Wednesday, November 28, 2012

Conversation with an Insurance Agent

Phone sings...

"Hello Sir, I am ... an Insurance agent. We met at XYZ's marriage"

"Yeah, I remember. How are you?"

"Fine Sir. I would like to meet you personally to discuss on an Insurance Plan"

"Sorry, I am busy these days"

"It will not take more than 15 minutes. And no commitments. You can simply say no, no questions will be asked"

"OK, come on tomorrow"

Next day.

"Good morning, Sir. I am Mr. Agent"

"Hi, I am bit busy, so hope we can wind up soon."

"Sure, here is the plan I want to discuss. This is an endowment plan, Endowment plan is a saving and insurance at the same time"

"Wait, I am more interested in Term Insurance"

"Term insurances are not profitable sir. You will get the sum assured only if you die. Who wants money after dying"

"That is insurance for. In endowment policy also part of my payment is utilized for insurance, right?"

"That is true. But still you will get sum assured + bonus when the policy matures. In term insurance, it is a pity you will not be rewarded for surviving the insurance term"

 "OK, in your endowment plan, tell me how much coverage will I get for Rs 5,000 premium per month"

"For Rs 5,000 and for a 20 years you will get Rs 12 Lakhs coverage"

"12 Lakhs! That is seldom sufficient for my family to survive in my absence. So to get a Rs 50 Lakhs coverage, I need to pay my entire salary as premium? Do you know that I can purchase a online term insurance coverage of 50 Lakhs just for Rs 9,000 annually."

"But online term insurances are sold only by private companies. You cannot trust on them, sir. What if they don't pay after your death?"

"Some of them have above 95% claim settlement rate."

"But there is no survival bonus"

"I am paying same way for my vehicle insurance and medical insurance. No benefits on maturity. Then why not for Life insurance?"

"That is true. But you see this endowment plan. It is very attractive."

"OK, go ahead"

"This plan is an insurance and investment at the same time. In this plan, if you pay Rs 5,000 per month for a 20 year period, you will get 12 Lakhs coverage.In addition to that if you survive these 20 years, the company will pay you the survival bonus acquired so far. For 5,000 premium it will come around 10 Lakhs. For the rest of your life, you will get 5.5% of the sum assured  monthly. This will continue until you turns 100. If you die before that age, the sum assured will be handed over to your dependents. So, this plan is an insurance, retirement plan and investment"

"It seems too complicated. So, you are saying that I will get 10 Lakhs after 20 years?"

"Well, sir. It is not guaranteed. Our company usually pays that much"

"What do you meant by usually?"

"Sir, our company pays 5-6% as bonus nowadays"

"But there is no guarantee it will continue for next 20 years?"

"No sir. But every one knows that traditional insurance policies are safe"

"How can you say it is safe, if there is no guarantee of returns?"

"Sir, all these people are purchasing insurance policies thinking those are safe investment. Are all these people fools?"

"Probably they are. If there is no guaranteed returns, I prefer Mutual Funds."

"But in Mutual Funds, you can even lose your investment"

"Then there are other investment tools where return is guaranteed. "

"But those are not combined investment, insurance and retirement plan"

"See, if I pay Rs 5,000 per month for next 20 years in a PPF, I will get Rs 31 Lakhs at 8.8% interest rate, compared to your 10 Lakhs and 12 Lakhs later. And it is fully guaranteed. PPF has all tax benefits as insurance has. Only problem is PPF is for 15 years, not for 20 years. Still it gives you better returns for 15 years"

"But you will not get insurance coverage"

"Well, if I spend Rs 1000 per month for a term insurance, I will get coverage of nearly Rs 50 Lakhs. Then if I invest the rest Rs 4,000 in PPF, I will get more than Rs 25 Lakhs. Still it is much more profitable than your brilliant endowment plan."

"You calculations seem correct, however, do you think lakhs of people, who are purchasing this policy, don't know how to calculate?"

"I think so."

"Sir, it is very hard to sell insurance policies these days. People are getting more and more knowledgeable. Good bye, I need to find some one ignorant today to sell my insurance"

"Good Luck"

Friday, November 23, 2012

What did I Learn at School?

All financial experts will agree on one thing - our kids at school are not taught even the basics of personal financial management. We teach them how to make money but do not teach them how to handle it. I am not sure how are the things now, but back in my days, the teachers thought even speaking about money will spoil the students.

When I look back to my school days, I cannot say I was taught nothing on money. I can remember two lessons I learnt at school about money, other than calculating simple interest and compound interest. I will narrate those two things here.

At my third standard, there was one chapter on Life Insurance. It was written as a dialog between a Father and his son. The son is gloomy to go to school as his best friend, Ramesh, is discontinuing his education. The reason? Ramesh's father, who was the sole bread winner of the family, passed away recently.

Then father consoles his son saying Ramesh can continue his studies, because his father had an insurance coverage. Then father explains to his son about the Life Insurance and how it works. At the end of the story, the kid becomes happy and goes to school.

We need to appreciate the people who included such a topic for such small kids. It was, of course, better than nothing. However, the second lesson I was taught at school is a horrible one, and  I had to struggle hard for years to unlearn it.

It was a poem on Money. It is written with a good intention, to educate students against greed. Well, it goes like this. If you get Rs 10, you will want Rs 100. If you get Rs 100, you will wish for Rs 1000. If you get Rs 1000, you will want Rs 10,000. The greed of human beings will never end. It was a Malayalam poem, and please excuse my poor translation. (They say what's lost in translation is poetry).

What's wrong here? Of course, we need to educate our children against greed. Greed and consumerism can easily spoil one's personal finance. But, if you have Rs 10, what's wrong if you try to make it Rs 100? Ideally, every one should try this. That's why we are investing our savings, to make it grow. We work for money, and if you invest the money wisely, the money can work for you, and grow by itself.

The purpose of education is to produce good citizens of the nation, not a few saints. In that case, we cannot accept including such pessimistic poems in school curriculum.

It was nearly three decades ago, and what worries me is that our outlook hasn't changed much. Recently I read an article that Central Government is planning to make finance education mandatory for school kids. A very welcome move. But not all people are happy, and some people commented that finance education will ruin the kids. Another one commented that we should teach our students moral values instead of personal finance. The moment we hear money, we assume that it is against values. It is disappointing to see that some people still believe money is such a bad thing.

I wish some one taught me the basics of personal finance management in the early years of my career. I wish some one told me how bad it is using credit cards, the importance of keeping track of expenses, and the importance of saving and investing. Do we want our kids also grow up as ignorant as we were? I believe it is high time we should include personal finance in school curriculum. Managing money is as important as earning it.

Thursday, November 15, 2012

Is it Possible to Buy a Car without Car Loan?

In my childhood if some one got a car, that means he is rich. Nowadays every household got one or two cars, is it every one getting rich or are the cars becoming cheap?

If I say that a major percentage of the cars running on roads are on car loans, it will not be an exaggeration. Is it possible to purchase a car without a car loan? If I ask this question to a group, I will get different answers like, "Yes, only if I won a lottery" or "I am not rich enough to buy a car without car loan" or "It is not worth buying a car by paying lump sum amount."

There are people who's monthly salary is near to half lakhs, and still believe buying a car without loan is impossible. Well, in this post I want to analyze one scenario to find out it is mathematically possible to buy a car minus a loan without any additional burden.

This is the scenario. You want to buy a new car worth Rs 5 Lakhs. Usually the banks will finance only 80% of the car value. So, you will get Rs 4 Lakhs as loan. If you go for loan from State Bank of India, who claims providing loans with most economical interest rates, you will have to pay Rs 1699 as EMI per One Lakh for seven years at 11.25% interest rate. So, for Four Lakhs you have to pay Rs 6796.

Then what will you do for the Rs One Lakh down payment? I have seen people going for other kind of loans like Chitties or Gold Loans. This can make things worse. For this example, I am assuming that you have Rs One Lakh with you.

But, I told you I will explain how to buy a car without the loan. Imagine, you have started a recurring deposit with any bank for the same amount you pay as EMI, that is Rs 6796. Well, most banks will not accept this amount as recurring deposit, so let's round it to Rs 6800. Keep on  investing this for next 4.5 years, exactly 55 months (again rounded). Just think you are already purchased the car and paying the loan. Considering 8.5% interest rates compounding quarterly, at the end of 55 months you will have Rs 4,57,919.62 with you.

Now, invest the Rs One Lakh, which you have for the down payment, in a Fixed Deposti for 55 months at the same rate (8.5%). That One Lakh becomes Rs 1,47,035.19 after 55 months.

So, after 55 months, you will have a total of Rs 6,04,954.81 with you. Assume the price of your new car increases by 20% by this 4.5 years. So, it will worth you Rs 6,00,000. So, you have enough frunds to purchase it comfortably.

So how much you paid for this? Rs 1,00,000 + 55 x 6800 = Rs 4,74,000.

If you have gone for the loan, how much you should have been paid? 1,00,000 + (6796 x 12 x 7) = Rs 6,70,864. That means you should have paid an additional amount of Rs 1,96,864. So you have saved nearly Rs 2 Lakhs. Not a small amount, eh?

I am not considering the petrol expenses and other maintenance expenses you saved for the 4.5 years, because as you have no car now, you are paying for public transportation.

Also, I am not considering the Income Tax acquired on the interest received. In this example, you receive Rs 130954.81 as interest (including both on recurring deposit and fixed deposit). If you are in 10% IT slab, you will have to pay nearly Rs 13,000 as income tax. In that case, you will need to pay two more installment for your recurring deposit. One way to avoid this income tax is go for a mutual fund SIP, rather than recurring deposit. This can provide more returns, and you can buy the car sooner. However, understand the risk associated with it.

It is not only about money. For the 4.5 years you are paying same money to RD that you would have been paying for EMI. But is there any difference? Yes, you are still not in a debt trap. You have freedom to stop it at any time before you purchase the car. But if you stop your loan EMI, well, the bank knows how to deal with it. So, it is all about your freedom.

When you are not in debt trap, you are more armed to face any unexpected financial emergencies, like loss of job or medical emergencies. OK, I don't want to be so much pessimistic, I will say a positive benefit. At the end of 4 years, you see one opportunity to make a big profit by investing 5 Lakhs. What you can do? Postpone your car purchase and invest there. On the other hand if you are in loan trap, you will have to watch the opportunity vanishing.

So you saved lot of money, you have financial freedom, still there is one big drawback to this method. You have to wait for 4.5 years to buy a car. Your wife is not going to accept this. What if you have planned this 4.5 years ago, and started an investment from then? You would have purchased your dream car. We cannot go back in time and start a regular investment in the past, however, we can learn from this. We can start planning now for our future financial needs. If you think about your retirement after 20 years, it will be too late. Retirement, Children's education, Children's marriage - let's list all our future financial needs and start planning.

Are you thinking all these too complicated? Then the easiest and simple thing is to just check you can afford the EMI payment. If yes, purchase the car in loan. If not, wait for your next salary hike. After all, most of people are doing it, no? As I always say it is your money. You can spend whatever way you want.

Image Courtesy: Wikimedia Commons

Friday, November 9, 2012

Stop Drinking, Save Tax!

A few years ago, me with one or two my friends went to a spiritual session by a well known Yoga Guru. During the session the Guru said "Alcohol is the major reason behind poverty". That makes sense, because I have seen many daily wagers spending most of their earning in liquor shops after a full day's work. This leads to poverty in their family.

Hearing this, one of my friends commented. "In that case, Government should make the liquor available free of cost. That way we can eradicate poverty". Another interesting aspect.

Recently I happen to see a liquor bill. I am not saying that I saw it from my friend, neither I am disclosing where I have seen it. What interested me is the liquor costs Rs 142 only.  The Government levies a sales tax of 100%. So, it becomes 284. The story is not over, an education cess of Rs 16 is also charged. So totally a drinker has to pay Rs 300. Just for the contents worth 142.

Let alone Goverment making Liquor free of cost, it is charging more than 100% of tax. And they say it is the major cause of poverty. Isn't the Government fueling poverty here?

I am really irritated when I see advertisements by Government Public Relations department, against alcohol. Why do they spend money to educate people to avoid liquor, when they can simply ban it? They say if liquor is banned, the families of the people who work in alcohol industry will be starved. Well, good argument. What happens if all the people take these advertisements in the right sense, and stop drinking? Then also the liquors workers will go jobless. So, the Goverment is sure not all people are going to stop drinking because of these advertisements. Probably they can save one or two from drinking. Does it worth? Spending so much money to save only a few people? I want the Government to stop this nonsense.

All the facts I said here apply to cigarettes and other tobacco products as well.  Even they are harmful to your family and neighbors. They are more addictive.This article in Economic Times says that the cost of smoking for 30 years is Rs 52 Lakhs (Rs 5.2 million).

We do different things to save tax. Now we know that for alcohol and tobacco, they charge 100% tax. Then why don't we stop drinking and smoking and save tax?


Image Courtesy: Wikimedia Commons

Saturday, November 3, 2012

What Stops you from investing?

I was reading the news that a college out from Kerala is offered a job in Google with annual salary Rs Seventy Lakhs (Rs 7,000,000). The immediate thought that came to my mind is what he is going to do with this much money.  His salary is a public figure now, I am wondering how he will deal with numerous requests for alms. He cannot say he has no money, no one will believe. Also, I am feeling happy our Government will get a big amount as Income Tax from him.

Some people may be thinking same thing about the IT Professionals (Not lucky enough to draw 7 million salary, but still their annual salary goes to a few lakhs). What these young guys are doing with this much money? But what the questioners don't know is when people get more money, the expenses also go up. They travel in big cars, stay in big houses, they get best treatments, but at the end of the month salary account of most of the people are in same way, no or less money. 

I read somewhere that average Americans save 3-5% of their monthly salary, whereas Indians Save 25-30% of their income. As per the statistics, Indians doing better here. I have still one or two friends, who are very reluctant to investments. I asked then during casual chats, what stops them from investing, despite their high profile salaries. I got many reasons, I am listing top 5 reasons I got.

Top n list was best way to get reader attention. Like top 10 mutual funds to invest, Top 10 stocks to buy, Top 10 investment habits etc. But nowadays it is overused by bloggers and authors, I usually skip such articles. I am not posting this top-5-reasons-not-to-invest to get more reader attention, but I want to counter some of the arguments against not investing. Some of the below were my excuses for not investing for a long time. As I told you, these are from my personal experience, not from any scientific surveys.

Here you go.

1. It is too complicated.

Some people think investment tools are too complicated. They have a point there. Some of the investment tools are overly complicated and opaque. But, the good news is there are simple and transparent investment tools as well. A bank recurring deposit, for example, is very simple. You pay fixed amount monthly and you will get a lump sum amount at the end of fixed term. If you are not mathematics savvy, you may think that the underlying compound interest calculation is complex. But who cares? You know what you are going to get at the end.

2. No leftovers for investment

"The expenses are so high that at the end of the month nothing left for investment. I will start investment when I get next salary hike." This is a serious problem. But who told you  to invest at the end of the month? Why don't you do it at the begining of the month? Immediately after you recieve your salary? If you do so, you will have to tighten your belts at the end of the month. Yes, do it, and it will make you stronger financially. Needless to say, don't use your credit cards at the end of the month, that will make things worser.

If you were rich enough to have some balance in your salary account at the end of the month, you can manage without the finanace management. Because, each month some amount is accumulated in your salary account. This amount will help you in case of a financial crisis. But what if no amount left at the end of the month? That definitely means you need to give immediate attention to your finances. You need to think about investment more than any one else.

3. Inflation may eat up my investment

Again, this is a valid point. If you have Rs 100 now with you, you can purchase goods or services of worth Rs 100. But if you save it for one year and use same amount to buy goods next year, you will not able to purchase goods worth today's Rs 100. Because, the prices of everything is going up year by year. This is the effect of inflation. So, don't you think it is better to spend now every penny you have?

When you invest it should be in a way that it should grow to beat inflation. For example, if your Rs 100 grows to 110 by one year (10% return), and inflation rate is 10%, you can still buy goods, which worth Rs 100 today, next year. If your investment gives 12% return, you can beat inflation. So, if inflation is your concern, you should invest in schemes, which offer high returns.

There is another side of this story. The debt based investment schemes, like bank recurring deposit and Public Provident Funds, usually give return below the inflation rate. For example, these schemes give 7-8% return, and for the last a few years inflation is near 10%. So, you will need to take risk, and invest in equity based investment tools, like Stocks or Mutual Funds. These usually give returns above inflation rate in long term.

4. I am not sure what happens in long term

This is one of the nasty excuses. "15 years ago, we were not heard of mobile phones or LCD TVs, except in science fictions. So, who can predict what happens in next 15 years? There may be drastic changes in future. What if those changes affect my investment? For example, what if the Government decides to catch all investments of citizens? or Who knows in what condition I am in after 15 years? So, I think it is better not to invest."

I have no comments on this. If some one believes in this, don't invest. That's all.

5. I am ignorant

I believe this is most common reason for not investing. People are not aware of the power of investment. I will tell you one scenario, which is narrated in an advertisement of a retirement plan.

If a person invests Rs 500 each month from his 18th age, and the investment gives a return of 12%, by the age of 65, he will get a lump sum of 1 Crore (10 million). This is the power of accumulation and power of compounding.

Well, if you are above 18 years of age, don't worry. Still if you start investment now, you will get a good amount in long term.


If you are not investing due to any of the reasons above and you are convinced by my explanations, start investing now. Or if you are still not convinced, don't invest. It is your money, I have no right to tell you what to do with it.

For others, happy investment.

Mean time, if you have any other reason for not investing, please feel free to put it in the comments.