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.