Gone are the days when parents had to sacrifice on their aspirations to give their kids a stable future. Clearly, the current aspirations are only limited by the sky. But so are the opportunities to meet them, and you quickly realise that even kids’ will need less financial support than moral. Also, even if you’d like to extend best financial support to your kids’ future, you need not give up on your aspirations. A little bit of planning before investment can offer you much more than to meet your dreams.
Maruti and similar cars are great for family, not just to ferry them places but also financially. But how do you know that this is the only thing you can afford?
To be clear about how much you should aim for, focus a little on planning where your money goes. Planning will consist of:
- Budgeting your needs
- Understanding your risk appetite &
- Investing in best possible avenues
Budgeting Your Needs
Your needs are of two types:
- One which you are addressing almost every day, every month or each year. For example, your household expenses, children’s school fee, loan EMIs, etc.
- Other needs are those which you must look after, but they are once in a lifetime. For example, marriage expenses for your kids, your retirement goal, your home buying goal, etc.
Once you budget the needs, you can start saving for once in a lifetime goals. A little math in advance will reveal if you can fulfil all your future needs within your limited savings.
How Long Before You Can Buy a Merc?
Take for example the question whether you can afford a Mercedes or not.
The current on road price (including taxes) of a Merc would be around Rs. 45 Lakhs. Assuming you would be buying something within this range a few years from now, you will need to invest approximately:
- 60,000 for 5 years [or]
- 20,000 for 10 years [or]
- 7,000 for 15 years
(Source: Financial Calculator)
The assumption here is based on a simple principle – ‘the longer the investment period, more investment risk you can assume.’ Thus, as your investment horizon stretches, your choice of investment assets also changes.
As you assume higher risk on your investment, your expected return also goes up. The only thing on your way to achieving that level of return is time. For the estimates above, our assumptions were based on historical performance of investments:
- For a 5-year horizon, you can select debt investments with tax free withdrawals after five years of investments. Equivalent returns average out at 8%
- A 10 Year investment may use higher equity component, and thus the average rate of return assumed at 12%
- When you stretch your investment tenure up to 15 years, you can freely capitalise on equity growth. Historically this growth has been 15 to 18% year on year
Even as a risk averse investor, you may park Rs. 7000 a month in an equity-oriented fund like ULIPs (Unit Linked Insurance Plans) or Tax Saving Mutual Funds (ELSS funds).
Though, when you are investing only for five years, you will only want safer instruments like fixed deposits or debt funds. Once again ULIPs can be your choice of investment for two reasons:
- Investment and maturity amounts are tax free
- Only tax-free debt investment to offer market linked returns
Why Unit Linked Insurance Plans Beat Everyone?
If you are planning to achieve this goal within next five years, your options could include Public Provident Fund (PPF), bank deposits, debt mutual funds and ULIP with debt investment option. The question is which one should you choose? Given that investing in multiple instruments for one goal could be complicated, let’s compare which is the best option for us:
Complete withdrawals from PPF is only allowed after the completion of the 15-year investment period. Thus, you will need to invest much more than what we estimated above. However, there is also the annual limit of Rs. 150,000, any deposit above this limit will be returned without interest. Therefore, PPF is out of the question, especially for 5-year investment period.
Taxability is the only disadvantage. You may lock in the returns to the tune of 8.5% (which is not the case right now). Plus, this will be taxable each year. So, assuming you fall in the highest tax bracket, you end up earning only about 6% p.a.
Additionally, you will need to deposit a lumpsum, to enjoy tax benefits and receive all the money within time.
Tax Saving Mutual Funds
First, these are pure equity investments. Second, there is a three-year lock in. Thus, your monthly investments must stop at least three years before you can withdraw your money.
Finally, ULIPs, although, the tax saving features are same, the disadvantages related to withdrawals and lock-in period is not there with ULIPs. After the five-year lock in you can withdraw full amount, even if your last investment was made just a month before maturity.
Remaining features of ULIPs that make it the preferable investment choice include an option to switch between safe and equity investment. As you get closer to your goal, your objective is to safeguard the returns from high risk investment with a low risk instrument. Additionally, the switch option allows you to benefit from market opportunities, whenever they arise.