How to Select Best Savings Investment Plan?

Savings is the first step on the ladder of investment and wealth creation. Every investment is made with an objective – either achieving a financial goal or for creation of wealth.

Risk Reward

All investments are also subject to risk. There is a direct relationship between risk and reward; lower risk translates to lower reward and higher risk fetches higher returns.

The objective should always be to strike equilibrium between risk and reward. This equilibrium does not lend itself to definition in empirical, numerical terms because the propensity to accept risk fluctuates with age, financial position, proximity to one’s financial goal and, inevitably, the perceptions of the investor.

But, nevertheless, financial goals such as purchase of a car, marriage, purchase of a property, education and marriage of children and provision for retirement can be achieved by investing in a range of financial instruments with diverse risk features.

Vikram’s Goals

Born in the year 1975, Vikram was 25 years old when he settled down in his second job, earning Rs.60,000/- per month. Saddled with payment of house rent and regular household expenses, he was able to save only Rs.30,000/- per month. But , his plans were ambitious.

Tax Savings

Vikram decided to reduce his tax liability by claiming the maximum deduction of Rs.1,50,000/- permissible under Section 80C of the Income Tax Act, 1961. From April 01, 2000, he commenced monthly investments of Rs.6.250/- in Public Provident Fund (PPF) Scheme and an Equity Linked Capital Scheme (ELSS). The advantage of the PPF Scheme is its risk free nature owing to the sovereign guarantee of the Government of India though the funds invested are ordinarily subject a 15 years lock in period. The investment in the ELSS, though riskier than that in the PPF Scheme, serves a dual purpose – like the PPF Scheme it also is eligible for deduction under Section 80C of the Income Tax Act, 1961 (subject to a lock in period of only 3 years) and the returns are attractive.

Vikram went ahead and invested Rs.6250/- per month in PPF and an equivalent amount in an ELSS; an aggregate amount of Rs.1.50 lakh per annum. The outcome after the 15 years period is tabulated below.

Interest on PPF has been calculated at applicable rates. However, investors should note that the interest rate will be reduced to 8.1% per annum for the quarter April 01, 2016 to June 30,, 2016. To get the benefit of interest for the entire month, investments should be made between the 1^st and the 5^th of every month. The compounded annualized growth rate earned by the ELSS worked out to 24.95%.

Cash and Cash Equivalents

Ordinarily, investors should retain the equivalent of 2 months’ expenses as balance in savings bank account. Vikram played safe and also invested Rs.2,500/- each month for 30 months in a liquid fund to build a further surplus.

As on March 31, 2016, the liquid fund investment was worth Rs.2,02,566/-.

Thereafter, Vikram opened a Recurring Deposit Account in which he invested Rs.2,500/- every month from April 2003 to March 2013 (the maximum period of 10 years) at an interest rate of 9% per annum. At maturity, the recurring deposit account was worth Rs.4,28.218/-. The maturity value was then invested in a fixed deposit for 2 years upto March 2015 by when it the value had increased to Rs.4.80 lakh.

Balanced Fund

In September 2000, Vikram also began an investment of Rs.5000/- every month in a Systematic Investment Plan (SIP) of a balanced fund. Based on an expected return of 15%, this would help him to reach his financial objective of accumulating Rs.5.00 lakh by March 31, 2006 to meet his marriage expenses.

With this, Vikram achieved his medium term goal of providing for marriage expenses of Rs.5.00 lakh by March 31, 2006. He redeemed 17,817.689 units as on March 31, 2006, and retained 8,286.28 units. As on March 31, 2015, these units were worth Rs.9,12,775

Equity Fund Investments

To reach his 2015 target of Rs.1.50 crore for purchase of property, Vikram hedged his risks by starting investments in two mutual fund schemes – a large cap and a multi-cap. These funds are suitable for investment when the investment horizon is more than 10 to 12 years. Large cap fund are more stable as the portfolio is of well established companies. Multi-cap funds are riskier as around 40% to 60% of the portfolio consists of mid-cap and small-cap companies. Vikram invested Rs.5,000/- per month in each scheme during the period April 01, 2000 to March 31, 2015. The aggregate amount invested in each of the schemes was Rs.9,00,000/-

The Picture on March 31, 2015

The question foremost in our minds is whether or not Vikram has achieved his financial goal for March 31, 2015. Let us see where he stands.

The target of Rs.1.55 crore set for March 31, 2015 has been exceeded by a handsome margin. Vikram has a platform and a strategy which he can use to build wealth for his future needs such as the higher education of his daughter, her marriage and his retirement fund. After investment of Rs.1.55 crore for purchase of property, and without taking into account the FD value of Rs.4.80 lakh, Vikram still has an investible surplus of Rs.80.00 lakh.

Even based on compounded annual growth rate of 15% which is much lower than the CAGRs earned from investments in the ELSS, Balanced Fund, Large Cap Fund and the Multi-Cap Fund, Vikram’s wealth would increase to

Rs.4.92 crore by March 31, 2028;

Rs.7.70 crore on March 31, 2032 (after withdrawal of Rs.0.52 crore for higher education); and,

Rs.11.25 crore on March 31, 2035 (after incurring expenditure of Rs.0.30 crore for his daughter’s marriage) at the time of his retirement.

These figures do not take into account the additional savings that would be possible consequent upon annual increases in the salary of Vikram.

The investments in PPF, Liquid Fund, and Recurring Deposit reflected Vikram’s conservative side, but he was aware that wealth creation calls for risk taking and that is the reason he invested in the ELSS, Balanced Fund, Large Cap Fund and Multi-Cap Fund.

Notes:

The funds that have been used in this article for the sole purpose of demonstration:

• the Equity Linked Savings Scheme (ELSS) is the ICICI Prudential Long Term Equity Fund (Tax Saving) (Growth);
• the Liquid Fund is the HDFC Liquid Fund (Growth);
• the Balanced Fund is the HDFC Balanced Fund (Growth);
• the Large Cap Fund is the ICICI Prudential Top 100;
• the Multi-Cap fund is the ICICI Prudential Multi-Cap Fund (Growth)

Disclaimer

This article provides general advice and recommendations and does not constitute personal advice. The selection of funds was made at random. While the calculations are accurate for the periods to which they refer, the opinions and examples in this article are for informational and educational purposes only. I have never invested in any of the funds named in this article. The statements in this article should not be construed as advice to invest in the funds named. Mutual fund investments are subject to market risks. Investors are advised to perform personal due diligence before investment. Readers are responsible for the decisions they take