A financial plan is a blueprint to achieve goals. It should include a thorough assessment of your present financial position and future cash flows.
However, the success of this plan depends on the execution – that is, investing the right amount in the right vehicle. To achieve this, you need to have the right asset allocation keeping taxation, liquidity and long-term goals in mind.
Asset allocation strategy: Many prefer to use thumb rules for allocating their assets. A popular one is subtracting age from 100. The result is the percentage of equity allocation one should have. However asset allocation is dynamic and should change according to goals, risk profile, investible surplus, and so on. Thus asset allocation varies for different people, in different situations despite being in the same age group.
You further need to get the micro allocation right, too. For example, while opting for a mix of mutual funds (MFs) and direct equity investments, you need to decide the percentage of allocation to each of it.
You also need to consciously avoid duplication of stocks in your mutual fund and direct equity portfolio. Direct equity holdings should be in specific companies in which deep exposures are recommended. Exposures can also be based on the potential these companies have. These may be small cap companies, which are in promising industries and have the potential to become multi-baggers overtime.
Within MFs, you need to have two-three diversified ones, and satellite funds that can be small cap, sector-based, or thematic. Similarly, debt products also need to be chosen based on the tenure, liquidity considerations, tax implications, net returns and risk profile of the product.
Liquidity management: Generally, three months' expenses are kept aside as a liquidity margin. In case you have irregular income, this amount needs to be higher. The expenses will certainly include any equated monthly instalment (EMI) on a loan.
Part of this fund can be parked in a savings account or better still, in a sweep-in fixed deposit (FD) in the same bank. This will ensure you earn higher interest and have sufficient balance when the lender requests your bank for the EMI amount.
Keeping the rest in a liquid or liquid-plus fund will give a higher return as compared to savings accounts. They are more tax-efficient, too, if invested in a dividend option. Another alternative, is to set up an overdraft account. In this case, one could borrow to the extent of overdraft sanctioned and need to pay interest only for the period for which the money is being borrowed. One can even earn ahigher interest for them.
Contingency Funds: Should meet our requirements during emergencies. The place to keep aside contingency funds is in fixed deposits of banks, medium term debt funds or hybrid funds. A portion can also be parked in large-cap mutual fund and balanced funds. The prime consideration here is liquidity and the ability to access the funds at short notice. So, do not keep this money in illiquid instruments such as fixed maturity plans or National Savings Certificate (NSC).
Optimising long-term returns:
Our investments need to give good post-tax returns. From that perspective, one needs to choose options that offer complete tax relief like equity shares, equity oriented schemes or public provident fund. One could also go for instruments where the tax incidence is low.
The long-term capital gains tax (after 12 months) in debt MFs are 10 per cent without indexation or 20 per cent with indexation. For investments below 12 months, a dividend option is beneficial as the dividend distribution tax is 14.16 per cent. Thus they score over the traditionally favoured investments like FDs, bonds and NSCs.
Pay attention to the taxation aspects while investing in insurance based products. Maturity proceeds of most insurance products in general are tax-free but the taxation for pension products is different. Only up to a third of the corpus accumulated can be taken out tax free; the rest is taxable. In addition, the annuities are taxable as income.