Financial Planning: Adjusting to a pay-cut

Ankit works with a start-up firm and usually has an investible surplus over ₹2 lakh per month. During the present lockdown, the business of his employer was affected severely. The salaries of employees were cut by 60 per cent. For Ankit, a surplus of ₹2 lakh per month became a deficit of ₹50,000 per month, after accounting for home loan EMIs.

How did he manage?

The current Covid-19 crisis has brought to light gaps in financial planning for many investors. A prolonged lockdown has affected cashflows, especially if one is self-employed and the work requires physical meetings or contact. Even for the salaried class, there are pay-cuts and layoffs.

At the same time, the equity markets have slid from their highs, making it psychologically difficult for investors to book losses and create liquidity. It is during such times that we see the merit in prudent asset allocation and keeping a contingency buffer or an emergency fund.

Investors are advised to keep money in liquid funds or bank fixed deposits to create an emergency buffer. Under regular scenarios, this may feel like a waste of money or one may think that money is not being invested in a fully productive manner.

But thankfully, Ankit.did not think that way.

Contingency buffer

He kept a robust contingency buffer equivalent to 12 months of his expenses. Since his job was with a start-up firm, he was advised to keep a larger contingency buffer than is usually recommended. An investor with a more stable jobcould have managed with a 6-8 months expenses as emergency funds. The contingency buffer/emergency funds is in a liquid fund and the portfolio value was not affected due to ups and downs in the equity market. Hence, this corpus could be accessed without any concerns about market levels.

The positive in Ankit’s case is that he still retains the job and is getting some salary. Hence, the emergency corpus does not deplete that fast and can last well over 12 months. Even in the worst-case scenario, he had enough money for 12 months. Ankit didn’t opt for EMI moratorium since he has enough liquid investments. He, however, decided to stop his mutual fund SIPs after the salary cut. In fact, he could have even continued his SIPs for a few more months and then decided. However, he chose the safer option. There is nothing wrong with such a choice.

Asset allocation benefit

In addition, Ankit’s portfolio outside of his contingency fund is not a purely equity portfolio. He is working with a 50:50 equity:debt mix. Due to this asset allocation approach, his portfolio didn’t suffer very badly in the crash. Portfolio losses hurt us and can even leave one disillusioned with equity investments. On the other hand, lower drawdowns (losses) in the portfolio help one maintain investment discipline.

As Ankit has better clarity about his income and employment, he can tweak his asset allocation and reduce volatility in his long-term portfolio. For instance, if the situation doesn’t improve after 7-8 months, he can consider selling equity investments in the long-term portfolio gradually and generate liquidity in the portfolio to meet short-term cash requirements.

Ankit has a family floater health insurance plan of ₹20 lakh for this family. In addition, he maintains a medical fund of ₹10 lakh to fund medical expenses that are not covered by health insurance or can be declined by the health insurance company.

While stopping SIPs is not really desirable, the intent here is to survive this difficult period. Knowing that you are covered for many months, you retain your financial and emotional peace. Once the income increases, the SIPs can be resumed.

The writer is a SEBI-registered investment advisor at personalfinanceplan.in