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Case Study: How should couples in their 40s with a new baby plan their financial future?

24 Jul 2022 - Contact Sayan Sircar
17 mins read

Did you welcome a bundle of joy in your 40s? This article will discuss ways of planning the child’s (and your’s financial future)

How should couples in their 40s with a new baby plan their financial future?

Disclaimer: The purpose of this Case Study article is solely to demonstrate, as a reference guide, how an investor can use the Arthgyaan goal-based investing tool to invest in a do-it-yourself (DIY) manner. This article is not investment advice and does not solicit buying or selling of any security, stock or mutual fund. Furthermore, the individual names and numbers in the case study are hypothetical and any resemblance to actual persons, living or dead, is purely coincidental.

Table of Contents

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Introducing the investors

Personal details

  • Viraj and Divya, husband and wife, age 42 and 40, respectively
  • One child, Aashvi, age eight months, girl
  • Income: 4.5L/month, post-tax in-hand combined from salary
  • EPF: 70,000/month combined over and above the amount above
  • Monthly expense: ₹3L/month (including home loan EMI)
  • Loans: joint home loan of ₹1.2 crores outstanding at 7.8%, 15 years term left, EMI of ₹1.14 lakhs
  • Credit card dues: none
  • No education, personal loan
  • Viraj’s parents stay with them, meaning there is no daycare cost. Divya is currently working from home full-time at her pre-maternity salary level
  • Divya’s parents are financially independent

Existing assets and investments

  • Bank account: ₹10L in a savings account and FDs
  • EPF: ₹40L in EPF
  • PPF: ₹15L in PPF
  • NPS: no investments in NPS
  • stocks: select bluechip stocks, around 25 lakhs
  • MF: 1.75 crores in equity MF, no debt MF
  • Insurance policies: no investment-cum-insurance plans like endowment or ULIP
  • Ancestral assets: Divya expects one apartment in a Tier 2 Indian city to come her way in a decade or two. Viraj’s parents also own a home in the same town, but the value of this property is low.
  • Primary residence: The family owns a 3BHK apartment in Tier 1 Indian city with a home loan. The market value of this home is not considered in the portfolio since they plan to live there indefinitely

The total market value of these assets:

  • equity assets: ~₹2.06 crores (MF + stocks)
  • debt assets: ₹51L (PF)
  • cash assets: ₹10L (bank)
  • total asset value is ₹2.67 crores
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Pre-requisites before you start investing

To build a house, you need 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 the family should complete 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. Investing in the wrong asset class in the wrong proportion (either equity or debt) can lead to either high risk, poor returns, or worse.

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, which is ₹3L x 6 = 18 lakhs. They should keep 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.

We could explore 12x expenses given the child’s age and due to a large home loan. However, given the amount of liquid assets in the family (~ 2crores in mutual funds), more capital kept as an emergency fund will be inefficient.

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

Viraj and Divya have corporate group cover for term insurance for four crores between the two of them. Apart from this, they each have term insurance coverage of ₹1 crore each up to the age of 60.

However, that coverage amount is not enough considering their goals. Given the value of their goals today, they need at least 10 crores of term insurance between them. Two additional life insurance policies of 2 crores per head, given their age and 20-year coverage, will cost around ₹55,000/year.

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
  • personal family floater of ₹25 lakhs covering self, spouse and child
  • separate policy covering Viraj’s parents. Since a policy’s premium depends on the highest age of the members, parents must be covered separately. Here we have allocated ₹10,000/month, i.e. ₹1.2L/year, for two senior citizen health insurance policies for Viraj and Divya’s parents
  • The family should explore a one-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, ₹5,000/year, is a small price to pay for insuring against a significant risk
  • The family should also take one crore personal accident insurance each for both Viraj and Divya, with a total premium of around ₹17,000-20,000

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

Pay off high-interest loans

Fortunately, the family has no high-interest loans like credit cards or personal loans. We will plan that the home loan is paid off in 10 years (EMI will now be 1.45L instead of 1.14L), so there is no need to pay too much interest. The accelerated payment will reduce overall financial risk as Aashvi enters middle school. Read more on this topic here: Should you use your stock market profits to repay a home loan?

Expense structuring

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 10% every year via skilling and improving their human capital: Your human capital, not investment returns, is your biggest wealth creator. Given the importance of human capital, we have allocated an upskilling line item in the monthly budget. The family can use this for courses, books and other related purposes. At their age, it is critical to keep their earning power intact: How to prepare today in case you are forced to retire in the next five years?

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 (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 ₹17.5L 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 ₹18.5 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 19 years when Viraj is 60

Child goals: foreign education and marriage

Children’s goals are very precious for a family. In this case, the family wants Aashvi to study abroad for UG and PG. They wish to fund most of the UG costs, and for PG, they will fund partially.

  • Specific: Aashvi’s school admission, UG and PG degrees (both preferably foreign), marriage
  • Measurable: In today’s money, these goals add up to nearly one crore, with the split being school:3L, UG: 1 crore, PG: 20L and marriage: 20L
  • 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 monthly output for this goal is small. Given that the UG goal is nearer than retirement, the model has already allocated a large part of the current assets to this goals
  • Time-bound: The goals are spaced out over multiple horizons over the next 30 years

Other goals

  • Regular Foreign trips: The family wishes to take a few foreign trips over the next 30 years and will save for those via their sinking fund
  • Next car: There is no loan on their current car. The family has a 3L/year sinking fund for car replacement
  • Early retirement: There are no plans for early retirement as of now

Derivation of investment amounts

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Case Study 24 Jul 22 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 this button:

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 24 Jul 22 SIP Output

Our new Goal-based investing tool will help you to create and manage all of your goals in one place. Click the image below to get access:

Arthgyaan creates a system for reaching your financial goals by sharing simple, actionable advice backed by research and analysis.

Your email address will not be shared with anyone and you can unsubscribe anytime.

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. An article discusses this choice: Which index funds to invest in and why?. Viraj should explore exiting the direct stock holdings over time in favour of index funds to avoid dedicating unnecessary time tracking and managing a mutual fund of his own.
  • Debt asset class: Apart from the 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, they should 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 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.
  • Other options: Cryptocurrencies, P2P loans, direct stocks and investment real estate/land (except a primary residence) should be avoided

Given the room in the debt asset allocation, the family should maximise their yearly contributions to PPF and Sukanya Samriddhi Yojana (SSY) accounts under Aashvi’s name. Over time, the PPF and SSY accounts, at the current interest rates, will generate:

  • PPF: ₹12,500/month for 15 years at 7.1% will give ₹41 lakhs at maturity after 15 years. This amount will easily fund a large chunk of the UG/PG fees, especially if extended for five more years.
  • SSY: ₹1.5L/year for 15 years investment at 7.6% will give ₹63 lakhs at maturity after 21 years

Note: Families without a girl child cannot have SSY. Instead, they should maximise the PPF investment and use a debt mutual fund for other investments.

Rebalancing plan

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Case Study 24 Jul 22 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.

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

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?

Practical considerations

There are some implementation issues in the plan, which will tackle one by one.

Initial rebalancing

The rebalancing plan calls for moving ₹50L of assets from equity to debt as per the asset allocation for all the goals. There are a couple of things that need to be kept in mind:

  • if the equity markets are falling, selling equity locks in losses
  • selling a large amount will attract capital gains taxes

Instead, suppose the entire SIP of ₹2.31L (minus the PF contribution) is diverted to debt mutual funds. In that case, the family can increase the debt allocation over time. As and when equity markets improve, additional profits can be harvested and moved into debt assets to achieve parity. The family should perform a portfolio review after six months.

SIP amount is higher than surplus

The family has an in-hand income of ₹4.5L/month plus ₹70,000/month going into EPF. However, the monthly expenses are currently ₹3.1L/month, which means that only ₹1.4L/month (plus ₹70,000 in EPF) is available for investments. At the same time, the model requires ₹2.31L/month. The shortfall is, therefore, around ₹20,000/month, which is reasonable.

Suppose you change the goal figures in a way the SIP amount comes to be much higher than income. In that case, you can refer to this article regarding the concept of reprioritising your goals: How to prioritise goals based on available monthly SIP amount?. The goal-based investing tool allows you to add or remove goals and see their impact in real-time. We will suggest not to increase risk by increasing the return assumptions and the salary growth rate.

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Asset Allocation (18) Basics (7) Behaviour (10) Budgeting (9) Calculator (11) Case Study (3) Children (7) Choosing Investments (24) FAQ (2) FIRE (8) Gold (6) Health Insurance (2) House Purchase (11) Insurance (8) Life Stages (2) Loans (10) NPS (4) NRI (3) News (5) Portfolio Construction (30) Portfolio Review (18) Retirement (22) Review (7) Risk (6) Set Goals (24) Step by step (4) Tax (12)

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