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Wednesday 13 August 2014

Being Disciplined


Being Disciplined

When it comes to personal finance, people tend to assume that they need to do a whole host of things and consult a zillion “experts” before they can get on to their “Path to phenomenal wealth”. They are completely off the mark and totally wrong.
While things are not altogether simple and absolutely easy so as to be trivialized, they are very much within the realm of possibility and can be accomplished by virtually each of you.
 
The trick is to
  1. Start early
  2. Be disciplined and
  3. Stay put
Of the above three steps, I would personally regard the second one to be the most critical: Be Disciplined!
Here are some easy-to-execute tips for being disciplined on the financial front:
  • Today, identify a time-slot when you will actually sit and start your basic planning process.
  • At the outset, jot down ALL your sources of regular income
  • Similarly, identify ALL your regular expenses that are completely unavoidable (Like Rent, Taxes, Electricity bills, Monthly groceries, etc.)
  • Identify a percentage of your regular income which SHALL be saved each month. In the initial years of your career, when financial commitments are typically lower, the percentage can be much higher than, say, when you’re married, have a couple of kids and a couple of loans.
  • Convert this percentage into a nice, round figure, say, to the nearest thousand or nearest hundred.
  • Each month, shift this amount AUTOMATICALLY to a separate bank account which will be a “One-way bank account” – This bank account will NEVER be used for routine withdrawals for regular expenses 
 
What you should do with this “One-way bank account” is the subject matter of a separate blog post, and will be dealt with in the days and weeks ahead.
 
For the moment, start off with the aforementioned “baby steps” to become financially disciplined. Those of you who are familiar with the Power of Compounding would know the likely positive impact due to these “baby steps”. The rest of you may wish to do a Google search to find out about what Einstein famously referred to as the “Eighth wonder of the world”. Or, if you so desire, refer to my own blog post on the Power of Compounding a few years back (Using the Power of Compounding).
 
Regards,
 

N

 
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Monday 11 August 2014

Maximizing Employee's Contribution to PF - To do or Not to do?


Maximizing Employee's Contribution to PF

To do or Not to do?

A couple of days back, a friend told me about his young IITian son’s first job. In the course of his conversation, he mentioned that he had advised his son to go in for “maximizing” the “Employee’s contribution to Provident Fund” so as to build an “automatic savings corpus” right away.
 
I did proffer my opinion about the same in brief – that it may not necessarily be a great idea if the individual concerned happens to be a thrifty individual and has adequate self-discipline, especially in matters pertaining to personal finances. During the course of the weekend that followed, I thought further about it. And here are a few of my thoughts: 
Considering the temptation to blow up one’s “newly acquired monthly inflows”, it is indeed a good idea to send away a part of the money “automatically” into the savings pool before it reaches one’s hand. This is certainly true for the vast majority of youth today. Even more so if the young kid satisfies one (or both) of the following two conditions:
  • The monthly income is just about sufficient for maintaining the chosen life-style of the concerned individual and / or,
 
  • The individual concerned is likely to yield to the temptation of blowing up all his/her money as soon as it lands up in the bank!
From anecdotal evidence, I would guess that at least one of the above two conditions will apply to well over 95% of people entering the corporate world today. My mom (and people of her generation) would be tempted to say that the figure ought to be 99.99% J!
What about the folks who don’t satisfy even one of the above two conditions? They will be under immense pressure from their parents, friends, colleagues and perhaps even some so-called financial experts to maximize the “Employee’s contribution to PF”. The logic would broadly be as follows:
 
  • “You’re earning quite a bit considering your life-style – Obviously you will be able to save this sum without even noticing it”
  • “The power of compounding works like magic – Before you realize, this contribution would have grown immensely”
  • “If you don’t save this money, you will spend it or lend it or give it or otherwise fritter it away”
At a superficial level, the logic is quite appealing. But I’m not convinced. In fact, I would strongly urge such an individual to ignore the logic and contribute the MINIMUM possible amount to the “Employee’s quota” of PF Contributions.
Here are a few reasons:
  • Being self-disciplined and financially thrifty, he will in any case save enough of his money on his own – He doesn’t HAVE TO maximize his contribution to PF.
  • In any case, the Provident Fund fetches a ridiculous sub-10% returns on the savings. This doesn’t in any way cover the real inflation rate that will be applicable to an upper middle class individual.
  • More importantly, considering the long-term horizon for this individual’s savings, he ought to look at maximizing returns, rather than safety. In fact, the past track record of the past 10, 20, 30, 40 and 50 years would confirm that returns of systematic monthly recurring investments equity shares / equity mutual funds have consistently and significantly outperformed any fixed income products like Bank deposits, Provident fund, NSC, etc. Hence, risk becomes almost a non-issue.
  • The same logic would perhaps hold true for investments in real estate as well.
Hence, I re-emphasize my initial point:
  • “If you’re a disciplined individual, thrifty by nature, you must MINIMISE your contribution to the Provident Fund”.
Instead, you MUST do the following:
  1. Shift any surplus funds over and above your typical monthly expenditure into a highly rated liquid mutual fund.
  2. From the balance in this liquid fund, build a corpus of perhaps 3-6 months of monthly expenses (not monthly income) and park it in a carefully chosen short term debt fund.
  3. Identify your real insurance requirements (Typically you will require a Term Insurance Plan to cover your life, a health insurance plan and perhaps an Accident Insurance plan) – Explore the possibility of taking adequate insurance cover for all these requirements.
  4. Once this “Emergency Fund” corpus as well as your Insurance needs are both “ready and done”, identify 3-5 high quality equity oriented mutual funds and start a Systematic Investment Plan to invest your routine monthly surplus to these equity oriented mutual funds.
  5. Stay on the look out to buy your own home For Living – As and when you identify a suitable property, you may wish to consider taking a suitable housing loan and buying that property.
  6. Watch out for the launch of high quality Real Estate Investment Trust products (REITS). SEBI and the FM have just approved the concept. I’m sure that reliable and trustworthy players like HDFC, Tatas, Birlas, TVS Group, SBI, L & T, etc. will very soon come up with their own REITS. Considering the fact that under the proposal, long term capital gains from REITs (units which are held for over 12 months) are likely to be completely exempt from Income Tax, REITs are bound to be hugely popular investment avenues for those who wish to park their funds in Real Estate for investment purposes. (To put things in perspective, if you sell a house that you have been living in for the past few years, your capital gains will be completely taxable, whereas, a corresponding investment in REITs would be tax-free).  
In a nutshell, remember that unlike your spendthrift friends who blow up their money, you are disciplined and thrifty. Hence, make the most of it and kill the monster of inflation with your hard-earned savings. Saving money is just the first step. The next key step is to convert your savings into investments.
 

This, I’m sure, will not only make you immensely wealthy over the next couple of decades, but will also ensure that you will be able to become financially free by the time you hit 40.
 
Don’t waste your money by maximizing your contribution to PF!
Regards,
N
 
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Sunday 9 February 2014

Significance of the Financial Sector

Why you MUST be overweight in the Financial Sector while investing ...


Came across a rather interesting article on how the Financial sector enjoys an undue and highly exaggerated status, certainly disproportionate to their true contribution to society (some would be tempted to add - "If any"):


The above article, which is set in a global context, is a bit "high-funda" and more relevant for those who have a predisposition to read such esoteric stuff. For the large majority of you, I would recommend that you simply take a quick and brief glance just enough to get the general drift of what the article is all about.

What's relevant for us is that

  • For the same quantum of capital deployed the financial sector generates much greater revenues vis-a-vis most other sectors- due to leverage
  • For the same quantum of capital deployed / revenues generated, the financial sector generates greater profits than a good chunk of other sectors
  • Ditto for the rate of growth of the firms in the financial sector - For instance, banks which started around a decade back like Kotak are far bigger today than similar-sized firms which started off around the same time in other sectors.
  • Due to systemic risks, more often than not, the governments around the world will NOT allow financial sector firms to go bust. They may allow a steel manufacturer or a real estate player or an automaker to go under - but not banks.
  • Due to all the above, the ever increasing proifts of banks accrue to the shareholders, but the downside risks due to issues like leverage are "sort-of" protected by the governments around the world.

Hence, while investing in shares, it may be a good idea to keep a keen eye on financial sector players and be willing to be significantly overweight in players in the financial sector vis-a-vis the market as a whole.

The gains will belong to you but not the losses.

Caveat: The last line above will obviously depend on your prudence, your entry levels, your fear and greed levels. But then, that's always true while investing in shares!

Regards,



N

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Thursday 26 December 2013

Importance of Insurance - Part 5

Be safe or You'll be sorry! Part 5
Choosing the right Life Insurance Policy




Here's the next part of my continuing coverage on Insurance. You would have read my earlier post on Choosing the right Life Insurance Company:


By now, you'd be clear about whether you need a Life insurance cover, the quantum required and the company / companies from which it is OK to buy a life insurance policy.

In this post, I propose to talk about how to identify a suitable life insurance policy...

Some points to note:

  • As a thumb rule, I dislike combining insurance and investment. Reason is quite simple - Lack of transparency. And in any case, once you decide to make an investment, especially for the long term, you would like to base your decision on factors such as returns, risk, liquidity and flexibility of shifting to better investment options and/or fund managers from time to time. Whereas, life insurance products should be bought primarily (almost exclusively) on the basis of reliability of the actual assurance given by the life insurance company to honour its commitment to cover the risk of your life. To combine two such diverse objectives would lead to certain lack of clarity and perfect confusion.
  • Hence, if a life insurance policy promises to return any quantum of money during the life time of the policy holder, be clear in your mind that they are combining insurance and investment. Such policies will usually come under the garb and nomenclature of money-back policies, endowment policies, return of premium policies, Unit-Linked Insurance Policies (ULIPs), etc.
  • All such "insurance+investment" policies, in my opinion, have the potential and high likelihood of turning out to be bad choices for a vast majority of people. In all such policies, a part of your premium is used for providing a risk cover. The balance part is used to make investments and provide you the returns. And in most such policies, you don't know the break-up of how much of your premium is going to cover the risk and how much is being invested. The portion which is invested, if invested in "debt products" such as bank deposits, government or quasi-government bonds, etc., the returns you get are sub-optimal vis-a-vis what you will get from making pretty much from the same bank deposits, bonds, etc. The reason: They have to "manage your money" and hence they incur certain administrative costs - Such costs are obviously deducted from the returns generated from your investments. In case of the investment portion being deployed in equity products, you are "stuck" for a really long time with that fund management house. If you were to invest the same directly, you will deploy the same in mutual funds which can be sold off if you find the fund performance inadequate or if other better options are available.
  • Hence, in a nutshell, when you are covering your life, make sure that you do just that and nothing more. Go in for a very simple, easy to understand, "no return of money till you die" kind of life insurance policy. They are typically categorised as  "Term Insurance Policies".
  • The concept of term insurance policy is very direct and simple: They take your premium and provide a risk cover. During the term of the policy, if something untoward were to happen and if the policy-holder dies, the insured amount as per the policy is paid to the nominee. If the policy holder were to remain alive at the end of the term of the policy, he/she can simply be happy that he/she is still around to crib about all those premium payments "going waste". He/she gets nothing in return. To understand this in a proper context, it is similar to insuring your car / two-wheeler. In case your vehicle gets involved in an accident, you can claim the amount lost from the insurance cover subject to the policy amount. If your vehicle does not get involved in any accident, most rational human beings don't feel sad or disheartened by it. On the contrary!
  • Now that you've hopefully decided to go in for a "Pure Term Insurance Policy", you are free to choose virtually any term insurance policy from those that are offered by the life insurance companies that you have shortlisted. A good and sensible option would be to choose the specific term insurance policy where the premium payment is the least. Obviously, it is preferable to have a policy which provides a cover for the maximum duration of time (ideally till the very end of your life on this planet).
  • In this context, you must seriously consider the relatively recent development of "Online Term Insurance Policies". These policies often provide an insurance cover at much lower premium vis-a-vis traditional Term Insurance Policies. This is because they are offered directly by the insurance company and a vast majority of the process is being done online and hence at a much lower cost. This elimination of middlemen (the insurance broker, insurance agent, etc.) and the reduction in process costs is passed on to you by way of a lower insurance premium.
  • Hence, my vote will be to go in for an appropriate Online Term Insurance Policy. Go for it. Go for it TODAY!

Caveat:

All that I've stated above happens to be quite valid - no conditions apply. However, it is imperative to remember the following:

  • Once you decide that you need a life insurance cover, it is better to have ANY LIFE INSURANCE POLICY than to have NO LIFE INSURANCE POLICY.
  • Hence, it is actually better to have one of those sub-optimal policies that I've described than to have NO LIFE INSURANCE POLICY.
  • The much desired Online Term Insurance Policy that you have identified must obviously be bought. But if you are under compulsion to buy some other policy from a friend / relative / spouse's relative / classmate, etc., it is actually better to buy such a policy from such a source than NOT to have any life insurance cover. If possible, minimise the latter and go in for a good quality term insurance policy over and above the sub-optimal policy.
  • In any case, if you already have one or more of those sub-optimal insurance policies (the baggage of history), DO NOT discontinue such policy / policies till at least three months AFTER you have received the policy papers from your carefully chosen Online Term Insurance Policy.

Critical words of wisdom:

  • You need to remember that the sole purpose of making premium payments for a life insurance policy is to ensure that you do have a life cover. You do not wish to be in a situation where after the demise of the policy-holder, the nominee fails to get the insured amount due to some fault while filling up the form or due to some intentional/inadvertent false declaration while filling up the form. Hence, while taking such a life insurance policy, make sure that you are very meticulous when it comes to filling up the proposal form. Ideally, you MUST fill it up all by yourself. Even if an agent were to fill it up, you must ensure that every single item in the form is filled up accurately and truthfully.
  • Especially, you must be very particular about the spellings of your name and that of your nominee. There must be NO MISTAKE in such basic details such as postal address, contact numbers, email addresses, nominee details, details of the chosen policy (including sub-options that may be applicable), Date of birth, etc.
  • And, having a medical check-up done by the insurance company's team of doctors is actually an ideal situation. Once that's done, they will not be in a position to reject a claim later claiming that the policy-holder did not declare his/her true medical condition.

In my next few posts, I plan to write about health insurance policies.

Watch this space!


Regards,


N

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Thursday 21 November 2013

Importance of Insurance - Part 4

Be safe or You'll be sorry! Part 4

Choosing the right Life Insurance Company

Here's the next part of my continuing coverage on Insurance. You would have read my earlier post on the quantum for which an individual should obtain a life cover:


In this post, I propose to talk about how to identify a suitable life insurance company.

How do you choose a life insurance company from which you can buy a life insurance policy? Some points to note:

  • The industry has evolved over the years. Despite MoneyLife (magazine, website) and others who claim that our regulators are toothless tigers, IRDA has evolved into a regulator on which I'll personally have quite a lot of confidence and trust.
  • Based on the IRDA norms, virtually every single player in the insurance industry has to take care of issues like capital adequacy, sustainability of the policy, basic levels of customer satisfaction, etc. There's always scope for improvement, but then, things are broadly "so okay" now that you can go ahead and rely on any life insurance company - All of them are "reasonably" reliable and trustworthy.
  • Having mentioned the above, it is possible that you might be personally uncomfortable with Company X or Management Y - with or without any reason whatsoever. By all means, drop those companies from your list of "suitable life insurance companies" - After all, unlike a few years ago, today you have the luxury of CHOICE - There are quite a few active life insurance companies even if you decide that you don't wish to buy a policy from half a dozen companies.
  • Next, look at GEOGRAPHY. It is possible that a couple of specific life insurance companies may be relatively inactive or perhaps even be absent in your city / town / village. While it may still be OK to take a policy from such a life insurance company, it is likely to be that much more difficult to handle issues related to claims processing - Certainly in comparison with another life insurance company which has an active presence in your place of residence.
  • Now, you have a bunch of companies which continue to survive in your shortlist of life insurance companies from which you can consider buying a life insurance policy.
  • Thanks to the first point above, you can virtually choose ANY of the above life insurance companies that continue to be part of your shortlist.

In my next post, I propose to write about the actual process that you need to follow to try and identify that particular policy that will be suitable for your specific needs.

Watch this space!



Regards,

N

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