Want to Simplify Your Financial Life? Not so Easy

There are many easy solutions to organize and simplify our financial life, but we tend to choose complexity. We often tell ourselves we want to simplify, simplify, simplify but on the flip side, we tell ourselves that the solution to an important problem has to be complex. On some level, we all understand that simplicity is the ultimate form of sophistication. It is, because of both beautiful and functional. Most of our clients get frustrate when we offer simple and plain-vanilla products on their financial planning process. They do not recognize the fact that these simple to do list things can create the greatest impact on their financial life. Perhaps, they are interested to do something thrilling that can deliver fast results. Many of us are always looking for “What is new in market” and seeking rosy products which tend to be appealed as complex and could make as fun. They are keeping very much excited to know their pro and cons; even they are not intent to invest into them. In fact, we are losing motivation is we are told that wealth creation is all about discipline. We, Indian people don’t recognize the importance of saving and investing until it gets too late and feel regret later. We do not understand that we need not do something extraordinary to win financially. We just need to follow certain basic tenets of personal finance that we endeavour to cover into this cobra post.

Keep Clean your Saving Account

Many of the self-employed, like doctors, entrepreneurs and lawyers, even well-paid salaried and professionals do let their robust money leave idle in a savings bank account, at a miserable rate 4 per cent. Perhaps they suffer from the burden of choice. When there are too many choices, we simply do not choose. We worry about making the wrong choice and living with the regret of not choosing one thing over the other. At this juncture, you can park your idle money in liquid fund until you make right choice in the investment.  Else, over the long term, the opportunity cost of letting your idle money lie in your savings account can be quite steep. With the long-term inflation rate in India at 5-6 per cent, you stand to lose 1-2 per cent to inflation every year if you stick to a 4 per cent savings account. While putting that money to work in a liquid fund, you can earn a 2-3 per cent real return over inflation. In fact, in the last ten years, despite the ups and downs of rate cycles, liquid funds have delivered a CAGR of 7.8 per cent, almost double the return on your savings account.

If you can lock on for three years, liquid funds could make more tax-efficient than savings accounts. Under Section 80 TTA of the Income Tax Act, up to Rs 10,000 in annual interest that you earn from your savings account is exempt from income tax. Though, the returns from liquid funds are taxable, while giving the indexation benefits on the gains after three years, even if your fund earns you just 7 per cent per annum, your net returns will be far higher than those from a savings account. Make it a habit to sweep your excess money into the growth option of good liquid mutual funds every month. After all, you can withdraw it anytime you need.

Set Realistic Investment Plan

The investment process starts just not with investing, but with the setting of a realistic goal. I often get queries from people who have started investing but have unrealistic goals—like wanting Rs. 6,000 a month over five years and expect to create a robust corpus at Rs. 10 lakh. They do not recognize the fact that what they are expecting unrealistic return on their portfolio as it requires more than 40% p.a., which does not exist in the real world. Though the future is uncertain and many things cannot be predicted, it’s good to have a financial plan in place about what is needed when. In any case, many goals like children’s education and retirement are predictable with a fair degree of precision. Based on these goals, you should work out how much you need to save to reach them. One good way of saving is to automate and enforce the process as much as possible. For example, all mutual funds offer the so-called Systematic Investment Plans (SIP), which is now possible a fixed sum of money can automatically be invested every month through ACH mandate. There are many advantages to get automating SIPs but the most important one is that that once begun, they enforce regular investments.

Increase your SIP

When we formulate one’s financial plan, we rely heavily on the time and regular contribution which create the magic of compounding. It is only when your returns compound at the assumed rate that your investments can get you to the goal by due date.            But your financial plan may go awry if you still stick with constant SIPs in the hope of getting to create abundant corpus by retirement. Well, you need to revise both the SIPs and your investment goal upwards to keep up with inflation, hence the need to step up your SIPs. Consider a 40-year old investor who has SIPs of  Rs 15,000 a month in large-cap equity funds. If she sticks to the same old SIPs until retirement, ignoring her pay increases as well as inflation, she will get to about Rs1.97 crore. But stepping up at 10% her SIPs by just 1,500 every year will get her to Rs 3.03 crore, a 54 per cent addition to the retirement kitty. It would be ideal to peg it to expected pay increases or at least at 10% of the existing SIP. Even your employer is skimping on your annual increment; you should still step up your SIP at least by the prevailing inflation rate.

Cleaning the portfolio

Many investors have held with cluttered portfolios due to their behavioural traits. They prone to buy funds or stocks out of sudden impulse. They fail to cut losses on their losers because that would mean admitting to mistakes. They also compound both errors by rushing to book profits on the winners, while hanging onto losers in perpetuity. Most of us know that it isn’t a good idea to own dozens of mutual funds in our portfolio; still we stick with rigid concentrated portfolio. When I look at the market for investment products today and see the kind of investment portfolios that people are just collecting, I think there’s a strong need for a self-conscious and aggressive minimalism in investment planning. The simplicity mantra is very useful here. For the ordinary, part-time investor, owning a portfolio with a long tail is even more of a challenge. With so many bets to monitor, he may have no time to weed out losers or to nurture winners. This depresses the portfolio return. While starting over cleaning your portfolio, you should have to forget your buy price for each fund and had to make decision about buying it today.  There is no other way out to get rid of it; else you will be left with a swacch, manageable portfolio.

Exit insurance-cum-saving plans

Life insurance is one of the most of us vital need but it is being mis-sold and mis-bought as insurance- cum-investment something that is both expensive and complex. Many gullible people have already stuck for a long-term traditional insurance plan with a hefty premium. I saw many investors, even my clients appear to reluctant for exiting insurance-cum-saving insurance plans. The biggest illusion among them about their insurance is that they are getting the right kind of return as they expected. Actually, we prone to think that we will pay Rs 5 lakh, we will get Rs 10 lakh and the life insurance is additional or free, so we feel it’s a good deal. But we don’t think about the percentage return of this policy, at the end, on a compound per year, and returns from traditional insurance plans don’t top 5-6 per cent even in the best of times. We do not recognize the fact how much cash we can free up just by getting rid of sub-optimal investments and can utilize the same into other growth-oriented instruments. Surrender them, even if they entail a loss. What you’ve already invested is a sunk cost and there’s no point in throwing good money after bad.

Get Term for your life

Let’s take a systematic, back-to-the-basics look at what insurance is and how it should be bought and compare this to investment. The purpose of insurance is to cover the financial aspect of risk. The risk can be of property, life, health, legal liability and of many other kinds. For instance, most of us life insurance has one purpose to replace an economic loss but it will never replace an emotional loss. Principally, insurance is a way to financially true protection for your loved ones who survive you when you are no longer around them. It should not be considered as an Investment that gives you monetary returns while you are alive. Unfortunately, our young generation has been brainwashed by insurance agents into thinking that buying term insurance is waste of money that will not get anything back. While estimating your new life cover, don’t go by simplistic thumb rules such as ‘ten times your annual income’. Instead, do calculate life cover based on your family’s living expenses, inflation, your financial goals, likely number of years for which you would like to support your dependents, outstanding loans and any other critical goals you may like to take care of.

Increase health cover amounts

With lifestyle ailments on the rise, don’t forget to top up the health cover for yourself and your family, too. Even if official inflation rates have fallen to 5 per cent, factor in a 10 per cent inflation rate on your healthcare costs while topping up. Health insurance is one financial product where skimping on costs (premium) can prove injurious to your wealth. As a rule, give a greater weight age to the quantum of sum assured and the breadth of health conditions covered when choosing a plan. Apart from this, screen the product for a low waiting period on pre-existing diseases, a wide network of hospitals where cashless treatment is offered and liberal subl-limits on room rent. Skipping the medical test isn’t necessarily a good thing as it can lead to disputed claims later.

Conclusion

I firmly believe that keeping things simple is the key to making the right investment decisions. Simplicity is not a useful characteristic, it is absolutely mandatory. If you do not fully understand about any financial product or service, then you are stepping towards in a dark future, regardless of how good it may otherwise appear or even actually be. And such understanding cannot come with complex products. Everything is simple enough to understand and simple enough to track. You will have a clear idea of what did well and what didn’t. The investments that do well will have a large and clear impact on your investments, and the ones that don’t will be easy to single out. The more complex your investments are, the more difficult this is. Simple ideas are best, simply because when they succeed, the reasons are obvious. And when they fail, the reasons are obvious too.

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