After Body and Mind, Check your Financial Fitness Also

This week Our Prime Minister announced fit India Campaign “Body fit hai toh mind hit hai (If the body is fit, the mind is fit),” said Prime Minister Narendra Modi while launching ‘Fit India Campaign’ on National Sports Day celebrated every year on the birth anniversary of hockey wizard Dhyan Chand. 

In this day and age, tracking our health stats is very important and we all put efforts to make sure that our body is healthy. But what about our financial fitness?

Let us look at major parameters to know how healthy we are financially:

1. Spending Less then Income:

To be financial healthy it is very important that on cash flow basis we are in positive numbers. Means our monthly expenses should be less than our monthly income.

2. Paying all the Bills on time:

There are many utility/household bills like electricity, gas, phone, Credit card bills. Paying all the bills on time and in full is the good indicators of financial fitness.

3. Have Emergency Fund:

There are emergencies which comes without any prior announcements like medical emergency, job loss etc. In general, the more inconsistent our income is and the more dependents we have, the larger an emergency-fund cushion required. As a thumb rule we should have 3-6 months expenses as emergency fund in liquid mutual funds/savings accounts.

4. Have Sustainable EMIs:

Debt-to-income ratio (DTI) is a figure lenders use to gauge how well we manage our debt. To calculate DTI, add up monthly debt payments and then divide the sum by gross monthly income, the lower the DTI, the better it is. It should not be more than 40% in normal case.

5. Have a Good Credit Score:

Similar to a DTI, credit score is another way lenders measure how likely we will be able to repay our loan — and a lower score usually means higher interest rates on everything from mortgage to credit cards. Normally the credit score should be above 750+ in the scale of 900 to get loans easily at decent rates.

6. Have adequate Insurance:

Covering the risk is another important aspect to be healthy. Health Insurance, Life Insurance and Accidental coverage are important insurances. Having appropriate insurance allows individuals to be resilient in the face of unexpected expenses, such as the death of a loved one or a medical emergency. Every person should have appropriate insurance based on his age, income, number of dependents and risk exposure etc.

7. Have Sufficient Retirement Savings:

In today’s world when even government employees don’t have fixed benefits plan it is all more important to have Retirement savings looking at the socio economic structure and inflation. We all need to have sufficient retirement kitty as our longevity of age is also going up.

To keep our mind fit we need to be stress free. Financial wellness is the most important factor to remain stress free hence we all need to ensure that along with our body and mind we are financially fit also.

Insurance: Are you covering Risk or just saving Tax?

Almost all of us have insurance policies, many of us have actually multiple policies, mostly sold by someone known to us. But do we really know whether we actually need them and how much risk cover we are having?

We should keep in mind that an insurance policy is supposed to protect one against a financial loss in the event of a casualty or untoward event. In the case of life insurance policies, such an event is the untimely death of an earning member of the family, resulting in loss of future income. The best way to buy protection against such financial loss is to buy an insurance policy for an earning member of the family such that the risk cover (or sum assured) is as high as possible for the lowest amount of premium payable.

Most of the policy holders do not know the amount of life insurance cover they have but they know exactly how much premium they pay each year and also insurance agents generally push more on investment based insurance products rather than pure risk cover products. Why is it so, let’s understand it?

1. According to the accounting principles followed by the Insurance Sector, the premium collected by an insurer is booked as its income, while the risk covered is the firm’s liability. A pure term plan is a policy that gives the least income to the insurance company, while creating the highest liability. Hence, it really does make good business sense for insurance companies to sell investment-linked insurance policies, to shore up their income. 

2. Since income is the main criterion, insurers fix sales agents target based on premium collected rather than total risk covered. This leads to the agents to sell those policies where higher premium can be collected.

3. The seller’s commission is linked to the premium and not the cover. Therefor pure insurance policies tend to lose out to investment-cum-insurance products in sales.

4. The Income tax deduction under section 80C is linked to the premium paid and not the risk cover. Therefore investors also focus more on the premium amount and how much they will save on tax rather than the risk cover.

5. The normal human psychology is to get something when we are paying for it. In pure term insurance policy a policy holder do not get anything if he survives over the tenure of the policy which makes it unattractive. But we should compare it with mediclaim or vehicle insurance where we don’t get anything if there is no claim.  In case of life insurance policy why we always want something. Read my earlier post Mutual Fund + Term Insurance: Best of both Worlds for to understand that how term insurance and mutual funds can give much higher returns as compared to traditional policies.

The most suitable policy for providing such protection is a pure term plan. Whenever a person tries to sell an insurance policy, we should ask for a comparison of features and costs across the various options available. The first step in buying insurance cover is to calculate one’s need. The next step is to find which insurance policy would serve the purpose.

As for tax planning, many options besides insurance are available. If we want to take risk, invest in an equity-linked savings scheme. If we do not want to take risks, there are longer-term bank fixed deposits, NSC, PPF, SSY etc.  which come under Section 80C. Certain expenses like: Children’s tuition fees, the principal repayment part of the home loan EMI, etc. are also eligible for Section 80C benefits:

We should always remember: As a life insurance buyer, our primary need is to get a risk cover. Focus on that. That will save us from mis-selling, too.

Mutual Fund + Term Insurance: Best of both Worlds

Investments comes for our help when we are there for long time and insurance rescues our family from financial crisis when the earning member is no more. Investment and Insurance both have their own importance but most of the time we get confused or confused by others and club both of them by this popular product called endowment plan - without realizing that these endowment plans give a return of 3% to 7% only. The best strategy that the layman investors could adopt is to take protection plan or what we most commonly call the Term Insurance cover and top this up with a Systematic Investment Plan (SIP) in an equity Mutual Fund Scheme.

A term insurance plan is an insurance cover taken by on the life of the person insured. In case of unfortunate death or disability or critical illness of the person insured, the beneficiary i.e. nominee shall receive the sum assured under the policy; however in case of survival the policyholder shall receive no return.

(A) Features of a Term insurance policy

1. This plan covers risk only: No return if nothing happens

2. Cheapest form of life insurance: The premium is as less as 10% as compared to traditional plans

3. Most suited for sole bread earners of the family: With less premium we get maximum coverage

4. Tax Benefits: It has same tax benefits under Section 80C of Income tax (max. limit 1.5 lakhs)

(B) Systematic Investment Plan of Mutual Funds

SIP or Systematic Investment Plan is a disciplined and a systematic way of investment in mutual fund schemes. Usually in India systematic investment in mutual funds is referred to as SIP. The investment can be made in any scheme i.e. equity, debt, gold or a blend of these. In SIP the money is directly debited from the investor’s bank account on a predefined day of each quarter/ month or week. The mutual fund scheme could be debt or equity oriented fund and can have tax saving equity linked saving schemes (ELSS). The below matrix suggest the various types of equity and debt oriented mutual funds, the risk return Matrix and their debt equity profiling.

For Example Let’s take LIC’s Most popular Plan New Jeevan Ananad:

For a thirty year old person the premium for 1 crore cover for 35 years tenure comes to Rs. 2,99, 434 annually or monthly premium of Rs. 25,516. For the same person if he takes LIc’s Amulya jeeva Policy (a Tem Insurance Prodcut) the Premium Comes to Rs. 32,096 annually or Rs. 2,675.

Suppose Mr. A takes Jeevan Anand and Mr. B takes Amulya Jeevan and invests remaining amount in Equity Mutual Funds. Let’s see the outcome:

Particular*	Mr. A takes : LIC's Jeevan Anand	Mr. B takes: Term Insurance + MF SIP
		LIC's Jeevan Amulya	Equity MF SIP
Monthly Premium	24,417.00	2,312.00
Service Tax	1,099.00	416.17
Total Monthly Premium	25,516.00	2,728.17	22,105.00
Timer Period	35 Years	35 years	35 Years
Death Benefit	1 Crore	1 Crore	NIL
Survival Benefit	Simple Annual Bonus + Final Bonus	NIL	Market Based Return
Assumed Bonus/ Return Rate (Annual)	6%		15%
Maturity Amount	2,45,27,244.00	NIL	15,30,39,096.00
*For A 30 Year old person and 35 years tenure

As we can see from the table above the maturity amount for Mr A comes to around Rs. 2.45 crores whereas Mr B who has taken combination of term insurance and mutual funds the total amount could be as much as Rs. 15.30 crores which is more than six times compared to Mr A who has taken Endowment Policy only. The difference in total return is really huge and makes a significant difference in the person’s wealth.

However, we should note that endowment plans are assured benefit products, in other words on maturity the insured will get the sum assured, plus the bonuses declared by the life insurance company every year. On the other hand, in the case of term plan + MF ELSS, maturity benefits are not assured, because there are no survival benefits in term plan and mutual funds are subject to market risks.

Further the 15% returns assumption for ELSS, is a critical element in financial case for term plan + ELSS versus an endowment plan. In the last 15 – 20 years, monthly SIP in top performing ELSS would have yielded more than 20% annualized returns, so this type of return can be expected in future. 

Life Insurance as Investment is that makes sense??

Insurance is very important for every individual but is it right to mix it with investment products, different peoples will have different opinions lets understand the pros and cons of mixing insurance with investments.

1. TRADITIONAL POLICY GIVES LESS COVER

If we buy traditional investment policies the life cover offered by them is quite low as compared to buying a term insurance plan. Generally traditional plan offers 10 to 12 times life cover. So for example a person aged 30 years group wants one crore life cover, he may need to have policy of about Rs. 10 lakhs annual premium to cover that much insurance. Overall return of these products range between 4-6% P.a. Same person can get one crore insurance cover in Rs.12000-15000 by purchasing a term insurance cover. The remaining amount can be invested more smartly in other investment avenues where he can get 8-12% returns.

2. WE GET OBSSESSED WITH TAX SAVING

Another major reason for buying insurance is saving tax. Historically if we analyse the data, last quarter of the financial year gives as much business to insurance companies as the other three quarters together. In the last minute planning people buy insurance just to save tax; not for insuring themselves and without understanding the implications and future commitments, this results into lots of policy lapses later on.

If a person’s objective is to save tax then insurance may not be the best option for tax saving. There are various other instruments available which offer tax savings as well as better returns. PPF (8% tax free), NSC (8% but interest is taxable) and those with daughters below 10 year can even opt for the Sukanya Samriddhi Yojana (SSY) that offers 8.5% tax free.

NPS and ELSS can also be a good option for investors who are willing to take some risk. These two offers market-linked returns. In NPS the investment gets locked till retirement and only 40% of the corpus is tax free. In ELSS funds the investment is locked for three years and have the potential to give significantly higher returns, though the risk out there is also higher. For ELSS like PPF the amount received is also tax free

If we compare the returns of a traditional endowment plan with PPF and term plan combined or with ELSS funds and term plan combined we see the eye opening difference between their returns. If we assume a return of 8% for the PPF and 12% for the ELSS fund, both combinations would give far better returns and higher insurance cover to the buyer.

3. WHY PEOPLE STILL BUY IT

Although they do not offer very high returns but still people buy it mainly

•      High Commission to agents : As other products like term insurance and ULIPS offer very little commission compared to traditional products, agents always try to push traditional policies. Generally the agents are from some reference and people could not say no to them and buy these policies.
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•      They enforce a saving habit in the policyholder : These policies are generally for very long duration (20-30 years) and the agent keep on reminding (although more for their own commissions) to pay , Further people take it as a responsibility towards their families and afraid of losing money due to lapsation they keep it alive.
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•     Time value of money: Generally people don't realise that the huge maturity amount being projected may mean little after 25-30 years.  The Payouts in these polices are not given as lump sum but are spread across the years, which reduces the net return significantly.

4. SO WHAT SHOULD WE DO??

Well as mentioned above it is better to keep insurance and investments separately. Normally we should have insurance of ten times of our annual income (though it may vary based on future responsibilities and expenses). Term insurance can be a better option which gives a large coverage in small premium. The remaining amount can be invested base on a person’s risk appetite and requirements. For example if he needs to save more for tax saving under section 80C then for risk averse investors PPF, NSC or SSY are right options and for those who are willing to take risks NPS and ELSS are right products.

For general investments other than tax savings, mutual funds could be a good choice where a person can invest in Debt funds, Balanced funds and Equity based funds based on a persons need and risk appetite.

Every person should have insurance however the insurances should be brought for the main purpose of insuring the family towards some unexpected events not for tax savings or investment purposes.

What we should not do in tax planning !!

Last quarter of the financial year is known for tax planning. Salaried employees get the notices from their HR and deadlines to submit the proof of tax saving and we all rush to invest in tax saving instruments. In this urgency, sometime we just focus on tax saving without understanding the long term implications of that particular investments. Tax planning is very important as it helps to pay less income tax. Something everyone wants. But smart tax planning will help you boost your portfolio. The actual tax strategy will have a different meaning and emphasis depending upon an individual's personal circumstances.

1) Have a holistic picture not in isolation

Generally we think tax planning in isolation and not from an investment point of view. Hence the approach is often to grab up investments that will give them the tax break, irrespective of whether or not it will help them reach their financial goals or fit into an overall investment strategy.

Tax planning investments are no different from conventional investments. Hence, it is imperative to obtain an in-depth understanding of all investment avenues available which offer tax benefits and choose suitable ones that will help save tax and achieve goals.

Most investors in a crazy dash to meet their Section 80C requirement will opt for unit linked insurance plans, or ULIPs, and endowment plans and often end up with products that do not suit their need.

Life insurance should never be bought with the intention of saving tax. Tax saving is just one of the benefits that come along with it. The main benefit is the provision of finances in the case of death of the policy holder.

Approach tax saving with a holistic mindset. For instance, if your portfolio is heavily tilted towards debt, it would not be wise to opt for an investment in National Savings Certificate, or NSC. Instead, think of an equity linked savings scheme, or ELSS.

2) Tax saving is not just by fixed-return instruments.

Individuals tend to look at the Senior Citizen Savings Scheme, or SCSS (current interest rate 8.5%), 5-year deposits, National Savings Certificate (NSC) and Public Provident (PPF) (current interest rate 8%) as the tax-saving investment avenues. Looking at the current interest rate scenario where the interest rates are expected to fall further fix interest rates offering options are going to become further unattractive and investor should look at other options which can offer better yields.

Under section 80C we can also invest in an equity linked savings scheme, or ELSS. These are diversified equity mutual funds that offer a tax benefit under Section 80C. They have the lowest lock-in period of just three years. As of January, 2017, the ELSS category average delivered an annualised 3-year return of 18.5%.  Scheme wise the highest return was 27% while the lowest was 12%.

However we should keep in mind that these are equity funds which means, the return is not guaranteed. So select a good fund that has shown consistent performance and stick with it over the long haul. Don’t be in a tearing hurry to sell the investments just because it has completed the mandatory three years. Exit from the fund when the market is rallying or you actually need the money so you walk away with a profit. If this means hanging on for a few more years, do so.

3) Its not just 80 C, Don’t ignore the big picture.

Tax saving is more than just investments and goes beyond Section 80C.

If you have made a donation to a charity that offers a tax deduction under section 80G, avail of it. If you are paying premium on a medical insurance policy for yourself and dependents, be sure to claim the deduction under section 80D.

Also, if you are servicing a home loan or an education loan, you are eligible for income tax deductions. Under Section 80C, you can even show the expenses of your child’s education to avail of a deduction under section 80E and interest on home loans can get exemption under section 24E.

When deciding how much to invest to max your deduction under Section 80C, take into account children’s tuition fees, principal repayment on home loan, contribution to employees provident fund (EPF), and any life insurance premium you are paying and then decide the remaining amount to be invested and plan it accordingly.

Finally

As an investor/tax payer, by smart investment planning we can convert the tax savings compulsions to wealth creation opportunities. For that we have to just go beyond the traditional option and look at all the options with the clear objective in mind.