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
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.
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
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
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.
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.
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:
Pension period:
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.
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.
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:
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.
Priority 4: Child education Plan
Child education is one of the biggest goals of parents these days because of the tough environment and high expenses involved. These days most of the parents want to send their kids abroad for higher education. In today's value abroad education costs nearly 40-50 Lakhs Rupees, after 15- 20 years the cost will be much higher. If you do not plan for this early then you will have to shell out your life time savings for child education. Similar to the pension planning here also, the important thing is, your child education plan must beat the inflation. Hence we will evaluate all available options considering the inflation in mind.
Investing all amount in the high risk instruments can jeopardize your kid's dreams therefore you must balance the investments between the high risk high returns instruments and the low risk guaranteed returns instruments.
Like pension plans there are number of private players in child education planning too. But, all of them offer nothing but a mutated version of ULIP as a child education plan. Having said that, let's see what the private players are offering us.
I got following illustration form one of the leading private companies' website.
The takeaway from this illustration is as follows.
Total money you will be investing in this plan in the span of 23 years is 29,420 * 23 = 6,76,660 Rs
And the guaranteed returns after 23 years are 6,90,000 Rs. It is almost 0%. I wonder, how one can secure his child educational aspirations with this kind of a plan. If you ask these private companies about the dismal returns of their investment plans then they say we offer you insurance benefits with these plans!!! Insurance benefits what the hell!! I need money for my child education, I can better insured myself with other pure insurance plans.
Your child dreams can never be secured with these kind of plans. One should never go for this option.
Design your own child education plan:
Option one: Using a PPF account (Public provident fund account):
Do you know, you can open a PPF account in the name of your child. If you open a PPF account for your kid and invest 29,420 Rs in it annually then after 23 years you will get total 21,44,455 Rs. And this is 100% guaranteed.
As compare to the private bank's child education plan your own plan is giving you 350% more returns.
Option two : Using a PPF account and mutual funds:
In long run mutual funds give you around 15% year on year returns. As horizon of a child education plan is 15-20 years you get a long time period to maximize the returns using mutual funds.
You can optimize the performance of your child education plan by investing partially in PPF and partially in mutual funds.
Let's see, how much benefits do you get if you invest 50% of the amount in PPF and 50% of the amount in mutual funds.
The above table shows you that if you follow this plan then you will get total returns of 39,95,514 Rs out of which 10,71,790 Rs are 100% guaranteed.
You may have a question that if in long run I am going to get 15% returns from mutual funds then why not invest in the mutual funds only? My view is, the history tells us that mutual funds give good returns in a long run, however it is not guaranteed, the returns may vary. In case of child education plan and pension plan we need some guarantee. The fate of your child and your retirement life depend on the child education plan and the retirement plan you choose.
Hence, I prefer a hybrid investment plan consists of guaranteed return instruments and high risk high growth instruments. How much to invest in each instruments in the hybrid plan is totally depends on your risk appetite. If you are like me then you will prefer to invest major chunk in guaranteed return instruments.
Priority 5: Emergency fund
Nobody knows what is going to happen tomorrow. It is better to be ready with a contingency plan. I am 30 year old and if you are of my age then you would have encountered at least two recessions by this time. Of course, recession will not be there forever but what if, you lose your job tomorrow. How will you pay your next month’s EMIs? How will you manage your day to day expenses?
One should have an emergency fund using which he can survive for at least 4-6 months. Your emergency fund should be six times your monthly obligations and monthly expenses. If you need one lakh rupees per month to pay your EMIs and manage your household then you should maintain an emergency fund of four to six lakh rupees.
The best way to maintain an emergency fund is investing in bank fix deposits. Bank FDs give you 9 to 10% returns and FD is a liquid asset as well. If you are in need of money then you can liquidate your FDs at any time.
Creating emergency fund using bank fix deposits is a onetime solution. Once you have built the required emergency fund you will not have to bother forever in your life. The fund value will grow with the time and you will remain protected forever.
Following table will help you understanding the concept.
At the age of 60, value of your emergency fund will be around 80 Lakhs!!!. You can go for a world tour with this money if you will not use it in your life time.
You need a short term emergency fund also, to support sudden unexpected expenses. Like, in case of hospitalization most of the hospitals ask you for a deposit of 15-25K Rs. If your car is broken then you need at least 10-15 K to fix it. Hence, it is a better idea to have short term emergency fund ready. In today’s value you need at least 20-30K in your short term emergency fund. You should put your short term emergency fund in a separate savings account, not in your salary account. Maintaining emergency fund in a separate account ensures that the fund remains untouched and it is always available to you.
Priority 6: Investments in safe heavens. Hedging against inflation
Each and every person aspires to be an affluent person and has a dream of prosperous life.
One can think that by earning money one can become rich. Of course, earning money is a necessary condition but it is not a sufficient condition. One should acquire wealth from the money earned then only the prosperity will come. The earlier you start acquiring wealth the better will be the affluence.
All above mentioned top five priority things help you in fulfilling your financial responsibilities and reducing your financial worries. Point number sixth and seventh will help you in acquiring wealth.
It is better to invest in safe heavens first than the high risk instruments. The safe investment options such as bank FDs, national savings certificate, tax free bonds and gold etc keep your investment safe and secure, and give you moderate returns to hedge against inflation. When you acquire sufficient wealth using safe investment options you feel confident and safe and you become ready to take risk on the backup of your safe investments.
Following is the list of safe investment options.
Priority 7: Investment in high growth instruments
Once you have acquired sufficient wealth in the safe investment options you should look for accelerating the growth of your investments. To accelerate the growth of your investments you need to take risk. You need to invest in high risk high growth instruments. Such as equities, mutual funds, real estate etc.
If you follow the overall strategy of this article then before investing in the high risk high growth instruments you would have addressed all of your financial worries and you would have acquired sufficient wealth in the safe investment options. This is important when investing in high risk options. In case of high risk investment we can mitigate the risk factor by increasing the tenure of the investment. We can only increase the tenure of the investment when we are not in need of the invested money i.e after all of our essential financial needs have been fulfilled. By increasing the tenure we can get guaranteed robust returns from the high risk investment instruments, and hence, we can convert them into safe investment options for us.
Hence, in the investment ladder I give last priority to the high risk investment instruments so that one can invest in high risk instruments with no worries and with full of confidence.
Following is the list of high growth investment options.
Priority 8: Managing your expenses
Actually this point should be the priority one point because if you could manage your expenses properly then only you will have money to invest. However, as the wise man says you should invest first and then spend hence I listed this point at the last.
Managing expenses is an art, if you want to live happily then you should be well versed in it. There are people who earn less but live happily and there are people who earn a lot but still find themselves struggling with the finances. This is mainly due to their expense management.
You won't find any financial institution offering you solutions for expense management you will have to do it yourself. If I tell you that you can accumulate wealth by properly managing your expenses then probably you won't believe in it. Expense management is a vast topic and hence needs a separate article on it. You can visit my following article on expense management.
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