Financial Planning mantra #6

Investment in ULIPs should be for a period of 10 years (minimum) or more, since it is a long term investment product and not an option for insurance cover.

Investors seeking insurance often end up investing in ULIPs, not realizing that ULIPs are market-linked and focus more on returns than on providing sufficient insurance cover.

ULIPs are investment products with very heavy costs (entry loads) in the initial 3 years, the highest being in Year 1. Broadly speaking, it can range from 10% to as high as 60% in Year 1. In short, if you are paying a premium of Rs 1 lakh annually, only Rs 40,000 is invested. Rs 60,000 is a sunk cost. So before investing in any ULIP, always check on the initial costs. The costs in the next two years are additional.

I have come across a number of people who buy ‘insurance’ in the form of ULIPs which are of 3-5 years of duration. There are three vital mismatches here:
- ULIPs are primarily investment products with little focus on the quantum of insurance
- In order to get good returns on short-term ULIPs (of 3-5 years maturity), one has to be very lucky, since the costs are prohibitive in the first 3 years, especially.
- If you pay the premium for the first 3 years only (when the costs are at their peak), then you tend to lose out. In the later years larger sums of your premium get invested (since costs are lower), so the chances of getting much better returns is more in the long run (10-20 years).

If the investor has a horizon of 3-5 years only, ULIPs are not ideal products to invest in. ULIPs are good products provided your time horizon is 10 years or more and you purchase it as another asset class of investment and not as insurance.

The annual ritual of tax-saving

It is that time of the year when the most mundane exercise of all - tax saving under Section 80C of the Income-Tax Act – needs to be undertaken. Most employees loathe the last four months of every financial year - December to March – when all employees get the ‘last reminder’ from the accounts department to submit proof of having invested in tax-saving instruments under Section 80C. There is a last minute scramble to meet the deadline.

People often confuse tax-saving with financial planning (or rather, saving for a financially secure future). In reality, the two are quite unrelated. Tax-saving should fit into your overall, larger scheme of ensuring a financially secure future for yourself and your family. Therefore, investments in tax-saving instruments should never be undertaken haphazardly. These investments need to fit into your overall financial plan. In order to accomplish that, we need to pick tax-saving instruments with care. People rarely share the same perspective on tax-saving.

Common mistakes

Here are some common perceptions and mistakes of investors:

I. 80C Limit - Current policy = New policy: The most common ‘mistake’ is to take the prescribed limit (Rs 1 lakh currently), subtract current investments and put the balance into another insurance policy.
II. Buying the product closest at hand: If there is an insurance agent at hand, then the ‘flavor-of-the-season’ insurance plan is purchased. If the bank is close by, then all the money goes into Public Provident Fund. The least ‘hassle’ product gets the maximum attention.
III. No investment required: If, for example, the annual PF deduction is more than the limit of Rs 1 lakh, then in most cases, no fresh investment/saving is made.
IV. Buying without a thought: In the rush to get over with this ritual, most people just pick up anything with little or no thought and move on.
V. Last minute stampede: This is where most of the investors are trapped. Instead of making the investment during the year, most choose or are reduced to making the investment at the fag-end or (even) on the ‘last day’.

Avoiding the mistakes

Have you ever asked yourself - ‘Why do I work?’ The answer to this question is likely to be one of the following:
i. To be gainfully employed
ii. In order to be economically stable and to provide yourself and your family a financially secure future

What is the point of working so hard and putting in such long hours if at the end of the day you can’t have a financially secure future? It is crucial that one spends some time with a financial planner to decide the way ahead in terms of the investments. What one sows now in terms of the kind of investment will one reap in future.

A careful and studied analysis needs to be done before making any investment. It is not sufficient to just buy a product for the sake of fulfilling a requirement. Tax saving has to fulfill your overall goal of ensuring a financially secure future for you and your family.

Some crucial questions that must be answered before making the investment:
a. Have you looked at what you have purchased? (Most people I know cannot even remember the name of the insurance company or mutual fund whose product they have bought; and yet others have no idea about the kind of policy that they have purchased.)
b. Is this what you really need? Or is this just another blind investment in the myriad investments that you have accumulated over the years?
c. Is the compulsory saving (within the limit of Rs 1 lakh) enough to meet your financial goals? Have you spoken to an (unbiased) financial planner (as opposed to an agent who is selling you a product) to figure out what kind of returns you may get after 10 to 20 years? Take a look at the table below to get an idea about what your investments would be like 15 years from now if all the saving you made are those under Section 80C:
i. Time horizon - 15 years
ii. Inflation @5% p.a.
iii. Annual investment - Rs 1,00,000
Type of investor Expected return End-corpus
Conservative @ 6% p.a. Rs 16.04 lakh
Aggressive @ 10% p.a. Rs 21.19 lakh

Assuming that your objective was to utilize the investments you made each year for your retirement, is 21 lakh enough for you to meet your post-retirement expenses? Do a quick back-of-the-envelope calculation and figure out how many months the money will last?

This clearly brings to the fore the fact that saving just the Rs 1,00,000 per annum cannot make you financially secure. It simply saves you some tax. In the above example, we have not taken any other milestone/event – such as your own marriage, buying a house, education of your children, their marriage, family contingencies, etc. into account. Setting aside Rs 1 lakh a year certainly cannot help you achieve all these goals.

Tax-saving vs. financial planning
Most people believe that buying a tax-saving product is equivalent to financial planning. Products are purchased by the name like ‘XYZ Children’s Plan’ or ‘ABC Retirement Plan’. The investor buys the product and thinks that all will be well in future. But there is much more to planning for the future than just buying a product. Just as in financial planning proper asset allocation and the dynamic management of the portfolio in tune with the changing of goals and objectives is a necessity, so it is in the case of tax-saving investments. In most cases, tax-saving products are haphazardly purchased every year or the entire limit is exhausted by putting the money in a single product. This is not a good approach since these are supposed to result in long-term benefits. But since the whole exercise is without any planning it is most likely not to give the desired results. Hence it is of utmost importance that there is a well-planned and analyzed decision before investments are made.

Where a Financial Planner can make a difference

Financial planning is still a nascent concept in India. Today most financial products – such as insurance, mutual funds, fixed deposits etc – are being bought and sold without the slightest of care and concern about the future. The presence of an agent with a glossy presentation and flashy numbers is enough to convince any investor, with scant regard for what these investments would actually fetch him/her 10-15 years from now.

This is where a financial planner can and should step in. He/she is there to sell a lifestyle and not a single product. His/her knowledge and acumen is bound to make a huge difference in approaching the subject of financial security and in providing an appropriate solution. His or her interest lies in providing proper long-term financial planning, thereby making the investor look at the ‘big picture’ instead of having a narrow and short-term outlook. A thorough analysis should be done of the current holdings and objectives that are to be met by making these investments. And based on these considerations, the financial planner must recommend a product that is suitable for his/her client.

In short, investments should be towards achieving a certain objective, with a tax-break thrown in. The goal should be to maximize your post-tax income since there is a limit to saving tax.

Luring distributors to overcome the market downturn

From giving a kilo of gold to ensuring trips abroad for distributors, mutual funds are adopting new tricks to increase AUMs

In the last month or two, there have been a few mutual funds that have launched insurance-linked products. The reason – the markets are down and so are the investments into equity mutual funds. So how does one entice the investor? Spice it up with insurance. Suddenly there is a huge surge of applications into equity funds.

Now you may ask the reason why? What has the linking of insurance got to do with sudden upsurge in the number of applications? Well, the distributors are being lured with ‘exciting guaranteed gifts’ ranging from movie tickets to a kilo of gold, bikes and even a trip abroad. All that he has to do is to bring in as many applications as he can. And what are the distributors doing to win the race – if you want to invest Rs 5,000 in a mutual fund, he will convince you to sign 5 forms. Then he will fill in the forms for you and submit 5 applications. The terms and conditions in fine print are not even mentioned, forget being evaluated and compared.

Being a distributor myself, I am appalled to see fellow distributors and sales managers of mutual funds running against time to ‘log in’ applications. I am not against marketing, but this is pure self-gratification. The investor’s interest is the last thing on the distributor’s and sales manager’s mind. Both are simply trying to achieve targets at the expense of the poor investor. Knee-jerk reactions like this to increase AUMs (assets under management) will increase mis-selling and kill investor interest.

Are we here to advise on mutual fund investments or is it just another ‘grand sale at a shopping mall’? I wish that the authorities realize what is going on and put an end to this ‘gift mania’ before it gets out of hand.

Inflation and its impact on our investments

Price rise or inflation is a ‘silent killer’ of our investments. The return you get must be higher than the inflation rate for your investments to serve their real purpose.

Inflation is a hot topic of discussion these days. Newspapers and TV channels are full of reports that talk about how inflation, or price rise, is affecting the lives of Indians. Every week, the inflation numbers are more eagerly awaited and discussed than the Friday’s film release.

So what is inflation? And how does in impact us in the long run?

We have all heard stories of their good old days from our parents and grandparents tell us about how you could get a litre of milk in twenty five naya paisa and eat a meal out for Rs 5; how movie tickets used to cost 50 paise and more recently how with one hundred rupees of petrol in your car you could drive to office and back for a week.

“Look how times have changed. Things are so costly now,” they tell us. In layman language, this is inflation. It is nothing new. And yes, it is reflected in the prices of all items we buy.

But let’s look at it from another angle – inflation suggests that the purchasing power of money has come down. In short, for example the Rs 100 that could get us to office and back has probably become Rs 1000 today. In order to get the same service or product we have to pay 10 times more now.

This is one truth that most of us don’t budget for while planning for our future.

Inflation is a ‘silent killer’ of the investments that we are making today. A client of mine had purchased an insurance plan wherein after paying Rs 12,000 p.a. for 10 years, he was ‘promised’ a return of Rs 1,50,000 after 10 years. Looks good on the face of it? But look at the return that you are getting after an investment of 10 years – 6-odd percent per annum, which is lower than the inflation rate. So in reality your money at that time will not even allow you to purchase what it can, today. A sheer loss and a waste of time and opportunity!

Let’s take two examples and look into the future:

Assumption – you are 30 years old today and inflation rate is 10% p.a.

- If your monthly household expenses are Rs 30,000 today: at age 45 you would need Rs 1,25,000 to meet these same expenses.

- Rs 10,00,000 today would be worth Rs 2,05,000 by the time you are 45.

Whenever we buy products like insurance or invest in mutual funds or PPF, etc. with the purpose of achieving a financial goal, we must always take into account the impact of inflation on our end-corpus. It is definitely not going to be worth what the numbers today indicate. It is imperative that the return on our investments beats inflation in the long-run. Only then will we be able to meet our future requirements.

So the next time your ‘advisor’ tells you that so-and-so policy will get you Rs 1 crore in 25 years, do ask him what that Rs 1 crore will be worth then.

An introduction to financial planning

Here’s a lowdown on financial planning and how it can help you lead a life of your dreams.

Welcome to my first blog. Let me begin by introducing myself, my firm - Knowledge Partners - and our philosophy. I am an Associate Financial Planner and have also done my PGCBM from XLRI, Jamshedpur. In 2005, I moved to Gurgaon after spending 14 years in equity research, media and marketing at various firms in Bombay & Calcutta. Numbers always intrigued me. So did various financial instruments. But I also saw how people all around me were getting mislead by so-called ‘advisors’ and ‘agents’. While everyone wants a financially secure future, most people were either unaware or confused as to where and how to start. The result - decisions got indefinitely postponed; or wrong products were bought based on misinformation.

That’s what reinforced my decision to start my own financial advisory. And in 2006, Knowledge Partners took shape.

Financial Planning, as a concept, is still quite new to India. Traditionally, financial advice in Indian homes (invariably) comes from a family elder - who is, more often than not, heavily under influence of an insurance agent or a family friend.

Often, agents and advisors give you an improper advice so that they can make a quick buck. They often sell you a insurance policy or a mutual fund that gives them the highest commission or brokerage.

At Knowledge Partners, we believe in having a long-term relationship with all our clients and advise them to buy financial products they actually need. Our endeavor is to be a partner of our clients till the time they achieve their financial goals.

Have you planned your financial future?

You can get answers to this question by answering these simple questions:

· Have you started planning for your retirement?

· Have you wondering how to plan for retirement, children’s education and marriage in the face of rising inflation?

· Do numbers boggle you?

· Are your savings fetching you sufficient returns?

· Have you ever thought as to how many years you can maintain your current lifestyle if you were to take a sabbatical / retire?

· Is your money lying ‘idle’ in your savings/current bank account – would you not like to earn more than the meager 3.5%?

· Most of us limit our investments to tax saving instruments – or the amount that is to be covered under section 80C. But is that enough to meet all your future expenses? Will that create a sufficient corpus?

If these are some of the questions that are bogging you down, Knowledge Partners could be of help. We are a Gurgaon-based firm offering fee-based services in the area of financial planning having a clientèle in the Delhi-NCR region, primarily, and also in Bombay and Calcutta.

How do we go about it?

Our investment process begins with you. We perform a careful assessment of your individual needs and aspirations, and our evaluation is based on:

· Goals and objectives,

· Investment time horizon,

· Liquidity needs,

· Desired rate of return, and

· Tolerance for risk

The result is a complete understanding of your personal profile that will serve as the foundation for defining a long-term investment strategy tailored to your specific needs and preferences and not just catering to your ‘tax planning’ requirements u/s 80C.

Our philosophy is designed to achieve long-term investment goals, and is based on the following core principles:

1. Identify Your Unique Needs, Goals and Objectives

2. Build an Asset Allocation Roadmap

3. Formulate a Plan & Portfolio Selection

4. Continuous Portfolio Monitoring

We educate our clients so that with time they are more focused to achieve their goals and objectives with the help of their financial advisor, rather than by relying blindly on the latter.

Our fee-based approach is designed to eliminate conflicts of interest and results in unbiased and honest advice.

Money isn’t everything, but having control and confidence about how you are managing it can allow you to concentrate on other things like your family, your career, and your future. We believe that all your dreams are achievable and we look to partnering you so that you can live your dreams!