Do you have an emergency fund?

To the above question, the most answers I receive are a big yes. However, I realise that most people do not understand the concept of emergency funds in a real sense of the word. Many people equate emergency funds to a common savings bank account or a salary account. Sadly, they operate the same account for cash withdrawals to meet routine expenses. The bare minimum amount keeps on fluctuating in the so called emergency fund kitty and is refurnished for a brief period when salary is credited in the first week of the month. Let us discuss the real purpose of these funds, how much is adequate and where to park them.

Significance of emergency funds: These are required in the event of unfortunate situations that life throws at us. It could be a medical crisis or a loss of job or something else. After the Global Liquidity Crisis of 2008, many employees in the IT and Finance industry were handed the pink slips. Many people take job security for granted and hence are not prepared for these kinds of situations. During a medical emergency in a family, liquid money is required even if one has bought a mediclaim policy and opted for a cashless settlement. This would be to clear ambulance charges, day-to-day medical expenses, initial diagnosis, etc. Certain hospitals even ask for a refundable deposit before settling the dues with the insurance company. During such difficult times, people usually end up breaking their bank fixed deposits or redeeming mutual funds or making huge payments by credit cards. An emergency fund helps to sail through critical times. It should thus be given precedence over your regular investments being made in equity, gold or debt instruments.

How much is sufficient: An emergency fund should cover house hold expenses of six months. This includes the groceries, utility bills, entertainment, children’s school fees, EMI,etc. It should also take into account medical emergencies as mentioned earlier. For any individual, the probability of using an emergency fund during a health crisis is higher in a lifetime than for any other situation. It could be normally about Rs.2-3 lakhs. However, it may vary from family to family. For instance, there are families where many members have chronic health problems or some have 2-3 senior citizens or some do not have adequate medical cover, sometimes none at all. Such cases warrant a higher emergency fund. The fund amount can be gradually reduced once sufficient medical cover is purchased.

Where to park emergency funds: The prime reason of maintaining an emergency fund is that an individual has access to instant cash during an unfortunate event. Liquidity and safety are the key things here rather than attractive investment returns. So, the best option to park emergency funds is a savings bank account. Another option is flexible fixed deposits with auto renewal option and linked to a bank savings account. One can break the FD during emergencies and withdraw money instantly using an ATM card. You can also split the money and put 50 per cent in a savings bank account and the rest in a flexi-FD.

Although the returns from short term liquid mutual funds will be comparatively higher, they are a riskier option. Redeeming them will take 24 hours at least (even more if it is a public holiday the next day) and the whole purpose of maintaining an emergency fund will not be served.

Before you park emergency funds, make a list of the nearest bank branches from your home and/or place of work and enquire about the ATM withdrawal limit. Distribute the emergency fund amount in at least 2-3 branches so that you can withdraw maximum amount through your ATM cards on a single days. Use the emergency fund amount for urgent crisis-like situations only. It should not be touched for your day-to-day spending affairs. More importantly, replenish you contingency fund once the emergency has passed.

Where to invest your retirement corpus?

This post is in continuation of my earlier article dated 17 September 2011 .......

http://www.moneyihub.com/start-planning-for-a-financially-stress-free-retired-life/

While it dealt with estimation of retirement corpus, the article link below discusses the investment options to deploy your retirement money.

http://www.moneyihub.com/investment-options-for-deploying-your-retirement-money/

Have you started planning for your retirement?

Most people usually go blank when asked about retirement planning. Some are not sure when to start planning for a corpus for the golden years or many feel it is too early to start. While people invest in stocks and fixed income instruments to take care of their goals like marriage, property purchase, child education, retirement planning figures at the bottom of the list. Why it should be one of the significant goals in an individual's life, read on in the link below :

http://www.moneyihub.com/start-planning-for-a-financially-stress-free-retired-life/

Virtues required to become a successful equity investor

With the stock markets plummeting day by day, I am reminded of the  concept of buying at maximum pessimism. It has has been immortalised in Templeton’s own words:

 “Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria.
 The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell.”

Here is the link of my latest article on qualities required as an investor to make good money in the stock markets

http://www.moneyihub.com/how-to-become-a-successful-equity-investor/

Create more income earning assets in your early working years:

Today’s younger generation is desperate, impatient and wants to make a quick buck. No doubt, they are intelligent, street-smart and opportunistic. They are not only capable of making a fast buck but also spend it quickly and impulsively. The latest gadgets – i-phone, i-pod, mp3 player, laptop, LCD – they have it all.  I have observed people buying a car on loan as soon as they start working. First EMI from first monthly salary! Does it sound exciting or scary to you? This is in stark contrast to the fiscal attitude of our older generation. They used to think 10 times before taking a loan and if possible would postpone some of their purchases to accumulate the money rather than borrowing.

So is consumerism bad? Not at all. In fact, the younger generation is fortunate enough to have ample options in terms of anything and everything. My point is inculcating a fiscal discipline right from day one of your working. Adopt an attitude of earn-invest-spend rather than earn-spend-invest.  Even if you adopt this approach stringently in the first 10 working years of your life, the easier it will become to achieve goals at later stages. By investing on a monthly basis, you will be creating a liquid asset kitty and these will be making money for you.

Suppose you invest a certain amount monthly from your salary income from the age of 23 for the next 10 years. As you progress in your career and achieve stability, the amount invested can be higher. For keeping things simple, let us assume an average monthly investment of Rs.8,000 in an equity mutual fund. Suppose, it will yield a conservative 10 per cent return compounded annually for 10 years. So by the age of 33, you would have accumulated a corpus of Rs.39 lakh. The amount can grow to Rs.47 lakh if the investment yields 12 per cent return and to Rs.64 lakh if the return is 15 per cent. That is a lot of money amassed in your early 30s.

I have observed some double-income neutral families who have accumulated a huge income earning asset kitty in their early working years. Many were able to make a big down payment for property purchase and took minimal loan as possible. Buying a car came second on their list and that too by paying the full amount in cash. No personal loans, no car loans and no credit card loans. In stark contrast to this, I have observed many families who have a big house, a car and many such assets which improve their standard of living but do not earn additional income for them. They are neck deep in debt and are not able to save at all even for investing. There is a good chance that their networth may turn negative as liabilities exceed the assets. The situation can become more troublesome if there is a medical emergency situation in a debt-laden family.

Creating more income bearing assets in the early working years thus helps one to comfortably take care of the life goals and gradually also improve the standard of living. So start investing early and let the power of compounding take care of the rest.  Einstein described it as the eighth wonder of the world!

Do you have a personal accident Insurance policy?

Personal accident insurance policies are the cheapest ones but also the most ignored. The importance of a personal accident cover cannot be undermined. Why this is a definite must-have, especially for the young and working, find out  more in the article below written by me.

http://www.moneyihub.com/definition-and-benefits-of-a-personal-accident-insurance-cover/

Do you have your independent health insurance cover?

Everyone faces problems in life, be it a small worry or a crisis. Some are under our control and can be solved and some are not in our hands. I believe the two biggest crisis in life an individual can face is financial and health problems. The lack of financial resources could cause mental stress and affect health and likewise lack of good health can result in high medical expenses and cause financial stress.

The cost of medical treatment is increasing exponentially. Having a good health insurance plan with adequate cover can to a great extent lessen our financial outgo in terms of hospitalisation, diagnosis and medicine expenses.  When I ask my friends and relatives about medical insurance cover, the usual reply I get is I am covered under my company’s health insurance scheme. So they do not bother to buy a separate medical cover. However, there are some risks here.

Firstly, the medical cover provided by employer is going to last only till your work tenure in the organisation. If you resign or retire from the company, the medical cover is going to lapse. I remember one unfortunate incident of a friend’s father. He had resigned from his company in Mumbai and was going to shift to Pune to join a new employer. During the transition period in shifting to Pune, he suffered a heart attack. His medical cover with the earlier employer in Mumbai had lapsed and he was not having a separate insurance cover of his own.  Although he recovered from the attack by God’s grace, the financial burden he suffered was tremendous. It had repercussions for many years because all the long term savings were exhausted in his treatment.

Secondly,   there is a waiting period of 1 to 2 years on pre-existing diseases in health insurance plans. This means one cannot claim compensation in the event of some medical emergency up to two years. If your medical cover lapses, a fresh policy under a new employer will again have a waiting period on pre-existing conditions. Additionally, premium rates will be high as the age of the policy-holder would have increased then.

Thirdly, your parents might be left out from the insurance coverage although many employers offer group insurance covers which include the employee’s family members. Many group policies have age restrictions which do not cover people above the age of 60. They are also standard in nature and do not offer flexibility to the employee in terms of cover and other features. Thus, the cover might not be good enough to cover the number of dependants due to age limit and also in terms of sum assured given the high cost of medical treatment.  

To summarise, while a medical cover from an employer is a good back-up, it is advisable to buy an independent health cover directly from the insurance company. Buying a comprehensive insurance cover which suits your whole family as per their medical condition makes more sense.

Home loan rates continue to soar, what should you do OR not do?

Home loans have turned expensive with the Reserve Bank of India (RBI) hiking borrowing rates 11 times in the last 16 months. The RBI appears resolute in continuing to implement such strict monetary measures to tame inflation in the future. Home loan customers are in a quandary as their equated monthly instalments (EMIs) are soaring and are further expected to make a deeper dent in their pockets. Should I switch to fixed rate loan or should I transfer the balance loan to a new bank are the common questions crisscrossing many heads. Prospective home loan seekers are wondering whether they should opt for fixed or floating rate loans. Let us address these issues one by one.

Avoid swapping floating rate to fixed rate loans: Let us assume you are at the start or middle of the loan term and have opted for a floating rate loan. Considering that interest rates will continue their northward journey as highlighted in the RBI’s policy, you are tempted to switch over to a fixed rate loan. However, it is not a very good idea. Firstly, because fixed rate home loans are around 1.5-2 per cent expensive than floating rate loans.  So assume if you are paying 11 per cent interest annually on your home loan, your bank revises the rate to 11.5 per cent under the floating rate scheme. But if you switch over to fixed rate loan, it will cost you 13 per cent per annum. Additionally, you will have to pay a one-time fee which could be 1.5-2 per cent of the outstanding loan amount. Ultimately, your EMI burden is expected to be higher.

Consider balance transfer: You may want to consider prepaying the existing loan and take a new loan from another bank at a lower rate. Bargaining for a lower rate will be easier if you have a good credit score. However, the old bank will levy prepayment penalty which is usually up to 1.5-2 per cent of the outstanding amount. Customers at the start of the loan tenure will face high prepayment charges as interest component in the EMI is huge. The fresh loan will also attract a one-time processing fee and mortgage charges. However, if the amount on interest saved during the loan term is higher than prepayment charges and other transfer costs, then it is viable to make the switch. Customers in the middle of the loan tenure are relatively in a better position to switch to a new bank. 

Strategy for new customers:  If you can withstand disruptions in your budget due to the uncertain nature of EMIs, then it is advisable to go for floating rate loans.  Presently, if you are getting a floating interest rate loan at 11.5 per cent, then fixed rate loans are being offered at around 13-13.5 per cent. So you still save money if interest rates rise by 1.5-2 per cent. Even if the floating rate increases beyond these levels, it will not be for the entire tenure of the loan as the rate cycle is likely to reverse over a longer period. So you will stand to reap the benefit of reduced rates.

On the other hand, if you are completely risk averse and cannot endure the volatility in interest rates, it is better to opt for a fixed rate loan. However, you will have to shell out a premium for the certain and secured nature of fixed loans. Moreover, fixed rate loans are not fixed in a true sense. Banks and financial institutions have a reset clause in the home loan agreement. Under this, they are entitled to raise interest rates in exceptional circumstances. Instead of hiking rates, many banks increase the loan tenure and you end up servicing debt beyond the stipulated period.

To conclude, choose a fixed or floating rate loan product based on your risk appetite. There are EMI calculators available on all bank websites. Calculate EMI discounting different interest rate scenarios and see what suits your budget. In this way your cash outflows are unlikely to go overboard and you will be able to comfortably save for other financial goals.

Are credit cards all that bad?

Let me clarify at the beginning of this post that I am not some telemarketer or a bank employee who is trying to sell you credit cards. J

While the use of plastic money has gained popularity in India, there is a general perception that they are bad and should be avoided. Credit cards could pose a threat to your long term financial security if used irresponsibly. And, if used prudently, you could reap a lot of benefits without piling up unnecessary debt. These perks are:

1.Free money: You can enjoy the float without having  to pay interest until the due date of the payment cycle.

2.Security: Your cash is lost forever in case of theft but not your credit card. You can immediately contact your credit card issuer who will cancel it and issue a new one.

3.Emergency: In case you do not have enough liquidity in emergency situations like car breaking down or some medical crisis, a credit card will be helpful.

4.International Travel: If you travel often across the globe, it is much more convenient and safe to use a credit card.

5.Loss protection: In certain cases, you have the right to withhold payment for unsatisfactory goods or services.

6.Incentives: A reward program entails accumulating points based on the purchases you make on your card. These points can be eventually redeemed for a wide array of options including travel, dining, electronic items, fashion, air miles, shopping vouchers, etc. There are also cash reward points in certain cards which can be redeemed for cash. Certain cards provide a complete waiver on fuel surcharge at select petrol pumps.

7.Insurance: A comprehensive air accident insurance cover is provided in many cards.

However, a word of caution comes with all the goodies in using a credit card. Do not just pay the minimum amount and roll over the outstanding balance. Pay the full loan amount or else you will end up paying a hefty interest on it (ranging from 24 to 40 per cent per annum).  Also, the additional purchases you make in the subsequent months will not enjoy a grace period and they will be charged interest from the date of purchase. 

Best still would be to avoid a situation where you are unable to pay the full amount when you buy something on credit. For this, make sure you budget your finances accordingly and are able to pay the amount by the end of the grace period.

To summarise, do not use credit cards to spend money you do not have or cannot afford. Otherwise, it will limit your future buying power and ruin plans of financial freedom.

 

Invest via your parents/children and save tax :

With the July 31 deadline nearing for filing tax return, we rush to invest in the conventional options to save on tax.  Investing under S/80C and claiming medical expenses and house rent allowance are some common modes of saving tax.The human tendency to procrastinate till the end hour in filing returns does not allow us to explore some not so common options for tax planning.

For instance, have you pondered that by investing in your parents and children’s name, you can broad base your income and reduce your tax incidence. If you are investing directly in your name, your tax liability will increase and might push you in the highest tax bracket.  Taking an indirect route by gifting your parents and major children money and assets for investment is the simplest way to save on taxes.

As per the Indian tax laws, gift received (in cash or kind) from relatives do not attract any tax. Relatives here include spouse of the individual, siblings, brothers and sisters of the spouse, brothers and sisters of the parents and any lineal ascendant or descendant of the individual or the spouse. Though gifts are not taxable in the hands of the recipient, any income generated from the gift attracts taxation. However, income generated from the gift given to spouse and minor children is clubbed in the total income of the donor.  For instance, you transfer Rs.1 lakh to your spouse or minor children and it is invested in a fixed deposit yielding 9 per cent per annum. The yearly interest of Rs.9,000 will be clubbed in your total income for the purpose of taxation.

If you want this interest earned to be treated as independent income, then you can invest the surplus money or assets in the name of your parents and/or major children. If your parents are above the age of 60, they do not have to pay annual income upto Rs.2.5 lakh each. Assuming they don’t have any other source of income, you can invest up to Rs.50 lakh ( upto Rs.25 lakh each) through your senior parents and earn a tax free income of Rs.5 lakh (assuming a 10 per cent annual return).

Similary, if your parents are above the age of 80, they are entitled to a basic exemption limit (BEL) of Rs.5 lakh, each. So you can invest up to Rs.1 crore (upto Rs.50 lakh each) in their name and indirectly earn a tax free income of Rs.10 lakh.

Investing in your children’s name is also simple if they are major in age and not earning. In the case of daughter, interest income earned from your gifted money will not attract tax until it crosses the BEL of Rs.1.9 lakh. Similarly, annual interest earned through your son will not be taxable until it exceeds Rs.1.8 lakh. 

This prudent mode of gifting money or assets to reduce taxes also helps in making your family secure in the case of some unfortunate event. However, one hitch in this strategy is that you may be uncomfortable gifting a lot of money to your major children. As you will be giving money on mutual trust, be sure that the recipient does not take advantage of it. So start planning your taxes from the current financial year by making the most of the gifting provisions.

Keep your insurance and investment goals separate :

We do a lot of due-diligence before shopping for an expensive item. We check out various shops to explore options and bargain for a value buy. Unfortunately, we do not take much effort in buying our financial products.

The basic financial literacy in India is very shallow and confined to the knowledge of different products available in the market. The basic notion ingrained in Indian minds is what returns to expect when they buy a financial product. Nothing wrong with that. However, it should not be at the cost of certain basic priorities. Like we pay for our regular household expenses, insurance is one of the basic necessities of life. In fact, the rule of thumb is that after paying your life insurance premium, the surplus money on hand must be invested in mutual funds, equities, etc. Unfortunately, insurance is perceived as an investment. Outlined below are some real-life examples which will reveal the basic misconception in people’s minds about life insurance. I found some funny too:

A. A life insurance policy (endowment) was sold to my       friend (working) when she was 25 years old. She is filthy rich, hails from a business family and does not contribute to run the household. Do you think she required life insurance when she has no dependants?   

B. One of my highly qualified friends bought a Rs.3 lakh insurance cover for his car. Did you know what his total life insurance cover was – Rs.2 lakh. Strangely, his car seemed more valuable than his own life!

C. Another friend bought an expensive ULIP which she did not even need. Why did she buy it, because she could not say no to the agent as she was her close relative!  

D. A Unit Linked Insurance Plan (ULIP) was sold to a senior citizen, who was paying hefty premiums on it. Now, does he require an insurance cover in old age when his children are well settled and looking after him? The agent who sold the ULIP argued that it was an investment product sold to him, not insurance. Imagine an expensive and risky equity product sold to your parents during their retirement years!  

E.While buying an insurance policy, the first question  that my neighbour asked the agent was how much return can he expect from the policy.  

Apparently, the loss of human life and its financial implications for a family seem so irrelevant when one refers to these instances of buying life insurance. Technical details like how much cover is adequate (refer to my article dated 22 June, 2011), number of dependants in family, existing liabilities, etc are hardly discussed. By keeping investment in mind, many people end up buying insurance which is not in conformity with their needs and goals. They pay hefty premiums on such products but still remain under-insured.

When you ask people about their investment portfolio, they invariably end up mentioning money back and endowment policies. In such policies, the family will get the sum assured and the maturity value in the event of loss of life during the policy term. If the insured survives the policy term, he gets the surrender value. However, under these policies popularly pitched by agents, hefty commissions are paid out of your investment. Thus your savings portion accumulates slowly leading to abysmal low returns of 5-6 per cent, not even beating inflation.

On the other hand, a term policy is a pure insurance cover. It is meant to cover only for the risk of life loss and does not pay you any money against the premiums paid. The commissions on term policy are low and are thus not heavily promoted by agents. It is the cheapest form of insurance offering the best combination of coverage and cost.

The difference in the premiums of a term policy and an endowment policy are quite stark. Consider this: If a 30 year old buys an endowment policy of 10 lakh for a 20 year term, the annual premium paid would be Rs.47,950. If he buys a term policy for the same cover and term, he will have to cough out just Rs.3,230. This is just seven per cent of the premium cost of the endowment policy. So if a term insurance is bought and the premium difference is invested in other option like PPF, equities, mutual funds, gold, etc., the returns are bound to be much higher. 

That does not mean endowment policies are not suitable to buy at all. If you can afford to pay heavy premiums, have a conservative risk profile and are content with minimal returns, you can go for endowment/money-back policies. But make sure you are adequately covered. One can also buy a huge term cover plan and balance it with a small endowment cover.

So do your homework and ask your agent the relevant questions. Evaluating the financial risk for the loss of your life is more crucial than focusing on how much return your insurance product earns for you.

 

               

How much life insurance cover is sufficient for you?

Does your life insurance agent/advisor ask this very basic question before offering insurance cover?

Sadly, the answer is no in 98 per cent of the cases. Agents just get down to the business of selling products which earn them high commissions. More on that in my next article. Here, the basic point is that without getting a holistic perspective on your financial profile, an insurance product is sold to you. The end result might be you pay huge premiums and still remain underinsured.

 This article aims to educate you to determine life insurance cover on your own. A most common formula used is insurance cover equivalent to five or ten times the annual income.  However, this formula may not be relevant in most cases as individual needs and requirements differ. (For e.g., a permanent disability cover would be suitable for a single working woman with no dependants than a life insurance product.)

What is required is a more holistic method to estimate insurance which will which not only help to pay your ongoing household costs but will also cover liabilities and children’s future goals in your absence. All these can be subtracted from your liquid assets and existing insurance to arrive at a rough estimate of your life cover. Outlined below are seven steps to assess life insurance cover:

Step 1: Present value of future requirement, estimating family and home maintenance expenses :

A.Annual food, clothing, fuel, enterntainment, maid,utilities,repairs,maintenance, health insurance,medical costs and other personal expenses.

B.Number of years

C.Inflation rate

D.Investment return rate

E.Real rate of return (Inflation adjusted)

F.Total lump sum  to cover

Note: First we calculate the future value of total annual expenses with (I as inflation and N as the number of years). We then discount this future value with real rate of return to arrive at the present value of annual expense. We use real rate of return to calculate present value assuming that the proceeds of the insurance cover will be invested.

 Step 2: Estimating children’s education expenses:

              G.Education expense per child (school, college, post-graduation)

          H.Number of children

          I. Total Children's Education Fund (G+H)

Step 3:  Estimating children's marriage expenses :

          J. Total marriage expense per child

          K. Number of children

          L. Total Children's Marriage Fund (J+K)

Step 4:  Existing Liablities :

          M. Outstanding home/car loan debt

          N. Outstanding credit card debt

          O. Other liabilities

          P. Total existing debt (M+N+O)

Step 5: Total Expenses :

          Q. Sum of all expenses (F+I+L+P)

           Note : To keep things simple, inflation for school, college, higher education and marriage expenses has not been considered here.

Step 6: Present value of existing liquid assets and insurance cover :

          R. Existing Life Insurance Cover

          S. Gratuity, Provident Fund Balance

          T. Savings Account Balance

          U. Other liquid investments like Shares, Mutual Funds,  Bank Fixed Deposits

         V.Total liquid assets and insurance cover (R+S+T+U)

Step 7: Recommended Life Insurance Cover (Sum insured)

            Sum of expenses less existing assets and insurance cover (Q-V)

The figure arrived in Step 7 will give you an approximate idea of how much insurance you need to have.If the number arrived in Step 7 is positive, then you need not purchase additional insurance.

The insurance cover calculation involves a lot of assumptions. And, these assumptions are sure to change with time. So don’t get hung up on details. It is easy to get a big life cover but if you are over-insured, you are paying a lot of extra money over 15-20 years.  So, review your insurance needs periodically to make sure you are not over or under-insured.

          
 

 

Where is your money going?   

A friend of mine was baffled to check her monthly bank account statement one day.  Even after reviewing the statement which outlined every penny being spent, she seemed so lost, still wondering where did the money vaporise. I bet most of us can relate to this account.

So how many of you who are reading this article know exactly how much money is present in your wallet right now? Or how many of you are totally aware of your bank account balances?  I bet very few. Its not about remembering the figures as it is about being aware of your money.

Ever pondered about how much do your monthly expenses constitute as a proportion of total income? Or how much are you able to save every month – 10 per cent or more of your total income? Or how much savings lie idle in your bank account and how much is invested regularly?

To know the answers, you need to keep a tab on your cash inflow and outflow. Or else, there is a possibility you might be piling up unnecessary debt.  You may require a desired big sum but it maybe not on hand at the crucial hour.

The first and foremost thing to do to manage your finances better is to journal your spending (has worked wonders for me). Jot down each and every expense (even if the amount is peanuts spent on a pen refill) on a daily basis or a weekly basis, as it suits you.  Once you get into the regular habit of maintaining an expense journal, you will be able to find holes where you can cap unnecessary spending. You could even segregate your expenses under the head ‘fixed’ and ‘variable’ and analyse where you could plug non-essential spending.  Here are some examples:

·  Under the variable expense head, it could be eating out on two weekends instead of four in a month.     Developing a tendency to eat out less will do your health a lot good as well.

·   When you go shopping, make a list in advance and then stick to it. Shopping with a plan will enable you to curtail spending on needless items and will save time too.

·   There are certain fixed expenses which you need to pay every month like your groceries, utility bills, EMI on housing loan and insurance premium. You can do your bit of homework here too. For instance, you can use your annual bonus or commision earned at work to prepay a part of your home loan. Prepaying the amount at the begining of the loan term will save more interest than at the end.

 

·  Review your insurance cover. Do you have expensive policies in your kitty wherein you are paying huge premiums but with inadequate life cover? If the answer is yes, then you have jumbled up your insurance and investment objectives. You may discontinue the expensive policies yielding mediocre returns and buy a term insurance policy. This is the most purest and cheapest form of life insurance cover. That way you can save on premium money and invest the surplus prudently in other high-yielding securities like mutual funds.

These were some instances about frugal spending. You can make your own list by taking a hard look at your spending habits,brainstorming and identifying the less important or avoidable items. Ask yourself,can I  cut this expense completely or downgrade it. Mind well, the aim here is not to become a miser but to differentiate between wants and needs. If you find you have to spend extra on one item, cut that amount from some other unwanted expense.

In a span of three months, reviewing your journal and comparing it month-on-month will help you get a better grip on your finances. You need not make too many changes in your budget in one shot. Take small steps and gradually build up the momentum. After a while, it will become second nature to you. And, soon you will be able to reap the benefits of more money in your wallet month after month. This new found surplus can then be used to increase the amount you dedicate towards saving for emergency or investing. Thus, taking charge of your money would mean having a better control on your savings and investment and a sure shot path to financial freedom.

So take a notepad now and get going...

Is the past track record enough to choose a mutual fund?

“Mutual Funds are subject to market risks and past performance is not indicative of future performance.”

Investors are usually ignoramus to this all pervasive disclaimer published in prospectus and propagated in advertisements. Since the start of the stock market bull run in 2003-04, most equity-oriented mutual funds (including new funds launched) have generated a compounded annual return of at least 20 per cent. These attractive returns of the past form the sole basis of investment decisions. Most investors breed unreasonable expectations of such fine performance continuing in the future. This is unfortunately not the case, a glaring example being NAVs of IT stocks falling like nine pins during tech bust.

There are mutual funds which have been around since the 1990s and have weathered the ups and downs of the market over longer periods. Their asset sizes have grown bigger by the day but they have been able to sustain good results. They have a good track record and have built good reputation overtime. Investing in these would certainly provide a comfort level but there are other factors which need to be considered in conjunction with past track records. These are discussed below:

Asset Allocation:  This should be the starting point for any investor before he ends up comparing returns of mutual fund schemes. Defining goals (what are you investing for), setting a time horizon for the same and determining risk tolerance levels will enable an investor to do proper fund allocation across different mutual fund schemes. These factors will have a direct impact on the fund being chosen and the return expected. Making realistic goals in accordance with risk appetite and time period of investment is crucial. An investor with a low risk appetite cannot expect an investment of Rs.10,000 to double in a year through a balanced (hybrid) mutual fund. Diversification in terms of fund house is also important. An investor should preferably have not more than two schemes of the same asset management company in his portfolio.

Recent operational changes in a fund: It is advisable to check the recent operational changes in a fund house before investing. The most significant of these are a change of fund manager. The portfolio manager who successfully generated impressive returns of a fund may no longer be managing it. Going along with a new fund manager is synonymous to investing in a new fund offer (NFO).  Other important events which may have a bearing on an investor’s portfolio return is a merger with another fund or a change in the investment strategy of the fund.

Examine fund charges: Mutual funds charge investors with fund management fees and various other expenses. The difference is not big between any two equity oriented schemes of the same category. But in case of fixed income funds, the difference in costs can be major even though the difference in returns is marginal.

For e.g, Fund A has an annual expense ratio of 0.5 per cent and Fund B 2.0 per cent.  These income funds earn a gross annual return of 7 per cent, each.  If you invest Rs.1,00,000 in Fund A, then you receive roughly Rs.1,06,467 at the end of one year. [after adjusting for expenses, net return – 6.5%]. On the other hand, an investment of Rs.1,00,000 in Fund B will fetch you Rs.1,04,901 (net return – 4.9%). Owing to a high expense ratio, Fund B earns Rs.1,566 less compared to Fund A. This is how the cost of different mutual funds can eat into investor returns. And, these can compound to significant variations over a longer period of time.

To conclude, finding a mutual fund which consistently tops the charts is next to impossible. So it is imperative to look beyond a fund’s past performance.

It is equally important to track the investments on a quarterly or half yearly basis.  Mutual funds publish monthly fact sheets and quarterly newsletters that contain portfolio information (company wise and sector wise holdings and weightages) and performance statistics on the schemes.  Such information is also available on their web sites. Periodically reviewing whether your investments are at least beating the benchmark and the category average will help you to earn the desired return which is consistent with your risk profile.

Financial Freedom - Introduction

There is no specific definition of financial freedom.  It may mean different things to different people. For some, it may mean getting rid of the debt trap. Or, it could be having enough money for children’s education to fulfil their dreams or having sufficient corpus in retirement age.  For some, it may mean escape from work drudgery and pursue their passion without having to worry where the next pay cheque will come from.  

Above all, true financial freedom means not feeling trapped or stuck by lack of financial resources and having the financial capability to deal with any critical situation in life. To attain this stage in life, you need to smartly make your money work harder for you rather than you falling into the money trap. A rise in salary, receiving promotion or a fat bonus and other perks are not enough to strengthen your financial foundation. Managing your hard earned money prudently is what matters most to achieve financial liberty.

 Through this blog, I aim to share simple, practical, easy-to-do tactics which would help one manage  finances better. For this purpose, this blog will touch upon personal finance topics ranging from investment planning, insurance, tax, and retirement.

Watch out for this space.