Category: Personal Finance

Answers to 20 Important Questions about Term Life Insurance

by Dev Ashish Leave a comment

 

20 questions Term Life Insurance

Term life insurance is the most basic form of life insurance. And I can safely say that it’s the most effective and the best form of insurance.

Why?

Because it gives you a very high insurance coverage (sum assured) at a very low premium. It’s perfect!

Many of you know about the benefits of choosing a term plan when compared to the whole menu of the available life insurance varieties. But this post is for those who are still not sure whether buying term insurance makes sense or not.

So here are answers to a few common questions that people have about term insurance plans.

Q1: How does Term Plan work?

A1: The buyer buys a term plan for a specified tenure. Let’s say 30 years. Now if the premiums are being paid regularly, then if the insured person dies between today and the 30th year, the insurance company will pay the sum assured to the nominee. If the person does not die during the tenure of the policy, nothing will be paid to either the insured person or the nominee.

Q2: Most people won’t die. So money paid in term plan premiums will be lost?

A2: Wrong way to look at it. Term plans are incredibly cheap. You can get a term plan of Rs 1 crore for just Rs 10,000 or even lower. On the other hand, a traditional insurance plan (like moneyback and endowment plans) can cost about Rs 25,000 for just a Rs 5 lac cover. The first thing to note is that this doesn’t make sense when you compare it with term insurance premiums. Second is that if you die, a payout of Rs 1 crore is more useful for your family than a payout of Rs 5 lac. Agreed that you won’t get anything back in term plan if you live. But what if you want to buy a Rs 1 crore cover using a traditional plan? Try to find it out. The premium will be so huge that you might not even be capable of paying it. So term plan allows you to give bigger protection to your family at a much lower cost.

Q3: What if I am lucky and don’t die? In any case, the premiums would be lost right?

A3: Read the answer to the above question again. That should convince you. Remember, insurance is being bought to protect the financial well being of your family if you die. It is not for your well being. But if it could make you feel any better, what you can do is this – Instead of buying a Rs 5 lac endowment plan for Rs 25,000, you go ahead and buy Rs 1 crore term plan for Rs 10,000. The amount you saved this way is Rs 15,000. Right? Invest this amount every year in equity funds. Chances are high that the total value of your investment after several years (like 20-30 years assuming that is your insurance policy tenure) will be much higher than what your Rs 5 lac endowment plan would give on maturity. And what more, all this while you had a big cover of Rs 1 crore as you bought the term plan. You get the best of both the worlds.

Q4: How much term insurance cover should I take?

A4: It is quite popular to go by thumb rules and take a sum assured of 15-20 times your current annual income. So for example, if your annual income is Rs 10 lac, you can buy a cover of about Rs 1.5 crore. But it’s better to not go by thumb rules alone and instead calculate it correctly. You can refer to this detailed post that I have already written on this topic – How to calculate the right life insurance amount?

Q5: How to decide the Right tenure of the Term Plan?

A5: Under most circumstances, an insurance cover may not be required much beyond retirement. And that is simply because most of your financial goals will be over by then and you would also have accumulated enough money to take care of your dependents (mostly spouse) if you were to die. So if you are 25, then you can take a cover of 35-years which covers you till you turn 60. But if you are 38, then even a 22-year term plan will be sufficient. Shorter the tenure, lower the premium. But if you want to be conservative, you can opt for a slightly longer tenure than what is necessary and just stop paying the premium when the need for insurance is not there. You can refer to this detailed post that I have already written on this topic – How to find the right tenure for the term life insurance policy?

Q6: Term plans are cheap no doubt. But why are online term plans cheaper than offline ones?

A6: When a term plan is purchased online, the costs incurred by the company are less, as there is no middleman between you and the insurance company. This lowering of cost is passed on to you as lower premium as no commission has to be paid to any agent. Most companies offer online versions of their term plans. If you are looking to buy the best online term plan, be sure to do your research and compare across insurance providers and then make the final decision.

Q7: Is the premium of term plans same for everyone?

A7: No. It varies for everyone as it depends on the person’s age, chosen policy tenure, the sum assured, payout method opted for and other premium loadings (if any) due to medical or lifestyle reasons.

Q8: Does the premium of the term plan change during the policy tenure?

A8: No. It remains the same.

Q9: If I die, are there different options in which the sum assured gets paid out to my nominees?

A9: Yes. Insurance companies allow you to chose how the money is paid out to the nominee in case of your death. Suppose you take a term plan of Rs 1 crore. Now if you die, the money can be paid out as any of the following (depending on what you have chosen):

  1. Full Rs 1 crore paid at the time of death
  2. Rs 10 lac paid at the time of death. Remaining 90% (i.e. Rs 90 lac) paid out equally as Rs 50,000 monthly (0.5% of sum assured) for next 15 years
  3. Full Rs 1 crore paid at the time of death. Additionally, Rs 50,000 paid monthly (0.5% of sum assured) for the next 15 years
  4. Full Rs 1 crore paid at the time of death. Additionally, starting with Rs 50,000 monthly (0.5% of sum assured) and increasing by 10% every year paid out for the next 15 years
  5. And there can be many other options depending on what the insurance provider is offering at that time.

Obviously, the premiums charged in each variety would be different. Which one should you chose depends on your need. If your nominees know how to manage a large amount to generate regular income, you can go for simple 1st option. But if you feel they are better of receiving money regularly, then probably you can go for 2nd option (or even the 3rd or 4th option which will have higher premiums). You can even have 2 separate policies with different versions chosen for payout in case of death.

Q10: Should I opt regular premium or single premium?

A10: You can choose either. In regular, you pay premiums every year. In single premium, you premium once and never again. But let’s say you buy a 25-year term plan and die after 5th year. Now if you have taken the regular premium route, then you would only have paid 5 small premiums. But if you had opted for the single premium, then you would have paid in one go and that potentially means that the 20 premiums got paid extra as you died early. Nominee gets the same amount irrespective of what you chose. But I think that’s too small an issue to bother about. You can actually do whatever you feel comfortable with. Some people want to just tackle it upfront (via single premium) and be done with it. Others don’t have a lot of surplus money to do it so prefer regular route. Whatever works for the buyer.

Q11: Does it make sense to buy term plans early or I should wait for some time?

A11: The premium amount increases with age. So earlier you buy, better it is. Also, with passing age, it’s possible that you may unluckily develop some disease that might make it difficult to get a policy later on. So don’t wait too long to buy a term plan later on. Buy it as soon as possible even if it seems too early to do so.

Q12: Does the term plan pay out even if I die in an accident?

A12: Yes.

Q13: Wouldn’t a Rs 10-20 lac term plan cover be enough for me?

A13: No. Don’t be penny-wise pound-foolish. Simply answer this question – If you die today, will your family be able to maintain their lifestyle, pay for children’s higher education, pay off loans and live well for decades to come in just Rs 10-20 lac? The answer will be a big No. So take a plan that takes care of all the above things. You can refer to the earlier mentioned post (about the same question) – How to calculate the right life insurance amount?

Q14: Will Rs 1 crore insurance be sufficient?

A14: Maybe yes. Maybe no. It’s not necessary. Different people will have different optimal insurance coverage requirements. Read this – Is Rs 50 lakh to Rs 1 Crore term insurance enough?

Q15: I want to take a term plan of bigger amount, say Rs 2 crore. Should I split it?

A15: You can do it. But keep it limited to 2-3 policies max. Better limit it to just 2. If you die, your family will have to run around to get all the policies paid out. So think from that perspective.

Q16: What if I am outside India if I die? Will it still pay money to my nominees?

A16: Yes. In most cases. Unless you go and die in a country that is on the unsafe list of the insurance company. So check the list before choosing a country to go and die!

Q17: I want to buy a term plan. But I have a health condition (or family’s health history is odd). Should I hide this information?

A17: Please don’t hide any such information. Death claims can be rejected if the insurance company finds out that you had hidden any critical information. So don’t do it. This may result in slight loading of premiums (increase in premium) that you have to pay. I think that’s much better than having a hanging sword of the possibility of claim rejection in case of death. Be willing to accept the loading of the premiums and move on with it.

Q18: I have few existing insurance policies. Should I disclose them while buying term plans?

A18: Yes. Don’t hide these either. There is nothing bad in having previous insurance policies.

Q19: I have purchased the term insurance. Now what?

A19: Tell your nominees about it. They should be aware of the policy in case you die. Only then they can claim the amount. Isn’t it?

Q20: Anything else?

A20: Stay healthy and try not to die. Your family will get the money if you die. But that’s not an ideal scenario. Isn’t it?

I hope that if you or someone was looking to answer – How to buy the right term life insurance policy? – then they found this article useful.

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Home Loan Tax Benefits – How much do You Really get?

by Dev Ashish 6 Comments

In India, home loans come with tax benefits. You already know that.

And there is no denying that these tax benefits make it all the more attractive to buy property using home loans.

But time and again I have seen people overestimating these tax benefits. Why?

Because the tax benefits available on home loans are capped. So depending on the home loan they take, the actual benefit may not be as large as what many borrowers think.

Now there are 2 components of a home loan – principal and interest. And the home loan EMI also has the same two components – (i) principal repayment, and (ii) interest payment.

So what tax benefits are available for Home Loan borrowers that can reduce their tax outgo?

  • Deduction of up to Rs 1.5 lac for principal repayment under Section 80C of the Income Tax Act.
  • Deduction of up to Rs 2 lac for interest payment for self-occupied property under Section 24 of the Income Tax Act. The interest payment of up to Rs 2 lac is available as loss under income from a let out property
  • Additional deduction of Rs 50,000 on interest payment, over and above the deduction claimed in Section 24 is available for the first time home buyers under Section 80EE.

Tax Benefits on Home Loan Principal Repayment

A deduction of up to Rs 1.5 lac is available for principal repayment of home loans under Section 80C of the Income Tax Act.

There are few things to note here.

First, Section 80C’s tax savings are also applicable on your investments in EPF, PPF, ELSS (Equity Linked Savings Scheme) and expenses like insurance premiums, school fee, etc.

So all these investments and expenses compete with home loan principal repayment for the Section 80C benefits. Chances are high that the sum of EPF + PPF + ELSS + insurance premiums + Home Loan Principal repaid will be higher than Rs 1.5 lac. If that’s the case, the cap of Rs 1.5 lac in Section 80C limits the benefit to just Rs 1.5 lac irrespective of what you claim from within EPF, PPF, ELSS, premiums or home loan principal repayments.

Even if you have a big loan and are repaying more than Rs 1.5 lac of home loan principal, the tax benefit is limited to just Rs 1.5 lac.

Tax Benefits on Home Loan Interest Payment

Deduction of up to Rs 2 lac is available for interest payment for self-occupied property under Section 24 of the Income Tax Act. And the interest payment of up to Rs 2 lac is available as a loss under income from a let out property.

This is where things get interesting and people get confused.

Due to the above-mentioned capping of benefit, even if you are paying more than Rs 2 lac interest in a given financial year, the excess interest above Rs 2 lac will not fetch you any tax benefits.

Here is a small example:

Suppose you take a Rs 35 lac home loan for 20 years at 9.5%. You EMI will be Rs 32,625 per month (read more about how home loan tenure impacts interest paid).

Home Loan Tax benefit Section 24

As you can see, in total Rs 3.91 lac is paid in EMIs in 1st year. Out of this, principal forms only Rs 61,633 whereas interest is Rs 3.29 lac. Out of this Rs 3.29 lac, only Rs 2 lac is eligible for tax benefits under Section 24. The remaining amount (can be seen in red-colored text) cannot get tax benefits.

The home loans are structured like this that during initial years, a major part of your EMI goes towards interest payment. So it’s possible that the interest you pay in the initial years will be much higher than Rs 2 lac (the limit for tax benefit).

Let’s take another example to find out another interesting aspect.

We compare two loans. First of Rs 25 lac and the second of Rs 50 lac. The loan tenure and interest rate on both are 20 years and 9.5% respectively. The EMIs are Rs 23,303 (for Rs 25 lac home loan) and Rs 46,607 (for Rs 50 lac home loan).

Now have a look at the table below:

Home Loan Tax benefit comparison Section 80 Section 24

For the Rs 25 lac loan, the interest part that misses out on tax benefit is very small (Rs 35,616 in the first year and goes on reducing). But for the Rs 50 lac loan, you initially pay Rs 4.71 lac as interest in the first year. This is much more than the Rs 2 lac per year limit. So you only get the tax benefit on Rs 2 lac of interest (under Section 24). The remaining Rs 2.71 lac doesn’t get any tax benefit.

And if you focus on the table (on right) of Rs 50 lac loan, you will see that you keep having an interest component that misses out on tax benefits till the 15th year. And more interestingly, during the first 7 years of loan repayment, the tax benefit on interest payment of Rs 25 lac loan is the same as tax benefit on Rs 50 lac loan!

So much so and hue and cry for home loan tax benefits. 🙂

This is all the more reason why one needs to look at the tax angle when planning to prepay home loans. And if that wasn’t enough, there is also the dilemma of whether to invest vs prepay home loan – to benefit from higher returns elsewhere as compared to low post-tax home loan interest rates that are prevalent in India.

But I suggest that before you decide to prepay your home loan, you run your own numbers or get in touch with an investment advisor to help you out.

And if you are one among those who are still deciding whether to take a home loan or not, then I suggest that even before you begin your search for home loans online, some time should be spent to understand how home loans actually work and how best you can manage home loans once you take them.

The idea of doing this post was to highlight that at times, people get over excited when it comes to tax benefits from their home loans.

It is quite possible that you may not even get as much tax benefit as you thought you would be getting from your home loan.

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

by Dev Ashish 1 Comment

How to accelerate Financial Freedom

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 Ashish Leave a comment

Age Life Insurance Tenure

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

Involuntary Early Retirement?

by Dev Ashish 7 Comments

Involuntary Early Retirement

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 Ashish 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:

Home loan EMI interest principal

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:

  1. 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.
  2. 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 Ashish 1 Comment

How to build your mutual fund portfolio from scratch

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 Ashish 1 Comment

Link Investments Financial Goals

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.