The High Cost of Financial Mistakes:

“I have decided to discontinue my life insurance policy”, said my good friend.  He bought an endowment plan from a life insurance company five years ago for a sum of Rs.8 lakh and was paying an annual premium of about Rs.43,700.

I was surprised why he would want to discontinue life insurance cover in his young working age. I wondered he might have suddenly inherited some native land worth crores which would take care of his dependants throughout their lifetime in his absence.

I asked the reason and he replied in desperation, “I simply cannot afford it now as the insurance premium is very expensive and my loan EMI has started on the new house bought recently”!

I did not appreciate the reason which guided him to take a decision of discontinuing the life insurance policy. The reason was of affordability and not because my friend did not require life insurance anymore. Nonetheless, I guided him to first buy a pure term insurance cover – the cheapest form of insurance, increase his sum assured which would also cover the home loan and then discontinue the endowment policy.

I have observed umpteen such cases where people have second thoughts about a financial product but after buying it. They are then stuck up with products which they do not really require or are not beneficial to the core.

Are you also one of those who buy a financial product first and regret later? We all make financial blunders at one point or the other in our lives. Some of us realize it early on and try to rectify them. Some of us drag along with the mistakes not realizing the consequences it may have on the financial situation for the rest of our lives.

The impact that these financial decisions have on an average salaried individual is huge compared to a high net worth individual. I have observed many instances of high net worth individuals (HNIs) where life insurance has been bought even if not required. A case of excess insurance! The super rich have built so much of wealth early on in life that the families and even next 2 generations would more than survive in their absence! Still, HNIs pay crores of rupees in insurance premiums annually for policies they do not require and which otherwise could be channelized into investment options which earn better returns. However, it does not really make a difference to their financial situation.

On the other hand, in the case of my good friend,  his decision to buy an expensive insurance cover only to discontinue it five years later costs him an opportunity to save more and invest more for the down payment of his new house. Also, the surrender value which he will now receive after discontinuing the policy will be far lower than the total premium paid.

Now picture this. Had my friend bought a pure term insurance cover five years back instead of an endowment plan, he would have paid an annual premium of Rs.2,180 for the same cover of Rs.8 lakh. So he would have saved about Rs.41,555 (43735-2180). Had he parked the savings on premium payment in a bank fixed deposit (assuming 8.5 per cent return p.a) and utilized it for the down payment of the house, he would have taken Rs. 2.67 lakh less loan. The number may appear small in present value for just one year but grows big after the effect of compounding for the entire loan tenure. 

On a lesser loan of Rs.32.3 lakh (35-2.67) he would have saved 3.8 lakh interest during the loan tenure! Further, the money saved on interest every year could have been invested in suitable avenues and would already have started generating additional income for him. (Refer to the table for the entire calculation)

As observed above, every financial decision is likely to have a bearing on other areas of personal finance. Secondly, the repercussions of financial mistakes are felt over a really longer period of time and it hits hard in the long run when an individual, particularly the average salaried class, falls short of funds to achieve his financial goals like children education, retirement, etc.

Here is a snapshot of some common financial mistakes usually committed and their possible consequences:

So what should one do to avoid mistakes or at least take quick action to minimize their impact?

Most people do not have the time, inclination or the knowledge to do the due diligence before committing their money in various financial instruments. They have no inkling what are they saving for and how much saving is sufficient to meet the desired goals.

There has to be a basic level of involvement required in personal finance matters. This implies not leaving buying of financial products entirely to your brokers, distributors, bankers, relationship managers, agents, friends, relatives, etc and be involved only in signing papers and issuing cheques. While we invest so much of our time everyday to earn money, we need to invest time to take decisions to manage that hard earned money as well. This particularly includes buying any financial product - equity share, mutual fund, insurance, pension policy, etc. 

We are fortunate to be living in an information age where huge amounts of simple & easy to understand content on personal finance is available - be it newspapers, blogs, websites and that too absolutely free. For more comprehensive solutions, we have certified financial planners who offer quality advice to people without the thrust on product selling and earning fat commissions. Even second opinions can be taken with other financial experts like we take in the case of medical issues from doctors. Ultimately, it all boils down to how involved one is in personal finance matters. One need not be a super expert on every aspect of managing finances but at least some basic acumen to a reasonable extent should be gradually developed so that financial mistakes can be avoided. Financial Literacy is the key here!