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You can still be home in time: Outlook Money - December 3, 2003

Ideally, you should start planning your retirement the day you start earning. But it never works out like that, does it? How to play catch-up with your life goals.

Udayan Ray

Glance at a mutual fund advertisement and you’ll find it exhorting you to start saving early and diligently to retire in comfort. Turn the page over, and the life insurance company beseeches you to do the same. Personal finance magazines like ours reinforce the message. In theory, the idea is perfect: save early so that even if you invest small amounts in low-risk and low-return options, the power of compounding will grow it substantially over time.

In practice, what if life decides differently? Kolkata-based Sabyasachi Chattopadhyay is now 57. A central government employee and a playwright in his spare time, Chattopadhyay started working in 1969 and, after his father’s death in 1975, became the sole bread-earner for his family. He had to get his four younger siblings married and settled before he could think of his own financial goals. He finally married at 36. When daughter Shilpi was born in 1986, Chattopadhyay’s financial planning task was cut out. In about two decades of working life, he had to generate enough resources to fund a house, his daughter’s education and other expenses, and his own retirement.

There are others in a similar situation, well into middle age without having accumulated much wealth at all. Do they abandon the whole planning process? No, says Sanjay Sachdev, CEO and managing director, Principal Mutual Funds: "It is better to start financial planning late than not to plan at all."

Outlook Money looks at some financial planning options that let you reach your goals even though you have begun late.

The three options

Before you get started, figure out which of these three paths you will take. First, you can try earning more, while keeping a check on your costs. Second, you could try and increase your work life–increasing your retirement age from 58 to 65. Third, you can re-evaluate your goals, making some compromises.

Wealth creation.

To earn more, you have to make an important distinction. "You have to ask yourself whether you want more income or you are interested in wealth creation," says Purvi Sheth, consultant, Shilputsi, a Mumbai-based human resources consulting firm. If you want more income, you would look at the obvious options of higher paying jobs. "However, the job content may or may not be to your liking," warns Sheth.

If your focus is on wealth creation, the option we recommend, you should look at jobs with different kinds of companies– those that let you access various wealth creation media. Such media include access to company loans, generally low-cost ones, for acquiring assets like house or car. These loans come without the cumbersome procedures of commercial institutions like banks and also, you are likely to get the amount you seek. Other wealth creation media include availability of stock options that can generate substantial capital, especially if you work for an MNC or a fast-growing company.

The retirement package is the other medium to explore. You need to look for a company that provides provident fund, gratuity and superannuation benefits, ensuring that the maximum possible 32.5 per cent of your basic salary goes into your retirement savings. This will enable you to have a decent retirement nest egg, even as you try to catch up on other financial goals. As far as containing costs are concerned, you can only do it to a limit. "You can’t cut personal costs beyond a point," says Rohit Sarin, partner, Client Associates, a private wealth management firm.

Stretching work life.

You don’t have to necessarily do this. But if you think that you will need to do so, you will have to prepare yourself accordingly. "You will have to develop capabilities, early on in the career, that can be used across industries and will not be constrained by age. You can’t be successful if you compete with the active workforce," says Sheth. Ideally, build expertise in an individual area so that you can function in an advisory capacity after retirement. The alternative is to build specialized skills low in availability. For instance, you can be a professional in market research, FMCG marketing, or training, and work as a consultant, even for your erstwhile employer, after retirement.

Redefining goals.

"I have gone in for a two-bedroom flat instead of a three-bedroom one," says Dipankar Barkakati, 41. Barkakati is a Delhi-based senior corporate executive who started serious savings only three years back, beginning with a Rs.1.5 lakh investment in a mutual fund scheme. "Any past savings I made were inadequate," he says.

This is the kind of pragmatism one needs while playing catch up in the wealth accumulation game. You have to examine the feasibility of achieving your goals. If some of them look tough to achieve, you need to downscale your expectations. Also, since resources are short, you would need to prioritize your goals. "Should there be a resource crunch, the funds can be used where they are needed the most," says Shikha Sharma, CEO & managing director, ICICI Prudential Life Insurance Company.

Hobson’s choice.

Once you’ve decided which option to take, the most common conflict of interest you are likely to encounter is between your retirement needs and your children’s education. You will want to make an equitable distribution of your savings between the two. Experts, however, recommend that you focus more on retirement. "Children taking care of parents in old age will soon be a thing of the past," says Sachdev.

To ensure that you don’t outlive your assets and become financially dependent on your children, invest for your retirement, which is a period of two decades or more. The income will supplement your mandatory savings like the provident fund.

Second, your children’s non-technical education can be financed through your current income itself. This is something that Chattopadhyay is doing for Shilpi, who is in Class XI. An aspiring singer, Shilpi is getting formal training in music. It is specialized education like engineering, medical or management studies that demand huge sums of money. "Children enrolling for such courses can take educational loans while the parents provide some initial lump-sum and furnish guarantees, if required," says Harsh Roongta, CEO, apnaloan.com. With falling interest rates, the rates for 5-7 year educational loans are today at a comfortable 10.75-14.5 per cent, a figure that could go down further. What’s more, there are two other benefits. The repayment starts only six months after your child passes out of the course, and in most cases, this coincides with the beginning of employment. Second, your child will get a tax break on the interest repayment up to a maximum of Rs 40,000 annually under Section 80E of the Income Tax Act.

The four mantras

Now, you have a fix on the big picture. To take your planning ahead and keep it on track, take the following four steps.

Insurance against risk

As it is, you’re playing catch up. You can afford even less to take risk than anyone else. Make sure you insure your life, health, liabilities and property. Any damage or loss in these areas could set your planning back even more. First, make a realistic assessment of the risks you face. "Asset protection, income protection and protection of liabilities must be realistically evaluated and covered with pure risk covers," says Devang Shah of Right Returns Financial Planning, a Mumbai-based financial planning outfit. This is important since overestimation would mean higher obligations in the form of premia payment while underestimation will make you stay vulnerable.

Get adequate life cover that will maintain the living standards of your family in the event of your untimely demise. "Don’t compromise on the sum assured, even if an advanced age means you have to pay correspondingly higher premiums," says Sharma of ICICI Prudential. Of course, you should shop around to get the best deal in terms of maximum coverage for lowest premium payment.

Do the same for non-life insurance like health, automobiles, homes and disability. "Age is not a deterrent in protecting oneself from risk. Apart from health insurance, where insurance taken at an early age comes at a lower premia, all other general insurance products can be availed of at any stage of life," says Antony Jacob, Deputy Managing Director, Royal Sundaram Alliance Insurance. For uninsurable risks like a job loss, keep a liquid contingency fund. Experts recommend anything from three to six months’ worth of regular expenses, but you have to finetune this to your own comfort level.

Create assets

One major problem faced by people trying to catch up is that most goals like buying a house, children’s higher education and marriage, and retirement have to be reached in a very short span of time. So, your first step after covering your risks is to start acquiring assets immediately. Starting this process early has the advantage of spacing out your cash outflows.

Loans for houses or cars are available at easy rates. This can work to your advantage if you don’t stretch your income too much. "In today’s interest rate environment, it is better to take a loan to acquire assets first rather than save first and acquire them later," says V. Vaidyanathan, senior general manager and head, retail banking, ICICI Bank. Paying EMIs now is far better than facing huge payouts close to or after retirement.

Home rules.

Topping your list of assets is, of course, a house. The reasons for this are many. "The tax breaks for housing are much more than for any other form of saving," says Roongta. You get an annual tax deduction of up to Rs.1.5 lakh under Section 24 for interest payments on your loan. You also get an annual tax rebate of up to Rs.20,000 under Section 88 for repayment of principal through EMIs. This is much higher than the tax breaks you get for savings instruments under Section 88 (Rs.1 lakh) or Section 80CCC (Rs.10,000), applicable to pension plans.

EMIs as savings.

A house is an asset that appreciates and beats inflation in the long term. Therefore, in effect, the EMIs you pay are a form of savings that will create an appreciable asset. Low interest rates and competition among housing finance companies make this asset more easily accessible than ever before. What’s more, as you progress in the repayment tenure, you can take a loan against your home equity, which is basically the sum of your down payment, the principal repaid, and the appreciation in the price of the house since purchase. This loan, should you need one and assuming you are under-leveraged, will come to you at rates much lower than those on personal loans.

It’s to take advantages of such benefits that Delhi-based chartered accountant Dheeraj Wadhwa, 35, decided to buy a home early this year on a 10-year home loan. Wadhwa started a corporate gifts business with his friends in 1995 about six months after passing his CA, while continuing with his fledgling CA practice. Most of his business earnings were re-invested into the business, leaving him little to invest. In 1999, two events changed the course of his finances. First, he decided to spend more time on the CA practice than on the business. Second, he got married. "I am the finance professional but my wife, Sujata, is more thoughtful about personal finance," says Wadhwa. The couple realized that acquiring a home should be among their top priorities. "I intend to repay the loan before the end of the tenure," says Wadhwa. He can thus be free of debt obligations before 45, and can devote his money to the higher education of his four-year-old son Kshitij.

Avoid overexposure.

Loans for cars and other consumer durables do not get tax breaks but the low interest rates still make them attractive and sensible acquisitions. However, while using loans to build assets, remember to ensure that you have a comfortable disposable income left over after meeting EMI payments. "People should have a fair idea of their cash flow for the next five years," says Vaidyanathan. Experts advise people to err on the side of caution while anticipating cash flows. Equally, do not accumulate costly credit card debt.

Weigh returns against risk

To make your money grow faster in a shorter time, you will have to take a higher level of risk. "Risk to the lay person is visible only when he loses money," says Shah. But risk is inherent in the nature of the investing instrument. Your requirement for high growth quickly should not force you to take a plunge in risky investments like equities that you are otherwise uncomfortable with. A large percentage of investors in chit funds are people close to retirement; they’re taking a high risk for quick money, and often end up losing all. "The paradox of inadequate wealth is that you can’t take a higher risk. Therefore, you shouldn’t aim for higher returns. No amount of planning can help you increase the rate of return dramatically without a commensurate increase in risk," says Shah. The key is to understand the trade-off between risk and returns, and accordingly take a decision to enhance risk or scale down goals.

Prioritize goals

"As time elapses there is much less flexibility for mid-course corrections," says C. Jayaram, director, Kotak Mahindra AMC. Give maximum attention to the goals with nearest proximity. "You should take the least risk for investments linked to such goals. A loss from a higher risk investment means that you have lost out on the advantage of the power of compounding," says Sarin, who strongly discourages high-risk investments if the goal is less than five years away.

You can take a higher risk in the shape of growth funds or shares if you do it early in life. The income from these should be earmarked for goals that are still far away. "Invest incremental savings in higher risk investments," suggests Sarin. These savings come after you have taken care of risk and have created assets. As you near retirement, risk exposure can be reduced and your money redeployed in lower risk options like income schemes, bonds and fixed deposits. Another standard way of managing risk is to have one portfolio of higher risk options like shares, while keeping your other portfolios safe. "You can control risk by doing your homework before investing and taking good financial advice," says Jayaram.

Clearly, all is not lost if your finances have not worked out smoothly early in life. You can still cover a lot of lost ground and meet your goals successfully. "In the investment planning world, the future is more important than the past," says Sachdev. True. Just make sure you have a plan ready to make up for lost time.