Why we buy insurance products?

The first financial product that I bought (around two decades back) was an Aviva ULIP policy. The amount of time I spent in choosing the policy was 10 minutes (to get rid of that agent). The premium amount I was convinced to choose was exhausting my Sec 80 limit (1.2 lakhs per annum) for income tax purpose. The worst part, I was single with no financial responsibilities and barely starting my career. 

This is the classic case of mis-buying (I don't call it mis-selling) simply because I was 

• Not sure what does investment means
• Did not understand meaning of "insurance"  
• Wanted to cover my a**, by saving income tax

Thankfully, I learned, understood and got richer in the personal finance world. I closed my ULIP after two premiums, thus spending 2 lakhs to learn a valuable lesson. Don't "invest" in "insurance".

The key points to understand is, don't buy insurance because 

1. You want to save tax
2. You want to grow your money by investing
3. As a diversification tool
4. To get rid of agent/relative selling the product
5. You are a conservative investor and dont know where to park your money

The only valid reason to buy any product containing the name "insurance" is to ensure that if you die during your working life, your family does not face financial burden. 

Let's keep aside emotions for now and think purely in practical terms. 

Do the following cases cause any financial implications to family if following person dies :

1) If your 2 or 5 years or college going child?

2) Unmarried person with parents still earning?

3) Housewife with no earnings or loans?

4) 65 years old widower with children settled and earning?

If the answer to above question is "No" for all cases, then I still don't understand why people take life insurance policies in the name of their kids or parents, on which there are no dependants. 

The only type of insurance policy you ever need is a TERM policy. It provides the cheapest risk cover. Since any other type of insurance policy whether it is endowment policy, whole-life policy, money-back policy or ULIP, they are combination of (term policy + saving scheme). 

The term-plan component provides the risk-cover and the saving scheme provides the cash value. As a matter of fact the term component is costlier than a stand-alone term policy and the saving scheme gives marginal returns compared to other investment avenues. 

I have heard many a times the argument "If I survive, term plan will return nothing, but other policies will give me back some money!!" This is the most stupid argument you can find. Why it is so difficult to understand that they are giving back your own money with marginal returns and charging you for that? If you have invested that surplus money in an MF over same period, you would have got much more. 

The simple fact is that insurance companies are into a profitable business and hence any premium calculation they do for any policy is going to be more profitable to them rather than the customer. I am yet to see an insurance product that beats the (TERM + MF) combination over the policy period.

Cardless Cash Withdrawl

Many banks (recently ICICI) have started providing facility to do "card-less cash withdrawal" from ATMs. The idea is similar to fund transfer, except that instead of recipient's account number, you provide his/her mobile number. The bank will generate unique sender code and SMS the receiver code to recipient's mobile number. You call up the recipient and tell your sender code along with amount to withdraw. The recipient can use these codes to withdraw money from ATMs without any ATM card. 

The idea is good, but currently there are several issues

1) Not every ATM of the bank will allow card-less cash withdrawal. It seems banks need to upgrade ATM software to allow this facility. 

2) Inter-bank ATM withdrawal is not available. So you need to withdraw from the same bank ATM. 

3) Every transaction (successful or failed) will cost the sender a fee (Rs 25 for now)

4) There is a upper limit on the amount that can be transferred

5) It requires sender to register for both internet banking and mobile banking

6) Sender needs to register the recipient. I thought a simple mobile number entry should have been good enough.

This is not really a new thing world-wide. Several banks in other countries have some or the other variation of card-less cash withdrawal facility. 

What I would like to see is allowing a limitless self-withdrawal facility with just my mobile phone. Something like this

A card-less self-withdrawal will be really cool and highly useful, since then there is really no need for ATM card ever. 

A better option would be to use bio-metric identification, like this

Real Estate - A bad investment

Yesterday I met an old friend after a long time (lets call him 'S'). Some four years ago he purchased a flat in Bangalore Sarjapur area for around 70 lakhs. He mentioned that the price of his flat is touching 90-95 lakh now and he was happy with his investment making awesome returns. 

I was not sure, since I have always been wary of Real-Estate true returns. I wrote a post in Nov 2010 questioning the same. So in this case, I did a quick back-of-the-envelope calculation. 

Purchase price of flat = Rs 70 Lakh  year 2010

Down payment = Rs 15 Lakh

Loan Amount = Rs 55 Lakh for 20 years

As per the floating rate of interest, his EMI comes to around Rs 54500 (although due to floating nature, his tenure has changed, but let me not add it). 

Till now he has paid 

54,500 X 48 EMI = 26.16 lakhs + 15 lakh = 41.16 lakhs

Current quoted price = Rs 90 lakh (Assuming he sells at 95 Lakhs, but he wont get entire money, since buyer will deduct the stamp duty, registration charges etc, lets say 5 lakh is deducted). 

Outstanding loan amount = Rs 50.92 Lakh, So his balance earning = 30.08 lakh

This amounts to a loss of 11 lakhs. 

Even if you include the tax deduction he received on interest and principal payment, it will not be more than 2-3 lakhs, which still puts his investment in red. 

I have not even considered the opportunity cost of the investment money or the builder related issues causing delays and shoddy construction, which will compound this loss to much more. 

A real-estate investment on borrowed money is a really bad deal. 

Whats the solution? My solution is simple

1) Never believe the fact that real-estate prices will keep on increasing. 

2) Instead of buying a house now, invest the EMI amount in recurring deposit. For e.g. if you plan to take a loan of Rs 50 laks today, rather invest Rs 50000 per month in a RD

3) Wait for your RD to be give you more than 50% of your house cost. In this case, in 3-4 years you will have close to 25-30 lakhs

4) Search for a house in the same budget (believe me you will get it even after 4 years), but now you can actually pay half cost of the house by cash. 

5) Take loan for remaining amount (EMI 25K now) and keep saving the remaining 25K in RD

6) In another 3-4 years you will be able to fore-close your loan with the RD.

Let me apply the same to my friend S's investment

So instead of EMI, he puts it in RD, 54500 Rs * 48 = 26.16 lakhs + RD interest = 30 lakhs (post tax). 

Purchase price of flat = Rs 70 Lakh  year 2014 (he can still get a house around 70 lakhs in many good parts of Bangalore)

Down payment = Rs 15 Lakh + 30 Lakh = Rs 45 Lakh

Loan Amount = 25 Lakhs

His now EMI = Rs 24, 792 + he starts another RD of 29708 Rs per month. So in 4-5 years (by 2018) he would have cleared his home-loan. 

The bottom-line in this plan is that you pay very little interest to the bank and hence can make your real-estate investment profitable. 

ESPP and tax implications in India

Recently I got an email from my company (US listed company) about ESPP program, which allows employees to purchase the company shares at discounted price. I started inquiring about ESPP with fellow colleagues and to my surprise everyone gave a thumbs up, indicating a simple and easy way to make money. 

I have a habit of becoming suspicious whenever it sounds too good to be true. So I started digging further and here are some facts that I came up with. 

What is ESPP?

Conceptually, ESPP is like a deferred-SIP, where you allow small amount to be deducted every month from your salary, during the offer period. Once the period is over, company will use the accumulated money to buy company shares at discounted price and deposit in your brokerage account. 

Lets take a quick example, say you are employee of company XYZ Inc. The ESPP offer period is say 5 Nov 2014 to 5 May 2015. Lets say you applied for ESPP with a deduction amount of 5% (anywhere between 1 - 15%) every month starting November 2014. So on 5th May 2015, your company would have accumulated some money and it will purchase the shares of XYZ in your name. The discount given typically is 15% of lower stock price value of 5 Nov 2014 or 5 May 2015.  

Assume, on 5 Nov 2014 stock price = 5$ and on 5 May 2015 stock price = 7$, you will get the stocks at 15% less of 5$. 

Once the shares are deposited in your account, there are no restrictions and you can either hold them or sell them immediately. 

It looks like a great program on paper with a straight 15% benefit and if the stock goes further up, your earnings will be much higher. 

Where is the problem?

There are two problems associated with ESPP

1) Stock market risks

2) Tax and transaction charges

Let me explain, each one of them. 

Stock Market Risks

Investment in ESPP is similar to investment in stocks & that too of a foreign listed stock. Any investment in stocks is associated with risks, if a stock can go up then as quickly it can come down and wipe your capital. As with investing in Indian stock market, you need to understand the financials and long term growth of your company. How many employees go through the quarterly results or historical financial data of their company? So just being an employee does not mean that your company's stock price will keep growing. Also being employee does not mean you have enough information to understand the future growth story of the company. 

Tax and transaction charges

Indian Income tax laws can also be spoiler here. The first tax that will hit you, is when the company has purchased the stock on your behalf. The 15% discount that you are so happy about, it will be called as perquisite and taxed as per your tax bracket. So being in highest tax bracket (30%), your 15% discount immediately reduces to ~10% straight away.

Also for most employee idea of entering into ESPP program is to sell on the day of vesting (immediately following purchase). So when you sell the shares, assuming you make some gains. This will be short-term capital gains.  There is also some brokerage charges taken by your broker (e-trade etc) which can also put a dent on your gains. 

Since the shares are not listed in India, short-term capital gains are taxed as per your income tax slab. If you held the shares for long-term, then long-term capital gains are taxed at 20% for foreign listed shared. 

I am not even considering the difference in Rs - $ conversion rate between the purchase date and sell date. It could potentially further dent your losses. 

Conclusion

To me, ESPP has too many variables to consider for investment.  I feel that ESPP for short term should be absolutely no-no, since it most probably will result in capital loss (unless your company share price jumped very high during the offer period). If you are very sure of your company's growth over a long period of time, then you may invest for long-term. 

As for me, I am skipping the ESPP altogether and looking to find some gem in the Indian stock market. 

Smart Tips for new parents

I recently read this wonderful article on Jagoinvestor, but having been gone through this experience, I have my own twists to these tips.

In summary, what they propose for new parents is:

1. Review your Life Cover
2. Add the child to Health Insurance
3. Start RD for school expenses
4. Update Nominations in various financial products
5. Register the birth certificate
6. Start Saving bank account for the newborn
7. Buy cloths and toys smartly
8. Don't invest in CHILD plans
9. Have a 24/7 reachable doctor
10. Make baby emergency kit

Here is my take on some of these tips

Review you life cover

Yes this is important point, but why wait till your baby is born. If you are first time parents, here is a warning. Once you baby is born, you would have seriously no time and energy to devote to anything other than "mis-managing" everything. I recommend that why not increase the life-cover during pregnancy itself. It will not only save you time later, but you can also plan your premium payments as per you convenience. 

Adding the child to Health Insurance

Another important point, but note that insurers want a birth certificate as a documentary proof for covering the new born. Hence the first thing you need is a birth certificate. I had posted my experience in getting a birth certificate in Bangalore.

Also it is better to check with your insurer if the newborn is covered from day one. Another important aspect is the coverage for vaccination. The vaccination cost with private doctors can range anywhere from 4-5K to 15K (at-least in Bangalore). 

Update Nominations in various financial products

To me this does not make sense. A nominee is just a custodian of the assets and does not have a rights over the assets. Also a minor nominee requires a guardian to sign on behalf of the nominee. So in the event of your death, the actual custodian of your assets will be the guardian on behalf of your baby until the child becomes adult. So why complicate the nominations, better to have either your spouse or parents as nominee. 

Start Saving bank account for the newborn

I do not think it is a good idea. The simple reason is because most banks which allow kid's account requires a minimum monthly balance, which blocks the money. The interest rates offered is below inflation resulting in loss of money. The alternative option that I recommend is to keep counting the money that the child received via gifts and at the end of year deposit the lump-sum amount either in PPF or a MF. This way the money received by the child goes for building a corpus for his/her future. 

Buy cloths and toys smartly

This is a personal choice, but in case you are not averse to using second-hand toys or baby stuff, then I recommend online portals like olx/quikr to find used items. Another interesting options is to rent the toys via rentoys website. I have not personally used it, but it sounds an interesting concept. 

Make baby emergency kit

There are two problems with having an emergency kit

- It needs to be checked from time to time to ensure that used items are refilled

- It needs regular checks for removing expired medicines 

My personal experience is that despite having the required discipline, we could not always maintain the emergency kit. There were always items missing from the kit. A better option is to have a near-by medical store deliver the medicines to your doorsteps in case of emergency. 

An additional tip for those who can maintain the kit is to have a spare kit in your vehicle for emergency purposes. 

Here are some additional tips

• Invest more in your health and fitness (more important after having kids).  
• Get a PAN card or Passport for your kid as an identity proof
• Create a WILL if you don't have
• Open a PPF in your kid's name and ensure regular investment (no need of a savings account)

Petrol Car Vs Diesel Car - Which one is economical?

Quick Post: 

I read an interesting CRISIL report (Sep 2014), which compares diesel vs petrol cars for regular consumers. The crux of the report says

Considering the way diesel and petrol prices are converging, the recovery period for a first-hand diesel car will be close to the higher end of the typical holding -- or ownership -- period of between four and six years if it is driven 10,000 kms per annum. 

An interesting read indeed!!

RBI 'tags' Loan Guarantor as Wilful Defaulter

RBI circulars are not typically "news worthy" items for common man, but it's new circular on Wilful Default created lot a flutter in the news. In the recent clarification to the master circular, RBI mentions

 In connection with the guarantors, banks have raised queries regarding inclusion of names of guarantors who are either individuals (not being directors of the company) or non-group corporates in the list of wilful defaulters. It is advised that in terms of Section 128 of the Indian Contract Act, 1872, the liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract. Therefore, when a default is made in making repayment by the principal debtor, the banker will be able to proceed against the guarantor/surety even without exhausting the remedies against the principal debtor. As such, where a banker has made a claim on the guarantor on account of the default made by the principal debtor, the liability of the guarantor is immediate. In case the said guarantor refuses to comply with the demand made by the creditor/banker, despite having sufficient means to make payment of the dues, such guarantor would also be treated as a wilful defaulter. It is clarified that this would apply only prospectively and not to cases where guarantees were taken prior to this circular. Banks/FIs may ensure that this position is made known to all prospective guarantors at the time of accepting guarantees

The primary focus of this circular is definitely companies or individuals, who acts as guarantors for other companies, ensuring bank loans despite not having enough credit-worthiness. But it seems even the common borrower is going to suffer now.

What is a wilful defaulter?

In simple terms, if a person or company is unable to repay the loan it has taken, it is terms as wilful defaulter. An exhaustive definition can be read here[PDF]. Once a banking institution, tags someone as "Wilful Defaulter", the person or company will have zero credit-worthiness and will be unable to get money on credit, apart from the possibility of legal proceeding against them. 

This is what is happening with Vijay Mallya, although he has got some favorable judgement recently. 

How does this impact a common person?

Until this circular, no one really thought much before becoming guarantor for a friend or relative, while they were availing loans. A guarantor is thought only as a referral and expected to just ensure moral liability to the person taking the loan. The provision existed for banks to pursue the guarantor for recovering of loans, but only as a last resort.

With this new circular, the banks can 

• Tag the guarantor as a wilful defaulter thus reducing credit-worthiness of guarantor to be zero
• Start recovery process of the loan from the guarantor in parallel with the original debtor. 

This is a significant power to the banks and definitely makes sense against defaulting companies, where the borrowing is several hundred crores. But for smaller borrowers who take personal loans or car loans, it is now going to be impossible to find a guarantor. 

Simple Tip : Get the EMI experience before buying that house

I am not really into buying a house (see here and here) and definitely not multiple of houses, especially via home-loan route. I have seen too many examples of people

1. Buying house and then forced to significantly cut-down their living standard
2. Getting cheated by even reputed builders (delayed projects, poor quality, document frauds etc )
3. Not really getting huge ROI (which is often the primary motive)

Yes, I know of many people, who don't enjoy life 'today' in the hope of a better 'tomorrow'. Some people take home-loans with EMI portion as high as 60-70% of their monthly inflow and then think millions of time, spending on smaller (but important) aspects of life like upgrading their car or buying new life insurance policy or a family vacation. We, Indians, are specifically tuned in "saving" mode from childhood. 

I was talking to a friend, who was very keen on buying a house in Bangalore. He was willing to take an EMI burden of close to 50% of his income. I believe that "experiencing the situation" usually helps in preparing for that tough time (think of mock interviews), so I suggested a simple method to him. I asked him to create a recurring deposit (tenure not less than a year) of exactly the max EMI he is willing to shell out.  Why a year he asked? I said, a full year will take you through all the planned and unplanned expenses that can occur like an illness in the family or a sudden trip to home-town or school fees for the kids. So he started an RD of 60K per month in his salary account. 

He came back only after two months and said its an eye-opener. As soon as his salary comes, close to 50% is gone from his account. So he has to manage the entire household expenses in the remaining amount. Six months later he prematurely cancelled the RD, but thankfully he realized that he is not yet ready to buy that house via home-loan. 

It is a simple trick but very effective to experience the burden of an EMI. As a side-effect you also get to create a good corpus once the RD matures. Try it and share your experience. 

Iron Man and Personal Finance

[This is a guest post]

What You Can Learn About Finance from the Ironman Movies
        Created in the 1960s, Iron Man was far from being a mainstream superhero when compared to characters like Batman, Superman, Captain America, Spider-man and the X-Men. In the late 2000s, however, when Marvel Comics had decided to launch a series of full length, live action movies featuring the superheroes that comprise the Avengers with Iron Man as it’s central character, the armored Avenger, and more importantly the man underneath, easily became the favourite superhero of almost every movie fan.

            Iron Man is the story of Tony Stark, genius, billionaire, and a professional weapons designer. After an encounter that led to a piece of shrapnel being embedded in his heart and being held captive by a terrorist organization, Stark realizes the evils of his profession and decides to create a weapon, an armour, that allows him to escape and make amends while also sustaining his life.

           The world of finance is filled with Tony Stark wannabes, aiming to one day roll down their favourite restaurant, flash their credit card and winning smile and just have life smile back. But in reality, we can’t be Tony Stark. However, there are things that we can learn from the brash character about finance:

Innovation Leads to Success

          From the start of the first movie, where Stark was shown pitching the “Jericho”, a weapon of mass destruction, to potential buyers, he pointed out the need for “having the bigger stick”. In the sequels, whenever Stark was in trouble, he opted to do what, to him, made perfect sense: upgrade his armour. That is a trait that we can adapt in our money making ventures. We should always be open to innovation because in this fast paced, constantly changing world of ours, the person with the latest information and the knowledge on how to use it usually comes out on top. Be in a state of constant upgrade, and your finances would show a positive result.

Technology is Our Friend

          In this day and age, there are still some people who prefer doing business the old fashioned way; opting not to use electronic communication. There are even a number of people who choose not to use credit cards. Tony Stark, in the three Iron Man movies, was shown not just to accept technology, but he made it a true part of himself in both the literal and the figurative sense. Because of this, he rarely fails in achieving his goals.

Invest in a Support Group

           Tony Stark, despite the brash way he carries himself, is actually successful mostly due to the help of his competent support staff. Even before he was in an actual team of superheroes, Stark worked with his best friend Jim Rhodes, his driver Happy Hogan and of course, his personal assistant Pepper Potts. Each and every one of those characters have helped keep stark grounded, focused, and in certain occasions, alive. When dealing with your finances, it would not hurt to have a support group of your own. Every needs friend who can give honest and reliable advice on credit card transactions and other financial matters. A financial adviser that would help you choose which investment is wise. No matter how much you trust your instincts, a group of people that you can rely on is always good. If Iron Man needs them, so do you.

         The Iron Man movies, as fun as they are, actually do teach invaluable lessons on how we handle ourselves financially. So, the next time you are on a Tony Stark kick, walk into a shop and swipe your credit card, knowing that you’ve applied what you learned, don’t be ashamed to say it. “I am Iron Man”.

About the author:

This article is prepared by Money Hero for Simplifying Money Matters. Money Hero is Hong Kong’s upcoming financial comparison website, which lets you compare a broad arrange of financial products - from credit cards, savings plans, to mobile plans.

Book Review - “Everything you wanted to know about investing”

You may have seen hundreds of books on personal finance, but very few can really cover the entire breadth of personal finance topics, that are useful to common investor. Here is a book by Shalini Amarnani, that attempts to do the same and which provides good coverage on all personal finance related topics. (You can buy this book at flipkart or amazon)

Buy at flipkart or amazon

In this book, Amarnani, starts with providing a new perspective to investing by encouraging the reader to explore their boundaries. This, I felt, is really an important but often ignored aspect of a personal finance book. The book is not going to make you rich quickly, but provides a definitive guide for financial success. Amarnani takes you through various financial instruments like equities, MFs, ULIPs, F&Os and provides a guiding line for making winning choices. 

There is an entire chapter devoted to tax planning. It definitely is a good read for young people joining their first company. It also has many nuggets for experienced folks. For example, here is a paragraph from the book

If you are planning to invest in property, it makes better sense to invest in a commercial property rather than a residential one. Not only does a commercial property earn better returns but also, you do not end up paying any wealth tax on it. Ownership of a commercial property enjoys the same eligibilities in tax deduction as that of residential properties.

Wealth tax typically targets unproductive, non-essential and idle assets, hence commercial property does not comes under its ambit. A very useful tip for the property hungry Indians.

Amarnani, has also covered the equity investment space very nicely, explaining the basic concepts involved in fundamental and technical analysis. This is a good introduction for a common investor. A small chapter on Futures & Options, in an easy to understand language, gives a quick introduction to these difficult investment instrument.

The author has also covered all the debt instruments like FD, Bonds or PF in a simplistic manner including useful tables for a comparative study. Did you knew that there are four kinds of provident funds? Amarnani provides a really nice table on the tax implications of various PF schemes.

The section “consolidating” provides a quick summary of all financial instruments related to loan and insurance, which is extremely useful for an average investor. The concluding chapter is also crisp and pragmatic, with a very interesting table called “life stage analysis”. It provides a quick investment strategy, across various life stages, that you go through.

One of the key learning come from the last page of the book,

Everyone lives his/her life differently and hence investment decisions are highly personal and unique. Four basic rules that apply to everyone

• Keep emergency cash
• Invest in equity
• Schedule annual review of your investments
• Align investments with tax structure

How true these wise words are!! 

My Personal take on the book

While I enjoyed the book and it is really an excellent read for anyone trying to de-mystify the personal finance world, but be aware that this is not a book that will give you tips on where to invest. It just shows you the various instruments available and their pros/cons, but what really will help you depends on your own personal situation. One key financial instrument, that I found missing is the NPS pension scheme. NPS is a low-cost equity based pension scheme existing today. I recommend that you keep a copy of this book as a ready-reference whenever you are scouting for a financial instruments be it equity or debt based. Overall a very good book for young folks!!

About the Author

Shalini Amarnani is contributor to various financial websites and blogs like http://investmentsbook.wordpress.com/ and a highly sought-after speaker.

Knowing how to manage money is one of the most beneficial life skills for people at every age. She is committed to simplifying money matters and increasing financial literacy both for the present and the future.  Utilizing a clear and straight-forward approach, she provides advice for integrated, holistic financial life planning and investment management.

Shalini holds a masters degree in Financial Management and has several years of experience starting from 1994. She lives in the financial heart of India, Mumbai with her husband and a son.

Shalini can be reached on shaliniamarnani @ gmail . com

You can buy the book at flipkart or amazon