will explore this in more detail
Time-bound: The goals are spaced out over multiple horizons over the next 25 years
Other goals
Foreign trips: The family wishes to take special a foreign trip in two years. This goal is already funded (see the section SIP amounts and split between goals)
Car purchase: Krish wishes to buy a new car every 10-year for ā¹20 lakhs in todayās money. We have added this amount to the sinking fund (see the Expense structuring section)
Derivation of investment amounts
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The table shows the SIP amounts split amongst different goals and the portion of the current corpus allocated to each goal. Investors have two approaches to investing:
We use the Arthgyaan Goal-based investing calculator to formulate the investment model with all the above assumptions and goals. There is a link to download a pre-filled copy of the Google sheet via the button below.
Important: You must be logged into your Google Account on a laptop/desktop (and not on a phone) to access the sheet.
Once you get your sheet, you can get access to video tutorials in the howto tab.
SIP amounts and split between goals
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Where to invest?
For most investors, this is the most critical question. It is a variation of finding the ābestā of everything: the best mutual fund, PMS service, insurance policy etc. However, suppose you have followed the process until now. In that case, you will realise that coming to this stage, at the very end of the goal-based investing strategy.
We will keep this simple with some typical investments that the family can follow and should be sufficient for their purpose.
Debt asset class: Apart from the NPS and provident fund investments already in place, the family can explore debt mutual funds: How to choose a debt mutual fund?
Cash asset class: For goals within three years and the emergency fund, a savings bank with sweep FD or a regular FD/RD is sufficient. For purposes beyond three years, please use the same debt funds as per the debt allocation above
Additional investment in Provident fund: Apart from the mandatory investments via EPF, the family should refrain from additional investment in VPF. Given the long time horizon of the goals, a high allocation to equity is critical
Insurance mixed with investment: ULIP, endowment and related mixed products should be avoided due to high commissions, opaque structure, low returns and lock-ins
current prices of goals change, or new goals are added/old goals removed
These factors will require a portfolio review exercise every 6-12 months. Then, the process goes through the above steps: goal setting, capturing current asset values and feeding them into the model to recalculate the numbers. The concept is explained here: Are your investments on track for your goals?
Rebalancing plan
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This section shows the current and target asset allocations for equity, debt and cash. The action on the investor will be to immediately implement the rebalancing plan as shown in the image.
Practical considerations
Moving to cash
The plan requires that a good amount of the cash holding to be moved to equity today using the Arthgyaan Have-vs-Need framework (image above) whose output we have seen in the rebalancing plan section.
Many investors have a lot of doubts as to the best way of moving a sum from cash top equity. In the bigger scheme of things, any sort of tactical market timing has no impact on future returns solely because once the full amount is invested, it is now exposed fully to market movements: SIP vs. lump sum: what should I choose?
SIP amount required is in line with the investible surplus
The family has an in-hand income of ā¹4L/month including ā¹40,000/month going into EPF. Along with the ā¹75k/month home EMI payments (ā¹48k/EMI plus ā¹27k prepayment), they spend a total of ā¹1.63L/month. These expenses leave them with an investible surplus of ā¹2.37L/month which is insufficient as per the model output. However, if they stop prepaying the home loan, then the gap can be filled easily.
Therefore the tradeoff is between reaching FIRE 10 years before vs. being debt free quickly. We suggest that the family considers this tradeoff carefully and acts as per their requirement.
In this case, the family is doing well in creating and following a goal-based investment process and they should continue it.
Investing for the childās first home
We are a big advocate of both
not having investments in real estate beyond the primary residence
investing for the goal of funding the downpayment of the first house purchase of the child
This position is due to our opinion that real-estate investments, after buying the primary residence, should be attempted only after primary goals (retirement / FIRE, children-related etc.) are fully funded vs. market-linked assets like stocks and bonds. We are also seeing the rapid increase in real-estate in major metro cities. We have made our case on this topic in detail here: Why parents should invest for the downpayment of their childās first home?.
In this case, the family wishes to give their son a gift on his 25th birthday. That gift can easily be a contribution towards the downpayment of their first home.
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This post titled Case study: can this double income single kid family reach FIRE at 50? first appeared on 17 May 2023 at https://arthgyaan.com
