11-Nov-2016 written by : FSI-Team
Sapan Sharma is a 26-year-old individual who works in the sales team of a Mumbai based textile firm and lives in Mulund in the eastern suburb of Mumbai. Over the last three months, Sapan has been worried because he has a credit card outstanding of ₹ 40,000. Though he has been paying off the minimum amount due, he knows that doing so is not enough to ward off the high interest debt that he is liable to. Consequently, a CIBIL score check revealed Sapan’s CIBIL score has dipped to 630 (out of 900) that is well below the satisfactory credit score of 750.
Though Sapan is largely financially conscientious and knows that a poor credit score may have disastrous consequences when he is in further need of credit, he has been struggling to make both ends meet with a single income. When his father broke a few months back, Sapan had little choice but to incur expenses on his credit card, as his medical insurance did not provide a cover for his aged father. But that fact that his CIBIL rating had dipped was giving Sapan sleepless nights.
The month of October however came in with happy tidings for Sapan. Along with a Diwali bonus of ₹35,000 Sapan received a performance bonus of ₹ 25,000 and won accolades for bringing in new business for his firm. Though he was overjoyed to have received a hefty bonus, Sapan was wise enough not to spend it recklessly. He had the good sense to approach his older cousin Varun who is a financial planner by profession. Varun suggested the following moves:
Paying off his credit card outstanding amount was the first and the most obvious task at hand for Sapan and Varun agreed that had to be done without fail. Thus Sapan utilised ₹ 40,000 from the bonus amount to pay off his entire credit card outstanding. This, so to say lifted a heavy weight from his chest as he was assured that he was no longer liable to pay an annual percentage rate of 36% on his card. This was the move that improved Sapan’s credit score. Varun added his two bits while chalking out a financial plan for his cousin.
He suggested that instead of investing in fixed deposits or any other investment avenue of a similar nature that provide returns of 8-10% it is best to pay off high cost debt with any lump sum that is received. If one is not carrying high cost debt like in Sapan’s case, he can also consider utilising proceeds from the Diwali bonus towards making prepayments towards other loans such as a home loan, that would not only reduce interest outgo but would bring down the tenure of one’s home loan, as Varun opined.
Sapan had been forced to spend money on his credit card in the past when his father met with an accident and broke his hip, because he had very little money saved for a rainy day. Sapan did save ₹ 2500 in a savings account each month, but it was evidently not enough. Varun suggested that instead of keeping his money in savings account, he should consider a SIP or a systematic investment plan of ₹ 10,000 that would not only give him superior returns (7.5% -8% as compared to a maximum of 4% on a savings account).
Varun explained to Sapan that though a liquid fund is mutual fund scheme, it is almost as “safe” as a bank account because it invests in short term debt securities. The other advantage that a liquid fund provides as its name suggests is “liquidity”, so the money invested in a liquid fund can be redeemed at a short notice. Varun advised Sapan that he should use the SIP route to build an emergency fund that would take care of all his financial obligations for at least three months and increase it to six months. He could use Diwali bonus for the initial SIP and then continue to save a higher part of his income month on month to build this fund.
Varun knew that his cousin harboured dreams of purchasing a small flat in Mulund and was trying hard to save for the same. But once again, the ₹ 10,000 that Sapan put away each month to save for the down payment of his home was locked in a recurring deposit. Varun suggested that to earn a higher rate of return, Sapan should re-direct these savings towards equities to get superior inflation adjusted returns. Since Sapan lacked the knowledge or time to do the required research for equity investment, Varun said it was a job best left to professionals.
He thus suggested that Sapan make another SIP with the remaining ₹ 10,000 towards a diversified equity fund that would give him the required exposure to equities at the minimum possible risk. Since Sapan was looking at a long-term horizon of 5-6 years before making the home purchase, Varun believed that linking an SIP to the down payment for home purchase would help him achieve his goal.
At the end of the day, Sapan did not have any surplus money to splurge during the festive season, but he could not be happier. Not only had he cleared off his high cost debt and improved CIBIL score, he had also managed to enhance his savings by smarter allocation of his funds. While offering his prayers to Goddess Laxmi during the Diwali Pooja, he thanked her for leading him towards financial wisdom and putting him on a definite path for achieving his future goals.