There is an old saying – well begun is half done. There is a strong need for financial planning to make a good beginning. Let’s take Vijay Chavan, 40, sales manager with a pharma company at Pune.
His job involves extensive travel and long hours. That leaves him with little time for family. While he is earning Rs 10 lakh annually, financial planning does not figure highly on his agenda. When he hears a concept like work-life balance, he wonders whether he will ever be able to achieve that. Children's education, maintaining the lifestyle and a retirement nest hounds him and he throws himself at work with more dedication.
Chavan does not believe in unnecessary expenditure and saves Rs 4 lakh annually. He has built a portfolio of about Rs 1 crore from past savings. Being risk-averse, he has put all the money in safe instruments like bank fixed deposits, PPF and PF. He is happy to see his wealth grow steadily and safely. He also feels happy when some of his other colleagues worry about the falling stock market.
Le's assume everything remains like this for Chavan over the next 20 years in terms of income, savings and investments. This unrealistic hypothesis is for the simplicity of making a point. Chavan’s debt portfolio yields seven per cent return, net of tax. He will retire at 60 with wealth of about Rs 5.51 crore. This comes form Rs 1 crore wealth at the beginning of the 40th year, another Rs 80 lakh savings accruing in the next 20 years and cumulative return on accumulated wealth, as well as savings.
If we assume inflation at eight per cent annually, a lunch which costs Rs 100 today will cost Rs 431 after 20 years. That implies the real value of Chavan’s wealth will be about Rs 1.27 crore in today’s terms.Effectively, this implies he will not be able to retire at 60 without compromising on his life style, because he ignored the impact of inflation on his wealth.
One the other hand, suppose he had met a financial planner at 40 and followed a conservative asset allocation model, equally split between risky assets like equity and safe assets like bank deposits. Equity gave 15 per cent annually and fixed deposits 10 per cent. However, equity provided a tax-free return in the form of long-term gains while debt net of tax return is about seven per cent.
Chavan would then retire at 60 with Rs 10.63 crore. Obviously, he will suffer the pain of volatility in his return in the next 20 years. But a good financial planner will make him understand the ‘no gain without some pain’ formula.
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The pain of no surety of return, volatility, possible loss in the principal value of the portfolio are like the fever one gets in vaccination. The pain of fever after vaccination ensures one gets immunity in future. Similarly, the pain of uncertainty of return creates the gain of better return in future. If people can take their kids for vaccination, I see no reason why they can’t apply the same principle for financial planning. I recommend that one embrace short-term pain for long-term gain, before it is too late.
(The writer is president, corporate banking, Axis Bank. The views expressed are personal)