I recently talked to a friend, who is running a Telecom business. The point he made was that his cashflows are highly infrequent and spread out. The exact opposite of a regular empoyee who has frequent cashflows in the form of salary each month (or periodically). His concern was that how could he be systematic with no salary, when his earnings are not periodic and predictable. And this got me thinking, on the way to arrive at a solution for him.
From earlier blogs, you know that – Our Total capital = Human Capital (our future earning potential) + Financial Capital
We also know that, this type of Human Capital (of my friend above) reflects the properties of an Alternate Investments. Highly random (illiquid), highly irregular cashflows, which reflect an Alternate Investment portfolio.
How can we solve this particular problem of my salary reflecting an Alternative Investment Portfolio?
1. Adding a nice term insurance to protect the Human Capital is the first step.
2. Obvious way is to Invest in more Fixed Income + Equity assets in his Financial Capital. And reduce investments in Alternate Investments.
The basic idea behind this is that we need to balance out our Financial Asset Allocation basis our Human Capital. If our Human Capital reflects a Fixed Income (stable government job with fixed earnings), then we should invest more in Equity and Alternate Investments. If our Human Capital reflects an Equity Instrument (good earnings in general, but very risky – hire and fire scenario), then we should invest more in Fixed Income and Alternate Investments as well.
In short, our asset allocation depends on both our existing financial assets + how we are earning those assets. Many of us miss the aspect of “Human Capital” or How risky are our earnings, in any plan we create.
Now that I created a theoretical plan for my friend, let’s get into how he can actually do it.
#1 – Invest the entire proceeds into a liquid fund (So funds are available for him in a days time)
#2 – Identify the immediate life goals till his next probable cashflow
#3 – Set aside funds for his business needs into your business account.
#4 – Set aside funds for his everyday house expenses till the next probable cashflow into a separate account.
#5 – The rest of the funds you have in the First Step, should be invested for your goals and retirement. And they need to be a mix of Fixed Income + Equity instruments.
Final step – The ideal way to invest for my friend is to do an STP (Systematic Transfer Plan) into a Nifty 50 Index fund.
So my friend then asks me what are the different fixed income assets he can invest. I generally use a “ladder strategy” for bond investment. Ladder strategy is investing, equal percentage in liquid funds, medium term funds and long term bonds. I generally buy liquid funds for the #1 step above. I invest in the general NBFC FD’s (Shriram, Bajaj finance etc which are at least in the AA+ credit rating). Also invest in GOI bonds for the 7-10 year time period.
So how much one should invest in Equity, depends on one’s overall portfolio allocation. Equity not more than (100-Age)% is a decent thumb rule.
Hopefully he can now be more systematic with no salary 🙂
