Note: While reading a book whenever I come across something interesting, I highlight it on my Kindle. Later I turn those highlights into a blogpost. It is not a complete summary of the book. These are my notes which I intend to go back to later. Let’s start!

  • Think of your financial life as a money box. The money box fills in your working–earning years with income; you use the money to pay for living costs, fees, rent, EMIs (equated monthly instalments), taxes, insurances and vacations, and a whole long list of what it takes to live the Indian urban mass affluent life. Usually the box shows a surplus left behind at the bottom each month

  • How should we think about our money box? A good money box is one that allows you to streamline your cash flows. It builds in safety nets for preserving your savings in the face of an emergency – typically a medical emergency, a job loss, or death of a salary-earning family member

  • Three buckets for the three functions of money: Income, Spending and Saving. If we can separate the money into these three buckets each month, we’ll be in better control

  • Use three bank accounts for each of these different functions and name them

  • My salary account I label ‘Income Account’. The second account I call ‘Spend-it Account’. The third is called ‘Invest-it Account’

  • Once your salary hits your Income Account, within thirty minutes (OK, take a day – but do it) move out your monthly expenditure to your Spend-it Account. And whatever is left, move it to your Invest-it Account. Salary accounts are usually zero-balance accounts, so sweeping all the money out is possible. But if you like to leave little pockets of cash for that little bit extra spending, like I do, keep a few thousand in your Income Account as a cash reserve

  • Use your Income Account as the sump for all kinds of money inflow that we get. You may quickly say: ‘Oh, but I get only a salary.’ But there is always some other cash that flows into your life. Cash gifted by parents or relatives, a bonus, a refund from work, a matured insurance plan, rent from a property you own, dividend on stocks or mutual funds, return of money borrowed

  • Other than interest earned in the other two accounts, rest of the inflow into your life falls into one account – your Income Account

  • Next, remove from the Income Account the money you spend each month. Move this into your Spend-it Account. That’s all you have for this month’s expenses – rent, EMI, food, salaries to pay, fuel, credit card bills, utilities, pocket money, medicines, whatever

  • Now, whatever is left in your Income Account, move it, in another thirty seconds (OK, at most thirty minutes!), to your Invest-it Account

  • Remember what the goal is: to have a hands-free money life. Remember what we’re doing right now is about creating a system so that, once it is in place, you can execute your monthly money moves in thirty seconds

  • We all need an emergency fund. This is a fund that will only be used in case of a financial emergency. We clearly label it in our heads as an emergency fund and don’t tap into it. No, you can’t use it even for the down payment of the house. This is the piggy bank you break only when you need the money for an unplanned emergency

  • How much do you need for the emergency fund?

    • A rough rule of thumb says keep aside six months’ living costs. Include everything in it – rent, EMI, school fees, utilities, premiums, credit card charges, club memberships, whatever. The cash flow system that we created earlier will tell you what your monthly transfer to your Spend-it account is. Multiply that by six

    • Set up an FD with your emergency money in it. If you are banking with a bank that allows flexi-FDs that allow you to sweep out just the amount you need, rather than breaking the entire deposit, go for that. Else split your emergency fund into smaller FDs so that you don’t have to lose the interest on the entire deposit

    • People familiar with mutual funds can use what are called short-term debt funds to build an emergency fund

  • Look at the health insurance policy purchase as a three-part decision.
    • One, how does it perform on the metric of price
    • Two, how does it perform on the metric of benefits
    • Three, how does it perform on the metric of claims. You may have the cheapest policy with the best benefits, but if the company’s claims policy rejects a large number of claims, the policy is not of much use
  • It is important to know what the policy costs right now and in the future. Unlike a life cover, where your premium gets locked when you buy a term cover, the premium of a medical cover changes as we age. You need to look at two things in price. How does the price compare with policies from other companies right now and how does the price compare over the years? Your policy may cost the least today but may become the most expensive when you hit age sixty or seventy

  • If you are buying from an agent, ask him to show you the price comparison at ten-year differences. If you are forty, ask for the price of the policy as it is today when sold to a fifty-, sixty- and seventy-year-old. If he can’t do the work, find another agent. He will be getting a commission on your purchase now and every year after you buy. Let him earn this commission by doing the work that you want him to do. Don’t get distracted by the sales spiel

  • We buy a medical cover so that when faced with a hospital bill we don’t have to dip into our savings. The deal is simple: You pay an annual premium and when you get hospitalized, the insurance company pays the bill. But then it is a complicated world. Insurance companies have the ability to set up the game so that you lose. And given how technical an insurance product is, there is no way you will know all that there is to know

  • You need to find out if your policy gives at least these eight benefits
    • One, ensure that you have a policy that does not have something called a ‘co-pay’ clause. This is called ‘co-pay’ because you agree to pay a certain percentage of a bill to share the costs with the insurance company. Unfair, you exclaim. It is, except when a senior citizen goes to buy a cover, co-pay allows him to at least get a cover. More of that later. For example, if you agree to a co-pay of 10 per cent, you have agreed to pick up one-tenth of the cost of the hospitalization. If your bill is Rs 2 lakhs, you will have to pay Rs 20,000 and the insurance company will pay 90 per cent or Rs 1.8 lakhs. Look for a policy that does not have a co-pay clause. Ask your agent to mail you the policy document and then do a search on the words co-pay. Search the net to see if the policy being sold has complaints related to it having a co-pay clause. Build an email trail with the company or the agent to ensure that you have something in writing that ensures that you have not been lied to. The presence of an evil co-pay clause has caused plenty of curses to fly in the direction of insurance companies when the glitzy promises of care turn into castles of sand at the time of a health crisis
    • Two, check for a ‘pre-existing’ disease clause. Insurance companies will not cover diseases that you already have when you take the policy. Insurance rules allow a company to refuse to pay for any treatment related to any condition, ailment or injury for which you were diagnosed or had symptoms when you took the policy, for four years. For example, if you were diagnosed with kidney stones and took a policy soon after, the company is within its rights not to pay for the surgery to remove those stones if it happens in the next four years. But there are companies that waive or reduce this waiting period, to pay up earlier. Check to see how long the waiting period is in the policy you shortlist. But a caveat here: People with any pre-existing disease find it difficult to get a cover. Some insurance companies use this clause to refuse claims for totally unrelated ailments. It is a good idea to disclose your correct present and past medical history to the insurance company when you sign up for the policy. Else they will have a tool in their hands to refuse your claim. And, believe me, they use it to refuse claims on very flimsy grounds
    • Three, check if your policy has a ‘disease waiting period’. Many companies have a cool-off period of thirty to ninety days during which they will not pay any claim. Some ailments such as cataract or hernia may have a ‘waiting period’ before the company will pay. Ask the agent to list out all diseases that are covered under this clause. Look for a policy that does not have a waiting period on diseases or coverage
    • Four, check if your policy has ‘sub-limits’. A friend was admitted for a knee surgery to one of Delhi’s upmarket hospitals. Confident of a Rs 4-lakh cover, she selected a single deluxe room. When the time for the payout came, the insurance company refused to pay the room rent, which was over Rs 8,000 a day. Her policy had a sub-limit of 1 per cent, which is the portion of the cover that can be spent on room rent. Her cover was Rs 4 lakhs, so her room rent over Rs 8,000 a day was not paid by the policy. Other expenses were also paid in line with a Rs 8,000-room, reducing the claim amount even more as some hospitals hike charges according to room rent. You need to check this carefully. A sub-limit is a limitation on what the company will pay out for specific things. We usually stumble upon a sub-limit on room rent. There are two kinds of limits on room rents – either by price or by category. Your policy may say that it will pay a maximum of Rs 2,000 as room rent or it may say that you are eligible for a double occupancy room with air conditioning. Room rents in the large five-star health shops (can’t call them hospitals any more) cost much more. Remember that the other expenses are associated with the type of room you take. You could find yourself paying for a lot more if you take a higher category room than what your policy will pay for. Look for a policy with no sub-limits.
    • Five, check for exclusions. A policy will list out diseases, conditions and medical services that the policy does not cover. Dental treatment, pregnancy and cosmetic surgery are standard exclusions. It is a good idea to get a list of all that is excluded in the policy you buy. What you can’t do much about is when the policy you buy excludes something at some future point in the policy. One firm excluded a costly cancer injection midway in a policy and people who bought the plan and made a claim were not paid for that injection. The dice is loaded against us, the individual customers of mediclaim
    • Six, ask how much of the costs before and after hospitalization the policy will cover. You can claim expenditure made on doctor’s fees, medicines and diagnostic tests done before a planned hospitalization and for three months afterwards. For example, a knee replacement will have MRI costs before the surgery and physiotherapy costs post surgery. Check if you can claim these costs. Check the exact amount and time your policy will cover
    • Seven, ask for a list of ‘day-care’ procedures that don’t need you to stay for twenty-four hours in a hospital any more. Procedures and treatment such as a cataract surgery or surgery for a ligament tear (there is a standard list of 130 such procedures) are treated as ‘day-care’ procedures and are covered. Check the details of the day-care clause, what will be covered, how much will be paid and how long you have to stay to claim
    • Eight, look at the ‘no-claims bonus’ feature. When you don’t make a claim in a year, you get rewarded by the insurance company. It does this by giving a ‘no-claims bonus’ (NCB). The usual way is to raise your cover by 10 per cent for the same premium. If your cover was Rs 15 lakhs, for a premium of Rs 25,000, when you have a claim-free year, you get a cover of Rs 16.5 lakhs for the same premium
  • Your search for that good policy is not over till you understand the claims history of the company you finally choose. You know if a telecom service is good or not when you use it. It is very here and now, but for a medical policy, the moment of truth is when you file a claim. Does the insurer pay up? How much does he pay? Is the process easy? How quickly does the company respond to complaints? These are questions that you must think about at the time of buying your policy. Unfortunately, in India, claims data is not standardized and is difficult to get. The regulator has not thought the disclosure of data through so as to make it meaningful to consumers

  • Ask the agents these questions on claims before you buy:
    • One, how many claims does the company settle? Out of 100, if the company’s claims history does not settle more than ninety-five claims, don’t buy from the firm. Claims are a tricky area because the companies club together group and individual claims data. Group claims get paid far more than individual claims. Ideally the disclosure on claims should be product-wise and not clubbed as one big number.
    • Two, look at the claim-complaints data and look for a policy that has less than thirty complaints on every 10,000 claims made. Be careful of firms that give data on complaints as a percentage of policies sold. What is relevant is how many people, how many made a claim, then how many went on to complain. This number should be low in the policy you finally choose
  • The best way to get a larger cover is to use what is called a ‘top-up’ plan. Think of this as a policy that will pay up after a certain threshold amount has been paid by you. Suppose you have an existing policy for Rs 3-lakh medical cover. Now you buy a top-up plan that gives you another Rs 5 lakhs of cover, but after a Rs 3-lakh deductible. If your medical bill is Rs 4 lakhs, you will pay Rs 3 lakhs from your basic policy and Rs 1 lakh from your top-up. Even if you get admitted twice, with Rs 2 lakhs your bill each time, your costs still will be covered. Remember to buy a top-up that allows you to claim after the deductible is covered across different episodes in hospital. If you are unable to get even a top-up, targeting your own medical fund is your only option

  • Some policies cover up to twenty such illnesses including cancer, kidney failure, heart attack, major organ transplant, stroke, serious burns and end-stage diseases of the liver and lung. A Rs 10-lakh policy should cost between Rs 3,000 and Rs 5,000 roughly. Prices will change and differ according to company, features and the person buying the plan. You should be able to add a ‘rider’ to your existing policy on the policy renewal date. A rider is an add-on at a very low cost to a basic policy. Riders look attractive, but I recommend that you buy a stand-alone accident policy from a general insurer. This cover is likely to be more comprehensive and will not lapse if you discontinue your basic policy for any reason.

  • A personal accident policy adds another layer of security to your by-now robust medical insurance portfolio. This kind of policy gives you a lump sum if you meet with an accident that leaves you temporarily or permanently disabled. A personal accident plan has four covers: death, permanent disability, permanent partial disability and temporary total disability.

  • For death or permanent disability, you mostly get the entire sum assured. For permanent partial disability, the policy pays a part of the sum assured, and for temporary total disability, it pays a weekly compensation, usually up to 104 weeks.

  • How much insurance you buy depends on how insecure you feel about your health and the future

  • A pure life insurance policy is called a ‘term plan’

  • An average thirty-five-year-old can buy a twenty-five-year term plan that gives his beneficiary Rs 1 crore (Rs 10 million) if he dies within those twenty-five years for the price of Rs 8,000 to 10,000 a year. Pull out your plans and see how much cover you have. I can assure you that if you don’t have a term plan, you don’t have much cover

  • In a term policy, your premium is a price you pay for buying a life cover. So if your premium is Rs 10,000 a year for a one-crore cover, this is the price you pay to the insurance company for taking the risk of you dying an untimely death. When you buy this policy, you understand that if you live beyond the policy term (usually till you reach retirement age, you get nothing back. Your Rs 10,000 a year for twenty to thirty years is a ‘waste’. You got nothing back

  • This is where you need to rework your own belief about this being a ‘waste’. It is not. It is the price you pay for buying a life cover. You hope that your family does not have to collect the insurance and that you die of old age

  • The typical endowment insurance policy gives you a tiny crust of life insurance cover; it is usually ten times your premium. So if your premium is Rs 50,000 a year, your life cover is Rs 5 lakhs. It also promises to give you a return on your money. And that is the carrot for you – you get a ‘cover’, so your family’s safe; you get a return and you get a tax break. The pista on the jalebi is that the money at maturity is tax-free

  • The way the policy is sold talks about the returns in terms of whole numbers: You invest Rs 50,000 a year for five years and you get back Rs 5 lakhs after another fifteen years. Or you invest Rs 50,000 a year for fifteen years and you get back Rs 10 lakhs. The whole numbers look big with lots of zeros, but ask the question what the return percentage a year is, and you get shocking answers. The first policy returns 4.15 per cent a year. The second, 3.98 per cent a year

  • Endowment plans destroy wealth over the long term. The day you realize that it is in your best interest to separate your investment and insurance products, is the day you move solidly towards building your financial security

  • If you died today, think of all the expenses that the family has ahead of them. Now think of how much they will need to put away in a fixed deposit or a tax-free bond or a mutual fund to generate a regular income?

  • The rule of thumb is that you need eight to ten times your take-home annual income. Or fifteen to twenty times your annualized monthly expenditure

  • Let’s work with some numbers. Suppose your annual take-home income is Rs 6 lakhs, or about Rs 50,000 a month. You die. Your cover was for a nice fat Rs 60 lakhs. Your spouse gets this money. She does not understand bonds or funds and just puts this in a 7-per-cent ten-year fixed deposit (FD); she is able to generate Rs 40,000 a month. In addition to a cover for your income, you need to buy insurance for all the debt you have. Each time you take a large loan – usually a home loan, sometimes a personal loan – buy a term cover for the full amount of the loan that you take. Suppose you take a home loan of Rs 80 lakhs. Buy a term cover of Rs 80 lakhs. Your bank may offer you a reducing cover policy whose premium is bundled with your EMI. Say no. It’s likely to be more expensive and there is another logic for buying a Rs 80-lakh cover. As your loan amount falls, you are growing older, doing better at your work. Your salary is rising; therefore the need for the cover is rising The cost of life cover rises exponentially as you age. A cover of Rs 1 crore for a thirty-year-old will cost between Rs 8,000–10,000 a year. For a forty-five-year-old, this cost will more than double

  • The policy you buy is a mix of getting a cheap plan from a company that is known to honour its claims. Why cheap? Term insurance is a pure vanilla product. You pay a premium; if you die, the company hands over a fat cheque to your spouse. Since this is a long-term contract – usually a twenty- to twenty-five-year policy term (remember, we’re getting you a cover till your retirement) – the cheaper you buy the better it is. Also, once you buy a policy at a particular price, you get locked into this price

  • The online plans are the cheapest since they remove the agent commission (up to 42 per cent of your first-year premium) – from the price of the insurance. When term plans were launched online some years ago, the prices dropped by almost half! A policy sold by an agent costs twice as much as the policy you buy online

  • When buying a term cover, check the claims experience of the insurance firm. Shortlist three or four policies that you like in terms of low prices for your age, cover and tenure, and then start looking at the claims experience. This is not so easy to find. A claims experience of over 95 per cent is fine. This means that the company pays 95 per cent of the claims filed

  • The job of the life insurance cover is to serve you till you are debt-free and financially independent. The moment that happens you can stop your term insurance plan. Remember that these are annual contracts; if you terminate it, you lose nothing. You lose a lot if you terminate your endowment policies midway. One more reason to just stay with a term plan

  • Pull out your mental money box and look at it again. Remember that the first cell has your cash flows, the second is the emergency fund, the third your medical cover, and the fourth has the life cover. We now create three more cells in the box for our investments. We name each cell: The first is called Almost There; the second, In Some Time; and the third, Far Away

  • Any planned expense that will happen within two to three years is a short-term need that you put down under Almost There. What could these needs be? Getting married, sending kid to school (some of these teaching shops take development fees that cost a bomb), buying a house, buying a car, going for a holiday, financing mum’s surgery, buying dad a car – go on, you write a few down on that paper

  • In Some Time are planned expenses that sit between three to seven years away. Already, it begins to get a bit difficult to plan ahead. But let’s try. Depending on your age and stage, In Some Time could fill with down payment on your house, kids’ higher-education fees, kids’ marriage and your retirement. Write down what you think your unique In Some Time needs will be

  • Far Away are expenses that are really hard to imagine today. At age thirty to thirty-five it seems impossible that you will ever get old. I’ve crossed fifty, and even I find it difficult to think that I will fully retire, and will have to depend on my savings for living costs sometime in the not so distant future

  • Next, we put down what each of these will cost you in the future. Put down a value next to each of these – what it costs today. For example, if you know that you will need money to pay for a down payment on a house in two years, you know already what your budget is and approximately how much you will need in two years.

  • The Indian habit of gold, FD and real estate is hard to break. But why buy the ’60s and ’70s products when you have the millennial financial products to invest in. Count the costs, count in the years of investing, and look at post-tax returns to see the true face of your investment returns.

  • In terms of investing you are doing OK if:

    • you have no more than 5 to 10 per cent of your portfolio in gold and they are in the form of government gold bonds;
    • you own one house as the roof over your head, and no more;
    • you have your PF and PPF, and no other debt products, no FDs, no corporate deposits, no chit funds;
    • your debt allocation is equal to your age; at age thirty, no more than 30 per cent of your portfolio is in debt products; at age seventy no more than 70 per cent in debt products; the rest is equity
    • you need an equity exposure rather than direct stocks. The best way to expose your money to equity is through mutual funds. Understand that there is a way to get safe equity returns, but you need a plan and you need to manage both greed and fear. You are doing OK if:
    • you understand that equity cooks over time and you need at least seven to ten years of patience to see returns;
    • you understand that you will not double your money overnight, but will get a return that is between 12–15 per cent a year;
    • you understand that mutual funds are the best way to give your money an equity exposure;
    • you understand that if you don’t have the ability to choose funds, you invest through index funds or ETFs
  • You can buy three kinds of asset classes through mutual funds – debt, gold and equity. Real estate will soon be available through special mutual funds called real estate investment trusts (REITs)

  • Equity mutual funds buy into stocks of listed companies. Debt mutual funds buy bonds and debt papers issued by the government and firms. Gold funds buy actual gold

  • You must buy debt funds to match the investment horizon of the mutual fund scheme with yours. Investment horizon, or the time for which you want to invest your money, can also be called ‘tenor’. You are going to match our holding period with that of the scheme you buy. This means that you will buy a debt fund that invests in short-term bonds if you need your money in the near term. You will buy a debt fund that invests in long-term bonds if you plan to hold the fund for a long time and don’t need the money in the near future

  • There are two ways to slice the debt fund market:
    • One, according to tenor, or the holding period of the bond
    • Two, according to the quality of debt paper bought by the fund
  • When you think of a debt fund, ask yourself these two questions:
    • Does the ‘average maturity’ of the debt fund match my holding period? If I want the money next week, should the average maturity of the fund be three years? Obviously, the answer is no.
    • Question two is – what quality of debt paper does the scheme hold? The better the quality, the lower will be the potential return. The lower the quality, the higher is the risk and the return. If you don’t want risk in your debt fund, settle for debt funds that only buy high-quality paper, and be willing to sacrifice some return for that safety
  • If there is a banking product that is like a liquid fund, it is the savings deposit. The purpose of a liquid fund is to keep money, well, liquid, or ready for use. The bonds that a liquid fund buys are short-maturity bonds, or bonds that will mature within an average of three months

  • Liquid funds buy short-term bonds. Therefore, the money you have to put in a liquid fund must be money you need in the short term. I keep money in a liquid fund if I know there is an expense coming up in the next three to six months

  • You can invest in Ultra-short-term fund if you need the money anytime in the next nine months to a year. These funds invest in bonds that have an average maturity of about nine months – they buy debt papers that mature in a week to eighteen months. These carry low levels of risk usually, but you need to constantly watch out for mutual funds buying lower-quality bonds to spike returns

  • Government bonds are the safest and, therefore, carry the lowest interest rates because there is zero risk of default. In other words, the government will always pay up its debts. But as the risk of non-payment of interest and principal rises, the bonds get graded lower and lower. If triple-A (AAA) is the safest kind of bond you can buy, a double-B (BB) means fairly high levels of risk. For now, all you need to remember is that if an ultra-short-term fund is showing very high (compared to the category of ultra-short-term debt funds) return rates, look deeper into why

  • What should you do if your investment horizon is two years? You should stay with the ultra-short-term fund, though I use a conservative balanced fund. These are debt funds with a small flavour of equity. The large bond-holding takes away the volatility that equity brings in a bad stock market. But equity adds to the overall returns in a good stock market

  • Gold funds are funds that invest in gold. They buy actual gold and track the price of gold in real time. The product is called a gold exchange traded fund (ETF)

  • Instead of buying physical gold, you can buy gold that is held by the mutual fund through a gold ETF

  • You buy a unit of the gold ETF at the current market price of gold and the ETF invests that money in bullion of 99.55 per cent purity. One unit of an ETF is equal to 1 gram of gold

  • There are two kinds of passive funds – an index fund and an exchange-traded fund. They both choose an index and mimic it

  • Sensex is a weighted average of the prices of thirty stocks. The index funds will buy the thirty stocks in the same proportion as they have in the Sensex and just stay with the investment. If the Sensex falls by 1 per cent, the index fund’s NAV (net asset value, i.e., the price of one unit of a mutual fund) will also fall by around 1 per cent. Your return will be equal to the Sensex return minus costs

  • An ETF also tracks an index like the Sensex but lists its units on a stock exchange, unlike a mutual fund. To buy and sell mutual funds you don’t need to have a demat account. But to invest in an ETF, you need a demat account. The other difference in index funds and ETFs is that you can buy an index fund at a price at the end of the day, but you can buy an ETF at any point in the day

  • Since there can be any number of indices in a market – broad market index, mid-cap index, small-cap index, technology index, PSU index, and so on – there can be any number of index funds. Remember that the risk of the index fund you buy will be the risk of the index fund category you buy into. So the risk of a mid-cap index fund is much higher than the risk involved with a Sensex or Nifty fund

  • There are three kinds of options that each mutual fund scheme offers you: growth, dividend and dividend reinvestment

  • If you buy units of an ELSS scheme, you get a deduction from your taxable income. In June 2018, the benefit was Rs 1.5 lakhs. It has a three-year lock-in period, and you cannot exit before that. Remember not to tick the dividend or dividend reinvestment option in an ELSS. Go for growth

  • There are three kinds of balanced funds – conservative, balanced and aggressive. Conservative funds have between 10 and 25 per cent in equity, balanced have between 40 and 60 per cent in equity and aggressive about 65–80 per cent in equity. Conservative balanced funds are also called monthly income plans (MIPs)

  • MIPs are not assured income schemes; they are just debt funds with a small crust of equity to give a slightly higher return than a pure debt fund

  • What is this NAV? It is the price of a unit of a scheme. The full form is net asset value. It is not ‘gross’, because the costs have been removed from the price, and you get the net value in your hand

  • Imagine there are 100 investors and each has put in Rs 1,000 in an equity mutual fund. Each bought a unit for the price of Rs 10; therefore, each investor holds 100 units. A sum of Rs 1 lakh is invested by the mutual fund in different stocks. A year later the value of the portfolio is Rs 1.5 lakhs, giving a profit of Rs 50,000. This will be shared equally by the units, but before that costs will be removed. If the cost is Rs 10,000, the profit that goes to the unit holders is Rs 40,000. This gets reflected in the NAV that goes from Rs 10 to Rs 14. Your 100 units are now worth Rs 1,400. Multiply the NAV with the number of units you hold to get the value of your mutual fund holding per scheme

  • A market-linked investment product carries three kinds of costs:
    • One, the cost to enter the product, also called a front load. If you invest Rs 100, and Rs 2 from that is cut out so that Rs 98 is invested, the Rs 2 is called a load. A load is part of the price of the product, or is embedded in the price – it is an invisible charge because it is not usually disclosed. Mutual funds have zero loads and are an extremely investor-friendly product. The question to ask when buying a market-linked investment product is: How much of the money I invest goes to work?
    • Two, an ongoing cost or the annual fees that you need to pay to have experts manage your money. To take care of the running costs and profits of investment managers each year, some fees are deducted from your money. The cost to you of handing over your money to professionals is captured in a number called the ‘expense ratio’. This is the fees that a mutual fund charges investors for its costs and the profits it makes. If you bought an equity fund and got a twenty-year annual pre-cost return of 15 per cent a year, the fund with the lower expense ratio will get you a net return of 14.5 per cent, and the higher expense ratio will give you 13.5 per cent. What difference does that make? If you had Rs 1 lakh invested in both, one scheme will give you Rs 15 lakhs, and the other will give you Rs 12.58 lakhs. Costs matter. Do look at the expense ratios of the funds you buy
    • Three, an exit cost, or the cost of selling the product. To take care of expenses of selling the investment you made or to act as a deterrent to frequent churning of money, funds levy exit charges. This is a percentage of your corpus and usually falls off to zero after about one or two years. Ask this question: What does it cost to redeem this product after one, two, three years and so on over the life of the product?
  • A SIP is a systematic investment plan. Think of this as a recurring deposit, but instead of putting money in a fixed deposit, you are making periodic investments into a mutual fund

  • A systematic transfer plan (STP) is a facility that allows you to space out a big investment over time. What if you suddenly got a big bonus or some arrears, or inherited a bunch of money? Instead of investing it all in one go, you can put the money in a liquid fund and set up a monthly (or weekly or fortnightly) transfer into an equity scheme. Remember that you have to choose a liquid fund of the same fund house whose equity fund you want to buy through an STP

  • A systematic withdrawal plan (SWP) is a facility to periodically redeem your units to generate an income. Yes, it works like a dividend plan, but in this case the control remains in your hand of how much money you want to take from your fund periodically. The risk in an SWP is of it eating into your corpus. I find an SWP a useful tool for my retired father who is in a conservative balanced fund

  • An investment-oriented financial product must be evaluated on six parameters:

    • Cost: What does it cost me to buy this product? When we buy an insurance policy or a mutual fund, it is not very obvious that there is a cost. Financial products have at least three kinds of costs that you must know about.
      • First, there is a cost to buy the product. Different products, even if they do the same thing, have different entry costs, also called loads. These are commissions that the person selling collects from the manufacturer of the financial product. In a ULIP the front load is about 8–9 per cent. In a mutual fund, there is no cost of entry. The front load was brought to zero in 2009. In a bank FD, PPF and PF there is no front load. The National Pension Scheme (NPS) has a front load of 0.25 per cent of your contribution, or Rs 250 on a Rs 1 lakh investment. Front costs reduce the money that goes to work in a financial product
      • Second, there is an ongoing cost. This is the money you need to pay each year for you to stay in the product. Also called expense ratio, this is usually a percentage of the money in the investment. If you invested Rs 1 lakh and the money is now worth Rs 2 lakhs, you will pay the expense ratio on Rs 2 lakhs. The expense ratios differ according to type of product you buy. They are low for debt-oriented products and high for equity-oriented products
      • Third, cost of exiting the product, or an ‘exit load’, which is the cost the fund manager charges to take care of the costs of exit. Most debt funds have zero exit cost, and most equity funds have an exit cost of 1 per cent if you leave before one year. Exit costs are very high for insurance products – if you leave midway, you lose a big chunk of your money. If you leave in the first three years in a money-back plan, you lose all your money. Ask the seller: What does it cost to exit the product?
    • Return: What does it return? The purpose of an investment product is to give you a return. You should know what a product returns, either definitely in a guaranteed product, or approximately in a market-linked one. Stay away from products that give you returns in absolute numbers – Rs 1 lakh will become Rs 5 lakhs. This does look like a return of five times, but when you understand that this is over thirty years, the return works out to an unimpressive 5.5 per cent a year. Also remember that returns and risk are linked. Low returns usually come with a guarantee. To get a higher return, you will need to take more risk. Stay away from low-return market-linked products like participating insurance plans. Remember the return must be in terms of your investment. A trick to fool you perfected by insurance companies is to link returns to a third number! You should be able to compare the return to your bank FD. Market-linked products and ‘participating’ insurance plans cannot give assurances of future returns, so ask to see how the product did on past returns. Ask for an average annual return of the product for the last three, five and ten years. Then ask to see benchmark returns. Then ask to see category returns. Category return is the average return of the category of the product. For example, if the seller tells you that your money will go into a large-cap fund, even in an insurance plan, ask to see what the category of large-cap funds have done over the past. How does the fund being sold compare to that?

    • Lock-in: Is there a lock-in? This is important to know. A lock-in means that you cannot withdraw your money for a certain period of time. For example, the lock-in with the PPF product is fifteen years. The lock-in with a five-year bank FD is, well, five years. Mutual funds are of two types, open-ended and closed-end. There is no lock-in in open-ended funds, but closed-end equity funds have a three- or five-year lock-in. The ELSS funds are locked in for three years. Open-ended funds may not have a lock-in, but can have a cost of exiting before a certain period of time (more of that in the next section). ULIPs have a five-year lock in. NPS has an age-linked lock-in – you cannot redeem before you hit age sixty. I like to invest for the long-term, but don’t like lock-ins. They force me to stay with a poorly performing fund manager. What happens if I exit early?

    • Cost to exit early: Early exit can happen in two ways:
      • One, you want to exit before the lock-in gets over. For example, in PPF, what if you want to stop the product midway and get your money back? Or you want to redeem your money before three years in an ELSS fund? Or you want to redeem your money from a ULIP before five years? Or exit the NPS or your PF? Well, you can’t. There are some special circumstances in which you can redeem a part of the NPS or your PF. A closed-end mutual fund does have an exit option before the tenure because it is listed on a stock exchange and you can get the current NAV if you sell your fund on the exchange. But historically, listed closed-end funds trade below their NAV, and most investors prefer to wait it out. Anyway, if you have a good emergency fund, your need for midway liquidity should be adequately met.
      • Two, what happens when you exit a long-term product? You need to ask: Is there a cost to an early exit? For example, if you want to exit from a three-year bank deposit in two years, you can do that, but it usually costs you 0.5 per cent of interest forgone. Products like equity mutual funds, ULIPs and endowment plans should be bought with an investment horizon of at least five to thirty years. What happens if you exit earlier than the product term? In open-ended mutual funds exit costs are used to keep investors in the product for a minimum amount of time. This is done using an ‘exit load’. For example, liquid funds are like the savings deposit and there is no exit load. Most ultra-short-term funds don’t have an exit load. Credit risk funds and debt funds that buy lower-quality paper to give a return kicker, usually have a 1 per cent or 1.5 per cent (that is, it will cost you 1 to 1.5 per cent of your money in the product as a cost to exit. If you had Rs 5 lakhs in a fund with an exit load of 1 per cent, and you exit before one year, then you’d pay Rs 5,000 on exit. You would get back Rs 4,95,000 if you exited before one year) before a holding period of 365 days as an exit load. Some income (debt) funds cost as much as 2 per cent if you redeem before 540 days. Equity funds usually cost up to 1 per cent on redemptions before a year. Do ask: What is the exit load and the period that would be considered an early exit?
    • Holding period: Each financial product has a use-by date on it. Unfortunately, regulators in India do not force manufacturers or sellers to put that date on the product material. If you use a financial product that releases its flavour over many years for a short-term need, you are courting financial disaster. Therefore, planners do not recommend pure equity products for financial goals that are less than three years away. Each product you allow into your money box must answer this question: How long do I need to hold it for it to work for me? This is one of the most crucial questions to ask, because the success or failure of a financial product is also dependent on whether you bought a product that is suited for your investment horizon. There are some products that even if held to term are bad for your money box. I will include ULIPs and traditional plans in this category. Do not bundle investment and insurance. Keep your investment cells of the money box free of the scourge of a bundled life insurance plan

    • Taxes: Returns need to be evaluated taking into account the costs, inflation and taxes. Once these three big bites are taken out of your returns, most products give a negative return. Taxes can be levied at various points in a product. And some products give you a tax break if you invest in them. The most well-known tax break is Section 80C, which gives you a break of up to Rs 1.5 lakhs (in 2018) if you invest in the eligible products. You get this break if you contribute to your PF, PPF, life insurance premiums, ELSS mutual funds, NPS, special five-year FDs and a bunch of other expenses. The ideal time to begin your Rs 1.5-lakh investment is from the beginning of the financial year, and not in February or March just before the year closes. It is a good idea to use your Rs 1.5-lakh investment in your PF (NPS, if you don’t have PF), PPF, your term insurance premium and ELSS funds. You also need to know if the return is taxed. Is there a tax to be paid on the interest, dividend or profit of that particular product? And finally, is there a tax on exit. The interest on your bank FD, for example, will get added to your income and be taxed at your slab rate. The dividend from your debt mutual fund pays a dividend distribution tax of 38.83 per cent – you don’t have to pay it; the fund pays it before it declares the NAV. Then there are two kinds of ‘capital gains’ that you need to be aware of. Short-term and long-term capital gains. In a debt fund, for example, if you sell before three years of holding the fund, you have to pay a short-term capital gain tax on the profit. This profit gets added to your income and you pay tax at slab rate on it. If you hold for three or more years, your profit becomes long-term and you pay a flat tax of 20.8 per cent. If you redeem an equity fund (that you should not, but if you do) within a year of buying, and you make a profit, you pay a short-term capital gains tax of 15.6 per cent on the profit. Hold for 366 days and your capital gain used to be zero till January 2018. But from 1 April 2018, you will pay long-term capital gains tax of 10.4 per cent, on equity and equity-linked products like mutual funds, for profits in excess of Rs 1 lakh. Life insurance policies with investment embedded in them enjoy tax-free status on exit. Equity ULIPs continue to enjoy a tax-free status after the tax changes in 2018. Despite this benefit, most plans from insurance compare unfavourably with PPF, bank deposits and mutual funds
  • Asset allocation:
    • We’ve now asked all the questions and have a short list of products we want to use. Can we finally begin to fill our money box with investment products? Yes, but only after we understand what asset allocation means. Think of asset allocation as a way of reducing your risk. Diversification of a portfolio is achieved through asset allocation
    • You need a mix of assets in your portfolio. Debt gives you the stable core. Include products like your PF, PPF, FDs, bonds and debt funds in the debt part of your portfolio. Equity gives the return kicker – it is the only asset class that gives you returns that beat inflation, at the lowest cost. You can include gold in this, but I prefer to stay with just debt and equity.
    • Keep about 5–10 per cent at the most of your net worth in gold if you want to. The exact asset allocation between debt and equity will vary from person to person. The thumb rule for equity is 100 minus your age. If you are thirty years old, you should have 70 per cent of your money in equity. If you are sixty years old, you should have 40 per cent of your money in equity
    • Each of your goals will need their own allocation between debt and equity. For example, the goal of retirement that is thirty years away may have an allocation of 100 per cent equity, but a goal for a kids’ education that is five years away could have an allocation of 70 per cent debt and 30 per cent equity. Again asset allocation depends on your risk appetite and capacity. The thumb rule is this: the closer you are to the goal, the lesser should be the equity part of your portfolio
  • A product for every cell:
    • It is time to put a product in every cell
    • Cash flow cell
      • You need three bank accounts when you are starting out. As you get more used to the cash flow system, you can use just two
      • Your salary account is your income account where all inflows drop
      • The Spend-it account can be a joint account with your partner or parent or child – whoever shares the routine household expenses with you. It is a good idea for both partners to contribute to running of the house. It is usual for a woman to use her salary to run the house and the man his to build the assets. Unfortunately, in a divorce situation, the law awards assets to the person that paid for them. So share the routine expenses and build assets in both names
      • The third account is the Invest-it account into which you move either the leftover money from expenses as savings or the amount you target each month towards investments
    • Emergency cell
      • When we need the money from this cell we’ll need it in a hurry – usually within a week or ten days. Even if you face a job loss, you usually get at least three months’ severance pay. Therefore, we need products that earn a little more than a simple savings deposit, but is easy to break
      • You have a choice between two products. The first is the reliable FD. We know these products; we find them safe and know how to get in and out of them. Just the familiarity and the ease of on- and off-boarding makes an FD a contender for the emergency fund cell. You can pick the period for the FD that gives the highest interest
      • At times, the three-year FD gives more than the five-year FD. There is a cost of about 0.5 per cent of interest for an early exit from an FD. It is worth it to pay that and keep the money in an FD rather than a savings deposit that gives you an interest of 3.5 per cent. You can use a flexi account that some banks offer to have the facility to sweep out the money you need from the FD into the savings deposit instantly. But that also increases the chances of you dipping into the emergency funds for an impulse purchase
      • The second product is a mutual fund. I keep my emergency money in an ultra-short-term debt fund. Choose a fund that is conservative and not aggressive. This means that you shouldn’t buy a product for your emergency cell based on just high returns it has given in the past
    • Medical insurance cell
      • This is a really tough one. You need either a really good financial planner who will choose for you, or you need some kind of help to compare policies so that you can choose the right one
    • Life insurance cell
      • You need a term plan to cover just the risk of you having an untimely death. You need between eight to ten times your annual income as a cover. You need to cover also any loan that you have. Car, credit card, personal, education, home – add these up and buy an additional term plan to cover the loans. You don’t want your spouse to be paying EMIs on the home loan you did not protect
      • Look for a combination of a low premium and a claims experience of over 95 per cent. You don’t want the cheapest plan that comes from a firm that rejects a lot of claims. Try and buy online to cut out the agent commission
    • Almost There cell
      • These are investments you make for needs that are two to three years in the future. The products in this cell are similar to the ones in the emergency cell. Use either FDs, if you don’t understand funds and are not willing to take on a higher risk for your short-term needs, or an ultra-short-term debt fund or conservative hybrid mutual fund that have a maximum equity exposure of 25 per cent, and keep the rest in bonds
      • We don’t want a pure equity fund for this cell, because equity can be volatile and we want certainty about the availability of the money. This is your fifth cell now looking good
    • In Some Time investments
      • These are for needs that are three to seven years in the future. For different age groups, the goals are different. From this cell on, the use of equity becomes really important. The closer your goal is to three years, the larger the proportion of safer products; and the nearer it is towards the seven-year mark, the more risk your portfolio can handle. For a goal that is three years away you can use a mix of ultra-short-term debt funds and conservative hybrid mutual funds, with the mix tilted towards the debt funds
      • For a goal closer to seven years, go fully into aggressive hybrid mutual funds and diversified equity funds. I would do a mix of aggressive hybrid funds and diversified equity funds for a goal that is seven years away
    • Far Away investments
      • These are for all goals other than retirement. Retirement has its own cell. You may be saving for your kids’ education or your own house, and the goal may be more than seven years away. I am for going all the way to 100 per cent in equity mutual funds for my goals that are beyond seven years
      • Within this cell, you can have a mix of more or less aggressive equity. If your goals are around the seven- to ten-year mark, go with more of aggressive hybrid mutual funds, diversified equity and multi-cap mutual funds, and have a smaller proportion of mid-cap, small-cap and sector funds
      • For goals beyond ten years, you can hike the proportion of mid- and small-cap funds. The largest part of the equity fund portfolio must remain in lower-risk diversified equity or multi-cap mutual funds. Only if you understand funds well should you risk a mid-cap-heavy portfolio
    • Retirement fund
      • This cell has a mix of products. The core is your PF and PPF. The rest is in equity funds. What kind of funds? The further away from retirement you are, the more risk you can take. For people in their thirties, a larger allocation to mid- , small-cap and sector funds would not hurt if chosen well. But if you are already in your late forties or early fifties, stay conservative with large-cap, diversified equity and multi-cap funds
    • Gold
      • Gold has its own cell. But it is tiny. No more than 5–10 per cent of your total portfolio is in gold, and that too paper gold, not jewellery. The government’s sovereign bond issue is very good and if you don’t need the money for the next seven years, you can begin to build a gold laddering system. It is useful for inflation protection at short notice and for use in marriages of the kids
    • Real estate
      • Real estate has its own cell, but the only product I have in that cell is the house I own and live in.
      • Keep it down to the one house you live in. If you can manage the stress that comes with real estate, add to the cell, but do remember to look at your overall asset allocation. Real estate as investment should not be the biggest share of the net worth
  • Two ways to calculate how much you need to spend for your retirement:
    • Save your age: At age twenty-five save 25 per cent of your post-tax income, at age thirty save 30 per cent of your post-tax income. At age forty save 40 per cent. This formula works if you don’t have a single rupee saved towards your retirement, till you are forty. For example, if you are forty years old and have not a rupee of provident fund or real estate or gold or mutual funds then you need to be saving very hard and will need to save 40 per cent of your post-tax income for your retirement. If your take-home pay is Rs 1 lakh a month, you are saving Rs 40,000 a month at age forty, but if you are thirty years old, you are saving only Rs 30,000. Notice how the saving ratio reduces with age – the younger you are the less you need to save
    • Multiply your spend: A better way to target a retirement number is to look at your current expenditure each month and each year. An expense multiplier is, in fact, a better way to crack the same problem, because at the same level of income, different families will have very different spending behaviour
  • If you have got your cash flows in place, you know your current annual expenses. Your first step is to use a simple future value calculator to see how much you will need today. For example, if your current annual expense is Rs 6 lakhs at age thirty, and we assume an inflation of 6 per cent, in thirty years, at age sixty, you will need Rs 34.46 lakhs a year. You’ll need 70 per cent of your last working year expense in your first non-working year. And then this expense will now grow at 6 per cent a year till you hit 100. I’m assuming you live till 100. What this means is that if you were spending Rs 1 lakh a month when you retired, your expenses will drop to Rs 70,000 a month in the first year post retirement. This is because costs related to travel to and from work, wardrobe, entertainment, food and other such expenses reduce once you stop going to work. But your monthly expenditure does not stay at Rs 70,000 a month, it begins to creep up again due to inflation. In how many years will this Rs 70,000 double? If inflation is 6 per cent, then at age seventy-two you’ll be spending Rs 1.4 lakhs a month. Use the Rule of 72 again to do the maths. This time you divide 72 by the inflation you are projecting into the future. For example, if we think inflation will be 6 per cent in the future, divide 72 by 6. This means you will spend twice of today’s expenditure in twelve years. If you spend Rs 1 lakh a month, in twelve years you will spend Rs 2 lakhs a month. In another twelve years, you will be spending Rs 4 lakhs a month; in another twelve years, you will be spending Rs 8 lakhs a month. Remember: Divide 72 with your inflation number to get the number of years it will take to double your current expenses. Now you know how much you will spend in the first year of retirement, but what does this mean for your retirement kitty? How much will you need at retirement? At age sixty, you need between eighteen to thirty-five times your annual expenses at retirement to retire with the lifestyle you are used to

  • At age forty, you should have three times your annual income as your retirement corpus already. If you earn Rs 15 lakhs a year at age forty, you should have Rs 45 lakhs in your retirement corpus. At fifty, you should have six times your annual income. If you have an annual income of Rs 40 lakhs at age fifty, you should already have Rs 2.4 crores in your corpus. At age sixty, or at retirement, you should have eight times your annual salary. Earning a crore at sixty, you must have Rs 8 crores as corpus

  • The composition of your money box changes as you age. For example, as you near retirement and your retirement corpus builds up, your kids become independent, the need for a life insurance policy goes away. We only need a life cover if the family depends on your monthly pay cheque. Once you have your retirement corpus in place, and are free from loans, you don’t need a life cover

  • Not making a will will tick the ‘most-selfish-thing-I’ve-ever-done’ box in my book. You’re leaving behind a mess for your family, especially if there are joint assets with an extended family or you have created assets with your parents, making your siblings an heir to the property you thought you were leaving to your kids

  • If you are a Hindu, and die intestate (without a will), your assets will be divided equally among Class 1 heirs. There is a list of twelve relations that fall in this category, including sons, daughters, surviving spouse and mother

  • Why make a will when I have nominations in place is a common enough pushback to creation of a will. But did you know that a nomination does not mean that the nominees get the assets? Look at the nominee as a caretaker of the asset, somebody to whom the money flows to for safekeeping till the legal heirs can stake a claim. In your head the nominee and the legal heir is the same person, but in the eyes of the law, the two could be different

  • How to make a will?
    • You’ll have to map the current assets – bank deposits, bonds, mutual funds, stocks, properties, gold, jewellery, vehicles, assets created overseas, books, art, wine and whatever you want to bequeath to your heirs. It’s a good idea to make an itemized list of things: where they are kept and where the papers that establish the claim are kept. It’s always a good idea to put down details like passwords to online bank accounts in a password-protected dynamic Excel sheet. Put down in writing the location of property papers and locker keys. Once the details are done, indicate who should get what. For example, if you have two flats and want to leave one to each kid, do specify which one goes to whom. If there is jewellery, mention who gets what. Maybe take pictures and specify who gets what. Don’t forget to include ownership of social media accounts, email addresses, intellectual property rights
    • A couple should make individual wills and not a joint will
    • You need to appoint an executor of the will. Ideally the beneficiary of the will is not the executor. This could be a family friend, your lawyer, your financial planner who ensures that the will is followed in letter and spirit in the asset distribution. You can write a will on a piece of paper, sign it with a date and place, and get two witnesses to sign as well. The witness and the beneficiary should be different people, and the witness and the executor should be younger than you. Do simple things like numbering each page, signing each page and putting down the date clearly

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