IMPORTANCE OF FINANCIAL KNOWLEDGE - PART 7

Many of you must have heard about ULIPs or Unit Linked Insurance Plan.  It is a Market-Linked Insurance Plan.  From the premium you pay, a small portion is used for Insurance and the rest is used to Invest in Equity or Debt Oriented Schemes.  In simple terms, it is a mix of Insurance and Investment Plan.  The amount paid as Premium is eligible for Tax exemption. 

 

Another term that keeps doing the rounds is the Endowment Plan.  It is also linked to the Market.  Endowment Plans offer a guaranteed benefit called the SUM ASSURED.   

 

Many Insurance Agents and Banks would highly recommend Investor to park some amount in such ULIPs and Endowment Plans.  They also offer option to switch between various Investment Schemes mid-way of the total tenure of the ULIPs.  These two are highly popular mode of Investments n India.  Mostly because of the Tax Benefits it offers in addition to the potential return.  Some of the Investors are the view that Insurance Premium is a useless expense and prefer to buy a Product that will give some return.  But the reality is they do not offer a sub-optimal combination of Insurance and Investment.   

 

The Objective of the Investment should be very clear.  Is the Investment made for Insurance or for Market Return?  These two cannot be mixed.  The Coverage you get under the ULIPs or Endowment Plans are very little.  The expenses hidden and otherwise has a significant impact on the total returns you might be able to generate.  As a middle-income and salaried person, you are better placed by going for a Term Plan plus Mutual Funds.  

 

The Coverage you get under a Term Plan is much higher for the premium you pay.  Insurance is always an expense and it should be treated that way.  One should not mix Insurance and Investment without understanding their requirement and objective.  Mixing the both will give less than moderate returns from Both.   

 

If one has financial dependents, it is better to keep the Insurance and Investments separate.  The first thing should be to do buy a Term Insurance Plan with an adequate Cover and Invest the rest of the Money in few diversified Equity Funds.  If you do not want to take a risk on the Equity Funds, then better to take a Term Insurance Plan and Invest the rest in Public Provident Fund (PPF).  It has a good chance of giving better returns than Endowment Plans.

 

For people in middle-income group priority should be to ensure safety to the family against all contingencies.  The next step for them is to plan for specific known expenses, like Weddings, Education, etc.  If after allocating funds in various Investment Categories as mentioned in the earlier issues, if one has some free cash available then it can be used for ULIPs or Endowment Plans.  Both these plans have advantage and disadvantage.  The ability of the Person who presents these plans to you will be a great influential factor.  Most of the Indians Invest in Insurance, ULIPs and Mutual Funds through known people in the neighbourhood.  This is a blessing a disguise as there is hope that this person who understand your requirement and suggest the right product.

 

Invest wisely and have your priorities right.  Financial Safety of the Family comes first than anything else. 

(The above article was written for publication in Nov. 2019 issue of PRINCE’S VOICE – A Community eMagazine)

 

IMPORTANCE OF FINANCIAL KNOWLEDGE - PART 6

The next big step in Investment is to look for Returns with some risk.  The ability to take risk depends on the appetite of an Individual and the knowledge of the Instrument in which they would like to take risk.  People generally are good at their own profession but do not have much knowledge about various Asset Classifications that are available for Investment.   

 

For many, Investing in Stock Market is like gambling.  Totally, a wrong understanding and judgement of the Stock market.  We will talk about Stock market later.  For now, let us understand that Investing in Mutual Funds is a best way to get good returns with some risk.   But many do not know how the Mutual Funds work.  Many feels that they need to spend time watching the market daily, if they Invest in it directly or through Mutual Funds.  Yet another wrong understanding.  

 

Mutual Funds is a pool of money invested by a group of Investors and managed by a Manager by Investing in Stocks and Themes as laid out by him.  The objective of the Fund, how it will be Invested and the Management Fees that need to be paid will all be notified.  There are hundreds of Mutual Funds available for Investment.  Some funds focus on Growth, some on dividends, some on one industry, some on debts, some on debts and equity, the list goes on and on.  How to know which one suits an individual’s risk profile and how to know which fund will perform better.  Both are very difficult to answer, especially, if one lacks basic knowledge of economics and financial markets.  

 

So what options are available for people who are new to Financial Markets?  Buying the total stock market is the best option.  There are funds that reflect the returns of the Stock market index.   The managers invest in stocks that represent the Stock market index and in the same proportion and weightage.  As a novice, one should not worry about these details.  If the market is up by ‘x’ percentage, it is likely that their fund is also up by ‘x’ percentage.  The market might have ups and downs but in the long run the market is always up.  

 

One must have heard from friends on how much money they gained in stock market.  Everyone wants to disclose only their good stories.  In the greed to make more money than the Stock Market Index, many of them underperform in the long run.  Data indicate that only 25% of the Investors perform better than the Stock Market Index.  So, if one invests in the Stock market index and get the same return as the Stock market, it should be considered a fair deal.  

 

Set aside an amount of Rs. 5,000 or Rs. 10,000 or whatever amount you are willing to Invest every month in Stock Market.  Give instructions to the Bank that this amount will be deducted from your Account on a specific day of every month and utilized to purchase the Index equivalent to this amount.  This way, as a discipline, every month, you will be Investing automatically, without a break.  What happens when one Invests for a specific amount every month?  When the Index is higher, you get to buy less units.  When the Index is lower, you get more units.  This mitigates the Price risk.  This systematic investment plan on a specific date of each month is called SIP.  This gives a better average per unit in the long run.   

 

Let your SIP run for a long term of 5 years.  Where to buy these Funds?  These Funds that are linked to the Stock market index is openly available in the Stock exchange.  That is why these funds are called Exchange Traded Funds or ETF.   

 

Investing through SIP in ETFs reduces the risk considerably.  One need not worry about timing the Market.  Meaning, try to judge the low price and buy more units.  One must always remember that success in Stock market is not about timing the market but about spending more time in the Market.   

 

The Stock markets keep rising and falling all the time, in a cycle.  With SIP, the cost of buying units is average out over time as one get more units when the markets are down.  By entering a SIP, one has a check on the emotions as well.   

 

Once you have set your SIP in motion, you need to worry too much about monitoring the market.  Your returns will compound gradually.  Since the Investment is made for long term goals, the fluctuations in the market should not worry you that much.  

 

Just to put things into perspective, the Stock Market Index SENSEX was around 20,840 on 2nd Jan 2014 and 38,667 on 30th of Sep 2019.   

 

(To be continued...)

 

(The above article was written for publication in Oct. 2019 issue of PRINCE’S VOICE – A Community eMagazine)

IMPORTANCE OF FINANCIAL KNOWLEDGE - PART 5

Once you have worked out your requirements and the free disposable income that is available, the next step to do is the allocation.  The question of how to multiply the savings that one has got to have enough when each of the events occur.  The first rule is not to put all the money in one place or one scheme.  When more returns are anticipated there is more risk involved as well.  It is important to diversify the available savings into various Asset Classifications.

 

The Bank Deposits will not give you the growth that is required when you calculate the Net Interest earned after paying the Taxes.  Despite the power of compounding, there are limitations on how much net return one can get out of Fixed or Recurring Deposits.  With the problems some of the Banks are into it would be better to look into depositing money in NSC or Kissan Vikas Patra.  One can avail loan on these as well, whenever any emergency arises.

 

The Importance of having Gold has been inborn in our Tradition and Culture.  It is slowly becoming out of practice these days, mainly because of the lack of understanding.  Gold is the perfect hedge for Inflation.  It is often misunderstood these days as an Investment.  We keep hearing people that they bought gold at ‘X’ Price and now it is has gone up or down by some percentage.  We also hear many people say that Gold is a dead Investment and it does not generate anything except sitting idle in the Locker.  This is totally a misconception.  Gold should always be treated as a Hedging tool and not an Investment Tool.

 

Gold allows you to retain the Value of the Money at which it was purchased.  We will take at a simple example to make it easy to understand.  Let us assume one had deposited 1 lakh in Fixed deposit or KVP and left it for around 8.5 years.  The amount one would have got today on maturity is 2 Lakhs.  Even though the amount received is double the amount of Investment, is the real value of 2 lakhs same as what the value of 1 Lakh was 8.5 years ago?  Not.  Whatever Basic requirements of life One could have purchased 8.5 years ago at 1 Lakh cannot be purchased today at even 2 lakhs.  So, in real terms the value of the Investment has gone down.

 

Now, let us replace it with Gold.  If 1 Lakh was used to Purchase Gold at 1,800 per gram (the rate 8.5 years ago).  Whatever Basic requirements of life you could have purchased with the value of 55.55 Grams 8.5 years ago can be purchased today irrespective of the Price of Gold today.  For academic interest, the current rate of Gold is Rs. 3.800 per Gram.  

 

Still not convinced. Let us ask our elders at home what was the rate of Gold when they Purchased it.  Obviously, it would be a ridiculous low amount.  Now ask them what basic things they could have purchased in 1 Gram of Gold those days.  Access the price today for the same basic items and you will find the amount required to purchase these items today would be equivalent to the value of 1 Gram of Gold. 

 

So, Gold is always an effective tool to counter the Inflation.  Gold is not a dead investment in real terms.  The Government of India frequently issues Sovereignty Gold Bonds to the Citizens.  In this scheme one can Purchase Gold Bonds from the Government in denominated Grams.  There will not be any physical delivery of Gold.  Instead the Buyer will be having a document that shows that he has ‘X’ number of Grams under his name payable by the Government of India.  The Government will give the holder of these Bonds, the money equivalent to the Value of Grams the Holder owns, on the day of Maturity.  In addition to this the Government give 2.5% Interest per annum on the Value of the Original Investment.  This is a fantastic option for anyone who want to fight against Inflation and also have an option of saving in Gold for their Child’s marriage. 

 

These Bonds can be Traded in the Open Market also.  So, even someone has no Money to Invest when the Government announces the next scheme, they can regularly buy these Bonds in the Open market on monthly basis.  But the rates may vary if one purchases this every month.  Even if one buys 5-10 grams each time the Government comes out with such scheme, it may be enough for the Salaried class to save considerable Gold for their future commitments.  The Government comes out with such schemes almost thrice a year.

 

Investing in Gold Jewellery may be a bad choice as an Investment as one has to pay for Making Charges when they Purchase and also forego some amount as wastage when they sell a Gold Jewellery.  When one Purchases Gold Coins or Paper Gold (Gold Bonds or Similar Products) they do not have to incur any such loses.  Our Elders were always right and that is why they wisely invested in Gold. 

 

(To be continued...)

 

(The above article was written for publication in Sep. 2019 issue of PRINCE’S VOICE – A Community eMagazine)

IMPORTANCE OF FINANCIAL KNOWLEDGE - PART 4

The Path the Middle-Income/Salaried People (MISP) need to take will be slightly different from the one taken by the High-Income and Highly Paid Salaried People.  But the Basics remain the same.  The biggest problem of the MISP is their Attitude.  Most of them feel that their Income is insufficient to warrant any Saving or Finance Planning. Some tend to believe that they are dealt with a hard hand by Destiny.  The MISP generally qualify has the ones who earn slightly more than their necessities.  The Aspirations and requirements outweigh their Income.  Sitting quiet and blaming their fate is not going to solve the Problem.  Anyone who Earns is a potential Saver.  The Amount saved might be different but the ability to Save is matter of willingness and discipline.

 

Wear Safety-Jacket First

 

The first thing the MISPs need to do is to secure their life and that of their Spouse if their Spouse is also an earning Member of the Family.  Financial Security and Contingency should be the foremost priority as they cannot leave their family to suffer financially, should anything untoward happen to them.  

 

Life Insurance is the first step.  The term and purpose of Insurance is not correctly understood in India.  Insurance is meant for Financial Safety and protection.  But it is often understood as an Investment Product or Tax Saving tool or a Corpus building mechanism.  Pure Insurance policy is a Term Plan that has a smaller premium amount and provides Financial protection to the nominee in case of the death of the Policy Holder.  If the Policy holder survives the Term, no returns are given by the Insurance Company.  This is the simplest and cheapest form of Insurance.  The premium per year is very low for younger people.  For a 30-year-old, a policy of 1 Crore might attract less than 20,000 per year as premium.  This high coverage – low premium, conventional Insurance Cover is the perfect for MISPs.  In case of an untimely death, the family is supported with an enormous amount of Money, when helps them replace the loss of income caused due to the death of the Earning member of the Family.  The other purpose of such Policy is to have enough Insurance Cover to pay off Housing Loans, should something happen to the Earning Member of the Family.  

 

The next biggest troublesome intruder is the Medical Expenses.  When someone might fall sick is beyond anyone’s guess.  The MISPs should get into Mediclaim policies for the entire family to face such situations.  If the Employer has provided Mediclaim policy, one must review the details of the Policy to understand how much the Coverage is and who are all covered under the policy.  All efforts should be made to Include the Parents under the Policy.  If the Employer is not providing any Mediclaim Policy or if the Policy is insufficient, immediate steps have to be taken to select a good Mediclaim Policy for the Family.  It is better to go for a Group Policy for the Entire Family (Including Parents).

 

Know the depth of the Water before you Jump In

 

With the safety measures taken, the next step is to know the financial requirements at different stages of life.  Financial Planning cannot be done with knowing the requirements.  The next step is to chart down your scheduled commitments, like College Admissions, Wedding, Purchase of House, etc, when it is required and how much money is required for each Item as per today’s cost of living.   

 

With the wish list out of the way, the next background work required is to prepare a Budget for living expenses.  The Budget should cover all the Basic Expenses required for Living without the Wish List Items.  To start with you can do a Budget for a Year.  Once you start living within the Budget, you can expand the scope to 3 years.  If you can make a long-term Budget, it is always better to revise the budgeted amount year-on-year to accommodate Inflation and other requirements.  For Example, you child might be too young to go to school this year but will start going to school the next year.  So, when you prepare budget for longer period, you need to keep in mind the additional expenses of School Fees, Transportation, Uniform, Books, etc.  These are expenses that will force you revise your Budget year-on-year.  To cover the inflation, It would better to increase the expenses by 8% year-on-year.  Always, remember, no Financial Objective can be achieved without Planning and Discipline. 

 

Budgeting will help you assess the free cash available every month.  Always keep your Income level as you receive it today.  Increment is optional from your Employer.  Hence it is not advised to assume an increment and predict more free cash.       

 

(To be continued...)

 

(The above article was written for publication in Aug. 2019 issue of PRINCE’S VOICE – A Community eMagazine)

 

IMPORTANCE OF FINANCIAL KNOWLEDGE - PART 3

There are 3 financial phases in one’s life.  An analogy can be made with the Education system.  We have the Basic (Secondary School) Education, Graduation and Post-Graduation as the 3 levels of Education.  Similarly, we too have stages in handling Finance. 

 

They are Wealth Creation, Wealth Management and Wealth Preservation.  Just like how one cannot spend more than required number of Years in any of the 3 education levels, one must not spend more than required in any levels of Finance Management.  

 

Wealth Creation is the first level or Phase of one’s life.  Here the focus and priority are to create Wealth.  This should start in a young age.  In this phase, the ability to take risk is higher.  Here the Investment Profile should be aggressive.  One should seek high growth Investment Opportunities to create Wealth.  Since the risk that will be taken is high for a high growth Investment Option, it is obvious that the Risk-to-Reward ratio will be higher.  Most of the people spend a greater number of years in this Phase due to lack of knowledge and assessment of their priorities.  

 

Taking the example of the Education levels, can one spend more years in the School learning the Basics (Secondary School)?  The Basic Education provides the foundation to understand and excel in bachelor’s degree Courses.  Similarly, Wealth Creation forms the Basis and Foundation to excel in the next phase of Finance Management, which is Wealth Management.  

 

Wealth Management is the second phase, where the Focus is only on Managing the Wealth that is Created.  That does not mean that the Wealth Creation process will stop.  Only the Focus and priority is shifted from Creation to Management.  In this Phase, the ability to take risk should be Moderate.  The Investment profile should also be moderate.  One should cut down the risk and focus more on managing the Wealth by diversifying the Investments.  In this phase the Risk-to-Reward will be slightly lower.  Since the appetite to take risk is cut down, there will be more discipline on the Investments.  This minimizes the chance of a failed Investment. 

 

Many people do not get excited in this phase of Finance Management.  They feel the creation of Wealth diminishes in this Phase.  It is not true.  Most of the Ultra Net worth have made and continue to make more money in this phase than any other phase.  It is always difficult to make the first Million/Crore.  The rest of the Millions/Crores are made by the first one.  

 

The Final Stage is the Wealth Preservation.  Here the Focus in more on preserving the Wealth.  The ability to take risk is close to Nil.  The returns will drop as well.  But the Wealth that was created and Managed so far, will be preserved and kept intact.  The returns will be minimal and, in some cases, very negligible.  This is subject to the type of Investment.  It has happened in many cases that people who have Investments in Real Estate have made more money in this phase just by Preserving it.   

 

Age of a person is not necessarily the only factor that determines the phase in which one should be.  The Priorities and Goals are equally influential factors.   

 

For those who are in middle-income category and are employed, the above levels might sound irrelevant.  Ironically, even though must fall in these 3 stages eventually.  Each one might spend varied number of years in each stage but they cannot escape the process.  

 

We will look into how the middle-income and Salaried people can adopt these 3 stages in the coming issues.  

 

(To be continued...)

 

(The above article was written for publication in Jul. 2019 issue of PRINCE'S VOICE - A Community eMagazine.)