Many financial institution websites have calculators to calculate how much you need to save for any goal. For example the website can give answer if you wish to know how much you need to save every month for your child’s education. Similarly you can calculate monthly savings needed for your retirement or other goals.
You may ask if these calculators are freely accessible, why a person should take services of a fee based financial planner. The reason is that a financial planner can add value through savings optimization and other techniques. To understand how savings can be optimized let us take a small case study. Please note that the case is simplified for current learning objective.
Case:
Mr. Sameer, CA, aged 35, is happily married and working as finance executive in a private company. His wife is home maker. Sameer has an eight year old daughter. He thinks that he will need Rs. 6 lakhs after 10 years for his daughter’s education and Rs. 5 lakhs after 18 years for her marriage. The amounts are in current terms and are not inflation adjusted. Sameer earned post tax income of Rs. 5.5 lakhs last year and his family spend Rs. 4 lakhs in same period. His income is expected to grow by 8% per annum till his retirement at age 60. Household expense inflation is also assumed to be 8% per annum throughout.
Sameer and his wife’s retirement expenses in current terms are expected to be 70% of current household expenses. Sameer expects to live till age 80. All investments put together, the family has Rs. 10 lakhs worth of investments. He wishes to tag the current investments for family’s retirement needs. Let us assume that he can expect to earn 10% per annum investment returns throughout the investment period and all monthly investments are made at the beginning of the month.
How much Sameer should save every month to meet his goals of retirement, daughter’s education and marriage?
Plan A:
Using the calculators available on any financial institutions website he can get following plan:
Generally the calculators do not have provision for savings growth on periodic basis. For his daughter’s education Sameer needs to save Rs. 6,430 monthly for 10 years. For retirement he needs to save Rs. 17,345 till his retirement, considering he has Rs. 10 lakhs already earmarked for it. Overall he needs to start saving Rs. 27,241 every month or Rs. 3,26,892 annually. Considering his last year’s savings of Rs. 1.5 lakhs, Sameer may painfully conclude that he can not meet his identified goals. He may feel tense and stressful. He may opt for reducing his cherished goals.
Here financial planner can add value by his/her knowledge and skills. Plan A does not provide for the fact that his income and expenses are increasing so he will be able to increase his savings by 8% per annum. Let us look how the plan will look after incorporating this information:
Plan B:
In plan B Sameer needs to start with total saving Rs. 14,769 every month or Rs. 1,77,228 annually. First level of savings optimization has reduced his first year savings need by about Rs. 1.5 lakhs. He needs to increase his savings every year by 8%. His income minus the expense is also increasing so it won’t be difficult to increase his savings as well. Plan A has serious anomaly because it does not incorporate increase in annual savings.
In initial years Sameer has shortfall of savings as shown in above table. In 11th year when child education goal is met, he has savings surplus of Rs. 74,107 which is not utilized for any goal. Therefore the required savings fall short of expected annual savings in initial years but surplus is created in later years.
Financial planner can provide second level of optimization. Note the important fact that Sameer is saving for only 10 years for child education and only for 18 years for child marriage. After achievement of child education goal he can very well channelize the possible savings for other goals. How to do that? Answer is, rather than looking at each goal individually, Sameer needs to look at them collectively and prepare a comprehensive plan. Looking with this perspective the requirement is to meet all the three goals by saving certain amount and then increasing the savings by 8% per annum till retirement. Plan C with this perspective will be:
Plan C:
In plan C Sameer needs to start with total saving Rs. 11,831 every month or Rs. 1,41,972 annually. Second level of savings optimization has brought his needed savings below his expected savings. Hopefully Sameer will be able to sleep peaceful knowing that he has plan in place which has higher probability of achieving his cherished goals.
