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Case study: how can this middle aged investor with two children plan for retirement and children's goals?

This article shows how a single-income middle aged couple with two small children reach their retirement and children’s goals.

Case study: how can this middle aged investor with two children plan for retirement and children's goals?


Posted on 11 Jun 2023
Author: Sayan Sircar
16 mins read
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This article shows how a single-income middle aged couple with two small children reach their retirement and children’s goals.

Case study: how can this middle aged investor with two children plan for retirement and children's goals?

📚 Topics covered:

All worked out case studies for goal-based investing

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Introducing the investors

Personal details

  • Karthik and Gayathri, husband and wife, age 47 and 40, respectively residing in a major metropolitan city in India
  • First child Adarsh, age 10, boy
  • Second child Saanvi, age 6, girl
  • Income: 2L/month, post-tax in-hand from salary including EPF
  • This is a single income family since Gayathri is on a career break
  • Monthly expense: ₹84k/month including annual payments like insurance
  • Karthik and Gayathri are joint homeowners. They stay in their own house
  • No home, education or personal loans
  • Credit card dues: none

Existing assets and investments

  • EPF: ₹14L in EPF
  • PPF: ₹12L in PPF
  • Banks / post office: ₹25L in different schemes, ₹10L in FD
  • MF: ₹65L in equity MF
  • Land: ₹25L is the current value of a plot owned by the family
  • Investment property: ₹60L rented apartment in the same city getting ~2%/year rent

The total market value of these assets:

  • equity assets: ₹65L
  • debt assets: ₹73L (investment apartment and plot are included here)
  • cash assets: ₹13L
  • total asset value is ₹151 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.

We have a risk-profiling tool here that investors should use before getting started: Do not invest in mutual funds before doing this

Emergency fund

A minimum of 6 times total monthly expenses and EMI, which is ₹84k x 6 = five 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 ₹10 lakhs in FD. 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 month’s investments should be diverted until the fund is rebuilt.

Term insurance

Karthik has a personal term insurance policy of ₹1.5 crores.

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 ₹2.7-3 crores of insurance (the model shows ₹2.6cr) between them. Karthik should take another ₹1.5 crore term life policy costing around ₹35,000/year. It will be a good idea to cover Gayathri with a ₹1 crore term policy as well in case she decides to resume working.

Any existing medical conditions must be declared at the time of taking the policies and there must be a physical medical test.

This step should be taken immediately.

Here is a guide regarding purchasing term insurance policies: Term life insurance: what, why, how much to get and from where?.

Health insurance

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 »> they have a ₹5L plan
  • personal family floater of ₹20 lakhs covering self, spouse and child along with a super top-up plan » they have a ₹10L family floater policy with a ₹20L super-top up from the same insurer
  • The family needs to increase their base coverage to ₹20L and take an additional ₹80L-1 crore super-top-up health insurance policy

Here is a guide regarding purchasing health insurance policies: Health insurance: what, why, how much to get and from where?

Personal Accident insurance

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 a ₹1 crore personal accident insurance cover for Karthik for around ₹30,000/year

Pay off high-interest loans

Fortunately, the family has no high-interest loans like credit cards or personal loans.

Did you know that we have a private Facebook group which you can join for free and ask your own questions? Please click the button below to join.

Expense structuring

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Case Study 11 Jun 23 Expense Calculation

We will use this retirement expense estimation tool to calculate today’s expenses and determine how much to spend in retirement.

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.
  • variable/discretionary: entertainment, transport, clothes, anything discretionary
  • 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

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.

Before going into the details of the goals, if you, dear reader, wish to cover another scenario as a Case Study, click the button below:

Retirement

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 ₹6.75L in today’s 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 ₹6.5 crores which is what should be accumulated by the point retirement starts
  • Achievable: Retirement planning can be daunting. Here is a step-by-step guide to getting started: A low-stress step-by-step guide to creating a retirement portfolio
  • 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 retire in 15 years when Karthik is 62 years old and target a total of 40 year in retirement. Given that Gayathri is 40 years old today, this plan provides for her up to age 95

Child goals: education and marriage

Children’s 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: Adarsh and Saanvi’s UG and PG degrees, and marriage
  • Measurable: In today’s money, these goals add up to ₹30 lakhs per child
  • Achievable: Children’s goal planning can be challenging due to its emotional aspect. Here is a complete guide on the topic: Goal-based investing: How to save for children’s future
  • Realistic: The model’s output for this goal shows that both the children’s goals are already funded
  • Time-bound: The goals are spaced out over multiple horizons over the next 20 years

Other goals

  • Gold purchase: Gayathri plans to accumulate gold for Saanvi’s marriage. This amount can come from monthly income as we will see below.

Derivation of investment amounts

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Case Study 11 Jun 23 Model Output

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:

Model output

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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Case Study 11 Jun 23 SIP Output

Where to invest?

For most investors, this is the most critical question. It is a variation of finding the ‘best’ 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.

Allowed investments

  • Equity asset class: Index mutual funds. Here is an article that talks about this choice: Which index funds to invest in and why?
  • 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

Disallowed investments

  • NPS: The family should not invest any amount in NPS beyond the minimum needed to get a deduction under Section 80CCD, i.e. ₹50,000/year and any amount under Corporate NPS. The logic here is that NPS locks in your money until 60 and requires that you invest 40% of your NPS corpus in an undesirable taxable annuity
  • 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
  • Other options: Cryptocurrencies, P2P loans, direct stocks and investment real estate/land (except a primary residence) should be avoided

Portfolio review

As time passes, three things happen:

  • markets move up and down
  • you invest or remove money from the portfolio
  • 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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Case Study 11 Jun 23 Rebalancing Plan

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.

Related:
This article explains what is rebalancing and why you should do it.

Practical considerations

Moving to cash

Have vs Needs Framework

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?. In this case, the Karthik can divert his entire investible surplus into equity until the equity gap is filled.

SIP amount required is in line with the investible surplus

The family has an in-hand income of ₹2L/month (excluding the rent from the second home) and spends ₹84,000/month (including the sinking fund). These expenses leave them with an investible surplus of ₹1.28L/month which is more than sufficient as per the model output.

Avoiding common mistakes

There are some common mistakes that investors make which prevent them from benefiting from compounding. We cover this concept in more detail here: 12 mistakes that interrupt compounding: what to do instead.

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 child’s 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 down payment 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 child’s first home?.

Dealing with extra investible surplus

This family is currently in a position where their goals are well funded and on track with extra investible surplus. The family should consider investing the surplus:

  • assuming that children’s college education goals will be more expensive
  • both the children will require additional support once they start earning and require homes as we mentioned above
  • Gayathri has an opportunity to either get back to the work force or start a home business once the children become bigger. This plan de-risks the cashflow from the income of Karthik and some home businesses can be started even today

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Next steps:

1. Email me with any questions.

2. Use our goal-based investing template to prepare a financial plan for yourself
OR
use this quick and fast online calculator to find out the SIP amount and asset allocation for your goals.

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This post titled Case study: how can this middle aged investor with two children plan for retirement and children's goals? first appeared on 11 Jun 2023 at https://arthgyaan.com


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