Bad side of Financial Products
POSTED BY ON November 10, 2010 COMMENTS (83)
Over time, we have seen a lot of products, and figured out some good ones. In the process of understanding them, we now believe that some things are always good — which sadly, is never the case.
So today, let’s have a look at just the flip side of all the products and concepts. This post is going to talk about the problems and issues associated with financial products & services.
Term Insurance
Term Insurance, as you know is pure risk cover, with a cheap premium. The problem with Term Insurance, is that many people get over insured because of the fact that premiums are cheaper in case of term insurance. Many people who need coverage of 25-30 lacs might end up taking higher amounts of insurance as it costs very less.
They might think that nothing is lost — What you lose, is the extra premium over the years for over insurance. At the end, your chances of death increases drastically (duh!). A lot of people on the other hand are severely under-insured because they think that just because term insurance does not return your money its a bad product , but these people are totally wrong (read why)
Equity Mutual Funds
Equity Mutual funds are taken as the best investment option by many. And they are, but not for everyone! A person needs to understand, that they are long term products, due to their inherent nature, equity funds should be invested in, for the long term.
Over a short period, like 2-3 yrs, Equity Mutual funds can be risky and can give you jitters whenever markets make a heavy movement to either side. Also your choice of funds matters! Choosing any equity mutual fund will not help you grow your money, since nearly half of the equity funds, under perform their benchmark indices themselves.
Debt Mutual Funds
Remember this, No Mutual fund is safe! There is always some kind of risk with every mutual fund, unless stated otherwise. Does any debt fund mention clearly that it’s 100% safe? No!
Watch this video to know more about debt mutual funds:
Debt funds are of different kinds and they are depend on several factors like inflation, price variation in bonds (More), the ability of corporate’s to repay the debt on time, and other economic indicators some times.
Overall, debt funds do not give negative returns and mostly perform better than plain FDs, but there have been instances of debt funds giving very low returns like 3-4%. Negative returns in short term, can’t be ruled out either. (link). Risk with debt funds though, is usually very small.
Many people also put money in Debt funds for very short term, just as an alternative to Fixed Deposits (FMP ?), which earns them marginally better returns but at what cost? How much in absolute terms? The quantum is so less, than it’s not worth the hassle.
Real Estate
“Real Estate is the best Investment!” – While that’s open to debate, let’s looking at the negative aspects and issues. First of all, real estate transactions are really complicated and as an investment it means you have to figure out a lot of things at every step of the transaction, else you might pay more than what it takes, every time if you don’t know the game.
There’s also no proper regulatory body in real estate, so things are unaccounted for, with no proper sound rules for the whole process. This means, every step has its own price depending on the city.
Another major issue with real estate is liquidity. You buy a flat, you spend 2-3 months on the whole deal and once things settle down, you live happily in it. But life takes a wrong turn, it can take several months to find a prospective buyer for your asset at the price you want.
It may be frustrating to see prices move down and no body ready to buy at your price, in which case you have to settle for less. You might have to compromise for a really low ball offer too, if you need money urgently for some emergency need, unlike fixed deposits, mutual funds and other products. (Returns from Real Estate)
PPF
PPF is considered to be the most secure and best debt product. However, putting money in PPF for 20 yrs can be just as idiotic as anything else. At the end, you are not getting more than 8% on your money, so only invest as much as is good & needed your asset allocation.
For a young starter his/her debt component is generally taken care of, by the EPF in the company. It makes no sense to put another 70k every year in PPF. It will just increase their debt percentage share in their portfolio to no good end.
Use PPF to build some debt component (Read a tip), but it’s not always prudent to put the whole 70K every year religiously. At the end, its not going to fight inflation very well. Want to open a PPF account at SBI , read here
Endowment/Money back Plans
They are totally secure products.., true, however the returns you get on your Endowment/Money back plans are pathetic . The worst part of these plans are that they trap you like anything.
Ask some one who has bought them recently, paid a couple of premiums and now wants to get out. The products are designed in a way that err, discourage you to move out of. If you do, you get a very small sum in return.
You cant beat inflation with these products, as the returns for all type of plans range from 3-6%, at the most 7% once in a while, depending on the bonus (and probably the phase of the moon :)) Don’t let the trust factor influence your thinking so much, it makes your financial life miserable.
ULIPs/ULPPs
Nothing wrong with the concept, but the costing of the product is such, that they are highly prone to mis-selling (and they have been mis-sold/mis-bought heavily.) You make some profit in a ULIP, but get out soon & the cost of the product will be very high. They are complicated products and 99% people don’t use ULIPs the way they should be (switching is not used by most people) .
A 3 year lock in period is often taken as “I can sell after 5 yrs and I will get 100% of my money”, which is not true. 5 years is just lock in, from a taxation point of view. If you sell the ULIP before 5 years, first you have to pay surrender charges and the the money you receive, will become taxable in the year of receipt.
However if you know how to use them, ULIP’s can beat mutual funds
Watch this video of Term plan vs Endowment plan vs ULIPS:
Direct Equity
The biggest problem with direct equity is that a very small number of people can do it right. Most of the people just feel they’re alright, till they get really screwed big time. Direct equity demands too much attention at times.
Also depending on your time frame, it can be addictive! And when you can’t control yourself, it can ruin your portfolio and wipe out your savings.
Gold
Too much confidence from investors. At the end of many years gold should be giving around 8-9%, a little more than inflation, but in this new generation, gold has done so beautifully that it might outperform earlier returns and end up giving 10-12%. Fingers still crossed though. Read a study on gold
SIP
SIP is sometimes seen as the ultimate solution for generating good returns, but SIP can give lesser returns in growing markets, so for people who have that ability to sense the movements in markets, SIP will prove to be wrong thing to do. These kind of investors can take a call on direct investment.
SIP is good for investors who does not have much idea about how markets functions but want to invest in equities without worrying about movements in the markets. So the best learning is, don’t start SIP after a bear market !
Diversification
You should always diversify your investments. Whats the problem with that? The main problem is that this is not true for a person who understands the ins and outs of an asset class and has all the time to closely look at his investments.
In that case, diversification will prove to be very costly. I know people who have 96% in Equity and they are doing wonderfully well, because they are masters of the subject and closely follow what’s happening to their money. So diversification is not the ultimate solution.
As Warren Buffet says, diversification is for one who does not understand what he is doing, which actually means that a person does not have much knowledge about an asset class to exploit it’s full potential. Most people fall in this category and for all those, it would make sense to diversify in Equity, Debt, Gold and Real estate etc.
Read more on Diversification
Health Insurance
I don’t see much negative in Health Insurance, other than the dilemma customers have, in choosing the right products for themselves. There are many things which a customer should look into a health insurance product which would suit him, but because of plethora of products & options, customers are confused and end up taking the inappropriate policies.
See 17 most asked questions and answers in Health Insurance here.
While we should cover ourself with health insurance, the best health insurance is good health by eating well and doing exercise everyday, read this ebook for more .
Saving Account
Though there is nothing called as “investing” in Savings accounts, maximum number of investors keep their money in their savings account unintentionally over and above their emergency needs and it’s like loosing your money to inflation , prices are rising at rate of 8-10% and your money is rising at 3.5% or even less. So in a way your money is depleting over time .
Fixed Deposits
While fixed deposits are excellent and easy short-term investment option, it leaves your money handicapped when you invest in it for very long duration like 10-20 yrs and many investors actually do it especially in smaller cities and towns , for them its the only investment option .
Though the number goes up in your bank account , the purchasing power remains at the same point or at worst decreases sometimes due to inflation and taxes overtime. So use Fixes deposits for short-term investments not very long-term.
Portfolio Management Services (PMS)
The biggest problem with PMS is that there are rare PMS which can be called good. PMS is also managed just like Mutual funds where some person or team takes the decision of buying and selling , the only difference is that its meant for HNI’s, who have minimum investments of 5-10 lacs.
There are high costs involved and most of the people fall in trap thinking that it’s some premium product which would deliver better returns . However there has been cases where PMS delivered great returns, in most of the cases they turn out to be a hype.
Most of the big companies in financial services run PMS schemes which do not have that strong performance or are half-baked . Read a review of ShareKhan PMS.
Comments ? Do you think I have left anything or any product ? Which was your favorite one ?
Thanks for the beautiful post.
I have dount in the following line –
Choosing any equity mutual fund will not help you grow your money, since nearly half of the equity funds, under perform their benchmark indices themselves.
Does that mean we should not invest in equity MF’s at all?
Kajal
No , all it means is that you cant choose equity funds randomly, because if you choose a bad one, you can hurt your returns in long term
Manish
thanks for yr advise.
Dear sir
I am approached by ICICI direct for PMS thr Tata or ING. They told me that they will recover the loss I am making in my shares investment. They charge 2.5% of portfolio per year.
Pls advise in this regard at the earliest on my e mail address .
milind
Milind
Just ignore .. PMS is something a common man should not get into .. If you are not very much expert on equity ,.. then better invest only using Mutual funds
Manish
Hi Manish
Its a good work done. But could not understand the flip side of SIP. Ya definitely for short term it may not be a good idea but in long term I think cost averaging factor shows its results.
VIkas
Yea .. in long run its a good thing .. Also in rising markets (you obviously cant figure this out , no one can) , you loose out compared to lumpsum
Manish
Ya you definitely will loose out when market is volatile. But no one can time the market, if at all some one is dead sure of market movements then he will definitely would play in shares than in MFs.
heyy your article is superb and information about all the negative side of each financial instruments gave me a good understanding to invest but I also want to know about NPS and its negative side….pls provide me this information also.
Sheetal
the problem with NPS is that its equity allocation is retricted to 50% , so its not good for a aggresive investor , also u will not be able to withdraw the money in between as you can only withdraw at the time of retirement .
Other problem is that you dont know what would be return at the time of pension , What if its 4% later ?
Manish
Many people claims FD investment as ‘Fools Destiny’. Recently I was going through HDFC bank annual report and it generated 4% margin i.e. differential between lending and deposit rate. The bank is able to generate this margin consistently over the last 5 years. I was surprised that this bank is able to show YOY growth of 20-30% and been the darling of investors. Where is the growth coming for this bank. It is just on the turnover. Means it is able to lend more money than previous years and with 4% margin and it could generate handsome profit. All banks are more or less doing the same with different margings.
Look at the same anology for the individuals. They should not only focus on maximizing the returns, they should also care about the amount of savings. If you are able to set a side fixed amount of savings each year and grow this savings amount little more based on pay rise and these amounts provide FD returns of 7-8% per annum, you are on path to outsmart banks and more importantly shall become as secured as banks. After all some of the banks are still going strong after 40-50 years.
Krish
Thanks for your comment , however its not clear that what is the point you are trying to make ? Can you let us know what is the conclusion of your statement ?
Manish
The banks are able to grow all these years with 4% interest margin. 7-8 % of FD return plus additional savings each year from the salary makes a great going for the individual. Let any one do it for 10 years with above approach and with power of compounding, it benefits tremendously. The conclusion is FDs are not as bad as most people shun it and investing means one does not have necessarily to look elsewhere. I was responding to your opportunity lost reply.
Krish
So are you saying that if someone wants to invest for 10 yrs in FD , is it a good choice ? I still dont agree unless all a person wants is to keep money safe and liquid .
Manish
Hi Manish,
Excellent summary of investment options. I am sure everybody related themselves to the post and said “Oh!!I am not doing this…or ..Oh!! I am already doing that”. Very interesting post.
About money in savings account/FD’s, not sure about others but I think most would agree. Everybody investing in policies/equity MF’s is still keeping a good portion of money in savings account or FD’s and if I have to look at myself..My 50% savings are in saving/FD and 30-40% in equity MF’s. Since the money in bank gives you a sense of safety more than a equity MF. May be I am a conservative investor(which I don’t feel) but what do you recommend about saving/FD investment option , definitely it’s buying power is dwindling but that feeling of safety comes from it. Do you have any thoughts on how to put it to better use and still feel safe?
Nitin
Yes its more in mind that its safe compared to other options like liquid funds etc, however the point is that you should replace your saving bank account with sweep in account or max liquid fund and not pure equity funds . Note that the sense of safety is costing you badly , if you leave Rs 10 lacs in saving account for 3-4 yrs, all those year you will get a sense if safety , but what you have lost is a very big amount , say 3-4 lacs in opportunity , I dont feel thats the cost of having peace in mind .
If you are a low risk person atleast buy Debt funds or invest in balanced funds for long term .
Manish
Thanks for replying Manish. Aren’t debt fund returns similar or equal to FD? Also balanced funds is good choice ,but how do they generate so much returns , like I am fan of HDFC prudence fund..it outperforms even equity funds sometimes…so I feel is it really balanced or does it goes overboard and invest’s mainly in equity and risking investor’s money..can you guide.
Nitin
Note that any product return depends on the quantam of the equity/Debt mix , so if equity is more , return is more, if its less , returns are less.. In debt funds, there is no equity or very less equity , so the returns are less , but stable , Yes FD returns are around FD only , but Debt oriented funds which have 15-20% equity component provides 11-12% returns also .
HDFC balanced and similar balanced funds have lesser equity compared to pure equity funds , but its returns are superior some times because of better managements, right investing and may be proper rebalancing at right time .
Manish
Thanks Manish.. excellent Blog’s..superb followup and comments !! Can’t ask for more !!
Nitin
Wait for another 1 yr , Picture abhi baki hai mere dost !
Manish
I don’t see the need for a pure debt fund. PPF can serve as solid debt component with 8% (as of now!) assured returns. The rate is likely to decrease in future but is likely to change only once every few years. A debt fund depends on way too many factors and requires constant watch.
With an equity allocation as per risk appetite the average interest cannot go below 8% in the long run. A debt funds simply swings too much.
According to Value research only 10 debt (Gilt Medium & Long Term) have out performed PPF and only 7 significantly over a 10 year period.
I don’t have the appetite for swinging debt. I have a hard time coping with swinging equity!
You may be aware that Gilt funds are as volatile as Equity Funds. That is also the reason why it gives long term higher returns than PPF (your bench mark). Gilts are mostly purchased by Banks and Pension Funds. They are the most liquid and most volatile especially the long end ones. They almost behave like stocks.
Other Debt available in Indian Markets like Debentures, Structured Obligations, short term funds etc. are not good for long term from return point of view.
You have mentioned about your appetite. That is why you should do a exercise by yourselves as per the method I indicated above. You can include Funds of your choice, PPF, FDs etc. in this excercise. That will indicate how much pain you can bear. Most investors fool themselves by thinking they can withstand the “Swing” and thereby become “their own enemy”. If things go wrong they blame brokers, markets, friends etc.
Investor need basic education in risk tolerance before embarking on serious investment and before allocating assets.
Please remember you cannot escape risk you have to cope with it. Only way is self education.
Sundar
Very nice view on “Risk” and how it breaks many people finances due to over confidence , A recent incident in Kaun Banega Crorepati is the proof of this when Prashant Batar played 5 crore questions without giving much thought of what he can loose , while he may argue that he atleast got something positive out of game, he actually lost “financial freedom” which he could have got from it .
Manish
Regarding Prashant Batar: Most people think of what he did as tragic. Yes in terms of loss of money yes. As they say easy come easy go!
On the other hand, he was playing in a game show. He had the courage to take risk and play it as a game. In an hour or so he made 3.25 lakhs. This was an avenue to take risks without losing much (that is your own money). He took a risk and it back-fired. He could still invest 3.25 L (-tax) and become a crorepati in the next 10 years.
It takes real courage to do what he did (mad courage included!). What would I have done? I would have walked away with the 1 crore. Not because I am smart but because I am a coward.
Nice points. Even without the exercise you suggested I know I am very uncomfortable about loss of principle which is why when I started I had equity of only 10-15%. After educating myself about the risk associated with debt (ie. inflation) from Manish’s articles, Shubra’s book etc. I have gathered enough courage to increase my equity to 48-49%. Considering my age (36) I think this is a decent equity allocation. The way I see it if I can hold this allocation until I am 50 I could then gradually decrease the equity component.
As you said self-assessment and self-education are crucial. You can’t just go to a CFP and sign where he/she asks you to sign.
1. People should invest with a goal and not with higher returns in mind. If one has enough monthly savings to achieve a long term goal with 8% interest then nothing wrong with it.
Higher interest comes into play only when monthly savings is small and cannot be achieved with lower interest. The point is the goal comes first, how much one can save second, based on which the instrument has to be chosen.
2. The exercise mentioned by you is fantastic and I think is essential for a beginner. Maybe when Manish gets his FP certification he could adopt this. Actually writing a code for this is not very difficult. getting reliable data is more difficult.
Pattu
When we talk about rebalancing , how will you use PPF as there is lock in period ? You can take money out and in only from debt funds . I guess you missed that point ?
Manish
Agreed. You could only change the contribution. It suits me because I am not interested in taking money out of a PPF.
Pattu
In that case how will you achieve portfolio rebalancing, I am assuming that you are taking PPF as debt option for PR. Is that true ?
Manish
In my case I have mandatory NPS tier I and voluntary tier II contributions in addition to PPF and pure equity MFs.
So to rebalance I can change the tier II contribution. I also have mandatory 85% debt in tier I so I can afford to decrease PPF to Rs. 500 per anum. So that all the rebalancing I need.
But for a person with EPF only I understand what you are saying.
Please note that most important assumption in any asset allocation is tolerance. That means investor will not give up his asset allocation under any market condition. If the investors sells in panic or buys in euphoria or keeps on changing his asset allocation as per advise from even well informed persons, then the whole exercise is futile. He should stick to his asset allocation.
Unfortunately almost all Financial Planners are “Wolf in Sheep’s cloth”. They are actually agents of Financial Institution and have conflict of interest. I know one financial planner who revealed to me that his own portfolio is in a mess as he was changing as per “commissions”. He took his own poison pill. How can he advise others?
Hi Manish ,
This question is regarding money left in savings account. Earlier i used to use the auto sweep and reverse policy where the money lying in the savings account would automatically convert into a term deposit so that i could earn a higher rate of interest for money depending on the duration the money left in savings account .This saved me the trouble of applying for fixed deposits and handling the documents. Also when i used the money the deposit would get broken in multiples of Rs 1000 and the rest of money would continue earning interest as a term deposit but then banks stopped this facility.Now the banks are offering this facility again but when i talked to my banker , he said that since interest is being calculated on a daily basis ,it is no longer a great advantage. I am a bit confused regarding the calculation of both options . what is the exact interest amt earned for both options at 3.5 and 7.5% resp for a period of 1 year.also what is the tax treatment of the interest earned in a savings account.
regards,
neet.
Neet
Even if the interest is charged daily, still the rate is 3.5% , it does not make different from earliar situation , It still a good choice to have a sweep in account
Manish
Manish,
I think it does make a difference. Earlier, when the interest was not calculated daily, the banks used to calculate the interest on the average balance amount quartely. Now after the RBI’s rule, they should be calculating it everyday which will fetch more interest for the account holder. Please correct me if I am wrong.
Regards,
Arudra.
Arudra
No, you are mistaken , first thing is that savings deposits used to earn interest on the lowest balance between the 10th and the end of any month, not balance of quarter .
another point is that yes , now they will earn more interested compared to earliar , but HOW MUCH MORE ?
Lets see how much was the yearly interest in both cases .
Case 1 : In this case it was 3.5% per year ( you get 1/12th of 3.5% in a month)
Case 2 : With 3.5% interest on daily basis , your 100 Rs will earn {1 + 3.5/(100*365)} ^ 365 = 103.56179710571844
Thats 3.561% yearly .
So its earing .061% more interest yearly now , unless you have billions in the bank , it does not make much difference !
Manish
Got it now, Thanks!
Manish,
I want to know how much percentage of one’s salary should be allotted for investment. Also i want to know the tax implications when a wife invests money got from her husband even if it is a paltry sum.
Anitha
How much percentage cant be generalised , the maximum you can is the good answer I guess , because it would be 50% for me , but can be 20% for you . As a rule of thumb the minimum should be 10% , but the more you can is better .
Also for your questions on tax implication if wife invests , you should read this article on clubbing rules http://jagoinvestor.dev.diginnovators.site/2009/09/what-are-income-clubbing-provisions-and.html
Manish
manish,
iam a housewife. last year my husband told me to plan our investment after thorough research. I scouted for papers, financial magazines for advise and finally settled on financial blogs. My god! I learnt so much in a short time by following blogs like yours, money quest and subramoney.
My financial plan made my husband happy. We scrapped 2 endowment policies. Got a good term plan, mediclaim and personal accident policy for my husband. We have saved a lot on premiums. I invest Rs.10000 on 5 mutual funds with proven track record. Thanks. Continue you good work.
My husband tells my relatives and his friends to ask my advise now. Thanks.
Anitha
Thats great to hear that some one is getting benefitted at this level 🙂 . Better contribute your knowledge by answering others doubts on this blog at comments section or helping others at our forum : http://jagoinvestor.dev.diginnovators.site/forum/ . Also help other ladies to join this group and benefit like u
Manish
Manish,
It is a nice article and this is the need of the hour. As someone pointed above that it is confusing but with my limited understanding I can say that it is essential to know the rule of the game before entering the field. To deter the investments after knowing the negatives is like refusing to bat on a cricket field after knowing that you can be given out LBW. On the contrary it ensures that now you can get the benefits and try to minimize the negatives as you can now keep an eye on them since they are no more hidden.
By the Way we need to be more careful to the propagandas about financial products. I am bothered by Bharati Axa ad which shouts over the roof that we will pay “FUND VALUE” within 48 hours of the claim. Please be aware that fund value is not sum assured so to get insurance claim you have to run pillar to post there as well. If one is insured for 5 lacs and pays a premium of Rs 25000 and dies in second year his fund value after deducting charges etc must not be more that 35000. Is Bharati trying to become angel by paying this amount which is always payable anyways as no insurance company can deny fund value no matter how the person dies. I am afraid how many people have fallen to this trap.
Manish, I think one post is required to teach people on “What advertisers say and what it really means” i.e. how it is going to affect you.
I heard a story when a marriage conselor tells the brides father that the groom is so rich and lives in such a mansion that stars are visible from the house. Later it was`discovered that it was actually a hut with broken roof. And of course the clever conselor refused the charges of cheating as he told that the stars are visible from house and that is true. So readers be aware.
Pramod
Yes .. These companies design their promotions in such a way that public do not give much thought to it and feel that its something special provided by companies. Will come up on that soon
Manish
Good post covering gamut of products.
After reading the comments, i would like to add my two cents.
Financial planning and invesment is not one size fits all game. High level of customisation is required to match various instruments to one’s investment philosophy and risk preferences. This customisation can be attempted by one after throughly understanding and studying implications of each. This can be attempted by self or preferably with the help of a advisor.
The help sites like JagoInvestor does is to provide knowledge and educate the reader so that one can take informed decision.
In this respect, i feel, this articale(and most of the previous ones on this website) did a fine job.
Good work Manish. Keep it up.
Srinivas
Yes , agree that not one size fits all .. also financial planner can be of help upto one level only , but main work is to be dont at investors attitude level because unless thats polished , it would be tough for any financial planner to work with the client in long run
Manish
Nothing is black or white..it’s all gray!
Nice Article.
But the Fundamental Issue is not discussed.
It is ASSET ALLOCATION.
It has been proved by researchers like Boston Group that 90% of return on any portfolio is dependent on Asset allocation.
Secondly most investors do not truly consider their true risk tolerance. During bullish times they consider themselves as “smart” and when bearish times hits then they see themselves having overextended themselves into wrong asset class and have lost their wealth. Further in panic they offload their asset at the wrong time and at great loss.
Third is discipline. This also involves rebalancing.
Finally Indian Investors should be well aware that here we do not have Social Security and Mediclaim as in US/Europe and Japan. Here we have to fend for ourselves till our death and leave something for our spouse. Hence reading books from US or Europe and tailoring portfolio is not advisable.
Sundar
ah .. i left asset allocation , thats a good point to cover, however do you think there is some wrong or limitation of asset allocation ?
Manish
Asset Allocation and Risk Tolerance is the most important aspect of any investment plan.
I have not seen one Financial Planner in India do a proper evaluation of his client’s true risk tolerance in this regard. At best he will ask the Client to fill a 5 page questionnaire and come to final asset allocation.
But a detailed and more true risk tolerance evaluation should be based on an example I give below:
For example please take a 50:50 Allocation to Stocks and Bonds.
In Indian context take a NIFTY fund like UTI Master Index or HDFC Nifty Index fund for stock portfolio. And take some Medium Debt fund like Birla Sunlife Income Fund for Debt portfolio.
Now take their End of the month NAVs say from Jan. 2007 till Date and actually put Clients Total Investment amount and also consider his monthly withdrawal from his portfolio. Now month by month see if his portfolio is suffering gains or losses and ask the client his reaction to his portfolio balance for each month and see how he took the pain of downturn from Jan 2008 to March 2009. If he could not bear the pain then it is certain that 50:50 portfolio is not suited to his situation.
Then repeat the excercise with 40(S):60(B) and see the results and so on till you feel the investor has got the right asset allocation to match his true tolerance.
Unfortunately not one Planner has inclination to do this detailed excercise.
May be you can create a mock portfolio on the above lines in your blog.
Sundar
Wow ! . thats a great method of finding the asset allocation required for some person , just that he will in reality miss that fear and joy as its not happening in real time 🙂
Manish
Just for your information: The above method is what is followed by reputed Financial Planners in USA. But it is quite expensive to do that. Hence in US also we have many quacks filling up questionnaire forms etc. Now you can diversity into this area by offering such premium service. Don’t forget to pay me royalty (joking). Thanks for your appreciation. If you do it live you may cause your Client heart attack. Hence real time is advised.
Sundar
Yes , it looks good overall. I feel it can be done single time and reused with different clients .
Manish
Sundar,
Nice points. Jim Otar at
http://www.retirementoptimizer.com
has an aftcaster along these lines to see how long a next egg will last. Your exercise is very interesting and possibly can be done using SIP calculators at value research money control etc.
Let ,me give it a go and see.
The correct link as once given to me by Manish is
http://www.mutualfundsindia.com/sip_calculator.asp
Nice compilation…. For me people should try to understand that endowment/money back plans, real estate and gold are not excellent investment in the long run.
I would say this one as excellent post for another hidden reason 🙂 because it lists out almost all financial products in a single post with excellent links to previous posts. It would be easy for the newcomers/beginners to read some of the important previous posts about the financial products.
Jagadees
Jagadees
Yea thats a good point that it links to older posts 🙂 . Do you think I have left any product which can be included ?
Manish
Pretty much all the products were detailed. If possible we can include poor performance and high commission involved in PMS(portfolio management scheme) run by brokerage houses.
Regards
Jagadees
Jagadees
Thanks for the suggestion of adding PMS in the article, I have added the PMS also in the article 🙂 .
Manish
Good one Manish.
I think almost every product has some bad sides to it however good it is. Having said that, the bad sides can be bad for some while being good for others – there is no one rule here I guess. Like for an investor like me, I see no +ve sides in moneyback and ULIPs at all while the product with the biggest + side for me has been equity mutual funds through SIPs. Now that might not be the same for others.
Radhey
Yes thats a good point that its not same for everyone , I was talking in general
Manish
Manish,
Excellent post. Infact we can also include Savings A/c and FD. Still a lot of people esp. senior citizens have lakhs in savings account and FD where the returns barely beat inflation.
Rakesh
Rakesh
Added them now 🙂 . Thanks for that recommendation , didnt come to my mind 🙂
Manish
hi Manish,
Thanks for confusing a new investor! I was getting my baby steps into stock market, and trying to get myself organized with taking a term plan and other ULIPs etc…and bang!!! here comes your article..and you’ve managed to highlight the negatives of almost every investment option (some of them I was aware of but was not sure of!)
So that leaves me confused on how I should go about planning my finance, with my limited income and yet build my wealth.
– Harish
Harish
What point confuses you ? It only mentions the other side of every thing which you should be actually aware of while planning thing , you have more information now, so you know what not to expect or do with each product , let me know how current info does not help you
Manish
Manish,
I did not mean otherwise. I liked your article, and have recently started following all your posts. It has some real nice helpful content. I was just disappointed that every investment option that there is in the market, has a negative aspect..but then, it has to be that way! I’m a newbie into investing..so knowing all this is helpful, but knowing how to use these to your benefits is what actually counts and I hope to do that!
Keep up the good work..
– Harish
Harish
Yes , its bound to happen that every product has some bad point or negative aspect , so that everyone chooses different products . Other wise it will happen that there is just one master product which every one is buying .
Manish
Manish,
Can a person overinsure? Is that technically even possible or allowed by the insurance companies? The answer is NO. In my opinion everyone is underinsured if one is taking a cover multiplier of income which is lesser than the technically allowed maximum one.
While advising a person about the quantum of insurance to be bought we planners never account properly for two rather three facts properly. 1) One is inflation and tax to be paid on the earnings from the invested insurance corpus received as death claim.2) The proper assessment of the ‘human capital’ of a person which is represented by his present earning potential and the future possible growth in the income which is to be replaced by the insurance mechanism. If this fact is factored in sensibly; which should be, you would find people are woefully under insured.3) NOW this factor is missed by almost all; including you and many renowned writers/commentators on personal finances. It is the relative use of money. (To explain it properly I need to give some inputs on ‘human capital’ and ‘financial capital’ which for the space constraints I cannot write upon at length.) So I ‘m just giving you a thought to ruminate over. –What effect on rest of your money/wealth would be if you buy so called over insurance? To what degree do you think it will affect your intermediate goals like children education, hsg need, marriage plans etc and to what degree it would affect your retirement planning?(because this is where you stop working for money and now the money has to start working for you). If you can come up with right answer, I promise, it would open a totally new window and provide completely new insight regarding financial planning to you!
Shashank
May be its my limited knowledge but if a person has salary of 8 lacs a year , has no financial depends and takes an insurance of 1 crore , should it not be called Over Insurance ?
Also consider a case where a person is earning 1 crore a year (suppose HNI) , but his life style is very simple and even 10 lacs is enough for his lifestyle , thought the person might be eligible for a insurance of 10 crores , in reality it would be overinsurance becuase that would be much more than what he needs in reality , the flaw is in the way insurance companies calculate the maximum insurance cover a person can have as they link it directly with their salaries and not thier life financial goals .
I dont think a advisor should take into consideration the inflation factor very seriously while suggesting life insurance as life insurance is a tool to take care of things if things go wrong “today” or in immediate future , the client is suppose to take care of addtional risk through his wealth generation , so if today a person dies his family might need 50 lacs , but if after 10 yrs his family needed 80 lacs , he should make provision of this extra 30 lacs from his investments in these 10 yrs .
If one wants to factor in inflation anyways , we have products with 5% increasing cover in the market .
I agree with your point that over insurance if takes through term insurance would not put any drastic bad effect of other goals as it would be small amount and through tradtional means I wonder if there would be even a single person who takes over insurance 🙂 .
Thanks for putting your points , it gives me some food for thought
Manish
Manish,
Would we call that 8 lakh earning guy ‘overpaid’ because he is earning more than the prevalent needs? Similarly is the HNI fellow over earning as he can live on only fraction of his income? I think both of would answer these questions as NO, isn’t it?
Then why do you want to create less insurance for them. Which asset we are trying to protect here? The human asset whose earning ability is so and so. We are not protecting his spending ability which may be any fractional/full part of the earning ability.
So the earning ability is the superset and all other goals which are fulfilled by use of these earnings are the subsets. You cover the superset ,the subsets would be taken care of automatically.
To my previous comment you reply was insurance is ‘hedging mechanism’. So what do you think should be hedged- the individual goal values or the fountainhead of all it-the earning potential itself!
So all these individuals should cover themselves to 8 lakhs and 1 cr earnings adequately.
The point about inflation and tax is with respect to the survivors not the insured person or cover. That is a separate issue and important.
Dear shashank,
As a pure term insurance practitioner, i am agree with your point….in context of………. what IRDA says that minimum insurance cover which we can give to any eligible person is 10 times of his annual salary…. and if he wants to take more cover he have to include his assets also.
RajniKant
Would like to hear your comment too on my reply to Shashank 🙂
Manish
Shashank
So if I understand clearly now , the difference on opinion between us is the way we look at Life Insurance , you are treating Human life value of an individual to be the benchmark for Life Insurance value , where as I am taking and also beleive that Actual goals value in current terms is the right benchmark for Life Insurance .
If a person who earns 10 crores a year, but has a life style and goals which requires just 30 lacs a year , should one insure him for 10X his current income , which comes at 100 crores or just an amount of money which can fulfil all he wanted in his life which can happen at just 5 crores total . With the way I look at it , his life insurance should be just 5 crores in that case , lets add 20-25% more to that and make it just 6-7 crores . more than that I would call it over-insurance , which would gives extra wealth to his dependents but its not required now give his family what they wanted .
I hope you would agree that this difference of thinking between us was because of the way look at life insurance . Let me know . this whole gives a good perspective on how even advisors can have different opinion on the same thing ..
Manish
Dear Manish,
As per knowledge , the term over insurance is confusing…..let us take an example…..insurer does not give risk coverage who is not earning….even LIC provide risk cover upto 50k under AAM AADMI BIMA YOJNA…..or u can say in microinsurance…… HUMAN VALUE is always calculated with the help of ANNUAL SALARY and PHYSICAL ASSETS he holds…….INSURANCE is not related to LIFE STYLE or FUTURE GOALs…..
Rajnikant
insurance does not give insurance to those who are earning because they cant pay premium or someone is not dependent on them financially already ! .
“insurance is not related to Life Style or Future goals” ! , why do you say that , there are different models of calculating life insurance , one of which is “Human Life Value” approach and thats the erronious one as per my faith and beliefs , thats the reason there is this opinion difference .
Manish
O.k…… I am agree with your point…..now suppose….reverse ur point..let us take an example.. i am earning 5lakh per annum and after 2 years i am aspecting my salary will be getting double……..but rt now i taking future promotion into consideration and taking insurance cover of 1 cr.
Am I eligible to take insurance cover of I cr today as my annual salary is 5 lakh.?????
Taking ethical insurance practice (i.e. min. 10times of annual salary by showing ITR or salary slip )… into consideration.
RajniKant
You are again linking Insurance needs with Salary , thats the problem . If you link your insurance needs with your salary , then you are correct, one can incorporate the future changes also . But that a wrong way as per my belief
Manish
Dear Manish……
Plz correct me if i am wrong….as per my knowledge today in Personal Finance HLV is calculated based on SALARY and ASSETS…. only. Is there any other method also???
HLV is always calculated using assets and salary , but HLV is one of the methods of calculating life insurance , another approch is goal based analysis which I feel is a better way . Where one’s insurance need is current value of all the future financial goals of a person .
Manish
@Manish/Rajni Kant – First of all, what you are saying regarding 10 times of annual salary is true only for ULIP and that too MINIMUM 10 times..There is no limitation for TERM PLAN..A person can take SUM ASSURED of upto 20 to 25 times of his annual salary under term plan, depending upon plan to plan..For Goal base planning via INSURANCE route, TERM PLAN is just one of the medium..An individual can take CHILD PLAN, PENSION PLAN etc to meet his long-term financial goals..
As for Rajni kant asking a question about his salary increase in the future, he can have a new term plan then and increase his COVER amount if he feels he need it..Although most of the people go for increase in cover when they have taken very less amount of SUM ASSURED since begaining, say 10 or 15 lakhs which is very less for anybody, anytime…
Hi Manish
Thanks very much for the wonderful article. I think you just miss New Pension Scheme (NPS).
Manu
I would consider it to be very new and not many invest in it compared to these products which are mentioned in the article 🙂 . So for now leave it .
NPS has a major issue and thats no-clarity about the pension returns you would be getting at the end ? What if its 4% ?
manish
Dear Manish,
If I am not wrong…..NPS is same as ULIP in which some portion of our saving which we do as RD in NPS account get invested in market through our selected Fund Manger…..
Correct me if I am wrong and enlighten me through your knowledge.
Regards,
Rajni Kant
Rajni
You should rather call it as ULPP , which is unit linked pension plan , because NPS is a pension product , upto 50% in NPS is invest in Equity and its managed by funds managers , but the major difference in NPS is that you can change the funds manager if you dont link them 🙂
Manish
Awesome 🙂 Article Manish – a must read for everyone.
I may not agree with few points but that’s problem with my nature 😉
Hemant
Which points you dont agree ? Lets discuss
Manish