Personal Finance – Page 2 – Stable Investor

‘The Secret’ – How to Accelerate your Financial Freedom?

by Dev AshishNovember 27, 2018January 15, 2019 1 Comment

Everybody wants to become financially independent. But very few actually get there.

Why?

There can be various reasons but I think that achieving something like Financial Freedom doesn’t just happen. It requires one to have a serious plan and more importantly, then commit to that plan. And that’s easier said than done.

Personally, I aim to achieve early financial independence.

If you were to ask me why then I will quote Charlie Munger – I did not intend to get rich. I just wanted to get independent.

And that for me is a goal worth having. But let’s not discuss my thoughts. I have already written about it in detail at F.I.R.E.

Let’s rather talk about you.

If you are beginning to get comfortable with the whole idea of financial independence or early retirement, then I am sure you would be wondering How much money do I need to Retire Early In India? Or how much is enough for Financial Independence & Retire Early (FIRE) in India?

It would be best to have a perfect formula for financial independence.

But there isn’t any.

Getting the right amount for regular retirement is a tough nut to crack in itself. And here, we are talking about early retirement. 🙂

But there are thumb rules that can get you going.

A popular one is – having a corpus equal to atleast 25 times your annual expenses.

This may be enough for some people but may not be for many others. For some 30X or 40X may be a more appropriate size. It depends on a variety of factors like current age, age of early retirement, life expectancy assumption, inflation % assumption before and after retirement, return estimates before and after early retirement and several other more serious factors like the sequence of returns risk, etc.

But as I said, if you are just beginning your journey – then the exact accuracy doesn’t matter and you can have atleast some target in front of you – which I think is a good one provided by the 25X, where X is your annual expenses.

You will, in any case, require several years to reach that first. 🙂 So relax about the accuracy a bit.

But as you get closer to your goal and/or the portfolio size grows, you need to run numbers more carefully and have additional buffers to make your early retirement plan more robust. And if it sadly means delaying it by a few years or saving more, then so be it. Better be safe than sorry when you are older.

So 25X is a good aim to have.

But what about the ‘secret’ that I mentioned in the title of this post?

Here it is…

If the X (i.e. Annual Expense) is small, you can save more and, in turn, reach the target of 25X faster.

Read that again.

And again if you are still unable to understand its importance.

Let’s take a small hypothetical example to make this idea crystal clear:

Suppose your annual income is Rs 12 lac. And your annual expenses (i.e. X) are Rs 8 lac.

So if we were to use the 25X thumb rule, then you would need 25 times Rs 8 lac – which is Rs 2 Cr as Early Retirement Corpus. And to achieve it, you will have Rs 4 lac every year (Rs 12 lac income minus Rs 8 lac expenses) to save for the goal.

Note – I have ignored inflation, etc. for simplicity here.

Now remember what I said earlier – If the X (i.e. Annual Expense) is smallER, you can save more and in turn, reach the target of 25X faster.

So let’s make the X a little smallER.

Your annual income is Rs 12 lac. And your smallER annual expenses (i.e. X) are Rs 6 lac (reduced from Rs 8 lac earlier).

Now if we use the 25X thumb rule, then you would need 25 times Rs 6 lac – which is Rs 1.5 Cr as Early Retirement Corpus. And more importantly, to reach it you will have a higher Rs 6 lac every year (Rs 12 lac income minus Rs 6 lac expenses) to save for the goal.

So the target has reduced from Rs 2 Cr to Rs 1.5 Cr. And you also have a higher amount of Rs 6 lac per year (instead of Rs 4 lac) to save for the goal.

So it’s a double benefit of having a reduced target and higher savings capability.

Decreasing your expenses (I know its tough) increases the potential to increase the savings – this fact alongwith lower target requirement can potentially accelerate your plan to reach the final corpus earlier.

Think of it like this – If your expenses are low, you will need a smaller corpus to support it for years to come. And a smaller corpus means that you will require a lesser number of years to achieve it. But if your expenses are high, then not only will your required corpus would be high, but it will also require more time and probably a higher saving rate.

And this is the real secret!

Remember – this 25X figure is just a thumb rule.

And you also need to understand the risks that such thumb rules or any early retirement plan is exposed to – like sequence of return risk, unexpected and unplanned expenses, living longer than you estimated(!), extremely high inflation in retirement years, high medical expenses inflation that isn’t covered by your health cover, etc.

The actual number will be different for different people and circumstances.

The idea here was to show that higher your saving rate, the sooner you can potentially retire.

If you save just 10% of your income, then you can forget about early retirement. You need to save a lot more – like 30, 40 or even more than 50%. I am able to do more than 50% as I aim to achieve financial freedom by 40. Fingers crossed. 🙂

So that was about the simple thumb rule for computing how much money do I require for financial independence and early retirement (FIRE).

I like to talk about financial independence on Stable Investor quite regularly. It is one of the big financial goals I have. But I must also warn you – the maths of FI is such that you can speed up the theoretical goal achievement if you reduce expenses by a lot. But then, that would mean you are sacrificing your present for the future, which is good to an extent but not beyond it.

We always know how much money we have but we never know how much time we have. So we cannot entirely sacrifice the present.

Financial independence is a difficult goal which most people won’t achieve.

But even if you were to achieve it partially, even then it would provide you with a lot of control over your financial life. A solid early retirement corpus with reasonable return expectations will cover basic living expenses for longer than your life expectancy. That’s a good achievement no matter when you achieve it.

I still feel that aiming for some degree of financial independence (and not early retirement) via a high saving rate is a fantastic goal for most people. More so for those who see real threats to their jobs in near future. You never know when you might be forced to retire early & involuntarily.

At the same time, I recognize that not everyone is eager to achieve early retirement. And there are also people who like their luxuries. And that is fine as it gives them happiness.

The bottom line is that your goals are unique and you need to do what is necessary to achieve your financial goals. If financial independence is not one of them, then you can ignore it. But if it is and it’s more than a passing wish, then you need to do something about it. The independence that a big corpus provides is amazing. It even gives you that magical ability to say F*** Y** to anyone without thinking too much about the consequences. 🙂

Imagine that kind of freedom!

So if you are planning early retirement in India, then sit up and take action. Just wishing and asking questions like how much money I need to retire early in India will not be enough.

Till what Age should you take Life Insurance?

by Dev AshishNovember 27, 2018 Leave a comment

When purchasing a life insurance, people get confused whether it is wise to have a cover till just the age of 60 or to keep it till 70 or even the age of 80-85. And then if the confusion wasn’t enough, there are whole-life covers as well.

Let’s talk a bit about till what age should you target your Life Insurance cover? Or let’s say what should be the tenure of term insurance?

You already know that life insurance is important if you have people financially dependent on you. The insurance premium is a small payment to cover the event that can be emotionally as well as financially demanding for these people. But yes, if you don’t have any dependents, then you obviously don’t need life insurance.

Let’s assume that you do need insurance.

So the obvious question you will have in mind is – How much life insurance do you need?

Some may ask whether Rs 1 crore life insurance is enough. Others may say that Rs 50 lakh life insurance cover is enough.

But there is no one right answer here.

Everybody’s financial situation is different and hence, they will have different answers to how much life insurance do I need?

So let’s proceed… the next question should be:

Till What Age should you take your Life Insurance?

For a moment think about it.

Life insurance is basically there to cover the risk of early, unexpected death of an earning person and to hedge the risk of loss of his/her income.

Right?

So ideally Life Insurance cover should only be there till the retirement if loss of income is the only factor. Isn’t it?

And conservatively speaking, by that time (i.e. your retirement year), most of your regular financial goals would have been achieved and you would already have enough savings to take care of you & dependents. And mind you, there are high chances that by then, your children won’t be dependent on you. So your only dependent might be your spouse. For which you would already have big enough saving (or call it retirement corpus) that can take care of everything. So, no need for insurance coverage much beyond the planned retirement age.

Another point here is that you don’t need life insurance if you achieve a state where you have enough wealth to fund your financial goals.

Think about it. It is fairly obvious. If you already have enough savings to fund your retirement and other financial goals, then you don’t need life insurance at all.

So first, you must figure out whether you need life insurance at all. If the answer is no, well and good. But if you need it, then correctly calculate how much life insurance you need and limit it to your retirement age or few years more. That’s it.

Now let’s see what is the impact of chosing different insurance periods.

Suppose you are 30-year old who wishes to buy a Rs 1 Crore cover.

Assuming you plan to retire at 60, the policy term of 30 years is fine. But let’s say that for some reason, you are contemplating coverage till the age of 75. In that case, the policy term needed is 45 years. I checked the premiums for a healthy non-smoking 30-year male living in a metro city. The annual premium for a 30-year policy was about Rs 9500-Rs 10,000. And that of a 45-year policy was about Rs 13,500-14,000.

Let’s take another example.

Suppose you are 45-year old who was late in realizing the benefits of correct life insurance coverage and hence, wishes to buy a Rs 1.5 Crore cover. Assuming you plan to retire at 60, the policy term of 15 years is fine. But let’s say that for some reason, you are contemplating coverage till the age of 75. In that case, the policy term needed is 30 years. I checked the premiums for a healthy non-smoking 45-year male in a metro city. The annual premium for a 15-year policy was about Rs 28,000. And that of a 30-year policy was about Rs 42,000.

So what is happening here is that you are paying more every year to have the flexibility of having the coverage till late in life.

By choosing the right tenure, you can save some money on the premium. But if being protected for few more years after retirement is what you wish, then so be it. I cannot stop you. 🙂

Another approach can be to ladder your insurance policies. This is known as life insurance laddering. For example, at the age of 30-years, you may buy 3 covers as follows:

Rs 50 lakh cover for 25 years
Rs 50 lakh cover for 30 years
Rs 50 lakh cover for 35 years

So, the effective life cover you have is:

Between age 30 and 55 – Rs 1.5 Cr
Between age 55 and 60 – Rs 1.0 Cr
Between age 60 and 65 – Rs 50 lakh
Beyond 65 – Nil

As you near your retirement, your coverage and premiums outgo reduces.

This laddering of insurance might seem like a smart optimization strategy but depending on your personal circumstances and premium quoted, it might even make sense to just keep one simple and large-enough life insurance policy and then stop paying it once you feel cover is not needed. Plain and simple.

Now here is an important thing – Whether you keep life insurance only till retirement or upto 85 years or whether you buy a single policy or create a smart life insurance ladder, you still need to invest for your goals. Life insurance will take care of things if you die. But if you survive, then you are on your own and only your savings will help you. Think about it.

Therefore, irrespective of whether you life cover stretches to the age of 60 or 85, it’s much more important to save enough for your retirement years. This is not going to be easy as with increasing life expectancy, you will live really long in retirement. So you don’t want to run out of money before you die. Isn’t it?

But I must mention that like investments, there is no one-size-fits-all solution to insurance needs.

Your unique situation might demand different products or tenures than what we discussed in this article. So it’s always best to understand your Insurance Portfolio needs and then take a call.

And please do tell your family that you bought a life insurance policy. No point having it and not telling them as it is them who will have to ask the insurance company to pay the money to them eventually.

Involuntary Early Retirement?

by Dev AshishNovember 15, 2018 7 Comments

Many of us aim to become financially free (or retire early). But not everyone is interested in it.

You too may not be considering early retirement. But it makes a lot of sense to prepare for it anyway.

Life isn’t fair (you know it) and is also unpredictable. It doesn’t always go the way we expect it too. And your actual retirement age may be much lower than your expected retirement age.

How?

You never know when you might be forced out of job due to the availability of easily replaceable cheaper employees, technological disruption, a collapse of the industry you are part of, your inability to remain relevant to the profile, etc. Imagine your situation if after several years of work, you are ejected out of your role/company and unfortunately, are then too old to be considered for other roles. Or in other words, you are unemployable. That’s a tough situation to be in when not young.

And these are just some of the reasons. There can be several more. Job losses are a reality. Reasons can be many.

As the dynamics of employment across sector changes, most careers are becoming increasingly stressful. Who knows how long you can tolerate such stress levels? You may eventually consider taking early retirement due to high-stress levels in your job. That’s possible and is happening.

Leave stress. Other health ailments or serious injuries can also sideline your career abruptly.

And it is not just about you alone. A serious illness of parents, spouse or children may require (force) you to be actively involved in their treatment – which may make it difficult to continue your current job. You then have this difficult task of earning as well as taking care of them. At this point, you may have to either reduce your workload or even quit your job for some time.

In all the above cases, your ability to cope with the situation would be better if you have savings to fall back to. Pursuing financial independence or early retirement can reduce your hardships, atleast to some extent, if your working years are cut short for reasons outside your control.

Even if you don’t want to prepare for early retirement, you should prepare for involuntary early retirement.

This is like having a Plan-B to ensure that life doesn’t f*** you.

And even the mathematics of investing supports this idea. Saving early makes it easier to accumulate a larger portfolio as you move towards the traditional retirement age.

You may be young today and not want to retire before 60. But when you turn 50 and are fed up of your job, then having a large corpus will give you the option of calling it quits and relaxing for the rest of your life. And that’s a great option to have.

Preparing for early retirement acts as an advanced preparation for normal retirement. It fast-forwards your retirement savings. And this front-loading of retirement savings creates an insurmountable advantage due to compounding that you will thank yourself in later years for.

And failure isn’t a bad outcome here. Even if you fail to reach the right corpus for early retirement, you will still be better off than if you didn’t attempt to pursue it at all.

I know many of you feel that early retirement is not real and there is no point pursuing it. But it is real. Maybe you don’t want to retire early at this point in your life. But who knows you might change your mind after a few years. Life can surprise.

But I must tell you that planning to retire early requires planning, discipline, high savings rate and proper management of your investments. It’s not easy. But as explained earlier, it helps to have tons of money when life is planning to surprise you unexpectedly.

Life comes with uncertainty. But if you plan well, this uncertainty doesn’t necessarily have to result in insecurity.

So do think about it. And if you feel what I am saying makes sense, then start preparing for early retirement even if it is not your immediate goal.

Choosing & Managing a Home Loan Wisely

by Dev AshishOctober 30, 2018 3 Comments

I was talking to a friend recently who was planning to buy a house.

No, I did not convince him to continue staying on rent. 🙂 His life, his decision and who am I to tell people about their big decisions.

Nevertheless, we got discussing home loans and how the loan repayment works.

I was surprised to see that he had some misconceptions about the loan EMIs. Essentially, home loan EMIs are made up of 2 parts – the principal amount and the interest on the principal amount divided across each month in the loan tenure. He wrongly assumed that equal parts of the principal and interest are paid to the lender every month. This isn’t correct.

Have a look at the following loan repayment table below and then we discuss:

As is evident from the above, the interest component paid is higher during the initial years. During the latter years, the principal component is higher. With each passing month’s EMI, the interest paid decreases and the principal repaid increases. Many people know this. And many (like my friend) don’t know it.

So don’t think that if it’s a 25-year loan, then you would have paid back half your loan in 12-13 years. The actual amount you have repaid would be about 23-24% only.

If you have a home loan, just ask your lender for the home loan amortization table. It will indicate what exactly is your outstanding home loan amount at any point in time. Or you can easily get a quick idea of the same using online loan amortization table calculators.

Choosing a Home Loan

This is a very generic question. What I mean here is that after you have finalized the house you want to buy, how do you decide on the home loan amount, loan tenor, loan EMI, loan interest rate, etc.

Let’s see what all points you should consider when finalizing the home loan. And I will try to make this very simple:

Lenders expect you to bring in about 15-20% of the cost as down payment. But I feel that a larger down payment (like maybe 30%) can also be considered. This means that you take a home loan equal to about 70% of the cost.
Loan tenor and EMI are linked. Longer the loan tenor, smaller the EMI. Shorter the loan tenor, higher the EMI. What you need to understand is that lenders will give you a loan so that the EMI is maximum of about 40-45% of your income. Now let’s say you earn about Rs 1 lac per month. So your loan EMI can be Rs 40-42,000. Now you wish to take a loan of Rs 50 lac. And you want to keep a short tenor of 15 years. But for that, the EMI works out to be about Rs 50-51,000 – which is more than what lender would allow your EMI to be. But if you increase the loan tenor to 25 years, the EMI for the same loan amount comes down to Rs 41-42,000 – which fits into lender’s criteria for you. But longer tenor also means higher total interest payout. So at times, you need to change your tenor to fit your EMI budget (self-affordability or lender-mandated) even if it means higher interest. I have written in detail about the dynamics or loan interest, EMI and tenor at How shorter home loan tenor can save you lacs?
But all said and done, I think limiting loan* EMIs to 40-50% of income is max that you should go. As you need money for regular expenses and saving for other goals too. (*for all loans and not just home loan)

Managing a Home Loan

The home loan has been taken.

Now comes the difficult part. Paying it back. 🙂

And for all normal people like us, loans are fairly predictable and have to be paid back on time. Some are lucky who don’t need to pay back their loans. 😉

Nevertheless, managing home loan is important.

Ideally, you would want to close it soon, pay as low interest as possible and if possible, invest elsewhere too as effective after-tax home loan rates are pretty low.

But at times, people get too influenced by tax saving and don’t think through clearly. And then there are others who have an obsession with loan repayment and early closure. They end up taking a holiday from investing when repaying a loan and that can be very harmful.

But let’s handle one thing at a time. Let’s first revise the tax benefits available for home loan borrowers:

Up to Rs 1.5 lac deduction allowed for principal repayment under Section 80C of the Income Tax Act. Unfortunately, this deduction is also applicable to other things like EPF contributions, insurance premiums, tuition fees, etc.
Up to Rs 2 lac for interest payment for a self-occupied property under Section 24 of the Income Tax Act. For a property that is let-out or deemed to be let-out, there is no cap on tax benefit available against interest payment.

Do you remember what we discussed little earlier about % of EMI going towards principal repayment and % going towards interest payment? Let’s make use of that concept to understand another thing:

During the initial years, a major chunk of EMI goes towards interest payment. Therefore, if you have a big loan, then the interest paid during initial years will be large. And possibly much larger than Rs 2 lac.

Now if this is your first house purchase and you use it, then the tax benefit for interest payment is capped at Rs 2 lacs per financial year. So even if you are paying much more than Rs 2 lacs interest per year, the excess interest paid (above Rs 2 lac) won’t fetch any additional tax benefits.

So if you are among those who want to close the loan as early as possible but are not doing it thinking that it will reduce your tax benefits, then check again. It’s possible that you are not even getting as much tax benefit as you think you are getting.

But I agree that the tax benefits for a let-out property are better. So loan prepayment strategy should look at all aspects.

Let’s see at some more points that should be kept in mind while managing your home loan. And I will try to make this simple:

Your loan tenor may be long, like 25-30 years. But I feel that you should aim to close it earlier. You may feel its better to let it carry for mathematical reasons, but I have this view that you should prepare yourself for early closure if your finances allow. Will discuss this shortly.
Remember, that loan repayment is not the only thing in your life. You have other important financial goals that need separate savings. Like children’s education, your retirement, etc. You really cannot just focus on one thing as the delay in saving can set you back by a lot.
So after accounting for your regular expenses, base home loan EMI and regular investing for other financial goals, if you have a surplus left, then you can consider prepayment of your home loan.
Broadly, you have two options.
First, prepay some amount every year. This can be done either by paying extra money with every month’s regular EMI or you can save up some money for few months (or use annual bonus) and prepay a chunk in one go every year.
The second option is for more aggressive people. You start investing the surplus money every month in an instrument which you may refer as Loan-Clearance Fund or whatever you wish. This can have equity funds too. So you keep adding money to it every month and allow the corpus to grow for some years. Once the corpus size grows to match the outstanding loan amount, you can use it in one shot to close the loan. If assumed maths of equity giving 12% returns and home loan costing 7% (after taxes) works out, you will mathematically close the loan very early and save a lot of money in interest too.
Basically what is happening in the second option is that you are parking the surplus every month meant for prepaying the home loan. But you are postponing the prepayment to a later date. With time, this will become a buffer for you too. If in some month’s you have sudden unplanned expenses that force you into a corner, you can use this fund to pay your EMIs. If RBI decides to increase interest rates and make them too high, then you can again use money from this fund to prepay and reduce the outstanding loan amount. Works well in most cases.

The home loan alongwith other circumstances of the borrower offers tons of permutations and combinations that can be analyzed. As a borrower, you should consider everything that is possible and then chose what’s most practical for you in your unique situation.

You may do any of the following and you will still be right:

Continue paying original EMI for full loan tenor.
Increase your EMI every year or two to reduce the interest outgo and the tenor.
Continue regular EMIs and use your annual bonus (partially or fully) to prepay once a year.
Continue regular EMIs and save surplus in equity-oriented funds for several years and hope for good returns and then close the loan in one shot when the value of your investment exceeds outstanding loan amount and become loan-free.

There is no right or wrong or ideal answer here. Every situation demands further analysis and then taking a call.

Always remember that your primary responsibility is to ensure that you pay all your loan EMIs on time. This, in turn, improves your credit score. In fact, lenders always look at your credit score even before approving the loan applications. It will do you good to check out free cibil score for yourself before you apply for home loans. You will know in advance what the banks might tell you. And if the score is good, then you can even negotiate harder with the banks to give you lower interest rates. There are options to take a personal loan for low cibil scores but that won’t help in case of home loans. So its better to find out your credit score and then decide to go or not go for the home loan. You can always first improve your score and then apply for a loan.

Once your loan payment is on track, you should focus on goal-based investing and start investing for your critical financial goals. After all, money is not just there for accumulation. It should be used to achieve your real life goals. Isn’t it?

How to build your Mutual Fund Portfolio from scratch?

by Dev AshishOctober 19, 2018 1 Comment

Perfect Mutual Fund Portfolio.

Yes I know that you are looking for exactly that. 😉

But you need to understand that there is no such thing as a ‘perfect mutual fund portfolio’.

There can be numerous reasonably good portfolios, and there’s no one-size-fits-all.

I recently wrote an article for MoneyControl titled ‘How to build your Mutual Fund Portfolio from scratch?’

Here is a short snippet…

Wish to start building your mutual fund portfolio from scratch? Or maybe you already have purchased funds and want to reboot it?

There’s one thing you need to understand that…

You can read rest of the article by clicking the link below:

How to build your Mutual Fund Portfolio from scratch?

Why linking Investments to your Financial Goals helps?

by Dev AshishOctober 13, 2018 1 Comment

The ups and downs of the market can test investors’ resolve to remain invested (or invest more).

In rising (bull) markets, it’s easy to say that you will do the right thing, i.e. remain invested + invest more even if the markets were to fall in future.

But saying the same thing in falling (bear) markets is not easy. And that is because people overestimate their tolerance for market falls.

This is why most people should link their investments to financial goals.

Goal-based financial planning gives investing a perspective and helps you stay on track. Investors who invest randomly and don’t have goal-tagged-investments find it difficult to handle volatility in the markets. And volatility is a normal feature of the market. It’s not a bug as many would believe.

Tagging investments to your goals help. For example – the recent volatility in people’s portfolio is pushing them to focus on unimportant things like how much is market falling, what new lows the stocks are making, etc.

But think of it – if you have 3-year old son and you are investing for his higher education, which is about 15 years away, then it really doesn’t matter what the markets are doing in near term.

If you are simply investing to beat the index or someone else, then these levels are important. But if you plan to use the money to reach your real life goals, then you need to think of investments as a way to achieve those goals rather than just chasing returns. Institutional investors or investors with a large portfolio can have the goal of maximizing returns and managing the risk.

But common individuals having small portfolios have multiple real-life goals with different time horizons. For them, it’s not about maximizing returns. It’s about ensuring that they save enough and allow it to grow at an optimal risk-adjusted rate and have sufficient money when needed.

Another benefit of linking investments to goals is that it prevents us from digressing. If you get some extra money from somewhere but don’t have goals or targets, it’s very easy to digress unless you are really disciplined. On the other hand, if goals are clear, chances are that you will want to use the surplus money to give an extra push to your goal-based savings in order to get closer to the goals.

Why this is all the more important is because when you invest for the future you are cutting back on spending your money now. So there must be a compelling future purpose for this sacrifice. And goals are what make this sacrifice worth making. Think about it.

I have already written in detail about how to set your financial goals (using this free excel financial goal sheet download). Also, I have written a huge resource post on how to do goal-based financial planning or call it a Step-by-Step guide to Goal-based Financial Planning. I suggest you do read it if you still feel goals are not important when it comes to investing.

I don’t know whether there is a term like this but I feel that taking the goal-based financial planning approach can increase the utility-adjusted wealth of people.

Some more points that I think further justify investing in line with goals:

It forces you to think about goals often much in advance. This, in turn, prevents you from underestimating how much money you’ll need in the future. So you get a clear picture of your financial future.
Once you realize that you have future liabilities coming down the road, you can start saving for your goal much in advance. And its proven that earlier you start, lesser you need to save.
Another rarely discussed benefit is that once you begin saving for your goals, you may use the remaining money guilt-free on whatever you like. No one will stop you. You can even gift that diamond ring to your wife that you wanted for so long. 😉
In a way, it helps reduce the gap between money you can afford to spend and money you want to spend.

I believe that goal-based investing increases the chances of reaching your financial goals. Please note that I am not saying ‘guaranteeing’. I am saying it ‘increases’. That is to say that if assumptions are correct, then there are 80-90% plus chances of achieving your financial goal. There is ofcourse a 10-20% chance of falling short too. But these odds are much better than what many people achieve by investing randomly.

Since this approach loan term investment planning, it must be realized that this is not a ‘do-it-once-forget-it’ kind of exercise. Financial planning is based on maths (at times complex maths) and chances are that there will be deviations from the expectations. As and when that happens, course corrections have to be made. It doesn’t mean that the plan was faulty. It just means that the plan needs to be tweaked to reflect the new reality. So review every once a year or two is necessary and recommended.

So think about it. You can still continue to invest as you have been doing (maybe giving very high priority to just saving taxes or buying wrong products and/or by relying on wrong people’s advice).

Or…

You can be wise and first put your personal financial goals at the centre and then build a solid goal-based financial plan around it. It is your call.

Short Term Personal Loans – To take or Not?

by Dev AshishOctober 13, 2018 1 Comment

After the recent fall in stock markets, I have (once again) started getting emails asking whether it makes sense to take a loan and invest now. 🙂

This isn’t surprising. Whenever markets start falling or remain subdued for some time, I start getting similar emails from ultra-aggressive investors.

And as if its Loan God’s wish, it’s pretty common these days to get unsolicited mailers in your inbox about pre-approved loans. To be honest, the idea seems tempting to take the loan and invest it. But I don’t do that. Borrowing to invest in volatile assets like equity is extremely risky. In fact, it’s a recipe for many stories of financial disasters.

Now before I simply brush aside the idea of investing on borrowed funds, let me also say that the idea of borrowing to invest itself is not bad. It is just a very risky one and not suitable for most investors. Most people who are attracted to it don’t really understand the dynamics of it.

So I strongly urge you to stay away from investing with borrowed money.

It is easy to get lured by the charm of earning handsome returns doing that. But equity markets don’t move in straight line and more importantly, don’t deliver returns on demand. They have a mind of their own.

So there is no guarantee that you will get profits. On the other hand, loans are fairly predictable. You have to repay your personal loans without fail and on time. 🙂

To put it more aptly, there is a sheer mismatch in the common tenure of personal loans (short term) versus suitable tenures that are needed to ensure good returns from equity (long term).

For the majority of people (and I am repeating) – they shouldn’t borrow and invest in equity markets.

If you really want to build wealth, it’s better to take the gradual and stable route – invest in well-diversified equity funds via monthly SIPs towards your financial goals. That’s a far surer way to accumulate wealth in the long term.

So with that aside, let’s get to the question about what should the short-term Personal Loans be taken for?

Again, it’s easy for me to say that you should not take personal loans and you should plan for your money needs in advance. For obvious reasons, nobody would borrow money if they could avoid it. Isn’t it? But life has its knack of surprising us.

People will have unexpected needs and emergencies and they will take loans.

If you need money and don’t have it, then depending on how comfortable you are, chances are that you might first ask your friends or family to lend you some money. In most cases, they won’t even charge any interest. But many people aren’t comfortable doing that. The next option is loans.

So let’s see what all factors should be considered before you take that short-term personal loan:

Important things to consider before taking Short Term Loans

1) Getting a Low Personal Loan Interest Rates

I know – the first question that comes to mind of borrowers (after thinking how are they going to repay it) is how to get Lowest Interest Rate on Personal Loan?

This is actually a no-brainer. Lower the loan rates, better it is for you.

But at times, you may even have to accept higher rates if the loan amount you need is available from a lender who is charging slightly higher.

Now here is an important thing. When making the decision, don’t just look at the interest rate being offered. There are other things to consider too. Do read the fine print or ask the lender whether the loan is being given on a flat-rate basis or a reducing-balance basis. This is one thing. Another is that the interest cost is not the only cost that you have to pay. There are other charges like Processing Fee (Lower the better) Prepayment Fee (again lower the better) Late Payment Fee (any guesses?)

So basically, the total landed cost of the loan (which is not just about the loan rate) should be the minimum for you.

Now personal loans are unsecured loans. That is, they don’t take any security from the borrowers. So naturally, the rates will be high. But if its possible for you to provide some security (like LIC policies, precious metals, other savings, etc.) and make it a fully or partially secured loan, then the lender would very easily reduce the loan interest rate by few percentage points. And that can help you a lot.

2) Getting the Optimal Loan Amount

If you need a personal loan for a specific reason, you would already know how much money you need.

But what happens is that lenders try to entice borrowers to borrow more than what they actually need.

Please don’t do that.

Just because you can avail a bigger loan, don’t go overboard. Take a loan of as small an amount as possible. If you need a loan of Rs 2 lac, then take a loan of Rs 2 lac or lower even if someone is willing to lend you Rs 5 lac.

A loan is a loan and you need to pay interest for what you borrow. And you don’t want to pay interest on the money you don’t need.

3) Loan EMI and Tenure

The maths of personal loans (or any loan) is such that the tenure selected along with the loan amount and the interest rate determines your final EMI.

How much EMI you should opt for?

To be honest, you yourself are the best judge. No one knows about your repayment ability better than you. But your income is limited and with regular expenses to take care off, there is a limit to how big EMI(s) you can afford. EMIs have to be paid month-on-month and without fail. It’s not an option but an obligation.

Do an honest assessment and chose the EMI which is affordable and comfortable for you to manage during the full loan tenor and not just initially.

So first find out what EMI you can comfortably manage first. And then manipulate the loan tenure and/or the loan amount to arrive at an EMI that is affordable for you. There are several free personal loan EMI calculators available online. Try them out. These loan calculators not only show the loan EMI but also tell you the total loan interest payable throughout the loan tenure.

And if you feel that the lowest EMI is the best one possible for you, then let me tell you that it may be comfortable but it is not the best.

Ideally, you should try to keep the repayment period as short as possible. The reason is that it will reduce your total interest burden during the loan tenor.

Although your EMIs for a short-tenor loan would be higher than a longer-tenure loan, it makes mathematical sense to reduce your total interest outgo. Here is a small example to help you understand this – Suppose you avail a personal loan of Rs 5 lakh at an interest rate of 16%. Then your total interest paid over the loan tenor would be as following:

5-year Tenor – Rs 2.29 lakh
4-year Tenor – Rs 1.80 lakh
3-year Tenor – Rs 1.32 lakh

Ofcourse, you need to consider EMI affordability too, which changes with loan tenor:

5-year Tenor – EMI of Rs 12,159
4-year Tenor – EMI of Rs 14,170
3-year Tenor – EMI of Rs 17,579

But I hope you understand what I am saying. If you can increase your EMI a bit, you can easily save a lot of money on interest. I did a similar analysis for home loans. You can read how shorter loan tenor reduces total interest outgo for home loans.

Once you have taken a short-term personal loan, you need to understand that you should regularly pay your EMIs. It’s not just because lenders want you to do that. It is also because your credit score can be improved by smart repayment of these short-term personal loans.

The credit score is used by lenders to evaluate your capacity to pay the loan on time. In general, higher your credit score is, the better chances you have of loan approvals. So how does a personal loan help improve credit score? When you take a small loan, it’s easier to repay than a large loan. So you can easily pay off all your EMIs on time (remember always go for affordable EMIs to ensure this). Once you do that, it incrementally improves your credit score.

And I don’t need to tell you why having a good credit or cibil score is important. Sooner or later, you will take big loans – like a housing loan.

At that time, lenders will check your credit score and history. So having a good score will work in your favor and increase the chances of loan approval. And as things are expected to pan out, the borrowers with a higher score will get loans at slightly lower rates than those who have a lower credit score. This in itself means that one can save a lot of money in lower interests.

For example – suppose borrower A and B both need Rs 75 lac home loan. Due to higher credit score, the bank is offering a home loan to A at 9%. Whereas the same loan is being offered to B at 9.5%.

Can you guess what is the cost of this difference over the course of the loan (assuming 25 years)? The total additional interest paid by B will be about Rs 7.5 lac.

So having a high credit score when you are taking bigger loans can save you a lot of money. If you do not have any credit history, then you can even consider taking a credit card against a fixed deposit and build up your credit score slowly.

Enough said…

I said this earlier and will repeat it again – it’s easy for me to write here that one shouldn’t take personal loans. But practically speaking, people will need to borrow and they will. So might as well be smart about it and manage the personal loans well.

If loans are taken for genuine unplanned emergencies, then its fine and make sure that you do consider interest rates, charges and convenience. But do not borrow to invest in stocks. Please don’t do it. 🙂

Why shouldn’t You ask Banks for Investment Advice?

by Dev AshishSeptember 16, 2018February 28, 2019 1 Comment

The banks in India mis-sell financial products.

Intentionally or unintentionally, they do it. And there is no other (softer) way to say it. Even the regulator RBI now accepts it.

And if you want to experience mis selling by Indian banks first hand, it is very easy.

Just walk into your bank’s branch and tell them that you have ‘more’ money and want to open a fixed deposit. They will surround you like vultures and try to push some product or the other, irrespective of whether you need it or not.

I don’t want to sound rude to our bankers but this is what really happens. That’s how most Indian banks are structuring their businesses – to maximize their incomes from non-banking activities even if it leads to mis selling of financial products.

What exactly is Mis-Selling of Financial products?

Mis-selling means any sale of financial products by any person (directly or indirectly) by:

Making a misleading or false statement, or/and
Not taking reasonable care to ensure suitability of the product to the buyer, or/and
Concealing or omitting material facts about the product, or/and
Concealing the associated risk factors of the product

Now mis-selling can be deliberate or unknowingly. But the end result is that the mis-sold products are either unsuitable for customer’s needs, are misrepresented or are too complex to be understood by the customer.

The problem of misselling is systematic and unfortunately, deeply embedded in the Indian banking system. And everyone is involved – from top to bottom level employees of the branches.

Banks already have a huge readymade database of their clients’ personal details and financial situations. This data is used by branches to systematically mis-sell life insurance products and to unnecessarily churn mutual fund portfolios. Most importantly, this is done without truly recognizing the customer’s need or risk profile.

And frankly, this kind of misselling is hard to catch because products are sold through verbal sales pitches. Customers, trusting banks as the protector-of-their-interests buy into the sales pitch and then, you already know what happens – customers end up with a lot of unnecessary and unprofitable financial products in their personal portfolios which doesn’t help clients achieve their real financial goals.

Just a couple of days back, I read about how a well-known private bank’s relationship manager duped senior citizens for lacs of rupees.

My blood boiled after reading about it. Senior Citizens are very easy targets for mis-selling. And that is just one example of mis-selling. Just try searching for mis selling of insurance policies in India and mis selling by banks in India and you will find out other horror stories.

What do Indian Banks Mis-Sell?

There has to be a good reason for banks to do this. Isn’t it?

Cross-selling products like insurances, ULIPs and mutual funds to existing bank customers help banks earn commission income. And banks want to maximize this commission income. So they just sell anything and everything as if there is no tomorrow.
Bank employees are put under a lot of pressure due to the steep sales and incentive-linked targets for selling such third-party products. And they have to secure their jobs and hence, try to push these products down everyone’s throat.
For all practical reasons, banks are unaccountable for doing this. There are RBI-issued checks and controls. But we all know how much such check & controls matter to the employees on the ground (who have sales targets to meet or else they will lose their jobs)
Lack of adequate training and expertise of bank staff is often quoted as one of the major reasons. And this is true to an extent. Most relationship managers know s*** about what they are selling. But I don’t think that just giving proper training will help curb mis-selling. They will still do it if the sales targets are steep and incentivize them to do so.

It is common sense that the investment advice should be based on your financial goals. That’s goal-based financial advisory. But when banks are selling you something, it’s their own goals (commission maximization, sales target achievement, etc.) that they are trying to meet, not yours. 🙂

Data on How Banks mis-sell Mutual Funds

Mis selling of financial products by banks in India is very common. Till very recently, RBI was in a denial mode due to lack of proof. But things are changing and so is the regulator RBI’s stance on mis selling of financial products in India.

Banks have been selling insurance policies for years by acting as the Bancassurance channel for Insurance companies. Since banks reach is huge, this has no doubt increased the penetration of insurance in India.

In recent times, banks are doing the same with mutual funds. They are actively selling mutual funds to their existing customers. And you all know that MutualFundSahiHai 🙂 Here is a success story of mutual fund SIP.

Since I talk a lot about mutual funds and mutual fund SIPs, I thought I will share some data that will prove that how taking mutual fund advice from your banks is wrong.

Many mutual funds come from the same business house as the bank. There are several. And most of these bank-sponsored mutual funds are dependent on their sponsor for sales of their schemes.

Have a look at the below table which I have taken from Outlook Asia’s Manoj Nagpal’s tweet. It shows which AMC pays the largest share of commissions to each of the large MF distributors (in this case, banks):

It is very clear that most banks, try and sell the schemes of their own fund houses.

Or lets put it this way – for each bank, the best mutual fund schemes to invest for their customers is none other than the schemes belonging to their own group! 🙂

That’s laughable!!

And there is a clear conflict of interest here!

Customers of the bank, unfortunately, don’t know this and tend to trust their bankers blindly.

The above table is based on data up to March 2017. Another detailed analysis (though of earlier years) can be found here and here. But the story remains the same.

Note – Please don’t think that here, I am trying to say that bank-backed AMCs are not good fund houses. I am not saying that.

But you really need to think about this – when you buy mutual funds through your bank, is the bank really advising you on what is right for you OR just acting as a seller who wants to get the maximum commission from whatever they can sell to you?

I think by now, you should know the answer.

What are the best mutual funds to invest in?

There are several ways to find this out. But one of the worst ways is to ask your bank or bank’s relationship manager. 🙂

And add the fact that banks only sell you the regular plans of mutual fund schemes and not the direct plans, it is quite evident that investing in mutual funds through banks is a bad choice.

Tip – If your bank tells you that you are their ‘preferred customer’ or ‘inner circle customer’ or gives you some similar classification, just run away! 🙂 A cross-selling bullet has your name written on it and will hit you soon. 😉

What should You do?

There is one thing that I should not miss saying here…

To be fair, it is not just about mis-selling of financial products by the Indian banks. It is also about mis-buying from the customers. It is their hard earned money and hence it’s their responsibility to find out what is right for them and what isn’t.

I agree that a subset of bank customers will still be unable to decipher what is good for their personal finances. But others need to wake up and acknowledge that the financial world is based on selfish interests of everyone. You need to look out for your own self.

As for the banks, they are still doing a fine job of providing ever-so-necessary banking services. But as of now, they are not suited for sale of other financial products. Due to their structure, they are geared to maximize sales and their commission income from financial products – and this leads to hard cross-selling of products which results in lots of mis-selling. Mis-selling by banks is very difficult to prevent unless radical structural changes are made.

So you should be wary of the advice you receive from your bank.

And banks may seem like doling out free advice in good faith. But free financial advice is very dangerous. And technically, it’s not even free. There is a commission hidden somewhere where you can’t see it.

For most people, banks are just good to do banking and nothing else. For real financial advice, you must understand that if it is good, then it won’t be free (just like legal and medical advice).

Before deciding the financial products you want to purchase, spend some time and find out your financial goals (download this free financial goal planning excel sheet), assess how much risk you can really take and then pick the correct financial products.

If you can’t do this on your own or need a second opinion, do not hesitate in seeking out investment advisors. Those advisors who are compensated only by you sit on the same side of the table as you and can work in line with your interests and help you make a solid financial plan.

Mis selling by banks in India is a reality. So now you know why you shouldn’t ask your Bank for Investment Advice or financial advice?