7th Pay Commission: put the money to work
Use the increase to fill gaps in your financial plan or make it more robust. Don’t fritter away the opportunity
Central government employees received higher salaries at the end of August, with the government crediting the month’s salary according to the 7th Pay Commission recommendations. At the same time, the arrears for basic pay for January to July period of 2016 were also credited.
If you are a central government employee, you would have already got arrears for the first 7 months of this year along with a higher salary for August. Chances are you have started planning on how to spend or invest the surplus income.
“Spending and saving does not go hand in hand. If saving is for future use, then spending is for present use, and both are important,” said Shilpi Johri, a certified financial planner and head-financial planning, Arthashastra Consulting. Hence, a balanced approach is needed. Here’s a look at how best to use the money.
Before making any plans to spend from the arrears lump sum, take a look at your existing loans. See if the money can be used to partially or completely pre-pay a loan.
Even among the various loans that one may have, preference should be given to personal loans and credit card outstanding since these have interest rates that are much higher than, say, a home loan. While the average personal loan rate currently is 15-17%, a credit card loan average stands at 40.8% per annum.
“Ideally, any loan should be cleared. But this is more true for personal loans, auto loans if there is no prepayment charge, and housing loan if the tax benefit is not available or you exceed the tax benefit,” said Surya Bhatia, managing partner, Asset Managers.
Partial pre-payment of a housing loan can have a significant impact on the total amount that you have to pay over the entire duration on the loan. Alternatively, one could increase the equated monthly income (EMI). This will reduce the principal outgo, and the tenor, and thereby reduce the interest charged by the bank. However, in such cases, one must take into account pre-payment charges. There is no pre-payment penalty on floating rate home loans taken from banks. But if the home loan is on a fixed rate, or it is from a non-banking finance company (NBFC), then there may be a penalty.
For a car loan, most banks allow foreclosure of a loan only after a period of two years. NBFCs may allow earlier foreclosures, but with a penalty.
Build a contingency fund
Once you are through with loan repayment, or are comfortable with a new repayment timeline, shift your focus to building a suitably large contingency fund if you don’t already have one. With the many responsibilities, at times, creation of a contingency fund takes a back seat. Usually, financial advisers recommend a contingency fund that has money equivalent to 3-6 months’ expenses.
“It may be health-related or any other unexpected requirement for additional funds—say, for a child-related goal, or a family dispute—that may appear. A contingency fund helps in dealing with such situations,” said Jitendra Solanki, founder, JS Financial Advisors.
Government employees—central and state—are covered under comprehensive health insurance schemes. Moreover, older employees, who joined service before 2004, are covered on two counts—they have health cover before and after retirement, as well as pension.
“However, in the past few years, the cost of medical treatment has increased tremendously. And in many cases, the government does not provide full benefit or reimbursement. Therefore, some provision for such gaps should be made,” said Johri.
For newer government employees, pension is contributory under the National Pension System (NPS). “So the scenario has changed. They should plan accordingly,” she said.
Moreover, even if your employer provides pension, the post-retirement income has to be planned as pension alone will not suffice in most cases, Bhatia said.
Invest the surplus
“After loans are paid, any surplus left in the cash flow should be invested in a regular manner. To be able to do this, understand your cash flows and your financial targets,” said Bhatia.
Since more pay means a fixed and regular increase in income, government employees can opt for regular investments such as systematic investment plans (SIPs) in a mutual fund scheme. “Start creating an SIP book across asset classes for all your financial needs. This can be done both for debt as well as equity,” said Bhatia.
Which asset class you choose will also depend upon your risk taking ability. “Individuals can choose from debt to equity. If they are risk averse or their personal situation does not allow them to take risk or they have need of money in the short term, they should opt for instruments such as bank fixed deposits or liquid mutual funds,” said Johri. “Otherwise, they can opt for equity-oriented instruments.”
As every individual is bound by her own financial situation as well as emotional makeup, a person should take such decisions based on her own conditions. “Blindly following what other colleagues are doing is not advisable,” Johri added.
For a central government employee, some expenses are covered by the employer so there may have a situation in which arrears are a surplus. “In such cases as well, one should follow the basic principles while investing. Avoid getting lured by high-return promises when approached by commission-driven advisers. Stick to the asset allocation approach and analyse the product well before you take a decision,” said Solanki.
Spending per se is not bad, if your debt, insurance, emergency fund and retirement planning are taken care of. “If buying a car or spending on any other luxury item—be it consumer durables or even a vacation—is part of your financial goals, then you should provide for it,” said Bhatia. “These expenses can be curtailed; more so if there is a shortfall in achieving our other financial needs,” he added.
“Unnecessarily compromising your present for the sake of future is also not healthy. It makes people feel miserable,” said Johri.
However, take care that the spending is not impulsive. The moment you receive a surplus in hand, the first thoughts may be to buy a bigger car and go for a vacation. In many cases, people buy a physical asset.
“But that is impulsive buying since you may not need the asset. The mistake one makes here is forgetting the lost opportunities of creating wealth for your family. It is advisable to focus on investing the money and not buy items one doesn’t need,” said Solanki.
Turning the economy’s wheels
You must also understand that your spending and saving of this income boost is also good for the country. The higher incomes are likely to drive up overall consumption to an extent.
According to the recently released 2015-16 annual report of the Reserve Bank of India (RBI), the hope is that consumption will drive economic growth in 2016-17.
“While a durable pick-up in investment activity remains elusive, consumption will continue to provide the main support to aggregate demand and may receive a boost from the revival of rural demand in response to the above-normal and spatially well-distributed southwest monsoon as well as from the seventh pay commission’s award,” it stated.
There are about 10 million central government employees and pensioners who are getting higher payouts, with retrospective effect from January 2016. RBI believes this boost to consumption will lead to gross value added (GVA) growth of 7.6% for 2016-17, up from 7.2% last financial year. Moreover, state governments are also expected to extend similar pay raises over the next couple of years.
This is not for the first time that higher pay for government employees will result in a consumption-led growth. “Notably, the impact of the fifth and sixth pay commissions’ awards on growth was also positive,” the RBI report stated.
An analysis by Kotak Institutional Equities found that 10% of the total increase in salaries during the 6th Pay Commission was spent on purchase of automobiles, which in turn had a positive impact on demand for passenger vehicles and two-wheelers. This time too, the passenger vehicle segment is likely be a key beneficiary of salary increases due to the 7th Pay Commission.