Personal financial management in thirties - Sumit Khedkar

Personal financial management in thirties - Sumit Khedkar

Today’s general trend is, a person completes his education in his early twenties and gets a good job. The early twenties period is a golden period of life with no family responsibilities, education completed and a good job with comfortable salary.  We spend a lot in this golden period as we do not have any obligations. We spend on parties, girlfriends, costly clothing, and vacations and so on, this list is never ending or it ends when we run out of money. This trend continues till late twenties and then suddenly we realize that dad is retired now, I am going to marry, I need a house, I want to settle now and I have no money!! Whatever I have earned has gone!! Has been spent!! Then, to solve our problems we run to banks for loans. And hence starts a home loan for buying a 1-2 BHK flat, a personal loan for marriage expenses, an auto loan for buying a car or a bike. We enter in our thirties with a set of loans, family responsibilities, increase in monthly expenditure due to family expenses and a set of worries regarding finance management too. The set of worries include what will happen to my family if I am not there? What if my parents need to undergo expensive health treatment? How to manage children education expenses? What about my retirement life / pension?  and so on. If we don’t do proper financial management in this period then we are planning for a financial disaster in the future. In this article I am going to discuss the eight most important things you should do in your thirties for personal financial management. I am going to give you options / alternatives for investments with explanations.

Priority 1: Personal Insurance - Sumit Khedkar

Priority 1: Personal Insurance

What will happen to your family, wife, and kids if you are not there? Have you ever thought? In most of the families, man is a bread earner. The entire family depends on you. Hence the first step is to get insured.

There are a lot of personal insurance schemes in the market and there are a lot of insurance players too. One can get confused while choosing a personal insurance scheme. One thing you    should remember while choosing a personal insurance scheme is the claim settlement ratio. It is all right if a company is offering you less policy maturity benefits but the important thing is you should get the claimed amount if in case you claim for it. And hence LIC stood first in this aspect. I personally recommend a personal insurance policy from LIC as they have the highest claim settlement ratio. Having said that let’s see what are personal insurance scheme types.

a.       ULIP: Unit-linked insurance plan: 

 

A ULIP is basically a combination of insurance as well as investment. A part of the premium paid is utilized to provide insurance cover to the policy holder while the remaining portion is invested in various equity and debt schemes. The money collected by the insurance provider is utilized to form a pool of fund that is used to invest in various markets instruments (debt and equity) in varying proportions just the way it is done for mutual funds. Policy holders have the option of selecting the type of funds (debt or equity) or a mix of both based on their investment need and appetite. Just the way it is for mutual funds, ULIP policy holders are also allotted units and each unit has a net asset value (NAV) that is declared on a daily basis. The NAV is the value based on which the net rate of returns on ULIPs are determined. The NAV varies from one ULIP to another based on market conditions and the fund’s performance.

 

The returns in ULIP totally depend on the market condition. ULIP has been a disaster in last five years 2008-13. But the basic question is, has it solved your real worry? Will the ULIP policy provide your family enough support in your absence? 

 

Let’s analyze ULIP using sample illustration. I got following illustration from the website of a leading insurance provider company.

 

Here, the calculation is simple. You are paying 15,000 Rs per annum and the assurance is of only 1,50,000Rs in case of your demise. The fund value at the maturity is not guaranteed. Fund value at the maturity totally depends on the market conditions and the ULIP fund manager’s performance. ULIP can give you negative returns also. Hence insuring yourself by ULIP is dangerous and a strictly no-no option.

b.      Traditional / conventional LIC Insurance Policy: 

This is a better option than ULIP. As I told you earlier, in insurance what matters is the claim settlement ratio and LIC indeed has a better claim settlement ratio. Claim settlement ratio of LIC is 96.21%.

 

There could be a better option than LIC too, but before that let’s see what LIC is offering us.

I got following illustration from the LIC website.

 

The takeaway from this illustration is, If you are paying 25,186 Rs per annum for the first fifteen years of the policy. The sum assured/ guaranteed return is maximum 6,25,000 Rs.  Average case return is 8,78,000 Rs i.e. near about 5.5% year on year returns, and best case return is 15,98,000 Rs i.e. near about 9.5% year on year returns.

I think whatever is offered is fairly good. One should go with this option. You are getting good maturity benefits as well as good benefits in case of your demise. People who do not want to put more efforts in personal financial planning should go with this approach, for those who are ready to put extra efforts, there is something more for you.

You can buy LIC policy online here http://www.licindia.in/index.htm

 

c.       Design your own insurance policy:

 

There is a third type of insurance called term assurance. Term life insurance or term assurance is life insurance which provides coverage at a fixed rate of payments for a limited period of time, the relevant term. After that period expires, coverage at the previous rate of premiums is no longer guaranteed and the client must either forgo coverage or potentially obtain further coverage with different payments or conditions. If the insured dies during the term, the death benefit will be paid to the beneficiary. Term insurance is the least expensive way to purchase a substantial death benefit on a coverage amount per premium basis over a specific period of time. You won’t get any returns from a term insurance policy at the maturity.

Let’s see how we can design our own insurance policy with the help of term assurance and a PPF (public provident fund) account. PPF account is the safest way of investment. PPF account gives 8.7% returns annually.

Following is the term policy illustration I got from LIC website.

             To compare our own insurance policy with the LIC policy illustrated above I keep the total premium                         amount same as that of LIC policy i.e. 4,02,976 Rs.

In the LIC policy you were assured of 15,98,000 Rs and that too in the best case scenario which is a distant possibility.

If you buy a term insurance policy for 25 years and for the total coverage of 15,98,000 Rs then according to the chart above you will have to pay 4,700 Rs annually for 25 years. So the total premium amount will be   1,17,500Rs.

Now you are left with 4,02,976- 1,17,500 = 2,85,476 Rs. This money you can put in a PPF account.

You can put 2,85,476 / 15 = 19,031 Rs annually in a PPF account. If you put 19,031 Rs annually in a PPF account for 15 years then after 15 years you will get total 6,09,057Rs !!!. And if you keep that money invested in the PPF account itself for the next 10 years then you will get total 14, 41,859Rs!!!

Following table explains the calculations.

Year	Investment for term insurance	Insurance cover	Investment in PPF	Maturity benefits
1 To 15	4,700 Rs Annually	15,98,000 Rs	19,031 Rs Annually	6,09,057 Rs
16 To 25	4,700 Rs Annually	15,98,000 Rs	Reinvest the maturity 6,09,057 Rs	14, 41,859 Rs
Total	1,17,500 Rs	15,98,000 Rs	2,85,476 Rs	14, 41,859 Rs

 

The total benefits you are getting from this customized policy are term insurance of 15,98,000 Rs from the day one for the next 25 years plus total return of 14,41,859 Rs from the PPF account. Everything is guaranteed here!! There are no ifs and buts. Isn’t it the best policy as compare to other options? JAGO INVESTORS JAGO.

Here, you can maximize your returns by investing in bank fix deposits or debt base mutual funds. However, I will still recommend investment in PPF rather than any other alternative as the goal here is to assure your family in case of your absence.

Priority 2: Health Insurance - Sumit Khedkar

Priority 2: Health Insurance

 

These days the hospitalization cost has increased a lot. There are many people who have become victims of financial stress due to rising medical costs.  An accident or a medical emergency can take away all of your savings unless you are insured. Hence, it is must to have a mediclaim policy covering you and all of your family members. In insurance what matters is the claim settlement ratio. Your insurer must provide you the money when in need. For this reason I suggest buying insurance from a government agency such as “New India Assurance”  http://newindia.co.in/Content.aspx?pageid=115 , "Oriental health care" etc http://www.orientalinsurance.org.in/index.htm . Government agencies have good claim settlement ratio.

 

There are many private players in the health insurance business but if you read the public reviews for these private players then you will get shocked.  Public has horrible experiences of these private players. Consider the situation that you or any of your family member is admitted to the hospital . You need a few lakhs rupees for hospitalization and your health insurer rejects your claim on the slightest pretense. For example, these private players can reject your claim if you do not inform them about your hospitalization within a week. This is just absurd indeed.

 

If you are an employed person and your employer has provided you the health insurance then also you should buy health insurance policy to cover you and your family. At the time of changing job you lose insurance cover in the transition period, so it is better to have a parallel health insurance.

Priority 3: Pension Plan - Sumit Khedkar

Priority 3: Pension Plan

 

One day you will retire. You will not be able to work. What will happen at that time? Who will provide you money? How will you manage your day-to-day expenses? You should plan your retirement in your thirties itself after that it is too late to plan. In case of pension plan the good thing is the earlier you start the better is the benefits. The most important thing in choosing pension plan is the pension plan must beat the inflation then only you will have enough provisions for the retirement. So, this is our thumb rule, we will evaluate pension plans by comparing them with the inflation rate.  

a. Pension plan from private players: 

We will first evaluate the private players first. Mostly all private players are offering same type of pension plan with some subtle differences. Most of the plans are in combination with insurance; this is a trick to hide low performance. See, we do not need accidental benefits or critical illness benefit with pension plans. We have already covered that risk in a better way in life and health insurance planning. My personal opinion is all private players are there to earn money they really do not bother about social security. Having said that, let's see what they are offering us in pension segment. 

I got following illustration from a leading private sector bank website. 

Pension plan:

Age at entry :40yrs                             Policy term : 20 years

Annual Premium : 50,000                 Premium payment term : 5 years

Assured benefit : 2,52,500 (Only)

 

  

    

In brief, you will be paying 50,000 Rs a year for first 5 years. Your money will be invested in the bank for next 15 years. After that you will start getting pension. And how much is the assured benefits after 20 years of investment it is just 2,52,500!!! Near about the same that you have given to the bank. Bank has utilized your money for 20 years and after that it is giving you the assurance of returning the same amount of money !!. This is indeed ridiculous.  And they advertise “Sir uthake Jiyo” !! with these kind of pension plans!!  

Now, consider the average and best case scenarios given in the above illustration.

In the average case scenario you will get pension of only 10,601 Rs annually and in the best case you will get pension of 49,323 Rs annually. Your accumulated savings will be yours only after your death!

Let’s evaluate this plan with our thumb rule that a pension plan must beat the inflation rate.

The average CPI (consumer price index) is around 7%. Hence the pension plan must return us more than 7% year on year and that too in the worst case scenario. The pension plan explained above gives us 0% returns in the worst case. This plan does not satisfy our thumb rule. 

 

Certainly this option is the worst available option. All private companies are making fool of people. Remember one thing, you must not fail is choosing or designing the pension plan. At the receding period of your career you cannot excuse that “Ohh, I had invested in the pension plan of XYZ bank, but the plan has performed worst, now I do not have money to manage my retirement life.” No one will buy that excuse.

 

b. Design your own pension plan: 

 

Now, let’s see if you would have done pension fund management by yourself with the same amount of money then how you would have performed.

 

Option1: Design your own pension plan with the help of Post Office investment options:

 

We can use post office’s National savings certificate (NSC) , recurring deposit scheme and monthly income scheme (MIS) as instruments for our own pension plan.

Post office’s National savings certificates (NSC) and Recurring deposit scheme give you around 9% year on year returns. There is no limit on the amount you invest and no TDS is deducted in NSC and recurring deposit schemes.

In line with the above mentioned plan suppose you invest 50,000 Rs yearly in recurring deposit ie. 50,000/12 = 4,167 Rs monthly, for the first five years and after maturity you reinvest the maturity amount in NSC and you do this for next 15 years. At the end of 20 years you will get a lump sum amount which you can invest in a monthly income scheme and start getting regular income.

Following table explains the calculations.

Year	Mode of investment	Amount invested	Amount  at maturity
1 To 5	RD for first five years	Monthly 4,167 Rs Total 2,50,000 Rs	3,16,090 Rs
6 To 15	NSC for 10 Yrs	Reinvest 3,16,090 Rs	7,69,739 Rs
15 To 20	NSC for 5 Yrs	Reinvest 7,69,739 Rs	12,01,185 Rs
At 20th Year	Total Returns	2,50,000 Rs	12,01,185 Rs

 

As per above calculation if you follow your own pension plan then at maturity you will have total 12,01,185Rs in your hand which you can invest in a monthly income scheme and start getting yearly annuity of 1,08,106 Rs. Everything is 100% guaranteed here there are no ifs and buts. And the good thing is your seed amount  12,01,185Rs is yours only. In worst case this pension plan is giving you 9% year on year returns hence this pension plan satisfies the thumb rule of beating inflation.

Now, let’s compare this plan with the plan discussed above.

 

Pension Plans	Accumulated Savings	Yearly Annuity	Guarantee	Returns	Remarks
Private bank's pension plan  in best case scenario.	7,38,242  Rs	49,323  Rs	No guarantee	6.50%	Accumulated Savings stay with the bank.
Your pension Plan	12,01,185  Rs	1,08,106  Rs	100%	9%	Accumulated Savings stay with you.

 

 

 

 

Isn’t your pension plan a better plan than the private bank’s pension plan? 

For those who are ready to put extra efforts, there is something more for you.

 

Option2: Design your own pension plan with the help of recurring deposit mutual fund and MIS (monthly income scheme): 

 

In today’s lifestyle as we grow our luxuries become our necessities. For example today a car may be a luxury for you but as you grow you will find it as a necessity. You need more money in the future as compare to your today’s need. Hence you should have a pension plan which gives you robust and guaranteed returns.

If you invest in debt then at maximum you can get 9-10% returns but if you aspire to get more returns from your pension plan then you should invest in equities. In long run equities give you around 15% year on year returns. As horizon of a pension plan is 20-30 years you get a long time period to maximize the returns using equities. And the safest way of investing in equities is investing in mutual funds using systematic investment plan (SIP). 

If I combine these two instruments viz. recurring deposit which gives me guaranteed returns and mutual fund which gives me robust returns in long run then this hybrid investment will give me guaranteed healthy returns. 

 

Let’s see the illustration in the example below.

 

Suppose your current age is 30 and you are investing 10K per month for your retirement.Out of the 10K if you put 5K in recurring deposit and 5K in SIP then after 30 years you will have total 91,53,717 Rs in your recurring deposit account (9% year on year returns) and total 3,46,16,398 Rs in your mutual fund account (15% year on year returns). To get regular pension from your investment you can put the recurring deposit returns in a monthly income scheme (MIS) and can convert the systematic investment plan (SIP) into a systematic withdrawal plan. Following tables will help you understand the illustration.

 

First thirty years of the investment period: 

Year	Mode Of Investment	Amount Invested	Returns	Amount At Maturity
1 To 30	Recurring deposit	5000 Rs per month, Total 18,00,000 Rs	9%	91,53,717 Rs
1 To 30	Mutual fund SIP	5000 Rs per month, Total 18,00,000 Rs	15%	3,46,16,398 Rs

 

Pension period: 

Year	Mode Of Investment	Pension	Returns	Seed Amount
31 To 60	Monthly income scheme	8,23,834 Rs	9%	91,53,717 Rs
31 To 60	Mutual fund systematic withdrawal plan	51,92,459 Rs	15%	3,46,16,398 Rs
	Total pension per year	60,16,293 Rs

 

Here, in any case you are getting 91,53,717 Rs guaranteed returns. The returns from mutual funds may vary.  However, if you invest vigilantly in good rated mutual funds then surely you will get better returns in long run.

 

c. National Pension System: 

 

National Pension System (NPS) is one of the best options available in pension fund management.

The Central Government had introduced the National Pension System (NPS) with effect from January 01, 2004. NPS was made available to All Citizens of India from May 01, 2009. Pension Fund Regulatory and Development Authority (PFRDA), the regulatory body for NPS, has appointed NSDL as Central Recordkeeping Agency (CRA) for National Pension System. CRA is the first of its kind venture in India which will carry out the functions of Record Keeping, Administration and Customer Service for all subscribers under NPS. CRA shall issue a Permanent Retirement Account Number (PRAN) to each subscriber and maintain data base of each Permanent Retirement account along with recording transactions relating to each PRAN.

NPS is offering around 12.5% year on year benefits, being controlled by PFRDA it is the safest and reliable option among all available options. This scheme also fulfills our thumb rule of beating the inflation.

 

You can open a NPS account in three steps.

 

Step1: Point of Presence (POP) :

Points of Presence (POPs) are the first points of interaction of the NPS subscriber with the NPS architecture. The authorized branches of a POP, called Point of Presence Service Providers (POP-SPs), will act as collection points and extend a number of customer services to NPS subscribers.

Almost all national and private banks have been assigned as POP for NPS. You can open NPS account online by using services from HDFC securities http://www.hdfcsec.com/product-services/new-pension-scheme/201008230423175468750

Or from ICICI direct http://content.icicidirect.com/newsitecontent/Home/Home.asp

 

Step2: Choose your pension fund managers:

 

The Pension Funds (PFs) appointed by PFRDA would manage your retirement savings under the NPS.

Following is the list of pension fund managers appointed by PFRDA. You have to choose any one from the list.

• DSP Blackrock Pension Fund Managers Private Limited
• HDFC Pension Management Company Limited
• ICICI Prudential Pension Funds Management Company Limited
• Kotak Mahindra Pension Fund Limited
• LIC Pension Fund Limited
• Reliance Capital Pension Fund Limited
• SBI Pension Funds Private Limited
• UTI Retirement Solutions Limited

 

    Step3: Select your investment options

           You will have the option to actively decide as to how your NPS pension wealth is to be invested in the following three options.

• E - "High return, High risk" - investments in predominantly equity market instruments.
• C - "Medium return, Medium risk" - investments in predominantly fixed income bearing instruments.
• G - "Low return, Low risk" - investments in purely fixed income instruments.

    

    

Auto Choice:

NPS offers an easy option for those participants who do not have the required knowledge to manage their NPS investments. In case you are unable/unwilling to exercise any choice, your funds will be invested in accordance with the Auto Choice option.

In this option, the investments will be made in a life-cycle fund. Here, the percentage of funds invested across three asset classes will be determined by a pre-defined portfolio. At the lowest age of entry (18 years), the auto choice will entail investment of 50% of pension wealth in "E" Class, 30% in "C" Class and 20% in "G" Class. These ratios of investment will remain fixed for all contributions until the participant reaches the age of 36. From age 36 onwards, the weight in "E" and "C" asset class will decrease annually and the weight in "G" class will increase annually till it reaches 10% in "E", 10% in "C" and 80% in "G" class at age 55.

Getting Your Money Out:

Vesting Criteria	Benefit
At any point in time before 60 years of Age	You would be required to invest at least 80% of the pension wealth to purchase a life annuity from any IRDA - regulated life insurance company. Rest 20% of the pension wealth may be withdrawn as lump sum.
On attaining the Age of 60 years and up to 70 years of age	At exit you would be required to invest minimum 40 percent of your accumulated savings (pension wealth) to purchase a life annuity from any IRDA-regulated life insurance company. You may choose to purchase an annuity for an amount greater than 40 percent. The remaining pension wealth can either be withdrawn in a lump sum on attaining the age of 60 or in a phased manner, between age 60 and 70, at the option of the subscriber.
Death due to any cause	In such an unfortunate event, option will be available to the nominee to receive 100% of the NPS pension wealth in lump sum. However, if the nominee wishes to continue with the NPS, he/she shall have to subscribe to NPS individually after following due KYC procedure.

 

NPS is India's answer to the US' retirement scheme- 401(K)-is a government-approved pension scheme for Indian citizens in the 18-60 age group. While central and state government employees have to subscribe mandatorily, it's optional for others.

For more details on NPS you can visit following link.

https://www.npscra.nsdl.co.in/citizens-scheme-informaion.php