Plan your Finances!
Things that no one tells you while entering adult life.
Let’s start from basics learn to manage your finances?
It’s pretty simple, we all are dependent on our parents for our survival in our initial 20-25 years, then we start making our own money. If we rent our time in exchange for money, chances are that our earning potential will come down post the age of 60-70 or after we retire. There is a need to build a corpus for our retirement, for our children’s education, for the world tour we have been dreaming about all your life, for various challenges that life throws at us.
If we are not intentional about what to do with our money, chances are we will spend what we earn and not save enough for all these goals.
So, let’s try and understand in a very simple manner, how should we plan our finances.
- Getting the basics sorted (Building an emergency fund)
- Protecting against life’s unforeseen circumstances (death and medical emergencies)
- How to beat the inflation and make your money earn for you (investing basics)
Getting the basics sorted – building an emergency fund!
What if I lose my job?
What if my partner loses their job?
What if another ‘black swan’ event happens?
In the VUCA world that we are living in, there is every possibility that a major event leads to total disruption which impacts our earning sources. When a disaster strikes in the form of a job loss, medical emergency or death, life goes on. Our expenses, our EMIs, our rents do not stop.
An emergency fund is like a seat belt. If there is a sudden impact on your life-as-usual, this is the first fund you access.
How much amount I should have in my emergency fund?
Ideally, you should maintain six-months of living expenses as an emergency fund in liquid form or in any short-term investment sources which are easily liquid.
If you are a dual-income couple, the probability of hitting an emergency reduces. In that case, you may maintain three-months of living expenses as emergency fund.
Living expenses should include all expenses, rents, EMIs, school fees, utility bills , etc.
You may keep the emergency funds in sources which are easily liquid and accessible during an emergency say short-term Fixed deposits, ultra-short-term funds, etc.
Protecting against life’s unforeseen circumstances
Not planning for medical emergencies or an unfortunate event of untimely death of an earning member of the family, is a sure shot way of upsetting your finances by burning a deep hole in your pocket. If the medical treatment requires multiple procedures and prolonged hospitalization, chances are it might even lead to a debt situation.
Medical and Life insurance are like air bags in a car. They absorb the shock and protect your life. Let’s try and understand each one in detail.
Planned or unplanned medical costs can be significant, especially in India where public health services are not of the greatest quality. We have seen many examples in our respective circles, where Covid treatment or treatment for any other major illness has eaten up the life savings of a family.
A good medical cover provides you a cushion for these unplanned emergencies.
But there are so many products available in the market nowadays, so many people selling the policies, how do we decide which option to go for?
- Co-pay clause: Ensure that the policy doesn’t have a co-pay clause. A co-pay clause essentially means that you will have to pay part amount for every claim you make. Say an 80-20 co-pay policy means that if you spend Rs. 10 lacs for a hospitalization, the insurer will pay only 80% of the amount that is Rs. 8 lacs and you will have to bear Rs. 2 lacs from your pocket.
- Sub-limits: Check if your policy has any sub-limits. Typical sub-limits include maternity cover, robotic treatment cover, room rent sub limit, etc.
- Waiting period / Exclusions: Do check your policy for what ailments are excluded from the cover. Some insurers have a specific waiting period of 1-3 years for pre-existing diseases. Say, if you have diabetes mellitus or hypertension, the treatment for the same will not be covered in the specified ‘waiting period’
- Exceeding room-rent clause: It is a general rule that if you exceed your room-rent by a certain amount, your claim will also be settled in the same ratio.
Say, your policy covers room-rent up to Rs. 5000 per day. But you got admitted in a room having per day room rent as Rs. 8000, for 5 days. The overall reimbursable hospital bill (excluding consumables) is Rs. 8 lacs, and you have a cover of Rs. 10 lacs. You are happy that the insurer will cover Rs. 8 lacs minus Rs. 3000 per day (ie. 3000*5= Rs. 15,000) and expect the insurer to bear Rs. 7.85 lacs. But, to your surprise the insurer clears only Rs. 4.85 lacs. This is because, if you exceed the room rent, the overall claim is processed in the same ratio (5/8 of Rs. 8 lacs in this case, minus Rs. 15,000 as deduction of excess room rent).
So, it’s always better to choose a policy with a higher room-rent limit.
- Other considerations while choosing a medical insurance policy is coverage of ‘day care’ procedures, OPD limit, no-claim bonus, pre and post hospitalization coverage, etc.
- Also, don’t forget to check the ‘claim settlement ratio’ of the insurer you are going for.
I get that this is indeed quite complex to understand for a person, who has no exposure to insurance products, but trust me, some amount of time invested in this area, and you will be able to take a right decision for you and your family. And it will be worth the effort and will surely make you feel like a carefree superhero.
Now, let’s talk about the second air bag which is having a good ‘Life insurance’ policy. We rarely think about death as it is the worst case scenario. But it is important to secure our family’s future if they are dependent on you.
The amount of life cover totally depends on how many lives are dependent on your earning.
If you are single person or a dual income group, with no dependents, then you don’t need a life insurance. But, if you have your spouse, your kids, your parents’ dependent on you, you definitely need one. One important thing to remember is to never mix your insurance and investments. You will receive plenty of requests from your insurance agents about so-and-so plan which considers life insurance cover as investment, you can get your premium back along with some interest on it, and on top of it, you’ll get tax-benefit. Chances are you will get lured, because who doesn’t like their money back along with an interest.
Trust me, in long run this is a not a good deal.
Buy insurance only for the purpose of insuring your life i.e. Pay a premium in exchange of an amount which will be paid to your nominee in case of your death. This is a basic insurance plan and is the cheapest.
Many people belief that the premium paid for insurance is a ‘waste’. It is actually a price you are paying to secure your loved one’s future. And we all should pray for it to go ‘waste.’
The hybrid plans which mix insurance and investment are costly because if you calculate their rate of return is usually below the rate of inflation. That means even though you are getting your money back, but the real rate of return is almost negligible. It is better to invest your money in some other instruments, which are specifically meant for investment and give you higher returns of 12-15 % and real rate of return of 6-9%.
Let’s come back to how to decide the ‘sum insured’.
A standard rule of thumb is that you need 8-10 times of your take-home income plus any debt you have. Say you are earning Rs. 10 lacs per annum and have a home loan of Rs. 30 lacs. Then ideally you should buy a cover for Rs. 1 cr – 1.3 cr. (i.e. 10 *10 lacs + 30 lacs)
Remember to check the ‘claim -settlement ratio’ of the insurer before finalizing one and always to go for a ‘basic life insurance plan’ rather than ‘bundled products’.
Making your money ‘make’ money for you
Now that we have our seat belt and air bags in places, we can speed up and enjoy the thrills of life. We can go for investing our money. Investing means your money makes money for you while you sleep.
We don’t need to have a huge sum of money to start investing. You can start with as low as Rs. 500 per month. To understand investing you need to understand the spectrum or risk and return. Actually, you just need to remember one phrase – ‘low risk-low return, high risk-high return’. Your risk appetite will determine the amount of returns you can earn.
On one extreme is a zero-risk situation, where you keep all your money in the form of cash in a safe at your home, you will give zero returns on it. In fact, if we adjust for inflation, you will lose money, with a negative real rate of return. On the other extreme is stock trading or options trading where your entire capital is at risk, but there is potential to multiply the money in a very short span of time.
We should plan our portfolio as per our financial goals classified as – short-term, medium-term, and long-term.
- Short -term goals will include getting married, vacation planning, buying a house, buying a car, etc.
- Medium term goals might look like children’s education, children’s marriage, vacations, etc.
- Long-term goals will be planning for retirement, leaving a legacy for our children, etc.
We must be very conscious and intentional while building our investment portfolio by including all kinds of instruments to diversify the risk. Some of the investment options are:
- Fixed deposits / recurring deposits
- Government social security schemes / pension schemes
- Equity Mutual funds
- Real estate
You may choose appropriate instruments as per your risk appetite. Say you are a person who likes to take low risk, then your portfolio can have Fixed deposits, PPF, Gold bonds, and a few mutual funds of low-risk category. You can earn an average interest of 7-9% through correct allocation.
In case you are comfortable taking moderate amount of risk, then Index funds are a good option for you. Index funds are funds linked to key market indicators like Nifty / Sensex.
The return on Gold / Real estate totally depends on your buy and sell cycle. Both gold and real estate go through huge high and low cycles. The return across a few years when the real estate market is booming will be pretty high vis a vis a period when the market is not doing well. Over a long-term period, return on gold / real estate averages out. But if your timing is right, you can make good returns through these asset classes. It is the same as stock market, unless you are a professional and have inside knowledge about the sector, its better to stay away from these asset classes.
It is best to outsource this work to experts. There are dedicated fund managers, who take the buy, sell and portfolio readjustment calls for you in case of mutual funds. Mutual funds charge you some management fee for the same. But, in turn you get returns in the range of 8-20% depending on the nature of fund. This is called calculated risk-taking.
National Pension scheme is another good instrument where you can invest your money for long term basis your risk appetite. It also gives you additional tax break and is a great source of investment for your long-term goals or retirement plans.
Fixed deposits, Voluntary PF and PPF are relatively safer options and give you returns in the range of 6-8%.
So, take out a piece of paper and a pen, or better, create an excel sheet with the amount of disposable income you have, what average return you wish to get and create your portfolio by balancing the risk and return as per your needs.
Do remember the power of compounding. Over a long-term period, getting even 0.5% more will make a lot of difference to your actual returns. So, be extra cautious about investing in the right instruments.