Do not mix Insurance with Investments

We are into the month of March – the last month of the current financial year. Tax planning is now uppermost on the mind of those who feel this is their last chance to save some income tax for the year. This urge to save taxes makes them highly gullible to the pointed sales pitch of ever available and savvy insurance agents who are on the prowl to ratchet up sales of their insurance products (endowment plans, savings plan, ULIPS, etc) in the guise of saving taxes for their clients. The lure is that most such insurance products are bundled as investments and promise to give back some multiple of the total premiums paid. Investors see a double benefit – tax savings plus money back at the end of the term. Consequently they are already sold and so quick to sign up for these products that their checks are already signed – they are just waiting to fill in the premium amount. This is how the vast majority of Indians are enticed into subscribing to sub-par investment products with hefty annual premiums for the meager purpose of saving a little tax. What they fail to realize is that by buying such products they neither get adequate insurance cover for themselves neither do they secure their future by way of making good investments. Lack of adequate regulatory prohibitions from bundling insurance products only makes it worse – ensuring this saga continues year after year.

The fact of the matter is this – Insurance does not equal Investments.

Let this message sink into your conscience through the above picture. Think of Insurance as an umbrella that protects you from unforeseen and sudden events. And think of Investments as an inverted umbrella that helps you accumulate and multiply your savings for a comfortable future. Do not ever mix the two – no matter how much the Insurance agent tries to convince you.

Insurance is a protection product and term cover is the purest and cheapest form of Insurance cover there is. That is the only form of Insurance you should consider buying – ideally for a sum assured of up to 10 times your annual income – to protect your dependents in the unforeseen event of any eventuality to your life. There is a cost that you have to pay for availing this protection - the annual premium. Think of this premium as an expense to protect your dependents if something were to happen to you. Do not be tempted by clever sales pitches that promise to recover this expense at the end of the term plus guaranteed additions plus reversionary bonus plus terminal bonus plus god knows what else. These sales pitches and the associated products are designed exactly to target your weak spot – your lack of willingness to treat Insurance premiums as an expense and your greed to recover this money at the end of the term. By succumbing to this greed you will end up owning products that neither gives adequate life coverage nor optimal investment returns. What makes it worse is that these are multi-year commitments which are often difficult to exit without talking a significant loss.

So the next time you are pressured by an insurance agent into buying such a product and are in doubt, ask for more time and then contact your financial advisor for a second opinion. Understand for yourself the tradeoffs between buying a bundled product versus buying a plain term plan and investing the rest of the money. Read The 4 ps of personal financial planning to understand how to go about planning your life’s finances in your own best interest.

Insurance vs Investment

We are into the month of February, the eleventh month of the financial year which spans from April to March. Historically the last three months of the financial year, i.e. Jan to March, have seen an increased demand for Insurance products in India. This is because the premium paid for Insurance products qualify for a tax deduction under section 80C of the Income Tax act up to an annual limit of Rs 150,000. This is quite liberal a limit for most Indians where the average annual per capita income is only Rs 135,048 (ref https://en.wikipedia.org/wiki/Income_in_India). In a country where the largest insurance company LIC – is owned by the government, Insurance companies and their agents have found it relatively easy to sell Insurance products to the vast Indian middle class on the basis of tax savings that will accrue to them for paying Insurance premiums. This narrative has not only suited the Government coffers very well (LIC paid a dividend of Rs 2,610cr to the Indian Government for 2018-19) but also the mindset of the Indian middle class which has been conditioned over the years into saving its hard earned income in tax saving instruments instead of investing it. Consequently millions of middle class Indians even today are more comfortable buying a LIC policy instead of investing in an investment product such as a Mutual Fund.

Truth be told, this mindset worked well during the post independence era when the Mutual Industry in India either did not exist or was in a nascent stage. However ever since the emergence of private sector mutual funds in 1993 and the stringent regulations put in place by SEBI since 1996, the Indian mutual Fund Industry has taken off and since 2004 has evolved into a mature financial industry with Assets under management (AUM) of more than Rs 27 lakh crores at the end of 2019 (ref https://www.amfiindia.com/indian-mutual).  In fact the AUM of Mutual Funds in India has registered a compound annual growth rate (CAGR) of 25 per cent over the five year period from 2013-2018, outstripping the CAGR of only 11 per cent registered by aggregate bank deposits of scheduled commercial banks during this period (ref https://rbidocs.rbi.org.in). Consequently the vast Indian middle class needs to wake up and re-condition its mindset and see-through the sharp sales pitch of Insurance agents who peddle Insurance products to them solely on the basis of tax savings.

Insurance is an entirely different requirement from Investing. Insurance takes care of the protection needs of the individual – due to sudden events related to life, job or health – whereas Investing addresses the topic of wealth generation for building a nest egg for your entire life. Therefore whenever Insurance is being sold as an Investment, you should de-link the Insurance need from the Investment need and only consider buying the Insurance portion (Term Insurance) to satisfy your protection needs and then invest the difference. Combining Term Insurance with Investments in the form of Savings plans or Endowment plans locks investors into long term commitments into products where there are expensive management fees and associated agent commissions which is a drain on the individual’s hard earned money.

The Finance budget for 2020 has taken a welcome step in this direction by giving taxpayers the option to decline these exemptions in order to avail a lower income tax rate. This is a soft signal from the Government that individuals are free to make their own choices for their saving requirements and should not rely solely on the tax incentives provided with Insurance products for this purpose. This option will force all taxpayers to now calculate whether they are better off availing the tax exemptions and paying a higher tax rate or declining the exemptions for paying a lower tax rate. In this process, the re-conditioning of the mindset to buy Insurance products solely for the purpose of saving tax will automatically take place. It is quite possible that existing investors who are heavily invested in Insurance products may choose to avail these exemptions. However new entrants to the job market and other young investors will certainly want to make their own savings decisions and avail a lower tax rate. Both classes of investors will do well to reach out to a qualified Registered Investment Adviser to guide them through this change.

The 4 Ps of personal financial planning

Someone's sitting in the shade today because someone planted a tree a long time ago.

Warren Buffet

Personal financial planning is a very important aspect of every individual’s personal life. Simply put, it is just the process of developing a roadmap for your financial well being – now, tomorrow and well into the future. When it is done well enough, it helps you in achieving your goals and your dreams, but more importantly it helps you navigate life’s ups and downs by overcoming the financial barriers that are an inevitable part of everyone’s life journey. This aspect of personal financial planning is rarely visible in public though. What is starkly visible however - mostly amongst your friends, neighbors and families - are the financial difficulties that arise in their lives due to lack of adequate financial planning and the discipline to stick to the plan in cases where a plan may even exist. These are the people who due to their own laziness or indiscipline or both land themselves in financial quicksand and then cover themselves with debt of all kinds - credit cards, personal loans, business loans, overdrafts and even loans from friends and families - to try and get out of it. If such people are lucky to have the benefit of good financial advice they do come out of their financial distress over a period of time. Else they continue sinking deeper into the financial hole which they have dug for themselves with each passing day.

The irony is that personal financial planning is not a difficult process at all. It is very easy and to make it even simpler to remember and etched into your memory I have codified it into a pyramid named the “The 4 Ps of personal financial planning” as shown below.

Provision: This is the first P of personal financial planning and is at the bottom of the pyramid. It is mostly applicable in your early years when you are young and preparing for a career although it can be applied all throughout your lifetime. It calls for making an investment in yourself i.e. educating yourself with the knowledge and the skills that will enable you to make your mark in society. It is equivalent to planting a seed that will grow into a tree someday. This is the stage in your life when you are in the red, when you have no personal wealth unless you are blessed with an inheritance. Hence the best thing to do at this stage is to build large provisions of knowledge and skills that will enable you get a job and earn an income. As you increase your knowledge and skills and grow in your career your income will grow and after providing for your expenses it will enable you to start building a nest egg, which will be the start of your wealth creation process.

Prevention: The second P of personal financial planning lays emphasis on preventing any illness that may come in the way of your ability to earn regular income. In this phase you invest in your health and hence you need to focus on best health practices – such as a healthy diet and regular exercise – but also supplement it with a good health insurance plan just in case some illness were to afflict you, god forbid. A good health plan not only pays for the cost of your hospital stay but also gives you cash for out of pocket expenses when you are ill. Most importantly it ensures that for a small fixed amount every year, your growing nest egg is prevented from being dented by a significantly large medical bill. 

Protection: The third P of personal financial planning is applicable when you have got married and started planning for a family. At this phase in your life you find that you have dependents, whose financial well being depends on you. This creates an additional financial obligation on you but most people do not realize it and those that do are inevitably late. Financial wizards have created a solution for this problem too and it is called life insurance. In this phase you invest in your peace of mind which ensures that for a small amount every year your life remains protected and that in the event of your untimely demise your dependents can continue to enjoy the financial well being that you had planned for them. Life Insurance products are often sold bundled together with investment plans in the name of endowment policies, ULIPs, etc. It is a best practice to always separate insurance from investments so that each product can work for you for the specific purpose for which it is designed. 

Profusion: The final P of personal financial planning is the one that focuses on multiplying your nest egg. In this stage you invest for your future. The future is not only uncertain but it is paved with ups and downs. The future also holds the key to your goals, your aspirations and your dreams. Realizing this fact early on in life will compel you to plan for the future by investing your nest egg in such a way such that your goals may be achieved without undue stress on your finances. There are multiple investment products available for multiplying your nest egg, ranging from fixed income products such as fixed deposits and bonds to equity products such as stocks, futures and options. Mutual funds are a convenient way of investing in these products since they not only reduce the ticket size abut also provide useful combinations of these products bundled together in a single fund. 

What to Do

If you have incorporated one or more of the above elements into your personal financial plan, you are already ahead of your peers. If not, it is better late than never that you start as soon as possible. Assess where you stand today and then if you need help, engage the services of a Registered Investment Adviser (RIA) to help you navigate the complex world of investments and select the ones that are best suited for realizing your financial goals. Your Investment Adviser will understand your financial goals, assess your risk profile, calculate the optimal asset allocation mix for your needs and then create a financial plan for you that is aligned with your needs. A regular review of this plan with your adviser will ensure that you stay on top of the financial markets and in control of your own financial dreams!

Happy Investing.