Financial Planning for Civil Servants

Strategy, Implementation & Tools

IAS Bhawan, Patna

October 23, 2018
Financial Planning for Civil Servants

 Investment Planning
 Retirement Planning
 Insurance Coverage
 Contingency planning
Investment Planning
Strategy

 Invest to achieve specific goals

 Choose Mutual Funds as primary investment channel
 Follow SIP / STP route rather than lumpsum investment
 Don’t avoid equity
 It should form the core of your investment plan
 Select funds for investment judiciously
 Review investments regularly
 Control your greed
Goal Based Investing: Why & How

 Why
 Provides focus
 Helps quantify the returns required
 You know when you have arrived
 How
 Set goal
 Select Mutual Funds
 Select agency through which investment will be made
 Link a specific bank account with investment account
 Adopt a feasible ROI
 Compute SIP / STP amounts
 Set up automated SIPs / STPs
Goal Setting

 Identify the purpose of investment

 Determine the future date when funds will be needed
 Calculate investment period (P = Future date – current date) in years
 Assess the amount of money required today to achieve the goal (Present Value)
 Compute the Future Value (FV) taking inflation into account
 Take the higher of annual CPI inflation for immediate past two years
 Add 0.5% to this number to arrive at inflation figure for calculating FV
 Use FV calculator in the “Calculators” Tab of Excel sheet named “Mutual Fund Investment”
to calculate the Future Value
 Invest in Mutual Funds to attain the goal
Why invest in Mutual Funds

 Mutual Funds give higher returns than Fixed Income Instruments

 Debt MFs – 6-8%
 Equity MFs can provide inflation beating returns – 12-16%
 Tax treatment of Mutual Funds is much more favorable as compared to other investment
instruments
 Only capital gains are taxed
 Three broad categories
 Equity Funds
 Debt Funds
 Hybrid Funds
Tax on Mutual Funds – Short & Long Term CG
Tax on Mutual Funds – CG Tax Rates
Equity Mutual Funds

 Invest in stocks of companies

 Have proven in the past to provide inflation beating returns (12-16%) over long term
 Stocks are volatile by nature as they are sensitive to economic factors such as inflation, tax
rates, currency fluctuations, market sentiment, etc

Sub-Category Invests in Sub-Category Invests in

Large cap Top 100 stocks Focussed 30 or less stocks
Mid cap Top 101-250 stocks ELSS 80% Equity + 3 year lock-in
Small cap 251 and below Contra/Value Undervalued stocks
Large & Mid cap At least 35% in Sectoral/ 80% in specific sector or theme
Large and Mid Thematic
Multi cap Various caps Dividend Yield High dividend yield stocks
Risk Level of Equity Funds

Sub-category Risk Level

Small cap High
Mid cap High
Multi cap Medium
Focussed Medium
Large and Mid cap Medium
Large cap Low
Debt Mutual Funds

 Invest in instruments yielding fixed income such as Govt bonds, Company deposits and
bonds, Commercial papers etc
 Returns in the range of 6-8%
 They are considered lower in risk vis-à-vis Equity Funds
 They are superior to options like Bank FDs due to their tax efficiency
 There are 16 sub-categories. For our purposes relevant categories are:

Sub-Category Invests in
Liquid Fund Instruments like treasury bills, govt securities with maturity of 91
days or less and provide easy liquidity
Short Term Fund Instruments with maturities between 1 year and 3 years
Medium Term Fund Instruments over 3 year maturity
Hybrid Mutual Funds

 Invest in more than one type of investment security such as company stocks and bonds
 On account of debt component, they are not as volatile as pure equity funds and provide
relatively stable returns
 There are six sub-categories and the ones relevant for us are:

Sub-category Invests in
Conservative 75-90% in debt
Aggressive 65-80% in equity
Balanced 50% in equity and 50% in debt
Fund Selection

 Selection of right funds is a challenge

 38 fund categories
 44 AMCs
 More than 2000 mutual fund schemes
 You can zero in on right funds following the method below
 Methodology for selection
 Step-1 : Decide asset allocation
 Step-2 : Select funds in the selected asset classes
Asset Allocation
Time Frame Duration Asset Category Asset Sub-category

Short Term 3 years Debt – 100% Short Term Debt

Medium Term 3 to 7 years Equity – 65% + Option-1: Aggressive Hybrid
Debt – 35% Option-2: Large cap Equity (35%)+
Multi cap Equity (30%) +
Short Term Debt (35%)
Long Term More than 7 years Equity – 75%, Option-1: Large cap (20%) +
Debt – 25% Large & Mid cap (20%) +
Multi cap (20%) +
Aggressive Hybrid (20%) +
Short/ Medium Term Debt (20%)
Option-2: : Large cap (20%) +
Large & Mid cap (20%) +
Multi cap (20%) +
Small cap (15%) +
Short/ Medium Term Debt (25%)
Selection of Funds - 1

 Consult one or more websites that provide info regarding MF schemes

 Moneycontrol (www.moneycontrol.com)
 Value Research (https://www.valueresearchonline.com/)
 Morning Star (https://www.morningstar.com/)
 Advisorkhoj (https://www.advisorkhoj.com/)
 You will see info such as
 Launch date
 AUM
 Performance data and peer comparison
 Portfolio composition
 Benchmark
Selection of Funds - 2

 Examine funds of the desired category / sub-category

 Shortlist funds
 That have been in existence for 5-years or more, and
 That have AUM of 100 cr or more
 From the shortlist, select fund with 5-star or 4-star rating
 If you have to choose between two funds with same star rating, go for fund with
 higher 3-year returns in case of short term investments
 higher 5-year returns in case of medium term investments
 higher 5-year / 10 year returns in case of long term investments
 Number of funds
 Short Term – 2 to 3 funds
 Medium Term – 2 to 3 funds
 Long Term – 1 to 2 funds from each sub-category
Growth vs Dividend Option

 Growth
 Invested amount remains invested until redemption
 No interim payout
 The principal plus notional profit benefit from the power of compounding
 On redemption, CG is taxed
 Dividend
 Fund pays periodic dividends, but these are not guaranteed
 Power of compounding is not as efficient as in Growth option
 Modest capital appreciation
 Dividend is tax-free in the hands of investor, but Fund suffers DDT of 20.36% on declaring dividend
Regular vs Direct Plan Formats

 Regular Plan
 Sold by intermediaries who provide various services to the investors during the entire investment
life cycle.
 They are paid certain commissions and incentives by the AMC. They may also charge a fee from
the investor.
 Higher expense ratio.
 Relatively lower returns to investor.
 Direct Plan
 Sold directly by the AMC
 Lower expense ratio
 Higher returns (0.5% to 1.5%)
 Of late, companies have come up that sell Direct Plans but are not paid any commission by AMC
 They do charge a fee from the investor
How to invest in Regular Plans of MFs

 Through a Distributor
 Easy and quick automated, online process
 Investor services available for entire life of investment
 Fees charged from investor on quarterly/ annual basis
 Only regular plans of MF available
 In addition to MFs, distributor may offer other instruments as well
 Top 20 distributor list on next slide
Top 20 Distributors
How to invest in Direct Plans

 Option-1: At AMC website

 All AMCs provide online investment facility
 No fees levied by AMC
 Investor can register his account and transact online directly
 For investment in funds of different AMCs, investor has to go to websites of each AMC
 Option-2: Through Direct Plan Platforms (Robo Advisors)
 Digital platforms offering automated, algorithm driven Mutual Fund services
 They provide facility for investment in Direct Plans (list on next slide)
 Investor can access MFs of most AMCs at one place
 Services include Dashboard / MF Transactions / investment history / Portfolio details / Gain-loss
reports, etc
 They charge flat fees or transaction linked fees
Direct Plan Platforms - 1
Direct Plan Platform Charges
Direct Plan Platforms - 2
Direct Plan Platform Charges
Setting up Investment Account

 Select Direct Plan Platform

 Register at their website
 You will need
 Laptop / PC
 Internet connection
 ID proof
 Address proof
 Bank account details
 Scanned copy of cancelled cheque
 Setting up account is automated, quick and easy process
 After account opening, Platform operator may send you some forms to fill and return
Setting up SIPs

 Step-1: Adopt feasible ROI depending on the portfolio of funds selected

 Short Term (Debt) : 7%
 Medium Term (Aggressive Hybrid) : 10%
 Long Term (Equity + Hybrid + Debt) : 12%
 Step-2: Use “Calculators” tab in “Mutual Fund Investment” Excel sheet to calculate SIP amount
using the data below:
 Investment period in months (P) for short term; P-12 for medium term and P-24 for long term
 Future Value = Target amount after P months
 Step-3: Distribute SIP amount among the selected funds as per asset allocation
 Step-4: Log in to your investment account and set up SIP for each selected fund
 Option: Choose growth option in each case
 Period: 12 months
 Choose the date on which SIP investment will be made every month
Managing SIPs

 SIP date - 5 days

 Make sure your linked bank account has requisite funds
 SIP date
 In the evening, check if order for each fund has been placed
 If for any reason, order for any fund is missed, place order manually
 SIP date + 5 days
 Verify if units have been credited to your investment account
 12 months later
 Set up SIP for next 12 months increasing the SIP amount by 5-10%
 Repeat this step every 12 months
Monitoring your investment

 The “Investments” Tab of “Mutual Fund Investment” Excel workbook has tables for
monitoring up to 10 funds
 Enter fund name and target amount in these tables
 For each fund, enter following data into these tables every month
 Fund NAV
 Amount invested or redeemed
 Table will calculate and show growth/ loss for the month and year
 The “Summary” Tab will show a snapshot of your investments and their current value
Annual Review

 Annual review should be undertaken for Medium and Long Term investments
 Use Annual Review tab of Excel Workbook
 Enter one year return data for
 Fund
 Category
 Benchmark
 If fund return is below both category and Benchmark return, flag it for quarterly review
 If the fund continues to underperform behind Benchmark and category average in terms
of one year returns for next 4 quarters, consider switching to another fund through SWP /
SIP route
Dos and Don’ts
Dos Don’ts
 Do invest in Equity MFs  Avoid timing the market
 Use SIP route for investments  Do not speculate
 Monitor your investments on monthly basis  Do not check market movements several
times a day
 Invest for long term
 Do not borrow to invest
 Invest for goals
 Do not be greedy
 When goal amount is reached, move
your money from equity to Liquid Fund or
Bank account
Retirement Planning
Post-retirement cash flow of Mr X

Before retirement After retirement

Monthly salary 2,25,000 Monthly pension 1,12,500
DA @9% 20,250 DR @9% 10,125
Other allowances 0 Commuted pension 45,000
Gross monthly salary 2,45,250 Net pension 77,625
Annual salary (a) 29,43,000 Annual pension (a) 9,31,500
Income tax (b) 6,38,400 Income tax (b) 1,10,880
Savings @20% (c) 5,88,600 Savings (c) 0
Carry home cash (a-b-c) 17,16,000 Carry home cash (a-b-c) 8,20,620
Monthly carry home 1,43,000 Monthly carry home 68,385
Dimension of Post-retirement cash flow gap

 To maintain same living standard, same carry home cash flow as during service required
 Large gap (Rs 75,000) between living expenses and pension cash flow
 After retirement, living expenses would actually go up
 Transport (petrol/ diesel, driver’s salary) – 25,000
 Communication & Information (mobile, broadband, newspapers and periodicals) – 5,000
 Hence, a Supplementary Pension of Rs 1,05,000 would be required out of investment
income
Bridging the gap

 On retirement, Mr X spends Rs 13L on world tour,

Retirement Benefits of Mr X vacation and gifts to his children.
Gratuity 20,00,000  He invests the balance amount (1.2 cr) in the safest
investment channel – Bank FD.
PF 15,00,000
 The FD earns a nominal interest of 7.5%
Leave Encashment 24,07,500  Post tax @30%, the effective rate is 5.25%
Commutation Value 44,24,760  Post-tax annual interest: Rs 6,30,000
Total 1,03,32,260  Monthly cash flow: Rs 52,500
Existing investments 30,00,000  To generate, Supplementary Pension of Rs 1,05,000
Bank FD of Rs 2.40 cr would be required
Grand Total 1,33,32,260
 Future interest earnings would be even lower
 FD interest rates are moving southwards
 Inflation will eat into the principal amount
SP through Mutual Funds

 It is possible to generate self-sustaining Supplementary Pension with Mutual Funds

 MFs provide inflation beating returrns
 Higher returns: Equity MFs give much higher returns than FDs
 Lower Tax: MFs suffer CG tax at rates much lower than IT slab rates applicable to FD interest
 MF investments are risky
 Such investments must be accompanied by risk mitigation measures
Characteristics of SP

 SP should have the following characteristics

 Equated cash flow: same amount of cash every month
 Regularity: Pension should be available regularly irrespective of market conditions
 Pension flow should not stop even when market is down or giving negative returns

 Inflation beating: Pension amount should increase every year @ >= inflation
 Corpus growth: Invested corpus should also grow @ >= inflation
Risk Mitigation – Capturing gains

 Equity funds are volatile

 They give handsome returns when market is upwardly mobile
 When market goes down, their values can drop sharply and may even give negative returns
 To address the volatility of Equity funds
 harvest their gains whenever they occur, and
 Sit tight when their value goes down
 To implement this strategy, redeem 50% of the gain over last month on a fixed date each
month
 Create a Holding Fund in a Liquid MF or Bank and credit redeemed gains into it
 Money for living expenses should be drawn from Holding Fund annually or monthly
Risk Mitigation – Contingency Fund

 Between year 2000 and 2016, there have been four Bear Phases in Indian stock market
 Duration of these phases has ranged from 11 to 19 months
 Hence, if there is a Contingency Fund that could fund Supplementary Pension for two
years, then the risk of market fluctuations will be mitigated
 Create Contingency Fund in a Liquid MF or Bank account and credit amount equal to
twice the value of annual Supplementary Pension into it
 Whenever the Holding Fund runs out of money, borrow from Contingency Fund
 Recoup the borrowing subsequently in Bull Phase when there are surplus funds in Holding Fund
 The Holding Fund – Contingency Fund mechanism ensures equated monthly
supplementary pension every month irrespective of market conditions
Setting up Supplementary Pension

 Step-1: Determine post retirement expense requirement

 Step-2: Compute post-retirement income
 Step-3: Determine Supplementary Pension required
 Step-4: Select Mutual funds
 Step-5: Calculate the investment required to generate Supplementary Pension
 Step-6: Set up SIPs
 Srep-7: Post retirement, set up Supplementary Pension cashflow through SWP
Determining Post-retirement living expenses

 Assess the salary level at which you hope to retire and assume that you are retiring today
 Compute current annual carry home salary after deducting
 Income Tax
 Savings & investments
 Loan repayments
 Add additional expenditure over transport, communication etc
 This will give be the current post-retirement living expenses (L)
Determining post-retirement income

 Compute current pension for the position from which you hope to retire
 Add to it the annual value of any other income that you may have e.g. rental income
 Compute the Carry Home Cash (C) after deducting
 Commuted portion of pension
 Income tax
Computing Supplementary Pension amount

 Supplementary Pension Required (SP) = L – C , where

 L = Current Post-retirement Living Expenses
 C = Current Post-retirement Carry Home Cash
 Compute future value of SP on the date of your actual retirement
 For this calculation, take inflation rate = higher of the CPI inflation rate for past two years + 0.5%
Selection of funds

 Investments made for generating SP are Long Term investments as they will continue for
your entire life
 Choose one of the two options suggested for Long Term investment in the “Asset
Allocation” slide
 Visit the websites that provide information regarding mutual funds and select funds
 Follow the method explained earlier for selection of funds
 Choose Growth option for each fund
 Select Direct Plan of each fund
Investment Quantum (Refer Excel)

 For the portfolio of Equity and Debt funds suggested, you may assume ROI of 12%
 Calculate Pension Corpus (PC) required for generating Supplementary Pension (SP)
 Compute the amount of pre-existing investments that would be reinvested in mutual funds
 Compute future value of pre-existing investments (EI) on date of actual retirement
 Assess the retirement benefits (RB) that would be available on date of actual retirement
 Out of RB, following funds will have to be set apart
 For Contingency Fund (CF) an amount equal to 2 x SP
 SP for first year
 Shortfall in Pension Corpus = PC – RB – EI – CF – SP
 Calculate SIP amount required to meet this shortfall on the date of actual retirement
Setting up SIPs

 Two sets of SIPs to be set up immediately

1. Out of your salary income to meet the Pension Corpus shortfall
 Increase the SIP amount by 5-10% each year

2. Reinvestment of pre-existing investment

 Entire amount should be invested through 12 month SIPs

 Third set of SIPs will be started in the first month following retirement
 Balance of retirement benefits after setting apart money for Contingency Fund and
Supplementary Pension for first year will be invested in 12 months
Supplementary Pension cash flow thru SWP

 Start SWP for funding Supplementary Pension in the first month after retirement
 Redeem 50% of the gain over last month in each Equity Fund on a fixed date each month
 No redemption in months when the current value is lower than the previous month
 Credit the redeemed amount into the Holding Fund
 AMCs do not offer automated SWPs structured in this manner, hence you would have to
operate this SWP manually
 It is not necessary to have monthly SWP for Debt Funds
 Their gains may be redeemed quarterly or annually
 Transfer amount of Supplementary Pension from Holding Fund to expense account
annually or monthly
Contingency Planning
Contingency Planning

 Create a General Contingency Fund in Liquid MF or Bank Account

 Its size should be equal to 3-4 months salary
 This money may be used to meet unforeseen expenses and the drawals should be subsequently
recouped
 Create a health Contingency Fund of Rs 10 lakhs
 Even if you have CGHS or Mediclaim cover, there could be situations where you have to incur
expenditure over hospitalization and treatment first and claim reimbursement later
 Money from this fund could be used for health contingencies
Insurance Coverage
Insurance

 Health Insurance
 Those who are entitled to participate in CGHS should buy a life time cover on retirement
 Others must buy health insurance for 10 lakhs from a private Insurance Company
 Choose family floater policy
 No cap on room rent
 No co-payment
 Buy health insurance before age 50, as people are prone to lifestyle diseases later and Insurance
company imposes waiting period of 3-4 years for life style diseases and also jacks up premium
 Life Insurance
 Buy plain vanilla term insurance plan – it is the cheapest insurance solution
 Avoid Money back and ULIP policies as they offer neither adequate insurance nor good return
 Property Insurance
 Buy insurance for house property