Insurance v/s investments and insurance in depth

In this article I would cover various aspects related to insurance like different types of insurance products, which ones to choose and especially which ones to avoid. Also will touch upon why one must keep insurance separate from investment.

Insurance basics

Insurance is required to cover the risk of certain undesirable events like loss of life, loss of income due to accident or illness, loss of property etc. Financial planning is not complete just with identifying goals and doing investments to reach those goals. You need to ensure that those goals are reached even if some undesirable event occurs. Since we can't control such events, we need to mitigate the risk by taking insurance.

How insurance companies work is, they insure many people for some amount called sum assured and take small amount called premium from each one of them. This way they get a large pool of money which they can invest somewhere to generate returns. They assume that not everybody will encounter those undesirable events hence they will be able to pay those unfortunates souls from the pool of money and still make some profit.

Main point to note here is that the aim of insurance is to mitigate risk and not wealth generation or savings.

Different types of insurances

Most popular form of insurance that most of us know is life insurance, i.e. that protects against loss of life. Those who own a vehicle, they might be aware of motor insurance that they are forced to buy in order to avoid penalty in case traffic police catch them. That pays when vehicle is stolen or damaged due to accident. 

Then there is health insurance which pays for hospitalization for more than 1 day, accidental insurance & critical illness insurance that pays in case of loss of income due to critical illness or accident respectively and home insurance which pays in case of theft or fire that damages home.

How much sum assured is reasonable

For life insurance the amount must be large enough to pay for your liabilities (say home loan or any other kind of debt), financial goals (kids education, marriage etc) and finally your dependents must be able to invest it in some safe avenue to get interest which is enough for taking care of their monthly expenses. Hence this must be a very large amount (say Rs 1 crore for somebody who has 25 lakh home loan and his family has monthly expenses about Rs 50000 per month).

Similarly health insurance also must be large enough to take care of hospitalization expenses in case of some serious disease or procedure like kidney transplant. Basically a cover of modest 2-3 lakhs may not be good enough. Prices of medical treatments, medicines are going higher and higher hence insurance amount must be enough for future needs too.

Life insurance

In it's purest form, insurance is to insure against loss of life for the payment of a small premium. Hence no benefit in case of survival. This is what is called term insurance. However chances are that many people might not have heard of it ever. What insurance companies try to sell is endowment plan (in which some money is paid at the end of period), money back plans (very similar to endowment plans but they pay in between too) or unit linked plans (much costlier but promises better return as money is invested in stock market). They sell it because as these are much costlier for consumers. Hence not only companies make much more profit out of it, they pay very high commissions to their agents for selling these aggressively. I hate these products because they offer very little sum assured hence fail to mitigate any real risk and returns from them are meager (like just about 6% from typical LIC policy hence one is better off investing that money in FD).

Let me give a concrete example of what I am talking about. I went to SBI Life's site and calculated premium for an endowment plan ShubhNivesh. For a 30 year old male, yearly premium comes out to be Rs 105830/- for sum assured of Rs 10 Lakh for 10 year. Now consider what good that 10 lakh do for the dependents of that poor guy if he dies!! In case of survival, they promise to pay Rs 10 Lakh plus non guaranteed payment which in the example is mentioned as Rs 345000/- assuming 8% pa return. Hence for the total payment of Rs 1058300/- over 10 years, one gets about Rs 13.5 Lakh.

Now consider term insurance premium from the same provider for a plan called smartshield. For the sum assured of Rs 1 crore for 10 years of coverage, yearly premium is only Rs 11686/-. Now if the balance of Rs 94144/- is invested in mutual funds through SIP for 10 years, assuming 12% annualized return, the corpus would be about Rs 18 Lakh.

Similarly ULIPs are as bad products as endowment/money back plans if not worse. They are much complicated to understand, provide very little insurance cover and have very high charges. Also they are far less transparent compared to mutual funds.

I hope it's amply clear with this example that by taking term insurance not only one gets a sufficiently large insurance cover which actually mitigates the risk, one saves much more on premium that can be invested for better returns elsewhere. Hence the bottom line is that endowment plans, money back plans and ULIPs must be avoided.

For the premium paid for life insurance, one can claim tax deduction under section 80C for amount upto Rs 1 Lakh.

How to select provider and plan

There are various sources that provide information & comparison of various providers, premiums etc. One can visit sites like valueresearchonline, policybazaar to compare and get quotes.

One can buy a term insurance policy through an agent or online. Online buying from providers site is much cheaper as no commission is paid to any agent.

A very important factor to consider while choosing the provider is claimsettlement ratio. It was highest for LIC (97.73%) but much lower for less known providers. One can go for LIC's term insurance plan but premium is higher because one must have to go through some agent as there is no completely online option. Good news is that the ratio is high enough for other private providers too like ICICI, HDFC, Max & Kotak.

Health insurance

As I mentioned earlier, health insurance pays when somebody gets hospitalized for more than a day. Everybody knows how high hospital charges are now a days and an hospitalization of somebody in the family can upset the financial plan  & destruct significant amount of savings.

For most salaried people, company provides health insurance. However one must assess if the amount is sufficient enough. Once you are out of job, health insurance cover cease to exist immediate. If you change job, new employer might offer even smaller amount or no health insurance at all. Also when you retire, you would be more prone to health risks and it will be difficult to get health insurance  or you might end up paying way too high premium. 

You must insure parents too if they don't already have a health cover.

You can go for individual health cover but better idea would be to cover whole family under a floater plan which covers individuals as well as whole family. For example there is "Family first" plan by max bupa in which every individual in the family would be covered by amount upto 5 Lakh and there will be additional cover for upto 15 Lakh which could be utilized for any member. Also watch out for policies that do not allow life long renewal.

Same sites mentioned above (valueresearchonline & policybazaar) can be used for finding out a health insurance plan.

There is tax benefit available OUTSIDE of 1 Lakh under 80C for health insurance. Under section 80D one can claim tax benefit for upto Rs 15000/- for self/spouse/kids and an additional amount of Rs 15000/- for parents. If parents are senior citizen, deduction could be Rs 20000/-. Hence for health insurance premium one can get upto Rs 35000/- additional tax benefit.

Read following articles from Manish Chauhan of Jagoinvestor for more information on health insurance:

• Health Insurance is Wealth Insurance
• How to Choose Best Health Insurance in India

Conclusion

For a smooth financial journey, insurance plays a very important role by mitigating risks. Even if life insurance & health insurance is provided by employer, one must take additional policies personally as the cover cease to exist after changing jobs. Avoid mixing insurance & investment and go for plain term insurance plans.

Please feel free to ask questions or share feedback on this or any of the previous articles.

Investing in mutual funds

Why another article on mutual funds? I am happy to see many people reading my blog and taking actions. At least 10 of my friends & colleagues talked to me and asked me doubts about mutual funds. I am happy to inform you that at least 4 that I know of opened fundsindia account, two people even started SIPs. They had some common questions that I believe some of you might be having too and I would like to address them in this article:

How does mutual fund investment work?

I described in my previous article about what mutual funds are, how they pool money from various people and invest, different types of mutual funds etc which you can read here.

To understand how the process works from investors point of view, suppose you want to invest Rs 10000/- in mutual fund A. You issue a cheque or place an order from fundsindia & pay via net banking. Suppose unit price of A on that day is Rs 50/- (that’s called NAV) then you will be allotted 500 units.

Now say after 2 years you want to sell those units and get your money back. You again place an order to sell through fundsindia or any other channel. Suppose unit price now has increased to Rs 75, you will get Rs 15000/- back in your bank account. As simple as that.

In case you opt for SIP (systematic investment plan meaning you want to invest regularly every month), which is the recommended way, you give an instruction to mutual fund to deduct certain amount every month from your account automatically and you will get units allotted similar to one time investment. Generally for SIP, minimum value could be as low as Rs 500/-. Also similar to selling units all at once, you can opt for SWP (Systematic withdrawal plan) and you will sell certain number of units or for certain amount of money gradually.

Do mutual funds really worth it?

I would like to let the data speak for itself. Suppose somebody starts a monthly SIP of Rs 8333/- (so total Rs 1 lakh every year). He would get yearly returns like following:

	Monthly SIP of Rs 8333/m for 3 years Return Value of 3 lakh today	Monthly SIP of Rs 8333/m for 5 years Return Value of 5 lakh today	Monthly SIP of Rs 8333/m for 10 years Return Value of 10 lakh today	Monthly SIP of Rs 8333/m for 15 years Return Value of 15 lakh today
HDFC Top 200 (Equity: large cap)	7.5% 3.45 Lakh	9.91% 6.52 Lakh	15.28% 22.45 Lakh	21.7% 93.37 Lakh
Franklin India Bluechip (Equity: large cap)	7.68% 3.46 Lakh	10.12% 6.55 Lakh	13.06 % 20.5 Lakh	20.08 % 80.8 Lakh
Franklin India Prima (Equity: mid cap)	14.42% 3.82 Lakh	15.13% 7.42 Lakh	13.16% 20 Lakh	22.09% 96.64 Lakh
Birla sunlife 95 (Balanced equity oriented)	9.03% 3.53 Lakh	10.56% 6.63 Lakh	13.53% 20.4 Lakh	17.08% 62 Lakh
HDFC taxsaver (Equity: tax planning)	7.7% 3.46 Lakh	10.25% 6.57 Lakh	14.13% 21.1 Lakh	23.27% 1.07 crore

Please notice that the longer the term, the better the returns are. Not just because of compounding but because of rupee cost averaging too.

Hence mutual funds do worth it when you invest in them through SIP because over the long term (10-15 years) they can give you 12-20% post tax returns versus say bank FDs which gives post tax returns like 6.3% (for FD with 9% interest for a person in highest tax bracket).

That's why equity mutual funds must form large part of the core portion of every investors.

Is SIP necessary? What if I invest once and forget?

Yes, SIP is necessary because it helps you from ups and downs without forcing you to time the market. Depending upon market conditions, returns could vary drastically in short term which could be like 6 years or more as shown in table below.

	1 time inv of Rs 1L in March 2009 when market was low Return Value of 1 lakh today (after 5 years)	1 time inv of Rs 1L In January 2008 when market was high Return Value of 1 lakh today (after 6 years)	1 time inv of Rs 1L for 10 years Return Value of 1 lakh today	1 time inv of Rs 1L for 15 years Return Value of 1 lakh today
HDFC Top 200 (Equity: large cap)	22.49% 2.76 Lakh	5.2% 1.36 Lakh	19.1% 5.74 Lakh	22.63% 21.3 Lakh
Franklin India Bluechip (Equity: large cap)	21.33% 2.63 Lakh	3.93% 1.26 Lakh	16.8% 4.73 Lakh	18.82% 13.3 Lakh
Franklin India Prima (Equity: mid cap)	28.33% 3.48 Lakh	1.59% 1.1 Lakh	15.89% 4.37 Lakh	25.34% 29.6 Lakh
Birla sunlife 95 (Balanced equity oriented)	20% 2.49 Lakh	5.2% 1.36 Lakh	15.88% 4.37 Lakh	21.22% 17.93 Lakh
HDFC taxsaver (Equity: tax planning)	23.27% 2.85 Lakh	3.48% 1.23 Lakh	19.76% 6.07 Lakh	27.15% 36.71 Lakh

To put above in perspective, 1st column values show returns on investment made in mid March 2009 when market was at rock bottom, returns today are pretty good for just 5 years.

On the other hand, invest made about 6 years back in January 2008, when market was at peak, returns are much worse.

However in longer terms like 10 years and 15 years returns are okay. Still SIP makes more sense because it helps us do investments continuously in disciplined manner.

How to select mutual fund?

I would like to reiterate again what I said in my previous article. You can take star rating of valueresearchonline.com into consideration and select 5-star or 4-star rated funds. Please diversify and choose multiple funds from different categories like large cap, mid cap, balanced and debt funds. Please take a look at the sample strategy in that article. Please feel free to reach out to me if you have any doubts. 

How much effort do I need to put? Can I just setup an SIP and forget?

No. Sometimes mutual fund performance degrades over the time for various reasons. Hence you must revisit you portfolio in say every 6 months and watch out for any degradation in fund ratings. Here is my thumb rule:

• Select only 5-star (or  4-star if required) mutual funds and start SIP in it.
• If rating drops to 3-star, please stop SIP in that fund and start it in another 5-star fund instead.

• If the rating remains at 3-star for about 6-12 months, please redeem your investment from that fund and invest into another 5-star fund.

How to open account in fundsindia?

Please follow the link and fill up all the required details. Download the form and sign it. You would need to submit copy of your PAN card and any address proof. Any regular address proof like Passport/DL/Aadhaar/Utility Bill/Bank statement etc will do. 

Either you can send them to their head quarter or call their local representative to come and collect it form you.

Disclaimers and disclosures:

The views shared here are based on my own knowledge and research. Whatever advise I am offering here is best based on my own knowledge & abilities. I would like to reiterate that equity investments are risky and there are no guarantees. However avoiding equity completely is riskier. The risk associated with them can be managed and that's what I am trying to put it across in simplest possible terms. More on this here.

I am not going to get any commissions from any mutual fund etc in case you act on my advice and I don't take any legal responsibility for any losses that you might incur (at the same time not asking you to share your gains with me :P). 

I am recommending fundsindia because I am using it for last 5 years and I found it really good and convenient. I am just another user for them and I would NOT be getting any commissions on any investments that you are going to make. If you use the link above to register, I might be getting a Rs 200/- coupon one time in case join them. However that is not my primary motivation and I have made my family & close friends join fundsindia even before they started any such campaign. 

Trading v/s Mutual funds and mutual funds in depth

In this article I am going to discuss about trading, speculation, investment and finally many relevant details about mutual fund investments.

Stock trading

Let me start with explaining a little about how stock market works. Suppose I have an idea about starting a business which will be the next big thing. To execute it I would need money to fund various activities like for office space, paying salary or buying raw material or some service. I can invest my own savings, ask my friends or family to invest, go to a bank to take loan, approach some venture capitalist or angel investor. Once the business is setup and becomes successful it would require a lot more money. Then I need to go to general public and many financial institutions to seek funding. I would issue them shares which would represent their stake or ownership. If my business succeeds further, they would make money.

Stock market provides interface for this. I need to approach an stock market (like NSE or BSE) with my detailed business plan and they would facilitate the initial public offering or IPO to sell my shares at a price fixed by me. Whatever money is raised in this process would be given to me and shares of my company would be issued to those investors. Then onwards share of my company would get listed and those investors would be able to buy and sell my shares through stock market.

Once stock is listed, price would be determined purely based on demand & supply of shares. That means if business makes a lot of money & becomes successful, many people will want shares and prices will increase.  On the other hand, if business doesn't do well, people would want to sell shares and price would decrease.

However it doesn't always work that way. Not everybody would be as rational and many would simply buy and sell without much logic. Sometimes they may ignore my shares completely, despite of my business making money or want to buys shares even if business doesn't make any money. Take Microsoft and Amazon for example. Microsoft makes a lot of money (many billions of profit every year) but stock market perceive that there future is bleak and the share price goes nowhere. Whereas despite of making a little or no money, Amazon rises like anything possibly in the anticipation of huge growth in future.

Investment v/s speculation

Determining how the business behind  a share is doing and predicting it's future prospects requires a lot of knowledge and effort. Most people do not have time, patience  and interest to learn and keep track of all this. When somebody lure them to trading, they depend on tips regarding when to buy and sell. In most cases that's the worst thing one could do with his hard earned money. It's not much different than speculating on a lottery ticket or horse race.

Unless there are definite strategies to protect against losses, what you are actually doing is speculation. I find people often trading futures, options and commodities. Tell me how do you predict whether prices of copper or mustard will increase or decrease over next few months? Mostly probably you can't and same will be the case with most people. However many still speculate on commodity trading.

To sum up, in my opinion regular investors like you and me should keep ourselves away from commodity trading or trading shares, futures, options etc so that we do not indulge in speculation and put our hard earned money at risk.

Time tested strategies of investing:

• Keep realistic expectations: It's temping when we hear stories about people doubling or tripling money on certain stock or real estate. However that doesn't happen to everybody and there are many more people who in fact loose in the very same avenues. Hence consider yourself lucky if you make 100-200% gains but the chances are that over the long term equity would provide you 12-15% returns which is still much more compared to other fixed income avenues.

• Play to win in the long term: Equity could be very-very risky for short term. Unless you are willing to stay put for 10-15 years or more, chances are you might loose a lot of money in equities.

• Know what you are doing: This is the most important thing. You must understand precisely why you are choosing certain investment avenue so that you can keep a tab on your investments and take corrective actions in case something goes wrong.

• Diversification: do not put all eggs in the same basket. In case something goes wrong with one investment and you loose money on it, gains in the other can compensate for the same.

• Rupee cost averaging: economies and markets see many ups and downs over the time and it's not possible to predict accurately when market is at absolute low or high. Hence it make sense to invest fixed amount every month so that the price averages out and we make better than average gains.

• Asset allocation: neither invest all of the money in equity nor in debt. When people are young, they can afford to invest larger portion in equity as they can stay put for longer time. The older they grow, they can gradually move it in debt. Thumb rule is to invest %-age of money equal to your age in debt and rest in equity. So a 30 years old invests 30% of his savings in debt and 70% in equity. Then one should keep reviewing the portfolio periodically and rebalance accordingly. This way when stock markets move up you will automatically move some money in debt and vice-versa to gain from market movements without timing the market.

Mutual funds:

Mutual funds receive money from people like you & me and invest it into multiple shares hence offer much better diversification. They hire one or more dedicated professionals called fund managers, with education and experience in equity research to do that job. Fund managers have skills to select right businesses to invest and track developments to make informed decisions regarding when to buy and sell. 

Mutual funds provide opportunity for all investors to take exposure to equity while minimizing risk with diversification and rupee cost averaging through SIPs.

Types of mutual funds:

• Equity oriented: these funds invest major portion of their portfolio in equity shares of various companies. They are tax efficient as gains made for period more than 1 year are tax free.

• Debt oriented: these funds invest major portion of their portfolio in various debt options like corporate deposits, government securities etc. They offer low returns compared to equity oriented mutual funds but are much less risky and tax efficient than bank FDs & corporate deposits.

• Hybrid: They offer somewhat middle ground by investing portions of portfolios in both debt & equity. There are Hybrid equity oriented or balanced funds that invest about 65% of money in equity. Hence they offer good returns compared to debt funds. At the same time risk is much lesser compared to equity oriented funds that invest 90% money in equity. Best part is that these are treated like equity funds and returns over 1 year are tax free. Then there are Hybrid Debt Oriented funds which invest some 10-15% portfolio in equity hence offer slightly better returns than debt funds.

• Sectorial funds: These are like regular equity oriented funds but they invest in only companies of certain sector say banking or IT. These are far more risker compared to diversified equity funds and unless you can predict which sector is going to outperform others, your investments would be at huge risks. These must be avoided by regular investors.
• Large cap/Mid-small cap: Shares of small companies have greater potential to gain because if small company does well and end up becoming huge overtime, investors of those will get huge returns. But as you might have guessed, risk of loosing money is far higher as many small businesses will eventually fail. Hence small and mid cap funds strive to gain more by taking more risk. Larger companies are more stable but they have limited growth potential. Hence large cap mutual funds which invest primarily in those bigger companies offer lesser return with lesser risk.

• Equity tax saving (ELSS): These are similar to equity diversified funds with lock-in period of 3 years and you can invest upto Rs 1 lakh to get tax benefit under 80C (more details in my previous post).

Selecting mutual funds:

Since not all mutual funds do well, it's critical that you identify best mutual funds to invest in and keep a tab on it's performance over time. In my personal experience, I saw that in 2006-07 timeframe, SBI mutual funds were doing really well. Than Reliance & HDFC funds seemed to do better. Now a days I see that most ICICI funds are doing better than others.

Hence we should be able to select winner and then review in every 3 to 6 months to ensure that they are still doing well. Else we need to switch to another good fund if our winners seem to loose out.

Can we select a mutual fund purely based on it's returns? No. Because chances are that fund might gain by investing in too many risky stocks. It might have been lucky to make huge gains in that timeframe but it's luck might run out next time. And don't just look at past 2-3 years returns as fund may not have seen enough economic cycles in such a less time. Prefer long term history over 5-10 years. 

Also keep in mind that funds return may not be much meaningful in isolation and you should always compare it with other funds in the category and general market. For example in last 3 years, market in general hasn't moved up much so most mutual funds have bad returns in that period. Then there are other parameters like beta to measure risk and alpha to see how fund generated returns compared to market.

All of above might sound too complicated again for regular investors. Hence I recommend taking a look at funds rating available at valueresearchonline.com. They rate fund between 1-5 stars, where 5-star is highest rating. While coming up with this rating, they account for risk adjusted return over a long time. I realized most funds which have good long term returns, low beta, high alpha and did better compared to benchmark & similar funds, had good rating too.

My thumb rule is that I strive to  keep investing through SIP in 5-star or 4-star funds. If it’s rating drops to 3-star, I switch my SIP into some other better fund. If rating remains at 3-star for extended period like 6 months to 1 year or drops below 3-star, I switch all my investment from that fund to a better fund.

But which type of mutual fund should I invest in:

First of all determine how much money you can invest every month which you may not need in next 10-15 years. This money could then be invested in a few good mutual funds from different categories and companies based on your asset allocation.

Suppose you can invest say Rs 10000/- every month. It would be a good idea to divide this money in 5 chunks of Rs 2000/- each. Now first SIP could be for Rs 2000/- in an equity oriented balanced fund like say

HDFC Childrens Gift Inv or ICICI Pru Balanced. 2nd SIP for Rs 2000/- could be done into a good Equity: Large Cap fund like Franklin India Bluechip. 3rd SIP could be done in a fund from Equity: Large & Mid Cap category like Quantum Long Term Equity and 4th from Equity: Mid & Small Cap fund like ICICI Pru Discovery. Finally 5th & last SIP could be in Hybrid: Debt-oriented Conservative fund like Birla SL MIP II Savings 5.

This portfolio would provide ample diversification amongst fund categories and fund houses. About 40% of it is in large & large-mid cap which provides stability with high returns, 20% is in mid-small cap that provides very high return with high risk, 20% each in hybrid equity & debt fund which provides stability with low returns. In 20 years this portfolio is expected generate wealth of about Rs 86 lakh assuming moderate return of 12% or Rs 1.22 crore at 15%.

If you are not willing to take much risk initially or want to get a feel of this process, I would recommend to start with a equity oriented balanced fund and start an SIP for few months and observe it.

For tax saving investments please see details in my previous post. Preferably  plan SIPs in them inline with your overall investment strategy. For example as ELSS do similar investments as equity diversified funds, you can swap either  Equity: Large Cap or Equity: Large & Mid Cap  with ELSS.

I hope this would have given you idea about how to select good mutual funds while  achieving diversification. In subsequent article on financial planning, I would touch upon how to plan mutual fund SIPs in order to achieve certain financial goals.

Where to search:

I use www.valueresearchonline.com. Go to www.valueresearchonline.com/h2_cat_5Years.asp, there are links for different categories of funds along with return information. For example  the link for 

Equity: Large Cap. You can sort by rating, returns etc and make a choice.

How to invest:

You need to be KYC complaint by providing details like address proof, ID proof and PAN card before you could invest in mutual funds. You need to approach a fund house (or AMC like HDFC mutual fund or Quantum mutual fund), distributors like various banks or online providers like www.fundsindia.com or registration agents like CAMS or Karvy. They will help you file for KYC, make investments, start SIP or redeem your units etc. Here are the details of these options:

• fundsindia: I use them because they do not charge up front fee and it's much convenient. You can open account in matter of days (including KYC) and start investing. You can do everything online including starting/stopping/switching SIPs, making new investments, redeeming your investments etc. They are safe and secure and I am using them for last 5 years. The only drawback is that I can't avail direct option hence my mutual fund pays them about 0.5%-1.5% yearly as trailing commission which is very less price to pay in my opinion for the convenience that they are offering.

• Banks: generally all banks distribute most mutual funds and you can fill up application form by visiting bank branch. They charge 2-3% upfront fee for every installment of SIP and get trailing commission too. This would be a bad option in my opinion.

• AMC or fund houses directly: You can visit their office and some of them provide option to invest online. For me it's a hassle to keep track of all those passwords and investment details separately and I prefer fundsindia.  Only positive point is that I could avail direct plan of mutual funds in which trailing fee could be saved.
• Transfer agent (CAMS or Karvy): they offer services like AMC only but you can invest in almost all mutual funds from 1 place. Still you need to visit them every time to make investment and manage your investments separately for all mutual funds.

Disclaimers and disclosures:

The views shared here are based on my own knowledge and research. Whatever advise I am offering here is best based on my own knowledge & abilities. I would like to reiterate that equity investments are risky and there are no guarantees. However avoiding equity completely is riskier. The risk associated with them can be managed and that's what I am trying to put it across in simplest possible terms. More on this here.

I am not going to get any commissions from any mutual fund etc in case you act on my advice and I don't take any legal responsibility for any losses that you might incur (at the same time not asking you to share your gains with me :P). 

I am recommending fundsindia because I am using it for last 5 years and I found it really good and convenient. I am just another user for them and I would NOT be getting any commissions on any investments that you are going to make. If you use the link above to register, I might be getting a Rs 200/- coupon one time in case join them. However that is not my primary motivation and I have made my family & close friends join fundsindia even before they started any such campaign. 

Basic concepts and different investment avenues

In this article, I will cover some basic concepts including inflation, compounding, savings, investments, financial planning, various investment avenues etc.

Why save money?

Most of us are earning good amount of money and many think why not spend it all and have fun? Why bother saving any of it as we are confident that we can keep earning in the foreseeable future? Short answer is to be financially secure. For life.

There are needs that require far more amount of money than our monthly salary. You need to pay 2-3 lakhs now a days to get your kid admitted into a good school and there are so many such requirements. True there are banks eager to offer loan for everything but they would expect you to pay back large interest and EMI would drastically reduce amount available to fulfill rest of your needs. 

What do you do if an accident puts you on bed for few months or a recession makes you loose your job and you fail to find another one for a few months? Would you have more peace of mind when you have enough savings to sustain for a few months or when you have nothing?

Everybody is going to become too tired of job some day and would retire. How would he survive if he has no savings? We Indians count on kids too help us out post retirement. I would be lucky if my kid earns enough and is willing to help me out. So am I going to count on my luck? No. I would rather plan, save and invest.

So it's very important that we must save a large amount on money during your productive years so that it would support us during bad time or post retirement. I would encourage you to read following articles:

I Invest, So That I Live Like a Man…Not a Donkey, Dog or Monkey, The Value of Saving and Investing Money

Inflation

We keep hearing about high inflation, CPI, WPI and all that jazz every now and then, but should we really care? Yes because inflation is far more than just a concept as it depicts that purchasing power of money decreasing over time.

As I remember during my childhood, monthly groceries used to cost hardly Rs 1000/- for the family of 4. However now just for the family of 2, even Rs 2000/- not enough just for weekly grocery. The 1 BHK that I rented in 2006 when I came to Bangalore for Rs 5000/- now costs Rs 10000/-. That is 100% growth in just 7 years which is roughly 10% inflation annually.  Prices of groceries, fuel, medicines etc have increased too.

That humble Rs 100/- note used to be far more valuable for my father when he was young. You would call me foolish if I tell you to put  Rs 10000/- in a piggy bank  for retirement because after 30 years, it would hardly be equivalent to about Rs 800/- assuming 8% inflation.

Hence for financial security, just savings are not enough. You need to ensure that you invest it wisely and get more returns than inflation. Inflation has been in double digits in last a few years and it would be safe to assume long term inflation of about 8-9%. Hence if your FD interest is 9%, or ~6.3% after accounting for income tax assuming highest tax bracket, the reality is that value of your savings is decreasing with time. 

Compounding

Hopefully we now agree that we need to save & invest. The next questions comes into mind is when is the right time to start? Most of us still have too many years to retire so why bother now?

Let's take an example. My friend 'A' starts investing Rs 5000/- every month in a good MF through SIP soon after joining his job when he was 22 years old. He wants to retire at 60 and guess how  much he would have assuming 12% return? Rs 3.66 crore for the investments of about Rs 23 Lakh.

What if he decides to start when he is 40 years old and invests Rs 25000/- every month? Rs 2.16 crore for investment of about Rs 60 Lakh.

What if he starts when he is 50 and invests Rs 100000/- every month? Rs 2.1 crore for investment of about Rs 1.2 crore.

So what is going on here? How come humble Rs 5000/- investment per month over 38 years beats Rs 1 Lakh per month by more than 70%? Let's see what happens in the first scenario. After starting at 22 with Rs 5000/-, when 'A' turns 40 years old, he has already accumulated about Rs 33 Lakh. Hence though this year he invests only Rs 60000, the interest that he gets is whopping Rs 4 Lakh. When he turns 50, his accumulated wealth is Rs 1.1 crore on which he earns interest of Rs 13.2 lakh. That's the magic of compounding my friends.

The simple message is start saving & investing and start as early as possible. Time is running out fast.

Financial planning

Is saving certain amount every month enough? No. That's certainly most important part of financial planning but there is more:

• Life insurance: when you have dependents , it's critical that you have some term insurance with enough sum assured in case something happens to you.
• Health insurance: health insurance too is equally critical as some sudden medical emergency might cripple your finances. Health insurance is actually wealth insurance.
• Emergency funds: you must keep enough money to sustain for 3-6 months in non-risky avenue  like savings account, FD or debt fund for some unforeseen emergency situation like job loss
• Planning for goals: you must have a plan in place for goals like retirement, kids education, buying a house etc
• Estate planning: having a will is really important to ensure that your heirs are not left in legal tangle if something unfortunate happens to you

More on financial planning soon.

Investment avenues

Debt versus Equity

Most of us are generally familiar with debt investment options that include bank accounts, FDs, RDs etc. where rate of interest is fixed and guaranteed. These options are less risky but return too is low.

Equity mean ownership. When you buy shares of some company, you become owner of it and you get proportionate claim on assets and profits. Your investment does well only if company does well and stock market acknowledges it. There is basically no guarantee regarding interest or return. In equity risk is far higher but so are returns.  

I can't stop stressing on the importance of equity and equity investments are critical to beat inflation in the longer term.

What are the different options available for saving & investing money:

1. Bank accounts, FD, RD, NSC, Post office deposits: saving account is good options for keeping money for day to day expenses or emergency funds. However you get hardly 4% interest per year. FD/RD/NSC returns are slightly more but after accounting for tax, they general don't beat inflation.
2. PF, PPF, Tax free bonds: These are promising instruments for long term requirements like retirement planning. Returns are tax free and they generally beat inflation. You can get some tax breaks too.

3. Traditional insurance policies and ULIPs: As I mentioned in my previous articles, these are bad investments and must be avoided at all costs.  More on these in my previous article
4. Real estate: is very popular choices among Indians. Home is basic requirement and generally own house is better than rented one. People however choose to speculate and in the hope for getting rich quick, they end up investing in multiple of them without realizing that not many of them give multibagger returns . Many people prefer to invest in land/plot and commercial properties like office or shops. Real estate is generally good investment avenue but it's highly risky, comparatively illiquid and requires a lot of care to get it right. 
5. Gold: is another very popular choice among Indians. Few years back it gave better returns than equity but this year it didn't perform as good. People believe it's value will always increase in long term but some also say it's a bubble. Gold is again a high risk investment and as per most experts, one should not investment more than 10% of his investments in gold.
6. Shares & trading: These are a very risky and bad options for general public. I see that most people just speculate in share market and do rackless & mindless trading. They seem to make some money during good time but are crushed during bad times. These could be as harmful as buying lotteries and may people end up loosing a lot of money (I am telling this with first hand experience :P). So in short these are very risky with high returns and requires very specialized skills. Hence they should be avoided by most people.  
7. Equity Mutual funds: Mutual funds manage pool of money from multiple people by investing it in shares by dedicated professionals. They are called fund managers and many of them have specialized degree and number of years of experience in share market. It's much easy to invest in these and they are low cost and tax efficient (no tax on if invested for more than one year)..  These are risky with high returns & are critical to beat inflation. Recommended way is to invest regularly in them through monthly systematic investment plans (SIPs).  More details on MFs in my previous article
8. Debt mutual funds: Debt mutual funds invest in corporate deposits which are risker than bank FDs. But again these are managed by professionals hence these are less riskier than corporate deposits. These are also low risk and low (and not guaranteed) return instruments and they hardly beat inflation. These are more tax efficient than FDs (income tax rate applicable is only 10% or 20% with indexation if held for more than one year v/s 30% in case of FDs assuming highest tax bracket). These are good for emergency funds and other similar debt/safe investment requirements.

I hope this article provides a good overview of financial landscape. Please let me know your thoughts, feedback and comments. Also if you liked it, please do share it on facebook/twitter/linked-in and email it to your friends & mail groups.

Further reading:

• The Equity Imperative: by not investing in equities for the long term, too many Indians are setting themselves up for old age poverty
• Time is Everything: the only reliable way of growing your savings at a rate faster than that of inflation is to invest it into equity or equity based investments

Disclaimers and disclosures:

The views shared here are based on my own knowledge and research. Whatever advise I am offering here is best based on my own knowledge & abilities. I would like to reiterate that equity investments are risky and there are no guarantees. However avoiding equity completely is riskier. The risk associated with them can be managed and that's what I am trying to put it across in simplest possible terms. More on this here.

I am not going to get any commissions from any mutual fund etc in case you act on my advice and I don't take any legal responsibility for any losses that you might incur (at the same time not asking you to share your gains with me :P).