Name: Noorul Hasan (with sister)
Age: 31 Years
Monthly income: Rs 44,000 (post tax)
Financial dependants: Five
Single vs Annual Premium
Hasan wants to buy an insurance cover of Rs 30 lakh. He is contemplating a single premium term insurance policy.
|A cover of Rs 30 lakh for 30 years will cost him:|
|Rs 1.43 lakh||Rs 9,700 per year|
|Per year cost: Rs 4,766||Total cost: Rs 2.9 lakh|
|Hasan is obviously attracted by the low cost of the single premium policy. But in reality the annual premium option works out to be more cost-effective. Here’s how:|
|Invest and pay: Instead of paying a lump sum of Rs 1.43 lakh, Hasan should pay the first premium of the annual option and put the balance Rs 1.33 lakh in a fixed-income option. Even at 8% per annum, this investment would earn enough to pay for his insurance premium for the rest of its term. What’s more, he would still have the Rs 1.33 lakh.|
Are you an investor or a fund manager?
Hasan wants to buy his own stocks, but he may not have the necessary skills. One shouldn’t dabble in stocks if one is prompted by these four reasons:
• You think you can beat the best money managers. If you can, you are obviously in the wrong profession.
• You want more control over your investments and are uncomfortable with letting someone else decide for you.
• You think mutual funds are for people who aren’t smart enough to pick stocks on their own.
• You want to earn profits by intra-day buying and selling, something that is not possible if you invest in mutual funds.
Iris suggests that Hasan steer clear of investing in shares directly and should instead channelise the investment through mutual funds. Hasan should sell his equity holdings as soon as he is mentally prepared to and then stick to mutual funds. That might mean an excruciatingly long wait because Hasan intends to retain the small-cap stocks and other losers in his equity portfolio till they bounce back to break-even levels.
Even his mutual fund portfolio is not without problems. Hasan has over a dozen funds, some of them investing in and holding the same stocks. It is always advisable to keep your investing strategy as simple as possible. Iris suggests that he should prune his mutual fund portfolio to a more manageable four or five schemes and gradually exit the others.
As for Hasan’s asset allocation, it is very close to being ideal. Given his age and risk appetite, a 60% exposure to equities is preferable. The equity portion is currently down to about 50%, but this will go up once the markets rebound to rational levels. As such, there is no need to rebalance the investment portfolio right now.
What he needs to do, however, is tweak his investment strategy and raise the monthly investment in mutual funds through the SIP route. However, he may not be able to save too much because after marriage his household expenses are bound to rise. But so will his investible surplus, because by next month he would have shifted into his own flat, thus saving Rs 9,000 on rent.
One major hiccup in Hasan’s financial plan is the Rs 20 lakh home loan he took last year, for which he is paying Rs 20,640 as EMI. Over the term of the loan, his interest outgo will be to the tune of Rs 29.5 lakh. That’s more than the cost of the flat itself! As we have said this several times in the past, just as being a long-term investor creates wealth, being a long-term borrower destroys it. Even at 7%, a 20-year loan is a financial pothole. At 12%, it is a gaping chasm.
Hasan should try and prepay the home loan as soon as possible. The savings on rent will come in handy here and he should use them to retire his long-term debt. The proceeds from the NSCs maturing in the next couple of years should be used for this purpose. Hasan agrees that the loan is a big burden on his finances. “The interest rate is very high. I plan to prepay at least 10% of the outstanding loan every year,” he says.
As things stand, Hasan’s present income may not be able to help him meet his financial goals. But as his income goes up in the coming years, he may be able to achieve this target. Meanwhile, he should consider scaling down some of his financial goals or postponing his retirement by at least a couple of years.
When it comes to investing in stocks, many (and perhaps too many) choices exist. Besides the thousands of stocks you can select from, you can hire a mutual fund manager or a stock broker to pick for you.
If you are busy and suffer no delusions about your expertise, you'll love the best equity mutual funds. Investing in stocks via mutual funds can be as simple as dialling a phone number or logging on to the Website of a fund house.
As with all investments, mutual funds have drawbacks. The issue of control is a problem for some investors. If you're a controlaholic, turning over your money to someone else, who decides when and in what to invest it, may unnerve you.
However, you need to be more concerned about the potential blunders that you may make investing in individual stocks of your own choosing or, even worse, those pitched to you by a broker.
Mutual funds offer you three basic advantages.
• Diversification: With Rs 5,000, you won't be able to buy too many stocks. A mutual fund spreads that money across several sectors.
• Expertise: The best minds in the industry work long hours to make your money grow.
• Convenience: You can buy stocks and other assets with ease. Brokers and investment advisers enthusiastically encourage retail investors to do their own stock picking. However, the vast majority of people are better off not picking their own stocks.
Several popular investing books try to convince investors that they can do a better job than the professionals at picking their own stocks. Amateur investors, however, need to devote a lot of time to becoming proficient at stock selection. Many professional investors work 80 hours a week, but it's unlikely that you are willing to spend that much time on it. Don't let those do-it-yourself stock picking books lead you astray.
(Excerpted from Investing for Dummies)