2. Goal Planning

Unless you plan your life and set the goals, you will never be able to make a plan for wealth maximization.

Here we will make financial plan for setting the important goals.

Time Value of Money

Present (PV) and Future value (FV) of a single cash flow

Present Value (PV): A single amount invested at time=0

Future Value (FV): Value of Money deposited at some time in future

Single cash flow here means one time initial investment

Value of single investment after x years

• • Rs 100 deposited for 10 years with 8% annually

  • =fv(rate, nper, pmt, [pv], [type])

  • rate: rate of interest per period

  • nper: number of period

  • PMT: recurring installment amount per interval

  • PV: A single amount invested at time=0

  • TYPE: Required only when PMT is made. 0: At end, 1: At beginning

• =FV(8%, 10, 0, -100,) = 215.89

• Outflow is -ive (e.g. -100)

• Inflow is +ive

The goal requires an estimation of PV and followed by FV calculation.

The next step is financial planning to achieve the FV of the goal.

Example: Child Education

• • Suppose PV is 50L for higher education when child is born

  • FV would be 1.6 cr considering 6% annual inflation, =FV(6%, 20, 0, -5000000,)

  • Now goal definition is 1.6 cr financial planning in 20 years

Now, what need to be invested today i.e. PV to achieve the goal

• • Calculate the PV using the excel

  • =pv(rate, nper, pmt, [fv], [type])

• =PV(8%, 20, 0, 14200000,0), 34L

• This means one time investment of 34L with Bank FD is required today to achieve future goal of tomorrow of 1.6cr

Suppose, instead of FD Nifty Index is chosen for investment, calculate PV

• • Assumed 15% long term return with Nifty Index, why?

  • If long term inflation is 6%, and real GDP growth is 8%. The nominal GDP growth would be 6+8=14%. This means the economy, corporate should grow by same rate and also the NIFTY which is reflection of corporate growth should also grow by 14-15%

  • =PV(15%, 20, 0, 14200000,0), 9.77L

  • This means one time investment of 9.77L with Nifty Index is required today to achieve future goal of tomorrow of 1.6cr

Now, what need to be invested as installments i.e. PMT to achieve the goal

• • Calculate the PMT using the excel

  • =pmt(rate, nper, pv, [fv], [type])

• =PMT(8%/12,20*12,0,16000000,), 27000 per month

• Considering 8% long term FD return

  • This means recurring investment of 27k with Bank FD per month is required today to achieve future goal of tomorrow of 1.6cr

Suppose, instead of FD Nifty Index is chosen for recurring investment, calculate PV

• • Assumed 15% long term return with Nifty Index

  • =PMT(8%/12,20*12,0,16000000,), 10700 per month

  • This means recurring investment of 10.7k with Nifty Index per month is required today to achieve future goal of tomorrow of 1.6cr

FV of annuity

• • Annuity: Series of equal amount of payments at equal intervals of time

  • Ordinary Annuity: Installment done at the end of interval, e.g. 50k installment for 5 years

• =FV(8%,5,-50000,0,0), 2.93L, type=0

• time = 0,1,2,3,4,5 yr, Installment done at time=1,2,3,4,5. Maturity at time=5

  • Annuity Due: Installment done at the beginning of interval

• =FV(8%,5,-50000,0,1), 3.16L, type=1

  • time = 0,1,2,3,4,5 yr, Installment done at time=0,1,2,3,4. Maturity at time=5

Example: If a 20 year old has to invest 1.5L till age of 60 as part of tax saving investment

a. Deposited in PPF at the rate of 7.1%

b. Invested in Nifty (assumed rate of return of 15% p.a.)

Maturity value with different strategy

• • 100% in PPF =FV(7.1%,40,-150000,0,0), 3.07 cr

  • 50% in PPF, 50% in ELSS, RoI as ~11% (7+15)/2, =FV(11%,40,-150000,0,0), 8.72cr

  • 100% in ELSS, RoI as 15%, =FV(15%,40,-150000,0,0), 26.7 cr

  • This shows the difference in the corpus based on selected investment instrument and the power of compounding even with most conservative PPF investment

PV of annuity

What is the amount of money to be deposited\invested today so that one can withdraw a certain amount every period?

The most important application would be for a retried person.

Example: Assuming a retired person at 60, with month expense of Rs 1 lakh upto age of 90, what is the amount one needs to deposit in bank to withdraw Rs 1L every month.

• Assuming no inflation, constant annuity

• =PV(8%/12, 30*12, 100000,0,0), 1.36cr

Insurance Cover a person needs

Example: A family's monthly expense is Rs 50,000. The only earning member wants to take a life insurance that pays Rs 50,000 for his family for 20 years, in case of member's death. What's the life insurance cover requirement?

• =PV(8%/12,20*12,50000,0,0), 60L

  • A life insurance of 60L is required to ensure 50,000 through bank deposit

  • * Inflation is not considered

  • Best plan is to take Term Insurance, usually ~10k for 60L insurance for 30yrs old

  • Flaw: This doesn't consider the inflation

Inflation adjusted return

• • Inflation: 6%

  • Bank FD Rate: 8%

  • Real return: 2%

• =PV(2%/12,20*12,50000,0,0), 99L

  • A life insurance of 99L is required to ensure inflation adjusted 50,000 through bank deposit

  • Flaw: This doesn't have balance corpus left

Suppose additional balance corpus of 30L of preset value is a requirement

• =PV(2%/12,20*12,50000,3000000,0), 1.19cr

• This would give corpus of 30L increased by 2% annually, to give higher value than 30L after 20yrs

• Means 21L is invested additionally, its value after 20yrs, =FV(8%,20,0,-2100000,0), 98L FV (Today's value 30L)

Options being practiced

1. Traditional insurance (with Money Back)

• • Low insurance cover - Doesn't serve the purpose

  • Low returns of less than Bank FD

  • Example: Insurance Premium of 1L with 30L insurance cover and moneyback

2. ULIP

• • Low insurance cover being insurance cum investment instrument

  • High expense ratios of 2-4%

3. [Recommendation] Term Plan - Keeping Insurance and Investment separate

• • Take term insurance cover as per the target corpus calculated above, e.g. ~15k premium for 1cr cover

  • Split additional fund into pure investment with options of Debt (PPC etc) & Equity (ELSS or Nifty Index) with higher than Bank FD returns

Financial Independence planning

How much money do I need to accumulate to be financially independent

• • Suppose Monthly Expense 1L

  • You have Investible surplus - 3 cr

  • Need to have a plan how to invest 3cr in different assets for safety and growth

  • Expense value after 12 years 6% inflation,=FV(6%,12,0,100000,0), 2L

  • This means average 1.5L every month for 12 years would be required

  • Invest Bank FD as safe investment for 12 years with 1.5L recurring, =PV(8%/12,12*12,150000,0,0), 1.38cr

  • Invest rest 1.62cr in Nifty, value after 12 years, =FV(15%,12,0,1.62,0), 8.67 cr

  • Now after 12 years you have got only 8.67 cr

  • Start same plan again for 12 years

  • Since inflation has doubled cost in 12 years, monthly expense needed 1.5*2 + 50% lifestyle improvement cost, 4.5L per month

  • Invest Bank FD as safe investment for 12 years with 4.5L recurring, =PV(8%/12,12*12,450000,0,0), 4.15cr

  • Invest rest 4.55cr in Nifty, value after 12 years, =FV(15%,12,0,4.55,0), 24.34 cr

  • Now after 12 years you have got only 24.34 cr

  • Same planning would continue

  • This is demonstration of planning with power of compounding

  • The factors could be relaxed based on comfort level - Greater fund than 3cr, higher duration Bank FD from 12 to 15yrs, higher inflation of 7% etc

  • The basic idea is how to do a sample retirement planning

Calculating payments

Example: My child is 1 year old today. I need to do education planning for a B-school after 25 years. The cost of MBA today is 20 lacs.

What is the amount of money to be deposited\invested every month for 25 years to accumulate required amount.

a. Deposit in Bank

b. Invest in Nifty Index

=PMT(rate,nper,PV,FV,type)

• • FV of 20L after 25years, required for MBA in future

• =FV(6%,25,0,-2000000), 85.83L

• Investment per month in Bank FD

• =PMT(8%/12,12*25,0,8583000,0), 9k per month

• Investment per month in Nifty

• =PMT(15%/12,12*25,0,8583000,0), 2.6k per month

Calculating rate

Example: Sensex is 1979 was trading at 100, now 2021 (for 41years) is 48,832. What is CAGR (the rate of return every year)

• =RATE(41,0,-100,48832,0,15%), 16% CAGR return in 41 years

Retirement Planning

Example: A 20 years old with 1L month expense.

• • Retirement age: 60 yrs

  • Life expentency: 90 yrs

  • What amount to be invested monthly till 60yrs to accumulate retirement corpus for 60-90yrs expenses

a. Deposit in Bank

I. What would be monthly expense after 40yrs, if today's monthly expense is 1L

• =FV(6%,40,0,100000,0), 10.28L

II. What would be corpus needed at retirement at 60yrs

• • =PV(2%/12,12*30,1028571,), 28cr

  • Effect interest rate = Bank FD % - Inflation % = 8-6 = 2%

III. What monthly investment needed from 20-60yrs to accumulate corpus of 28cr (calculated above)

• Bank Deposit

• =PMT(8%/12,40*12,0,28000000,), 80k per month

• Nifty Investment

• =PMT(15%/12,40*12,0,28000000,) 9k per month

• 50% Bank 50% Nifty, rate = (8+15)/2 =11

• =PMT(11%/12,40*12,0,28000000,), 32k per month

Retirement Planning - 30 & 40 yrs old

30 old

I, FV of monthly expense

• =FV(6%,30,0,100000,0), 5.74L

II. Corpus needed at 60yrs

• =PV(2%/12,12*30,574000,), 15.52cr

III. What monthly investment is needed

• Nifty Investment

• =PMT(15%/12,30*12,0,155200000,), 22k per month

• =PV(15%,30,0,155200000,) , 23.4L one time investment

40 old

I, FV of monthly expense

• • =FV(6%,30,0,100000,0), 3.2L

II. Corpus needed at 60yrs

• • =PV(2%/12,12*30,574000,), 8.65cr

III. What monthly investment is needed

• • Nifty Investment

  • =PMT(15%/12,20*12,0,86500000,), 58k per month

  • =PV(15%,20,0,86500000,) , 53L one time investment

  • Invest 25L lumpsum, to reduce per month investment

• =PMT(15%/12,20*12,-2500000,86500000,), 25k per month

Growing annuity

Increase in monthly saving\investment with increase in earnings

With fixed annuity

• • =PMT(15%/12,20*12,0,86500000,), 58k per month

With growing annuity

FV of growing annuity

Constant perpetuity

Ex-1: You decide to give Rs 10,00,000 every year, starting one year from now till eternity. What is the amount you should deposit in the bank to meet this requirement, Assuming bank rate = 8%

Solution:

PV of a constant Perpetuity = PMT/r ; 1000000/0.08 = 125,00,000

Growing perpetuity

Ex-1: You decide to give Rs 10,00,000 every year, starting one year from now till eternity. You want this annual payment to grow every year by 6% (that takes care of inflation). What is the amount you should deposit in the bank to meet this requirement, Assuming bank rate = 8%

Solution:

PV of a constant Perpetuity = PMT/(r-g) ; 1000000/(0.08-0.06) = 500,00,000