Prakash Mehra is 58 years old. He lives in Hong Kong and is going to retire at the age of 60; 2 years from now. Upon retirement, he plans to settle down in Mumbai, his hometown. The month of October 2007 will go down as the most historic month of his life.
He has sold every share and mutual fund he owned. His bank account now has Rs 5.5 crores (Rs 55 million) and that is totally tax-free! All these are long-term capital gains. In addition, he has his own apartment in Mumbai, which became free of loan about 10 years ago. He still has about Rs 1 crore (Rs 10 million) invested across RBI Bonds, Public Provident Fund (PPF), Post Office Monthly Income Scheme (POMIS), Kisan Vikas Patra (KVP) etc, that are still to mature over the next couple of years.
He has been investing in all types of products available in India over the last 35 years of his working life. He had much more investment surplus during his 10-year stint inAsia.
The question is: Why did he sell out? Was he scared? Is he trying to do profit booking? No.
He has sold because he achieved his ‘optimal level’ of money. He has reached his goal. The Indian bull run is perhaps far from over but he does not want to be bothered by that. This is his game plan going forward.
- In about 2 years’ time he must get a monthly inflow of Rs 1.5 lakh (Rs 150,000) pre tax, so that post tax this may work out to about Rs 1 lakh. On a yearly basis, this works out to Rs 18 lakh (Rs 1.8 million) and Rs 12 lakh (Rs 1.2 million) respectively.
- Each year he wishes to have an increment of about 10%.
- The funds should be enough in case he lives till the age of 90.
- He still has about two years to work. All savings from current income will be kept as contingency funds post his age of 60.
- In the event that he and his spouse die before reaching the age of 90 his children will have an inheritance, and this he feels is quite likely.
His wishes to lead a non-compromising lifestyle. He will have his holidays and chauffer-driven cars. He will wine and dine at all the places he desires. And enjoy all other life’s luxuries too.
The optimal level of money for him was Rs 6.5 crore (Rs 65 million). This was worked out based on the following assumption: If these Rs 6.5 crores (Rs 65 million) earned him an 8 % per annum (pa) before tax, then he would have a stream of cashflows starting from Rs 1 lakh (Rs 100,000) post tax per month and increments at 10%, every year.
The future
To be able to earn 8% before tax, Mr Mehra does not necessarily need professionals help to manage his investment strategy. I am sure anyone can do it. The only thing he needs to do is to invest in a way that will yield him 8% before tax. To get this 8% pre-tax assured return is also quite easy and straightforward.
The past
You may think he is fortunate to have an equity portfolio worth Rs 5.5 crore (Rs 55 million). Far from it! As a matter of fact he has broadly followed a strategy of 60:40 equity to debt allocation. Normally, he buys and holds for a couple of years before selling a stock or mutual fund. He has done such a grand selling only once in his life. It was to happen between now and another six to 12 months.
Note: His money could have possibly doubled or tripled in the next 10 years if he continued to hold his portfolio! But he is content with what he has now; the most important thing for him is to reach his ‘optimal money’ level.
Optimal money
Now, here lies the challenge. The question to ask is, ‘If I wish to stop working today, what is my ‘optimal level’ of money? And if I plan to quit work in say 1, 2 or 20 years, what is the optimal level that I must aim for’?
Mathematically speaking, optimal level of money is that amount, which when invested at a certain rate of return for a certain number of years will enable you to create a stream of inflows such that the money will last you for your entire lifetime and probably leave you with some surplus for inheritance as well.
The optimal level is different for each person and depends on your family situation. You need to take into account the entire family, when making the calculation.
A good description with example. Its really affective to me.
In my opinion, at the present stage of Indian economy,legal system, markets, transparency (or lack of it ) in the accounting system etc., investing in stock market is the last option for retail investor. I know all the financial wizards will jump on me and will not agree for obvious reasons. It is better to invest in real estate like preferably in land. I have seen many who have reaped immense benefits just by making investment in lands without much botheration. The question of loss of capital does not arise if one exercise little prudence.
Very nice article on Optimal Money. The concept is described easily with the example.