Article Summary

• A temporary or prolonged situation of surplus cash may result from having more income than spends, or generating regular passive income from dividends and interest, among other reasons. 

• Surplus cash could also result from the receipt of lump sums such as inheritance, commissions, bonuses and incentives, and stock option pay outs.

• With surplus cash many prefer to prepay expensive loans. Some may review insurance covers, emergency funds, or pay for continuing education. 

 • You may reinvest interest and dividends and diversify existing investments using your surplus cash. 

 • It’s helpful to earmark a part of the surplus for near-future, big ticket acquisitions like a wedding or down payment for a house.

Contrary to popular perception, financial planning and management is not just about distant financial goals like children’s higher education and retirement. It also includes less discussed but important aspects like managing surplus cash.

What is cash surplus? Situations of surplus cash may occur more often than many envisage. This is the situation when your total income exceeds expenses under an ongoing financial plan.

Investment strategies for wealth management and asset management need to cover such situations since they significantly influence the success of our financial planning. Moreover, investors learning how to invest in mutual funds, need to know how such funds can help in situations of surplus cash.

Cause and nature of cash surplus Before taking any decision on using surplus cash, a person needs to determine whether it’s actually a surplus. Often, what seems like surplus cash is a result of actions or developments like a missed loan payment and end of a regular obligation like a subscription. They could also be due to oversight of an upcoming obligation or expense like an insurance premium or buying a gadget.

Once such situations are ruled out, one needs to determine whether the cash surplus is a one-time event or is likely to be a regular feature. A one-time cash surplus can be due to windfall gains and lump sums like inheritance, commissions, bonus and incentives, stock options pay outs. Regular cash surpluses could arise from dividends and interest payments, besides rental income from residential or commercial property. 

While investment strategies for financial planning and management will vary according to the nature of surplus cash, some other steps are required. 

Managing Surplus Cash

#1 
Prepay Outstanding Loans 

With surplus cash arising out of receipt of any lump sum, you may opt to fully repay or foreclose expensive loans or credit card outstanding. 

For home loans in the second half of the loan term i.e., eighth year and beyond for a 15 year loan, when interest repayment component in the EMI is much lower than principal repayment component, partial or full loan repayment can prove beneficial. This is because the annual tax deduction of home loan interest payment of up to Rs 2 lakh under Section 24B (under old tax regime) is much lower than at the beginning of the loan term and will only keep declining progressively. 

At the same time, eligible items such as tax saving investments compete with annual tax deduction of up to Rs 1.5 lakh under Section 80C for principal repayment (under old tax regime). Home loan prepayment helps lower the overall interest outgo during the loan term, more so in case of floating rate loans that have major impact during periods of rising interest rates.

#2
Review Risk Management Plan 

After loan repayment, the next port of call is risk management. First, existing insurance protection needs to be reviewed, with existing gaps and future needs identified. This needs to be followed by higher insurance coverage for life, health, disability, besides big ticket assets like home buying.

#3
Augment Emergency Fund 
The purpose of this fund is to meet emergency expenses like those related to unexpected job losses. Experts recommend creating a fund equivalent to 3-6 months of expenses with money parked in a mix of savings account, short term fixed deposits, besides liquid and short term debt funds. A surplus cash situation provides an opportunity to review emergency fund needs and bolster it if the need be.

#4
Prepare for Short Term Needs 

Own requirements Cash surplus can be used to boost preparations for meeting short term needs arising in 18-24 months. These can be expenses like acquiring a household gadget like a fridge or washing machine, home improvement and repairs, education expenses, trips, and vacations besides social events. Depending on the size of the cash surplus, a part or the full amount can be invested in short term debt funds or liquid funds.

Own business For those having their own businesses, smartly managing cash surplus may help meet regular obligations like vendor and salary payments, besides utility and tax payments. This can be done after building a corpus with liquid, overnight or short debt funds. With the help of capital gains and dividends, the business owners may earn money on a lump sum, something not possible from a bank's current account. A similar outcome is possible if start-ups invest a part of their seed capital, not immediately needed, to stretch their seed capital. 

#5
Consider Geared Investments 

These are investments made after taking a loan, ideally those with significant long term appreciation like real estate. For individuals, cash surplus can be used as a down payment to buy a home with a home loan. The effective interest outgo on a home loan would be less due to a permissible annual tax deduction for interest payment up to Rs 2 lakh under Section 24B and principal repayment of up to Rs 1.5 lakh under Section 80C (under old tax regime). 

#6
Invest Cash Surplus 

Reinvest interest and dividends This is asset wealth management more relevant for relatively small surplus cash for individuals and small business owners. Periodic receipts of fixed deposits (FD) interest, bond coupon payments and dividends from stocks and mutual funds can be reinvested in new or existing investments for long term goals. 

Opt for new SIP or Top Up SIPs If regular cash surplus amounts are available, new or top-up SIPs may be done in mutual funds. This can enhance the impact of long term growth investments such as those in equity and equity-oriented funds.

Parts of windfalls or lump sums can also be invested in existing mutual fund investments through Systematic Transfer Plans (STP). Here, the lump sum is initially parked in a liquid fund or a short term debt fund, and then regularly invested in equity and equity-oriented funds of choice. 

Create an “opportunity fund” Like the emergency fund, a separate corpus can be created to tap investment opportunities. Often termed as “dry powder” by experts, this fund can be built with regular investments in highly liquid options such as liquid funds through SIPs. The fund, as part of wealth management strategy, can help tap opportunities arising in the short term such as undervalued stocks. Also, as part of asset wealth management strategy, it can create passive income such as rental income through fractional real estate ownership. 

This can also be a secure parking slot for long term capital gains from growth investments besides help correcting major imbalance in the investment mix through portfolio rebalancing. Further, an opportunity fund along with an emergency fund, helps avoid planned liquidation of investments during adverse conditions. This fund can be at least 5% of overall investments and go all the way up to 20% during short periods of time. 

To conclude, surplus cash is a financial advantage that needs to be emphasized. With a game plan, a person can make the most of this advantage. 
 

FAQs

1. What should be the approach for investors wanting to avoid exceedingly high risk equity fund categories for surplus cash?
Such investors can redirect the EMI amounts of retired loans to existing equity fund investments through Systematic Investment Plans (SIP). These can be further bolstered by reinvestments of passive income like interest.

    2. How much of the surplus cash should be in liquid and lower risk investments like liquid and debt funds to meet emergencies and short tern needs?
While much depends on individual needs but as a thumb rule 20% of assets can be in low risk investments such as liquid funds and various debt funds. 

Disclaimer: The tax provisions, as mentioned in the article, are updated as per the Union Budget 2024. However, the tax benefits will be as per the prevailing tax laws at the time of investment & redemption, subject to the regime opted. You must consult your tax advisor for detailed tax incidence for your investments.
The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. Readers are requested to make informed investment decisions and consult their Mutual fund distributor or financial advisors to determine the financial implications with respect to investing in Mutual Funds. Any action taken on the basis of the information contained herein is not intended as on offer or solicitation for the purchase and sales of any schemes of UTI mutual Fund. 

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.