Fortification of your finances:

What does fortification of your finances really mean?

The term fortification essentially means creating a defence or reinforcement that gives you strength against any attack or in other words – risk. True financial fortification would mean that your defence or support has to be very strong and all protective against any kind of risk of financial loss or expense. Essentially it would mean that you and your family is financially ready to deal with any unpleasant, unexpected developments.

Typically any person or family always is faced with some financial risks which may follow any unpleasant event like death of earning member or hospitalisation or accident or illness of any person. There are also many other type of financial risks, but we will ignore them for this article. Without adequate protection against death, disease, disability, etc., the long term financial goals of a family like education for children, purchase of home, marriage plans, etc. too are put on high risk.

Life insurance, health insurance, critical illness insurance and accidental insurance are tailor made products that help you in fortification of your finances. They protect by minimising the cash demands on your existing savings or wealth earmarked for your financial goals. By providing you with additional capital, the insurance plans should take care of your financial needs at such times. However, it has to be noted that the insurance protection cover has to be adequate to ensure that you remain in safe waters.

Here are some of our thoughts on your fortification of finances.

Emergency fund: The emergency fund is your first source of support should any unexpected development take place. There is no product for emergency fund however, it is very important that such money be kept in liquid assets. Mutual fund liquid schemes can be good avenues for keeping your emergency fund. The fund should be kept secured and whenever any withdrawals are done, it should be replenished back. Typically at least three to six months of your total household expenses should be kept in emergency funds. How much to save will depend on case to case basis and typically those with volatile income streams should have higher targets.

Life Insurance: While many of us have life insurance, typically the underlying product is a traditional insurance plan sold by your friendly insurance agent. Unfortunately, such plans normally have very low insurance cover which will prove to be inadequate for your family for sustain themselves for the future. So how much should be the cover for?

The life insurance cover should be able to

(a) repay all your existing liabilities,

(b) provide for all pending financial goals like education, marriage, etc., and

(c) provide for regular household expenses (inflation adjusted) for foreseeable future.

You may realise that your existing life cover will be very inadequate to meet all the above. Traditional plans will come at a very high cost for such cover and will be unaffordable. The only product that can meet your need is the – pure term insurance product which provides at the highest cover at the lowest cost. However, there is also an upper limit on same. We would recommend that you should sit with your financial advisor to really understand the cover you should take. Typically for a middle class family with four/five dependents should have term insurance of at least Rs. 1 to 2 crore.

Health Insurance: Health insurance is indispensable today and a must for everyone. There are many products available in the market that will help you smartly plan for health expenses of you and your family. Products like floater policies, top up and super top up products are popular and a good mix of right products will truly help you manage your financial risks in this regards.

The question here too is how much cover will be adequate? With fast rising medical health costs, the health cover amount should be regularly assessed. Typically a family should have at least 5 to 10 lakhs of family cover depending on your financial status and city. Buying a health insurance at early age when everyone is healthy is highly recommended as you may find it difficult to get a policy in future post any medical condition arises.

Accident Insurance: The accident insurance is another basic product highly recommended. It is more of an advanced product and protect you against hospitalisation, treatment expenses for certain kind of accidents. It will also protect you against temporary or permanent – partial or full disability unlike any other product. It will also provide you with protection against temporary loss of income post accident. Being an inexpensive product, it is highly recommended. The cover amount should be at least upwards of Rs. 50 lakh and if possible should be even higher than term insurance as family expenses will be very high post any disability /accident. However, getting a higher cover is not easy and will depend a lot on your income and nature of job.

Critical Illness Insurance: The critical illness is a bit more advanced product which you should explore. It would provide you with financial support when any critical medical condition develops. The need for critical illness is subject and if you have a family history or likelihood that a critical medical condition may develop in future then it is more recommended. Also, it can be seen as an extra layer of protection which you may opt for to further fortify your finances if you can afford it along with the basic insurance products. A critical illness cover of about 20-25 lakhs would be adequate for most people.

Guaranteed ways to lose money

We have discussed a lot of personal finance in our previous issues. But there also exist a lot of products or should we say things or habits that lead to wealth destruction. Every product and asset class has its unique features, but it is important to understand that every asset class is different from the other and is having its own peculiar risks. If you play with an asset class in the wrong way, it can destruct your wealth in a big way rather than creating it for you. Let's have a look at some of the practices, which help in losing money

1. Day Trading

Day trading, simply put is the activity of buying and selling the shares on a single day without taking any deliveries with a purpose to gain from the daily volatility in the stock prices. Day trading is the most common practice followed by new entrants into Equity investing. This would also apply to people who buy on deliver but to hold it only for a few days or weeks to benefit from trend movement. There are many so-called experts and even coaching institutions teaching this skill to others. 

It is the most exciting feature as the prospect of making lakhs by sitting in front of the screen and just guessing the right prices is a mouth-watering one. Always remember that fluctuations in share prices during the day does not truly represent the functioning of the company. The person who makes the most money through day trading is the broker. For an investor, the chances of making money in day trading are as good as winning a toss and true success stories are very rare and far in between. Even the people who claim to be experts earn more from teaching this to gullible persons than by earning through trading itself.

2. Investing in FD's over the long term

Investors are obsessed with the safety of their investments and jump on any product giving guaranteed returns. Fixed Deposits as an asset class are good for short term investments of say less than five years. Some part of your investment for long-term can also stay in debt products, including bank FDs. The key here is the asset allocation you are following. 

However, there are a very large number of individuals who only save in bank FDs. They generally start an FD for a tenure of say 6/8 years and then keep renewing it. But by doing so, the investor does not realise that it losing money as the value of money also keeps on declining due to inflation. So, if you have got an attractive return of say 8.5% on your FD and the inflation during the period was 7%, your actual rate of return is 1.5%. To make matters worse, if you are into say 30% tax slab, your real earnings will be a negative of 1.05% (8.5% less 30% = 5.95% less inflation 7%). Thus, your post-tax real returns are declining by investing in bank FDs. So, if you are investing for so many years, you are losing money as well as the opportunity to create wealth by investing in other market-linked products /equities.

3. Derivative Trading

Futures & Options are available in the stock market for the purpose of better price discovery and for hedging your investments. Unfortunately, these derivatives are used as tools for making quick money and they turn out to be more dangerous than day trading. In derivative trading, you can trade for 25 times more than the money you have.

So if you are having Rs. 100, you can trade for Rs. 500 through derivatives. So with the same investment, you can make 5 times more profit (and conversely 5 times more losses, wiping out your capital). There have been instances where people have lost their entire saings and even homes dabbling in derivatives. No wonder that they are called as 'weapons of mass destruction' by people like Warren Buffet. Derivatives are for use of professionals and playing in them without their guidance can be highly dangerous. Period.

4. Keeping cash

Another Myth for keeping money safe is to keep it in cash. Cash not only has its own risks for storage but is also the only asset class which gives “0” returns. The value or the purchasing power of your cash goes down continuously due to inflation. This can be best understood if you list down the items which could have been bought in Rs. 100, 10 years back and the price of those items now. You should keep cash only to ensure your basic needs. With the increase in popularity of digital payments, namely say UPI and rise of applications like Amazon, Flipkart, Big Basket, Bookmyshow, Google Pay, Paytm, etc., most of your payments can be done online or by using the QR code even at retail shops. So cash is effectively not required unless you need it. 

Going even a step beyond keeping cash, there is also this thought that too much money should not be kept in your savings account which is not earning anything from you. Keeping this money in products like mutual fund liquid funds which offer insta cash facility - immediate redemption and credit in 30 minutes at any time, subject to certain limitations, will provide a lot more earning opportunities for you. 

5. Using your credit card as a free money instrument

Credit cards are the most widely used instruments these days in place of cash. It gives a lot of conveniences as you don't need to pay at the time of purchase. In fact, you enjoy an interest-free period of up to 45 / 60 days on your purchases. But many a time, people tend to overspend on the credit card. It is important to pay your dues back on time, else you can be subjected to interest rates as high as 3.5% compounding per month (which works out to an annual rate of 51% interest). 

Never fall in the trap of skipping your credit card payments or paying “minimum amount due” as you start getting charged heftily on all transactions done then on. The interest rates are so high that if you default you might end up paying higher interest than the principal amount. Though, if you keep paying on time, there is no better option than a credit card. Besides you also keep earning reward points for the money spent by you.

It may take you a long time to create your wealth, but to lose it can be done in a matter of seconds. It is better to stay away from practices that can erode your wealth and make good use of every product available in the right way. That way, we will not only save wealth but also will be able to sleep peacefully.

The 7 Commandments of Investments

Being successful at your investments is not a numbers game. It is a mind game. Successful investing is a play of some basic things which can be practised and followed by anyone. Today, we bring these basic principles together in the form of 7 commandments of investments for our readers.

1. Asset Allocation is the key:

Studies have shown that asset allocation is the primary factor, the biggest determinant of how much returns your portfolio will generate. This is very simple to understand. For eg., if your equity portfolio is just, say 10% of your entire portfolio, inclusive of real estate, gold, bank deposits, insurance policies, etc., then it would not matter how well your equity portfolio performs. Having the right asset allocation is most important in the wealth creation journey over the long-term. And it begins by your understanding and having a proper look over your entire portfolio, not just that part which you can track daily.

2. Investing is simple but not easy:

Many investors often believe that to succeed and make money in the market, one has to be an expert, have inside information, try to best time the markets, predict what is going to happen tomorrow and so on. However, the most important fact to realise is that investing is very simple and based on some principles which do not need an expert to follow. Things like - being patient, starting early, saving regularly, following a right asset allocation, not making too many investment mistakes and staying invested for long or doing nothing are perhaps the most important factors for the success of your investment. Although these things are simple and easy to follow, in reality, they are not easy to follow at all.

3. Investing without goals is meaningless:

Often we invest without any goal or target. Most of our investment is also lying around without any purpose or target or any objective. On the other side, most of our traditional investments are kept aside for say retirement or marriage of daughter without ever planning or knowing the exact requirement for fulfilling those goals. Thus, most of us do not have goals and even if the goals are there in mind, they are rarely properly planned. Proper planning requires very little time or even expertise, however, it can prove to be very critical. Proper goal planning will ensure that your goals are never compromised and you fulfil them. Goal setting can be event specific and even general like wealth creation of say XX amount at YY date in future. Without goals, there is no direction and investments will be at the mercy of many different and less important things.

4. Investor behaviour is the reason for underperformance:

Many studies have shown the markets to deliver good returns but the investors are found to be under-performers by a great margin. The average market returns are always higher than the average investor returns. The gap between the two returns is attributed largely to investor behaviour. Investor behaviour, as per many studies, is found to be illogical and often based on emotion which is not good/wise for long-term investing decisions. An average investor typically buys when the markets are high, over-reacts to situations or short-term market events and sells when the markets are low. We are instantly reminded of the famous cycle of fear, greed and hope which follows every time.

5. A good financial advisor can contribution great value:

There is no doubt that a good advisor/ expert can deliver great value to your portfolio. An advisor's primary role is to manage investor's behaviour or emotions apart from everything else he does. An advisor will make sure that you do not sell or buy at the wrong time. This in itself has the potential to add great value to your portfolio. Further, an advisor is likely to suggest you the right, optimum asset allocation as per your needs, something most of us do not follow. Apart from these things, an advisor normally helps us to make our financial plan, save towards our goals, push us to save more, take proper insurance coverage, help ongoing management of the portfolio, operational support, and so on.

6. Equity is the best asset class in the long term:

From the past equity market experience, this is evident. Long term investment in equities will likely exceed returns from every other asset class. BSE Sensex returns since inception (1st April 2979) till today is nearly 15.8%. Just staying invested in the index would have multiplied your wealth by over 370 times in the past 40 years. However, there have been also many times that in one year the returns have been in negative 50-60%. The instances of negative returns steadily decrease as the duration increases and perhaps over say 10-15 years, the negative return instances (for investment at any point of time) is very rare to see.

7. Mutual funds are the ideal vehicle for investment:

One does expect you to perform like Warren Buffet who had the skills and the patience to identify and hold on to good businesses to become wealthy. Most of us do not have adequate time, resources, skills and information to go and find the winners. That is a full-time task of investment professionals. The next best thing for every one of us is to make use of the fund management team of mutual funds. Mutual funds, in essence, are vehicles for investment and the underlying can be any asset class or products. Mutual funds offer investors the widest choice of investment and many other advantages over traditional investments, including tax benefits and operational convenience and much greater transparency.

Newly married? Congratulations.

After all the music and celebrations of marriage die down, a new life starts and it is time to get back to the business of living like others. For the couple, this is a precious time – time to know each other, understand the family cultures and habits and to commodate to each other's lives. The time spent together learning about each other would be cherished for the rest of their lives.

Marriage is a true partnership between two individuals. As is mostly the case today, both individuals are earning and financially independent. As a new partnership begins, there are certain things to be considered also on the financial front – mutually. An open, transparent and realistic financial assessment and subsequent actions also may be done at this important juncture of life. So what is this assessment and actions we are talking about?

Identifying your financial goals:

The first step is identifying your shared financial goals. What can be these goals? It can be anything like – higher studies, buying of own house, buying a car, vacation plans, repaying existing loans, starting a family and so on. After settling in life, identifying your financial goals is the first important thing to do. However, finalising your goals sounds easy and may rather be difficult to finalise the same. So here is what one can do...

1. Discuss each other's dreams and aspirations and also the priority for same. One should be reasonable in their dreams and also be considerate to the present financial situation.

2. Dig deeper into what exactly is the goal – buying a home may sound ok but it is not. One needs to identify what type of house, how big should be the house, which locality, what amenities, when exactly is it targeted, etc. Only then the real picture can be drawn for the goal.

3. Put out an approximate target value to each of the goals, considering the inflation for the targeted period.

4. After the goals are shortlisted and break down the goals into short – medium – long term goals.

Prepare the financial plans:

After the goals along with time horizons are mutually agreed, the next step is to plan your finances. This starts with sharing the income and expenses budgets for the month between the couple. Estimated household expenses will have to be deducted from the combined income. The couple may mutually share some of the expenses between them. The balance savings will have to be directed towards the goals. You may also like to consolidate all your assets and liabilities to find the true financial picture for both. An expert can be consulted for doing this entire exercise.

Take Actions:

Once the financial plans are ready and you have your savings plan also ready with you, it is time for action. Choose the right asset class and products to invest in. There are a few things you need to keep in mind here too especially beyond financial goals. Every newly married couple should explore the following popular products...

Life Insurance:

Needless to say, life insurance is the most important thing you have to buy for the financial security of your new family. A pure term plan that gives the maximum financial security is a must-buy product. This will protect your spouse and also your family in case anything happens to either of you. Remember to buy the life insurance covers individually for both husband and wife.

The early you buy a life cover, the cheaper it is. Further, any medical condition developing at a later stage will also increase your premiums later. So it is better to buy term insurance of a good amount early in life.

Health Insurance:

Protection against health insurance is also now a big priority for you. With escalating health and medical costs, it will become increasingly difficult to manage affairs in case of medical emergencies. Note that the cover provided by your employer may not be adequate for and/or cover both of you. It is recommended that you buy an independent health cover to cover your family. The amount of cover should be at least 10 lakhs considering medical inflation today.

It is also highly recommended that you cover your parents in some health plans, even if they are financially sound. Medical care for the elderly is becoming very costly and having insurance as a backup plan is highly recommended. Perhaps it may be the right time start health insurance as your parent's age may not be too high now and policies would be available. As they age further and medical conditions develop, the policies will be hard to get by and also may be very expensive.

Sharing /update of records:

Another important activity a couple should do is to share the important financial records and documentation. Records should also be updated w.r.t. say nomination, company records for insurance, etc. Sharing of such financial information would make life easy for your partner to manage the state of affairs in case of any emergency or your absence.

Mutual Fund SIP:

From the savings plan that you have drawn for yourself, a mutual fund SIP is today like a no brainer. Done with a long term investment horizon of say at least 7-10 years, this investment method promises to deliver decent, inflation-beating returns better than any asset class. A SIP is an ideal way to invest for your long term financial goals and also for wealth creation purpose. The sooner you start, the more you save, the better it is for you.

A SIP helps you the best by enabling you to save little amounts every one from your budget. This SIP amount can also be increased automatically at a set frequency (say every six months or yearly) to match with growth in your income. It is important to note, however, that equities are a risky asset class and investments should not be done for a short term.

Emergency Fund:

It is also recommended that you create a small emergency fund for the family. This emergency fund can be an equivalent of say three to six months of your household expenses. The fund will keep you better prepared to manage and handle any financial emergency or temporary shocks you may come across in the short term.

Conclusion:

A marriage is a beautiful creation of society and mutual love and trust can make it even more wonderful. With proper financial planning and timely actions, you would also lay strong financial foundations for the long journey ahead. These financial foundations are not to be ignored as they will prove themselves and make your relationship even stronger as you go out into the world creating our own space.