I sometimes receive queries over email from readers who are in a particular situation with respect to their personal finances and want to know what actions they ought to take in order to move ahead. Some of these queries are generic enough to apply for a broader audience. In the past, I’ve tried publishing these ad hoc in one way or the other, but would like to have a more organized approach moving forward. My plan is to collate these queries and my responses over a period of one month and publish them here.
Here’s what was asked and answered by Capital Advisor in January, 2011.
Query #1: Saving for higher education.
I want to save for the higher education of my 2 daughters aged 13 years and 11 years. I’m already investing Rs 5,000 per month in the Post Office Recurring Deposit since 1 year. I can set aside (at maximum) another 4,000 to 5,000 rupees per month. I am a single parent and cannot invest more that this. What should I do? Please advise.
Since you have started a Post Office RD for Rs 5,000 per month a year back and since the Post Office RD requires you to make monthly contributions for a period of 5 years, I’d suggest that you put the additional Rs 5,000 per month into what I’d call a buffer fund. Being a single parent, you could run into a financial situation (for whatever reason) where you’re unable to make the monthly contribution into the Post Office RD and that’s where the buffer fund would be quite handy.
First save up a 6 to 12-month buffer fund. This will cushion you against defaulting on the RD in the event of an economic hardship. Once you do that, you could consider investing the additional Rs 5,000 each month in a Moderate Allocation Fund with a great track record. I particularly like HDFC’s Prudence Fund (Growth option) — I have a SIP in D’s name.
Useful Reading: MorningStar Fund Investor — November, 2010.
Query #2: Building a contingency fund through high-returns investments.
I am looking for an investment scheme wherein I want to invest biweekly or monthly with a variable amount (say Rupees 2,000 or 5,000 or 10,000 — depends on the amount I have with me) and which gives higher returns (15%) and from which I’d be able to withdraw at any point in time.
Follow-up revealed that the reader wanted to do this for contingency planning (read emergency use).
I’m afraid that’s the wrong approach. Funds meant for contingency planning or emergency use shouldn’t be put in investments that seek to generate higher returns. Funds meant for contingency planning/emergency use need safety of capital (read as low a risk as possible) whereas investments that seek to generate higher returns promise exactly the opposite.
If you’re still willing to be adventurous, I’d recommend that you preferably stick to a Conservative Allocation Fund — you can begin your research here.
Query #3: Prepaying a housing loan.
I have a home loan of around 10.5 lacs. I have saved 5 lacs in the form of a fixed deposit and have earmarked this as an emergency fund. I’ve been thinking of using this for making part prepayments on the home loan but haven’t taken a decision yet. I also have a ULIP from ICICI Prudential with an annual premium of 1 lac. It completes 4 years next year and I want to close this and invest in a Post Office Monthly Income Scheme. What would you suggest?
Wouldn’t it be a better idea to close your ICICI Prudential insurance policy sooner? If you’ve already completed 3-years, you can surrender it right away. Think about the Rs 1 lac that would straightaway appear on your cash flow each year. You can use this to make part prepayment on your home loan (and make your home truly yours) instead of dumping it in that lame insurance policy for another year (and making ICICI richer!).
If your goal is to be debt-free, you could also use the surrender proceeds to make an immediate and huge prepayment on your home loan. But if your goal is to create a passive source of income, you could opt for the Post Office Monthly Income Scheme and do what I suggested earlier.
I’d continue to keep the Rs 5 lacs as a major-emergencies fund — probably split it into 5 fixed deposits of Rs 1 lac each.
Would you recommend anything different?
Wanted to write this to an earlier post but forgot:
What I like about your approach to fin. planning is that you recommend starting in debt instruments and then shifting to equity. I think this is terrific balanced and sane advise. Its best to expose oneself to equity slowly so that they are aware of the intrinsic fluctuations in the principal.
There are may internet bloggers who would have said stop the PO RD and get into equities. I think what you have recommended is pretty sensible.
A strong foundation in debt instruments is essential for such a crucial goal.
Thanks for the vote of confidence. :-)
One of my earliest exposure to personal finance was an RD at SBI. My dad had opened an RD in my name (with my mom being the guardian) a couple of years after I was born. The deposit was Rs 200 per month (seems paltry now!). My mom religiously did the deposit each month (and I used to walk to the bank with her) and did this for about 20-years!!! I was stunned by the balance in that account when we finally closed it.
Like you’ve commented elsewhere, there’s indeed a lot to be learned from the FD/RD generation. :-)
In my case, even my financial independence portfolio has the RD and PPF at the core.
Don’t you think a preclosing a housing loan is not such a good idea? I understand that you will be deft free but, the housing loan gives you huge tax benefits.
I think we have to compare the tax benefits v/s the cost of preclosing a loan. In some cases, the finance companies take 5% for preclosing the loan.
Wanted to have your take on this.
I’m always in favor of pre-closing a loan — any loan — immaterial of income tax benefits. Because, given the uncertain nature of our jobs and economy, having long-tenure EMIs (that always seem to increase but never decrease) isn’t a good idea irrespective of the income tax benefits.
Sure…it might mathematically make more sense to not pre-close a loan but life is seldom mathematically precise. You wouldn’t want to be burdened with a loan that you simply can’t repay.
What do you think?