Do we need Insurance?

Insurance is a contract between two parties where one pays the premium to other to cover a specific potential financial loss. It is not an investment at all. It is just like the foundation of a portfolio. Any good portfolio is incomplete without a cover. As we can’t think a multi-storied building with a deep strong foundation we should not even start thinking of investing for future without insurance. There is an old say i.e. “safety first” so we should think about Insurance first then Investment.

Most of the time people get confused with Investment and Investment. Most people do not understand that the basic Logic of Life Insurance is to provide security to your Family from an unfortunate event. Insurance should be bought for protecting your financial future and for securing your financial future. It should not be mixed with Investment which should be done for creating wealth for the future. Insurance is an expense or cost to protect our financial future from an unfortunate event. It is always better to avoid mixing your Insurance with Investments.

In India if you look around then you can easily find that maximum number of people pays their premium between December and March just before the financial year end. What does it mean? It means. People buy Life Insurance for the purpose of saving tax which is again wrong thing to do. Just because buying Life Insurance lowers your tax burden it is understood by most people that it is the best form of Investment. These are the money back policies which can give 5 to 6% per year. They offer very small cover too, which will not be sufficient for dependents after her or him.

So what should be done? When it is insurance then we should only have the pure term insurance policy. Here the premium is very less compare to money back policies form same amount of coverage. Rest all the saving should be invested in high yielding instrument like equity or equity related assets. In any time period this combination can give better return than any money back policies. Let me explain this with an example.

Suppose there are two friend Ravi and Shashi. Both are 25 year old. They have decided to save ₹30000 per year for 30 years. Ravi has decided to invest this surplus in a FD which can give max 8% return(on higher side). It will also give the coverage of ₹600000 to ₹700000. On the other hand Shashi buys a term plan with ₹6000 with a cover of ₹2500000. And remaining ₹24000 in Equity mutual fund. Equity has a historic CARG is 17%. But for my calculation I have taken on 13% CAGR return.

Now refer the above table. At any point of time Shashi will get better corpus. One thing I like to mention that equity return will not be so steady. It is going to be volatile but in long run it will beat any fixed return asset class.

If both friends increase the investment by 5% each year then the return will be like this.

You can download the excel file for you reference from here.

Hope this will help……

No Loss Mutual Fund Investment

When it comes to investment in market, most of us first think about safety. Safety of principal amount becomes more crucial if you have a large sum to invest. I must say this in the start of discussion that when we go for safety then we should not expect return more than 7-8% per year, which is very near to standard FD a rate. But the products available in Mutual Funds we can generate alpha over this FD return. We must also need to consider the Liquidity aspect of an investment. This plan is useful for:

• Investment for Emergency Fund creation.

• Funds for Down Payment of Home, Car etc.

• Investments for the proceeds of Redemptions near Goal.  

• Retired Person.

What is the plan?

Suppose an investor have Rs5,00,000. He needs this money for down payment for home. This means he can’t take risk on this amount. So what does he has as option for the risk free investments? One of the most common answers would be fixed deposits. But if he finalized any property then it will attract the pre-closure penalty. This will reduce the value of investment. If decision takes longer than inflation will also play its role.  This has the same effect on the value of investment.

Now see the option in mutual fund space for this type of investment, where risk should be zero with variable time period. The option is Liquid Funds. it invests primarily in money market instruments like certificate of deposits, treasury bills, commercial papers and term deposits. These funds are designed in such a manner that it helps a fund manager in meeting the redemption demand from investors. We can take out our money any time without any exit load. We can get proceeds of redemption in 1 day. Liquid fund can also give instant payment. Sebi has capped this limit to  90% of your folio's value, whichever is lower. CRISIL Liquid Fund Index has given 6.9% return in one year.  But you can say that where the alpha is then? Let me explain.

Liquid fund investment (rs500000) with 7% CAGR will give about Rs2900 per month. If an investor invests this amount any large cap equity Mutual fund then it will create an alpha with. If the Equity fund give return 12% per year then the investment would be Rs732795 where as Liquid fund alone will give us only Rs704701. But if we choose fund having better return than difference will be more significant. Nifty has a CAGR of 12.1% in last 20 years (since 1997).

You can download the Excel file for your reference from here.

Retirement Calculator

As in last post I have discussed about the financial freedom. I have created a excel calculator which tells that if we have saved our 30% of household income then it would be sufficient to replace household income in 15 years. Shocked? But it true that it will be enough to generate income same as our salary in just fifteen years.

For this calculation, I have consider continuous 8% growth in income per year and 15% return on investment per year which quite possible with equity exposure. And I have assume 8% safe return on investment after retirement.

As you can see that I have taken 10000 as starting salary per month in second column. In fourth column there is compounded value of saving assuming we have invested the savings with a return of 15% per year. And in fifth column there is monthly income if we have kept our corpus as 8% per year to generate regular income. And in last column shows the balanced amount need to be generated for income.

You can download the file here.

Loan EMI Calculator with variable ROI

Equated Monthly Installment, i.e., EMI is the sum of amount payable at regular interval mostly monthly to the financial institution until the loan amount is fully paid off. It consists of the interest on loan as well as part of the principal amount.

I have created a Loan EMI Calculator to help my readers to calculate the term. It can also help you to change the ROI as and when reduce by your bank. We can also see the effect of down payment or increase in EMI.

1. Enter your Loan Amount in cell D4
2. Enter your ROI in E column
3. Enter your EMI in G column

You can download it from Google Drive.