Here is a plan which anyone can implement to tide over a crisis situation in life – world war, tsunami, flood, COVID 19, or any more to come. One would have already heard about some of these ideas earlier, but probably not taken so seriously. Now is the time to go through them once again and act with determination and a sense of urgency. Smart people learn from others’ mistakes. Some learn from their own mistakes. There are some who never learn. The first category will ‘flourish’; the second category will ‘manage,’ and the last category will ‘perish’ during testing times like this! Here are five simple steps to be financially prepared for those who wish to flourish or manage:
Identifying financial goals in life, well in advance, is the first step. This is the most important step among all. A life without goals is like a journey without a destination. So, write down all future goals. Don’t just have it in mind; put it down in a piece of paper or personal computer or even mobile notepad.
Ask each member of the family about their dreams in life. Check whether each of those dreams qualifies to be a goal by answering the following questions. If the answer to all the questions is yes, then it is a goal:
• For example: ‘To buy a good car soon’, is not a goal; rather, it is only a wish. But,‘To buy a Tata Tiago XT model car worth Rs 5.50 lakhs by March 2023’, is a goal for a middle-class family. Remove the wishes; retain the goals from your list. Group them into Short Term, Medium Term, and Long Term. Short term goals are those to be achieved within a year. 1 to 5 years is a medium-term and above five years is long term.
While planning long term goals, one should consider the inflation in the economy. For example, ‘To construct a 1000 sq ft house costing Rs 25 lakhs by the year 2030, can be challenging to achieve if inflation is ignored. Considering about 7% average annual inflation, it will cost almost double after ten years.
Statistics show that this is not taken seriously by most people. Indians are grossly underinsured compared to people in developed nations. Are we prepared for emergencies in life, like hospitalisation, flood, fire, theft, or sudden loss of an earning member in the family?
A single policy is enough for the entire family. Example: Family Floater policy of New India Assurance Company. Ensure sufficient coverage, for example, Rs 5 lakhs. Add maximum riders and benefits to the policy. Consider top-up policies to enhance the coverage with a very low extra premium. There are new policies like the Heart & Cancer Policy, in which some amount of the coverage is paid in advance for early treatment once the disease is diagnosed. Remember, it is always better to take insurance while being healthy. Post disease, taking a policy will be more expensive, and conditions will be more stringent too.
Life insurance coverage should be a minimum of 12 times of annual income. Only earning members need to cover. It is a matter of personal choice, whether one should have a life insurance cover, and how much. However, it is very important for those having big liabilities like Housing Loan. In the absence of the borrower, the liability falls upon the family, and it could become a nightmare for them. For this, Term Insurance is better than traditional insurance and Unit Linked Insurance Plans (ULIPs). Term Insurance gives high coverage at a low premium. Term Plans, being pure insurance plans, the premium won’t be returned. Insurance is a means of protection from financial loss, not an investment tool.
People running their own business should also insure their valuables against fire, theft, natural calamities, and other perils. Valuables at home can also be insured at nominal premiums. Insurance has to be planned on a top priority before planning for investments because it offers immediate protection. For example, by paying a premium of just Rs 12000 ‘per annum’, the insured gets a large life insurance cover of about Rs 100 lakhs within a few days. Whereas, to create an investment of Rs 100 lakhs, one needs to invest about Rs 12000 ‘per month’ for 20 years, assuming 10% returns per annum.
This is one step that demands elaborate preparation. Here we discuss various solutions available for achieving financial goals.
A study in India reveals that a vast majority of people achieve their financial goals through loans. It may not be possible to achieve all the goals without borrowings. While some loan is good, too much of it can be the biggest headache during crises. A healthy mix of investments and loans will be a better way. It is vital to limit the loan-to-income ratio to a maximum of 30%. After productive years in life, it is better not to have any loans at all. A debt-free situation is essential for a peaceful retired life.
To invest, one has to have savings, and to have savings; one should learn to live within means. There are many people in our society whose expenses are more than their income. These people will suffer during a crisis because they don’t have any reserve money for the next day. World’s richest investor Warren Buffett said: “Do not save what is left after spending, but spend what is left after saving”. There is a commonly accepted rule for how much to spend and how much to save. It is ‘30:30:30:10’, i.e., 30% of our income should be saved, 30% for loan repayments, 30% for household expenses, and rest 10% for entertainment and charity work.
Having saved some money, where to invest is the next big question. There are genuine schemes and fake schemes. How do we identify them? If a scheme offers very high returns at very low risk, there is every possibility that it is a fake scheme. Example: Money chains, pyramid schemes, and other such Ponzi schemes. They are short-lived, and in most cases, investors have lost their principal amount itself. So, stay away from such luring offers! Below given is a risk-return chart of some of the popular genuine investment options.
Money Market is considered safest but offers low returns. Examples: Treasury Bills, Certificate of Deposit, Commercial Paper, Liquid Mutual Funds, etc. Equity is considered riskiest with the highest potential for growth. Examples: Shares, Equity Mutual Funds, etc. Real Estate offers moderately high risk and return, whereas Gold, Gold Bonds, Gold ETFs, etc. offer medium risk and return. Fixed income instruments, otherwise called Debt instruments, offer moderately low risk and return. Examples: Fixed Deposits, Bonds, Debentures, Debt Mutual Funds, etc. Below given are the expected returns and ideal holding period from each of these options:
Money Market & Fixed Income: 5-10% per annum (Short to Medium Term Investment) Gold: 10-15% per annum (Medium to Long Term Investment)
Real Estate & Equity: 15-20% per annum (Long Term Investment)
The above is only a projection based on past trends. Returns from Gold, Real Estate, and Equities could be even negative at times. One shouldn’t try to compare the above-mentioned returns with actual returns during crisis times. World over, wealthy investors suggest that one should invest more in high-risk options when markets are down. There are many scientific ways to understand whether markets are down, like, for example, ‘PE Ratio’ for the equity market. While PE of above 25 is considered the best time to book profits, PE of below 15 is the best time to buy. But gold is a reverse asset, in the sense that when all other assets underperform, gold will outperform. Gold is considered a safe place to park funds in troubled times. Historically gold prices have shot up during the crisis and fell during the recovery phase. So it is important to have at least 15-20% of the overall investment in gold.
How much of our savings should be invested in these assets? There is a thump rule for this also. ‘100 minus Age of the Investor’ should be the maximum exposure to risky assets. Example: If an investor aged 45 years is having a total investment of Rs 1 Crore in various options, his maximum exposure to real estate and equity should be Rs 55 lakhs. Like the old Malayalam saying ‘adhikamayal amruthum visham, too much exposure to any option is risky.
Chit is another popular investment option among people. It is an investment until you get the prize money and utilise the same, but it becomes a loan once you do that. Therefore use it with care. There is no harm in trying some new concepts like crypto-currency, collection of rare items, etc., so long as it is legal. Understand the risk involved in it before investing large amounts. Trading of any sort – whether it is shares or currency or commodity – is not an investment, but a very high-risk income-generating activity. Only experts should attempt it.
Tax planning is another important aspect. If you are a taxpayer, it is advisable to work out your projected tax for the upcoming financial year, as per the old regime as well as the new regime. If the tax amount is less asper the old regime, start planning your tax-saving strategies now itself, rather than waiting till March. Through proper planning, an individual having an income of Rs 10 lakhs can also avoid paying tax using various provisions.
Proper implementation of the plan is another crucial step. A plan without action is of no use. Many people who know about the above steps also fail to achieve results because of faulty implementation or inaction. Don’t blindly depend on agents or brokers. Try to get some basic awareness about whatever you are doing. Several free awareness programmes are being conducted by AMFI (Association of Mutual Funds in India) at the directions of SEBI (Securities and Exchange Board of India). Keep a proper record of all your financial transactions. Sign documents only after reading and understanding the future implications. Follow a disciplined approach to savings and investments. Ensure nomination in all investments and accounts.
Once the plan is implemented, it is important to review the same at periodic intervals, say once in 6 months. Do not keep changing your plan every now and then. As far as possible, do not utilise the investments meant for one goal, for any other purpose. Any change in your address, phone number, or email ID should be intimated to your service providers at the earliest. In India, banks and insurance companies hold around Rs 32000 Crore as unclaimed deposits as informed by Central Government in Lok Sabha recently. So, do not keep financial information totally secret. Share vital information with close family members so that in the absence of the investor, such funds are made available to the nominee. It is always safe to have a written ‘Will’ kept ready at all times.
This idea can be explained through an example: Mr. Ramesh avails a housing loan of Rs 25 lakhs for 20 years at 8.50% interest. The EMI comes to about Rs 21700 per month. While availing the loan, he starts a SIP in a top-ranked Hybrid Mutual Fund for Rs 3300 per month. By the end of 20 years, he would have repaid the housing loan with an interest of Rs 25 lakhs in addition to the principal. However, by then, the value of his mutual fund investment would be around Rs 25 lakhs, assuming 10% annualized growth. So, in effect, his housing loan interest is refunded.
Financial markets are subject to price fluctuations. During a crisis, markets swing rigorously. In such situations, a systematic way of investing is better than lump-sum investment. Imagine an investor is doing a SIP of Rs 10000 per month in an Equity Mutual Fund for a period of 10 years, and assuming 10% annualised returns, the maturity value will be around Rs 25 lakhs. This happens because of a few reasons. One, the investment is into equity, which has the potential to generate high returns. Two, the SIP route of investment comes with twin advantages of ‘Power of Compounding’ and ‘Rupee Cost Averaging’. It is important to continue a SIP during the crisis since it further reduces the investment cost and increases the profit potential during recovery.
Whatever is your investment corpus, approx. 0.80% can be withdrawn monthly through a Systematic Withdrawal Plan (SWP). For example, in the above point, we have seen how one can create a corpus of Rs 25 lakhs in 10 years through a SIP. Suppose a person starts this SIP at the age of 48 years, he will have around Rs 25 lakhs when he reaches 58 years. At this stage, he can stop further investment and move the corpus to a safer option like Hybrid Mutual Fund. From next month onwards, he can withdraw about Rs 20000 pm, through SWP, for an indefinite period of time. The corpus will not reduce much, since we are withdrawing only the appreciation in the investment. Another advantage is that this monthly income continues even after the death of the investor and goes on to his nominee if the nominee wishes to continue with this idea. There are so many NRIs in our state. They work overseas for many years, and when they return, they don’t have a pension. For such people, SIP and SWP will be a great help.
“Never depend on a single income, make an investment to create a second source” – this is yet another famous quote by Warren Buffet. Ideally, one should try to create multiple sources of income. Wages, tips, commission, brokerage, salary, business profit, professional fee, gain from buying and selling of assets, agricultural income, etc. are active income in which our active physical participation is required. There are passive income sources like rent, interest, dividend, royalty, patent, copyright, etc., which are earned irrespective of any active participation, which will be a blessing during crisis situations. For example, interest from a Fixed Deposit will be given even during a national level lockdown.
A crisis may come and go. But it will become increasingly difficult for people who live ‘hand-to-mouth’. Better be prepared with your financial plan right now. Spend some time every week to enhance your financial awareness. Refer to important sites like www.sebi.gov.in, www.rbi.org.in, www.incometaxindia.gov.in, and www.irda.gov.in to learn more. Build your own financial plan as a strong wall against the waves of crisis to come. “Sampath kaalath thai path vechal aapath kaalath kaa path thinnaam”.