Ignoring the details

Name	Binesh (left) and Bijal Patel
Age	36 and 34 years
Monthly income	RS 49,917 (post tax)
Financial dependant	One (daughter)
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As a race, Indians are known to be pricesensitive. We want our money’s worth irrespective of what we are buying: a bunch of coriander leaves or a leather settee. So why do we forget that investments also come with a price tag?

For most, the only consideration for investing in a financial product is its report card. If the returns have been high, they want a bit of the money-maker in their portfolios. Who cares about how much it comes for.

Thirty-six-year-old Binesh Patel, an executive in a pharmaceutical company, is no different. Consider his equity exposure: no stocks (which gets a thumbs-up from us), three mutual funds (bad choices, but at least he hasn’t binged on them) and six Ulips. It is this last item that betrays Patel’s disregard for the cost of investment. The annual premium for his Ulips is Rs 1.01 lakh. This money provides Binesh an insurance cover of Rs 8.6 lakh and his wife Bijal, 34, a cover of Rs 1.5 lakh.

Binesh is aware that this is an expensive deal. He has bought a term plan for himself that offers a cover of Rs 10 lakh at the cost of about Rs 11,000 annually. So why did he go on a Ulip overdrive? “It is a three-in-one product. Ulips offer insurance, equity exposure and are a tax-saving option,” says Binesh.

This explanation must be the well-rehearsed sales pitch used by the insurance agent who sold these products to Binesh. But as usual, this is only half the truth. There are independent financial products for each of the three functions of Ulips. Hence, one should find out whether there are better alternatives for the same investment purpose.

For instance, Binesh could have used mutual funds for equity exposure. They have a distinct advantage over Ulips—you can stop investing in or get out of a fund if it is not performing well, without incurring the loss that comes from exiting a Ulip prematurely.

The most important shortcoming of Ulips is their high cost in the initial years. For most of Binesh’s Ulips, only 40-60% of the premium has been actually invested in the past two years. Add to this the policy administration charges ranging from Rs 70-90 a month. If a Ulip’s premium is Rs 10,000 a year, this amounts to 8.5-10% of the cost. And we still haven’t included the asset management fees of Ulips. It is true that some Ulips are cheaper than mutual funds in the long run, but this depends on the amount of investment and the Ulip’s charges.

 Iris believes that Binesh has chosen very expensive Ulips. Hence, it is best to stop paying the premiums. If Binesh is unable to bear the loss of about Rs 2 lakh (he bought the Ulips two years ago), he should pay the premium for the minimum term and then divert the money to mutual funds.

This switch to funds will also increase the couple’s monthly surplus. Binesh’s net monthly income is Rs 49,917, of which Rs 9,167 comes from his stint as a visiting lecturer. The couple spends about Rs 17,000—a reasonable 34% of their monthly income. After deducting the average insurance premium of about Rs 9,800, SIPs in three mutual funds totalling Rs 2,000 and another Rs 2,000 committed to a recurring deposit, the monthly surplus amounts to Rs 19,917.

Amar Pandit, Financial planner TRAPS TO AVOID Based on my interaction with people, I have zeroed in on four of the most common errors committed by stock investors. Make sure you do not make these mistakes. Overwhelmed by news: Just because the Sensex delivered about 40% returns during 2003-7, it does not mean that the future returns will be similar. Individual stocks can go down by as high as 90-95% in a short period of time. Some investors blindly follow every piece of investment wisdom available in the media. Remember, stock investing is not a game or a contest and requires a deep understanding of the market dynamics. Ensure that there is no mismatch between your expectations and what the markets deliver. Borrowing to invest: The lure of tantalising returns makes many people borrow to invest in IPOs or exotic derivatives. This is a sin. You will be vulnerable to a loss that is more than your investment. Trying to time the markets: Whether it’s on the basis of technical analysis or fundamental analysis, or a combination of both, getting your market entry and exit right is very difficult to achieve. Market ups and downs happen in very short spurts of time—a movement of 35-40% has been witnessed in just one week. It is impossible for you to outguess the market all the time. Swayed by extreme emotions: Before 2008, investors had become overconfident of their abilities because the market was booming. Now the sentiment is very pessimistic. Do not allow market changes to rush you into a decision that will nullify all the good work done previously

Iris suggests that Binesh and Bijal buy a term plan of Rs 40 lakh and Rs 10 lakh, respectively. The total annual premium will be about Rs 18,000. After including this premium in the couple’s cash flow and deducting the premiums of the Ulips, the monthly surplus will increase to about Rs 33,293.

Armed with information Here are some facts that will save you from being duped by insurance or mutual fund agents: Guarantee of returns: No equity-linked product can guarantee returns. It depends on how the market performs. Cost of investment: Always consider the annual administration charges of the fund or Ulip as these can comprise a significant percentage of the investment. Commissions: Higher commissions are a common incentive for selling the wrong product. Always ask the agents about the commission that a fund or an insurance plan offers them. Investment time: Do not sign up for a mutual fund or a Ulip without finding out about the minimum investment period. Past performance: It is not necessary that a fund or Ulip that had performed well in the past will do so again. Compare returns over long periods and different time frames. But this should not be sole criterion for investment. Iris believes that Binesh has chosen very expensive Ulips. Hence, it is best to stop paying the premiums. If Binesh is unable to bear the loss of about Rs 2 lakh (he bought the Ulips two years ago), he should pay the premium for the minimum term and then divert the money to mutual fund

Where should the couple invest this money? Equities, of course. The couple does not have a meaty portfolio: the total investment in debt and equities is only about Rs 1.4 lakh. Binesh attributes this to a late entry in equities.

Hence, to accelerate the growth of his finances, the emphasis must be on equities.

This might seem contradictory to the recommended asset allocation for the couple (see facing page), which includes 45% debt instruments, but this is not so. Binesh must build towards this asset allocation gradually and the first priority is to fire up his equity portfolio.

To do this, the path chosen by Binesh, SIPs in mutual funds, is correct. He is rightly averse to stocks as he does not have the knowledge or the time to monitor a robust stock collection. The bad news is that Binesh’s choice of funds is appalling. He does not have a single large-cap, equity diversified fund.

Instead, he has chosen a mid-cap fund, Reliance Growth, which is more risky. Then there is a sector fund, Reliance Power, which adds an unnecessary degree of diversification to his elementary portfolio. The Fidelity Indian Special Situation fund, which invests in niche stocks, is also too sophisticated for Binesh.

Iris suggests that he exit these funds and distribute the investments in DSP Black Rock 100, HDFC Top 200 and HDFC Equity. If he does so, Binesh can retain Reliance Growth to add some zing to his portfolio.

For the debt component, Binesh can invest in debt funds and fix deposits. We suggest that he discontinue the recurring deposit as its income is taxable.

The couple plans to buy a house worth about Rs 21 lakh in the next three years. A part of this amount will be financed by a home loan. Binesh and Bijal should easily be able to accommodate the EMI in their monthly budget.

Unfortunately, the same cannot be said for the other goals. The monthly investment required for fulfilling them is a steep Rs 92,630. Even after following our strategy, the couple will fall short of the amount by Rs 57,337. Therefore, downsizing some goals is a must.

Exploring other options Do not buy Ulips just because they combine investment and insurance, and help save tax. In some of these functions, other instruments score over Ulips. Here’s a comparison of Ulips with the other options
INVESTMENT ULIPS Cumulative returns from a Ulip» Rs 16,01,696 Total cost of investment» Rs 74,740 (not including policy administration and fund management charges). Mutual Fund Cumulative returns from a mutual fund» Rs 17,26,382 Total cost of investment» Rs 25,250 - Some Ulips are cheaper than mutual funds after a specific period. - Choose Ulips that have annual administration charges lower than 1% of the AUM.	Investment amount» Rs 1,01,000 Annual returns» 10% Tenure» 10 years
INSURANCE ULIPS Cover provided by Ulips to Patel» Rs 17 lakh (approx) Term Plan Cover that would’ve been provided by a term plan» Rs 2.7 crore (approx) Premium of a term plan that provides a cover of Rs 17 lakh» Rs 6,000 (approx) Saving on premiums» Rs 1,01,000-Rs 6,000 = Rs 95,000 - If you do not understand Ulips, stick to a combination of term plans and mutual funds for a cheap insurance and equity exposure.	Annual premium» Rs 1,01,000 Tenure» 20 years
SAVING TAX - Clearly, when the market is booming, both Ulips and ELSS score over debt instruments for saving tax. - Ideally, you should choose the taxsaving option as per the overall asset allocation of your portfolio.	Tax-saving instrument return ULIP: Variable ELSS: Variable PPF: 8% Five–year FD: 8.5% NSC: 8%
For investment, we have assumed that the cost of the Ulip is 30%, 20% and 10% in the first three years, respectively, and 2% in the following years. The expense ratio of the ELSS is assumed to be 2.5%, and for simplicity, has been calculated on the investment, instead of on the NAV.

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