How you can organise your Annual Expenses and earn an extra buck too….

It is easy to budget for monthly expenses as they are fairly predictable and can be funded out of latest month’s salary income. But we usually lose sight of the expenses that hit once or twice a year and pay attention to it only when it is due. 

Typically, the annual expenses incurred are children’s school fees, vacation expenses, festival expenses, gym membership, insurance premiums, etc. These are usually spread throughout the year. For e.g, your children’s school fees could be due in June, your gym membership in September, your insurance premium in February and so on. And then there are one time unpredictable expenses too which entail untimely cash outflow like home repairs or computer repairs. (In just less than a year, I spent about Rs.6,000 bucks on my laptop repair) 

For those who have abundant funds, the usual tendency is to fund one-time requirement from the past salary earnings which in most cases is lying idle for many months in savings account. 

And for those who live on a tight budget or are overtly spend thrift, they may be unprepared for it. They may fall short of funds to cover an annual expense, forced to charge it on credit card or may have to dip into long term investments.

But there is a wonderful way to organise your annual expenses.

Firstly, ascertain the cost of each annual expense & their respective timelines by looking into past bank or personal records. Be realistic in estimating your expenses. Convert it into a monthly figure by dividing by 12. This would help you to ascertain the monthly amount you need to keep aside to create the specific corpus. You can create FDs/RDs/liquid funds for each specific expense for the desired time frame. For instance, you can create a school fees fund for your children by opening a fixed deposit or investing a regular amount in recurring deposit. At the time of payment date, you would have the fund ready plus some extra buck as interest which you can utilise for your children’s tuition fees or some other expenses.

The benefits of saving & earmarking specific expenses to specific funds for a specific time frame are that:

(1) It would ensure that the big fund would be there when you need it. You would not have to scramble for cash at the last hour or resort to loan or disturb your long term savings.

(2) It would help you to remain disciplined to manage even the monthly budget as you would compulsorily be keeping aside a certain amount for your annual expense need. Think of the monthly amount to be compulsorily saved as your monthly SIP investment or home loan EMI and you would sure shot meet your annual requirement in a disciplined manner. The exercise would also automatically set the limit for expenses like vacation where you are tempted to go overboard in spending.

(3) The monthly saving that you would invest will also be growing & earning money for you until you need it.

(4) And the best part is zero stress. You would feel immense freedom to spend the money you have saved as you had already budgeted and arranged for it. 

Do you have any other method that you follow? Anything that works for you. Let me know your suggestions.   

My interaction with a personal banker….

While I had heard many stories of rampant misselling of financial products, I was not really aware of the brazenness with which it was done. Until, one fine afternoon, I had a conversation with a personal banker. 

I had gone to the bank with my husband to liquidate a fixed deposit which was in our joint name. While the banker was taking care of the procedural formalities, he casually slipped in the topic of how fixed deposits earn low returns post tax for the highest tax bracket earners. He then went on to mention that the bank had a better product which can earn higher than FDs & that too, tax-free guaranteed returns.

Besides PPF, I had not heard of any such product. I decided to lend him a humble ear without disclosing my financial planning background. Here is how the conversation went: 

Banker: Madam, instead of putting your money in FD, you can invest every year for 7 years in our product which can earn you 8-8.5% guaranteed tax free returns

Me: What is that product?

Banker: It is a debt product. It will invest a major portion of your funds in government securities. Last year, it yielded about 8.5-9% returns

Me: Is this a debt mutual fund product?

Banker: No

Me: Aren't G-sec yields linked to general interest rates and the liquidity in the markets? Then how can your product assure guaranteed returns

Banker: No madam, the returns are not guaranteed (contradicting his earlier statement), but over the past one year, it has yielded good returns and going is expected to remain good

(I was wondering how it would sustain over a long period of time especially since the interest rate cycle after peaking out had gradually reversed over the past one year. Till this time, I am not told what kind of a product the banker was talking about.)

Banker: Plus, you also get a free life insurance cover! And, you get your investment plus bonuses back after maturity of 10 years

Me: Are you talking about limited pay endowment insurance plan?

Banker: Madam, nowadays you get free insurance cover with everything, even if you buy debit card/credit card…!

I was quite taken aback with the answer and I found it meaningless to further continue the conversation. I realised that these people would always find a convenient way to camouflage a product (which is already complex) without ever addressing the genuine needs of customers.

Finally, I refused him politely stating that we have adequate insurance cover with a term insurance plan & we do not prefer to mix insurance with investments. The interesting part of this entire conversation was that the banker had not disclosed the name of the product. At the time of leaving, I did ask its complete name and the banker finally obliged.

Later, I checked the details of the product on the insurance company’s website and confirmed that it was a traditional endowment assurance plan.  I also calculated the returns and it came to a pathetic 6.5 per cent for a policy term of 10 years! I am not saying that all endowment insurance plans are bad. Few may be good and may be suitable for a certain section of people. But in most cases I have come across, people are better off investing in other options.  

You must have heard of the ‘KISS’ principle – “Keep it Simple, Stupid”. You can apply this rule to your personal finance life. Avoid getting into complex products like ULIPS, Endowment plans, Money Back plans, etc. Instead, buy a term plan with adequate life insurance cover for your family, buy adequate health insurance and invest in PPF, mutual funds & a certain amount in gold. Trust me, by doing only this, you would have won half the battle in keeping your financial life on track!

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!