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Financial Planning Case Study one

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Financial Planning Case Study One – Real Estate Heavy portfolio

This one is the first case study to discuss financial planning for a highly successful corporate executive, working as a senior executive in a large company. The financial planning is for Mr Ajay aged about 40 years; married and has two beautiful daughters aged 3 years and 6 years. Mrs Ajay also works in a similar profile and the combined family income of Rs Rs 8 lacs per month. Mr Ajay has created good real estate assets worth about Rs 10 Crores, and he thinks that he has a sound financial plan. Following are the cash inflow and outflow from these assets:

  1. Property worth about Rs 4 Crores, with a home loan of Rs 1.80 Crs realizing a monthly rental of about Rs 75,000/- and an EMI of Rs 1.77 Lacs. Mr Ajay would realize an annual rental of Rs 9 lacs from this property and would pay an interest  of Rs 18,31,689/-. Mr Ajay is able to claim a loss of Rs 931689/- towards income from house property and save income tax on his income to the extent of Rs 931689/-. A good financial planning.
  2. Under construction Property worth about Rs 3.50 Crs and a home loan of Rs 1.50 Crores on the same. Mr Ajay is paying a monthly EMI of Rs 147000/- on the same. The asset is not generating any income, but adding to the net worth of Mr Ajay.
  3. Property worth about Rs 1.25 Crs, with an outstanding home loan of Rs 30 lacs and earning a rental of Rs 20000/- p.m. Mr Ajay is paying an EMI of Rs 29,000/- on this loan. Mr Ajay is able to claim a loss on the house property to the tune of Rs 9000/- per month again able to claim an income deduction of Rs 108000/- per annum on this property and reduce his tax liability even further. Another good step towards prudent financial planning and part of an effective tax planning.
  4. Under construction property worth about Rs 1.75 Crs, on this property Mr Ajay has a home loan of Rs 50 lacs and is paying an EMI of Rs 49082/- per month.
  5. Mr Ajay also has car loan of about Rs 30 lacs and pays an EMI of Rs 50000/- per month.
  6. Mr Ajay has a contingency fund of Rs 10 lacs in his short term bank deposits. He also has a health insurance for him and his family for Rs 10 lacs. Mr Ajay doesn’t believe that he should have a term plan as he has enough assets and in case of any untoward situation the survivors can sell the property and repay the loan.

Flawless Financial Planning?

Financial Planning Case study

Financial Planning Case study

Mr Ajay thinks he has a very sound financial planning, and it is flawless. Does a reader agree that he has a very sound financial plan and the same has been executed to the perfection? Though the financial planning discussed above is very sound one and saves a lot of money in the form of tax savings and is on the way to create good real estate portfolio, I find the following risks to this financial planning:

  1. No Will: Mr Ajay’s whole portfolio is quite skewed towards a real estate portfolio and even if he considers, in case of an unfortunate event his spouse can sell part of the assets and repay the loan and the life goes on. Time to rethink now. It is not the case here. In case of unfortunate event, the assets of Mr Ajay would be inherited by his spouse and two daughters. Daughters being minors the property cannot be sold. While the household income would have come down substantially, Mrs Ajay would have to still repay the loan through EMIs till the daughters become major or the bank would take over the property in case of default and recover the money. If Mr Ajay executes a will in the favour of his wife, his wife can get the loan transferred in her name and sell the property to reduce the monthly EMI burden. The property would get much higher value compared to the property auctioned in the bank. Not having a will is quite common; in our experience almost 99% people don’t have a will. This is a major threat to your financial planning. No financial planning is complete without a proper will.
  2. Term Insurance: The second problem with the above financial plan is not having a term plan. Mr Ajay requires a Term plan of Rs 4.10 Crs only to cover his home loan. Which he can easily do. Term plans these days are not very expensive and the easiest way to secure your financial planning. In case of an unfortunate event Mr Ajay’s wife would receive the money from the insurance company which she can utilize to repay the loans and the life goes on. The financial planning still works.
  3. Portfolio is highly skewed towards real estate. Though Mr Ajay has a strong net
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    worth of more than Rs 10 crores, but most of his money is in real estate assets. Real Estate assets are not very liquid. And cannot be liquidated in parts. Supposing Mr Ajay Requires some money for his daughter’s education or for some other requirement he cannot sell the property immediately and raise money, and even if he is able to do it the requirement might not simply match with the money raised. Therefore Mr Ajay would end up either more money sitting idle or less money so he would have to liquidate some other asset. Liquidity is another major risk to this sort of financial planning only with the real estate assets.

  4. Returns on the portfolio: Though on a long term basis Equities and real estate are two asset classes which give you the highest return, and Mr Ajay has quite a significant part of his portfolio allocated to real estate, can expect to generate handsome return on a longer term basis. However Equities and real estate both don’t move simultaneously. If you see the period from 2008 to 2012, when the real estate had gone dirt cheap post the market crash the real estate portfolio generated significantly higher returns. However from 2012 onwards the real estate market is either flat or down, whereas equities in the similar period have given significantly higher returns. Portfolio Skew is another risk to Mr Ajay’s Financial Planning.

So what should be the financial planning for Mr Ajay?

First threat to a sound financial Planning is not having a will. A will should be executed to secure the financial planning for your family immediately. The second point in our case study Mr Ajay can buy a Term plan of Rs 2 Crores for 10 years, 1.50 Crores for 15 years and 1 Crores for 20 years. This way he can reduce the cost of term plan and also secure his financial plan. The

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third and fourth points about skew in the portfolio can be addressed if Mr Ajay considers liquidating his asset mentioned at point no 4 and repays his home loan, and start a systematic investment plan for the Rs 2500/- each in equity funds as part of his daughter’s Education planning. This way Mr Ajay can reduce his exposure to real estate bring down some of his debts and start building an equity portfolio. Children Education planning can be done through having a systematic investment plan into equity funds. And some part can also be allocated to generate retirement corpus.