case study_sapm_risk

8/8/2019 Case Study_SAPM_RISK

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Case Study: Financial Planning for Retirees

"Is Rs. 1.50 crore enough to meet my life

expenses?"

Often, as individuals, we believe that our finances

are under control, but the truth is it may be just an

illusion.

An individual who was 65 years of age, and had

already retired and wanted to plan for cash flows for

the rest of his life. Please note, he already had a

financial plan created for him by another financial

planning firm, and wanted to create another

financial plan for him so he could see how to

proceed.

So, what was his main financial planning objective? -To invest his corpus of Rs1.50 crore, so as to meethis expenses of Rs 1 lakh per month (i.e. Rs. 12lakh per annum) on an ongoing basis.


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Another noteworthy point was he had a secondarycorpus of Rs 50 lakh which he preferred not to usefor the plan

Details were as follows:

Name: Mr. Retired (changed toprotect privacy)

Status: NRI

Life Stage: Retired

Investible Corpus: Rs 1.50 crore

Risk Appetite: No risk - no capital loss isacceptable.

Goal: Assured monthly income of Rs1 lakh, starting immediately, going on for life.

Life Expectancy: 85 years

On the whole, this situation to Mr. Retired seemedabsolutely okay. "A corpus of Rs 1.50 crore shouldbe enough to meet my lifes expenses"

But unfortunately that was not the case.


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Reason No. 1:

The required return was not achievable inpresent times, by taking shelter under "safe debtinvestments" alone.

In order to earn assured income of Rs 12 lakhs p.a.

(post tax) from a corpus of Rs 1.50 crore, assuming30% tax, the pre tax income required isapproximately Rs 17 lakhs per annum. The rate ofreturn needed to earn this income is close to 11.50%p.a., which is currently unachievable, especially ifcorporate deposits are also not to be considered.Moreover, taking into account his low appetite for

risk and guarantee for monthly income, exposinghim to an equity allocation wasnt the right option.

So, what were the available investment Optionsin "safe debt instrument":

1.Small Savings SchemesWhen an individual looks at safety andguaranteed return, small savings are the firstthat any financial planner looks at. However,


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noting that he was an NRI, this option too wasnot available to do his planning.

Small savings schemes such as PPF, PostOffice Monthly Income Schemes, SeniorCitizen Savings Scheme - are off-limits forNRIs.

2.Bank / Corporate FDsYes , we did explore this option too, notingthat the required rate of return is 11.50% p.a.But, presently as bank FDs are offering onlybetween 7.00% and 8.50% for the 1 - 2 yeartenure for senior citizens, this option too wasruled out.Talking about corporate FDs - 1 year corporateFD rates were offering interest rates between

7.00% (these are the well known companiesincluding housing finance companies - wherethe risk is much lower comparatively) and11.25% (these companies are much morerisky and risk of default and losing the capitalinvested is greatly increased) - all pre taxrates.

So, this option was ruled out as well.3.Immediate Annuity Pension Schemes

Taking into account that hes a retiredindividual, we evaluated this option too. But


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this again did not meet the expectations of11.50% rate of return, as the rate of returnoffered on such products are 7.50% per

annum - again pre tax.

These are schemes wherein the investorinvests his money as a lumpsum / regular

premiums today and starts receiving premiumpayments immediately, going on for aspecified term period or for life, as opted.

So, clearly, from a rate of return point of view, wewere in a fix. And there was yet another reason whythe corpus would not have been enough...

Reason No. 2:

INFLATION

To put it simply, inflation creeps into what you eatand how much you eat.


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Mr. Retired needs Rs. 1 lakh per month (i.e. Rs. 12lakhs p.a.) post tax today. Thats 11.50% return pretax. But taking 7% average inflation rate, he will

need more income, from the same principal (Rs 1.50crore), to meet the same lifestyle expenses.

Heres a snapshot:

Monthly

Income(Posttax)

in Rs

AnnualIncome

(Post tax)in Rs

AnnualIncome(Pre tax)

Rs

Pre taxrateof

return

Incomerequired

today

1,00,000 12,00,000 17,15,000 11.50%

Incomerequiredin 5years

1,40,000 16,80,000 24,00,000 16.00%

Income

requiredin 10years

1,96,000 23,50,000 33,60,000 22.40%

Income 2,76,000 33,12,000 47,32,000 31.50%


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requiredin 15years

*Figures are approximate

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