Archive for November, 2006

The Investment Game Plan

12 comments Written on November 8th, 2006 by
Categories: Uncategorized
A little insight into how you should invest.

1. Figure out where you are

The first thing to do is to prepare a personal balance sheet of sorts. Describe your assets - which is what you would call anything you own that is of real value. That means a house is an asset, money in the bank is an asset and stocks/mutual funds are assets. Your TV is not an asset. Your car should not be considered an asset (unless it's less than 3 years old, in which case consider the value declared to insurance).

So add all the values up and you get a list of assets, like so: 

Assets
Cash in bank: Rs. 50,000
Fixed Deposits: Rs. 200,000
Stocks: Rs. 150,000
Mutual Funds: Rs. 70,000
Gold: Rs. 20,000
Current value of house: Rs. 25,00,000
EPF: Rs. 8,500

TOTAL: Rs. 29,98,500
Underdeclare values of stocks, gold etc. by at least 25% since these are variable commodities.

Now figure out your liabilities. Meaning, how much do you owe other people? 

Liabilities
Oustanding housing loan: Rs. 20,00,000
Personal Loan: Rs. 100,000

TOTAL: Rs. 21,00,000
Don't include things you intend to pay back immediately, like credit card bills, or phone bills etc.

Subtract your LIABILITIES from your ASSETS to find out your NETWORTH: meaning, how much are you worth today. In the example above, NETWORTH = Rs. 8,98,500.

2. What's your "cash flow"?

Now find out how much you spend. Include all standard expenses (in fact, keep a record of this for about six months, and find out the real average) and also amortize your annual payments (like insurance) into the monthly amount.

Add the total income you earn (minus taxes and any other deductions) 

Expenditure:
Apartment Maintenance: Rs. 2,000
Phone bills: Rs. 3,000
Petrol: Rs. 2,500
Credit Cards: Rs. 5,000
Internet connection: Rs. 1,000
Interest payment on housing loan: Rs. 11,000
Insurance Amortised: Rs. 3,000
House taxes etc. amortised: Rs. 1,000
Cash expenses: Rs. 8,000

Total: Rs. 36,500

Income: 
Salary: Rs. 45,000
Dividend: Rs. 2,500
Total : Rs. 47,000

Cash Flow: Rs. 10,500 per month.
If your cash flow is not positive, i.e. Expenditure is greater than Income, STOP RIGHT HERE. Go back to the drawing table and figure out how to reduce your expenses or increase your income - there is no other way around. Investments are only for cash flow positive people!

3. What and when do you need money? And How Much? Find out any longer term requirements to fund a large one time requirement. The way to do this is: 

Ongoing: Liabilities, Rs. 21,00,000
After 5 years: School Donation for Child, Rs. 100,000
After 10 years: House repairs and upgrades, Rs. 10,00,000
After 15 years: College fees for Child, Rs. 10,00,000
After 20 years: Marriage costs, Rs. 10,00,000
After 25 years: Potential medical expenses, Rs. 10,00,000
After 30 years: Retirement, Need to have corpus of Rs. 30,00,000
Discount all these amounts by inflation of 6% a year.

4. The Investment Plan Recipe

Now's the time to act. You need to increase your network every single year to reach your goals. Your immediate goals for the next ten years are to build up a corpus for your child's education, and to clear out your loans. Always pay out your first house loan - that is the house you live in, so you must attempt to make that debt free. Further real estate can be financed by loans etc.

To finance the above goals, you have a sum of Rs. 10,500 a month, of which you invest Rs. 3,000 per month (say) in the principal of your housing loan. The remaining Rs. 7,500 must be invested.

What do you need? Here's an illustration:

Mnthly Return Years Corpus Grows to Withdraw? After Inflation Remaining
7500 20% 5 900,000 3,189,560 2,000,000 2,676,451 513,109
15000 20% 10 513,109 2,909,698 1,000,000 1,790,848 1,118,851
25000 18% 15 1,118,851 5,138,964 1,000,000 2,396,558 2,742,406
30000 18% 20 2,742,406 9,586,741 1,000,000 3,207,135 6,379,605
35000 15% 25 6,379,605 16,543,093 1,000,000 4,291,871 12,251,222
40000 15% 30 12,251,222 29,358,528 3,000,000 17,230,474 12,128,054
The idea is that:

1) You get 20% on the first 10 years of investment and you increase the quantum of investment per month every five years.

2) After ten years you move money to less risky investments and get lesser return, and this goes on.

3) Every five years you withdraw the amount of money needed to finance your needs.

4) After thirty years you are left with about 3 crores, which will most likely be just enough for your current expenditure for a while.

This is an investment goal. You can see where your goals like and try to achieve them. Update your networth statement once a month, and estimate your free cash flows every three months. That way you are aware of how close you are to your immediate goals and whether you are making it or not.

Posted in Uncategorized

How Much Insurance Do You Need?

28 comments Written on November 2nd, 2006 by
Categories: Insurance
This is perhaps the most often asked, and misunderstood question. Insurance advisors will tell you that you need to be covered for a sum that looks big (like Rs. 30 lakhs or so) but that much money is not at all enough! In fact they sell you those amounts so that you can buy endowment plans and ULIPs which are not at all beneficial to you.

What you should do FIRST, is buy term plans to cover your insurance requirement. Buy only term plans where you don't get your money back, since these are the cheapest. And buy them early in life - the later you wait, the higher the premiums are (but it's never too late, unless you are 55+).

Let me take an example. If you earn Rs. 4 lakh a year, and you want your better half to live the same lifestyle for the next 30 years, you must also consider inflation and tax. 8% FD is subject to approx 25% tax overall, and inflation is around 6%.

If you were to die today, your wife will need Rs. 1.09 crores to survive 30 years from now without having to work. This is the amount you need to be insured for. (For an age of about 30, term insurance for this amount costs about Rs. 35,000 per year)

If your wife is 30, you should assume life expectancy is 75 years. Add Rs. 50,000 per year as your investment towards FUTURE medical costs, and then you need an insurance for: Rs. 1.91 crores. (For an age of about 30, term insurance for this amount costs about Rs. 62,000 per year)

Note: This is a simplistic model, not considering things like one time payments needed for education, marriage and such. You will have to add those and recalculate manually.

Some of you have mentioned that for an income of Rs. 4 lakh a year, this is a HIGH amount. Rs. 35,000 a year is Rs. 3,000 per month, and you save tax too on this amount. But Rs. 62,000 is way too high, one can imagine. So Let's consider this: For a 30 year old what can be the real cause of death? Disease is usually far away, and stress isn't usually that developed for heart and brain ailments.

Accidents, however, are unpredictable and can happen in a vehicle, or even when walking! Such incidents are what you should insure against. Most insurers provide "double accident benefit", meaning that if you should die in an accident, your next of kin will get DOUBLE the sum assured. So if you need an insurance of 1.1 crores, you can buy a 55 Lakh policy, with double accident coverage, which would cost around Rs. 21,000 per year. Much more affordable!

But also consider this: You will also be saving and investing money (that's why you're reading this blog). Therefore as your wealth grows, you don't need SO much insurance, because your investments will cover a part of the money required. If you run the calculation every year, you may find that your investments cover a significant part of the money required, so why pay for extra insurance?

The way to do this is to buy multiple term plans. Instead of buying one term plan for Rs. 1.91 crores, buy TEN term plans for Rs. 19 lakhs each. Then, everytime you see that your insurance requirement has come down by Rs. 19 lakhs (because your investments are that much now), Throw out one policy.

Term policies are very easy to throw away; simply stop paying the premium! There is no legal requirement for you to to pay the premium every year, and companies give you upto two years of "grace" period, meaning if you don't pay the premium for upto two years and then want to reinstate the policy (say you invested in a property that went bust) you can do it. (They may change the premium though, to your disadvantage)

Eventually, you may become so rich you don't need (life) insurance at all. That's fine; if you already own 1.91 crores and spend 4 lakhs a year, do you care about insurance? Probably not life insurance. Yes, you still have to insure your property, car, gold etc. against fire/theft/damage etc. but those are, by definition, term insurances and should be bought to cover those risks. The risk of losing your life should only be covered as much as your dependants need in order to live the rest of their lives in comfort.

If you have understood this, tell me how much insurance a 60 year old widower needs, if his children are all earning for themselves and he has no dependants?

Answer: ZERO.

How much insurance does a 1 year old child need? ZERO.

But if you have dependants, provide them a secure and comfortable life by insuring your life, for the amount that they need.

Posted in Insurance

Newer Entries »