Don’t confuse insurance with investment

(Source: The Times of India, August 31)

It’s the most common mistake, and they get hit on both sides, says financial planner Gaurav Mashruwala

Ashfak Shaikh never asked his parents for pocket money. Since his childhood, he knew his father was working double shifts to support the family–with the Pune municipality during the day and giving tuitions in the evening. He managed to educate three sons. Ashfak rose to the occasion and became a broker for second-hand two-wheelers. “I must have traded in 50-60 two-wheelers,” says Ashfak. He believes in the joint family system where bonding counts for more than materialism.
Ashfak, now 38, holds a BE and works with a multinational company. His wife Jasmine is a doctor. They have an eightyear-old daughter, Aliya.

WHAT IS THE COUPLE SAVING FOR?

(1) Ashfak wants to ensure that even in the worst of times he can support his parents (about Rs 60,000 per year) (2) A larger house (Rs 40 lakhs) (3) Rs 5 lakhs for Aliya’s higher education after a decade and another Rs 5 lakhs for her marriage after 16 years (4) When they retire, after 23 years, they need a corpus which will generate Rs 9 lakhs per annum. They also dream of a luxury car (Rs 10 lakhs) and foreign travel.

WHERE ARE THEY TODAY?

Cash flow: Total yearly inflow from all sources is Rs 17 lakhs. Against this, they spend Rs 13 lakhs on EMI for car and holiday home, taxes, insurance premium, support to parents, regular savings and expenses incurred on travel and entertainment. The last car EMI is due in October. Total EMI payout is about 10% of inflow. Mandatory monthly outflow is about Rs 95,000.
Statement of net worth: Value of total assets is Rs 48.70 lakhs. Of this, assets worth Rs 30 lakhs are for self consumption and non-earning (house, car and jewelry). Outstanding loan on car
and holiday time-share is Rs 1.07 lakhs, about 2.21% of the assets.
Contingency fund: Total in savings bank, FD and in cash at home is Rs 3.95 lakhs—about four months’ mandatory household expenses.
Health & life insurance: Ashfak’s employer provides health cover of Rs 3 lakhs for the family. His life cover is Rs 17 lakhs through a ULIP and endowment policies.
Savings & investments: Value of assets other than those for self consumption is Rs 18.70 lakhs. Out of this Rs 3.95 lakhs is in cash/near cash. Apart from this, the value of direct equity is Rs 1 lakhs, equity-based mutual fund Rs 75,000, bonds/FD Rs 2 lakhs, EPF/PPF Rs 3 lakhs and stocks of Cosmos Bank valued at Rs 2 lakhs.
Total premiums paid till date on ULIP and other investment-oriented policies is Rs 6 lakhs. However, its market value is currently lower.

FISCAL ANALYSIS:

Very good income level. Savings rate is also good. Health and life cover are insufficient. Amount spent on insurance premium is too large. Borrowing is within permissible limit. Equity component is low and is also skewed in favour of single Cosmos Bank stock.

WAY AHEAD:

Contingency fund: Keep only Rs 2.85 lakhs for contingencies. Deploy surplus as follows.
Health insurance: Increase health cover of Ashfak and Jasmine to Rs 5.00 lakhs each and that of Aliya to Rs 3.00 lakhs.
Life Insurance: He must discontinue certain expensive insurance plans after completion of five years. Further opt for term plan worth Rs 75.00 lakhs.
Financial Goals:
Parental responsibility: Surplus in cash/near cash asset should be transferred into a monthly income plan of a mutual fund. However, continue supporting parents from regular income. Only in turbulent times use this fund to support parents.
Home buying: Preferably wait for twothree years, and then save about Rs 5 lakh per year in a debt fund. At the time of buying a new house, sell old one. Use sale proceeds plus investment in debt fund. If there is a shortfall, liquidate a part of the equity portfolio.
Aliya’s education and marriage:
Firstly, reduce investments in Cosmos Bank stocks to half. Park proceeds in a debt fund and systematically transfer into an index fund. After purchase of new home, systematically invest in index fund and gold fund for her education and marriage.
Retirement: Next two years’ savings would be needed for home buying. For another three-four years, deploy surplus for Aliya. Later, invest entire surplus in large cap fund and international equity fund for retirement.

PLANNER’S EYE:

The family’s weakest link in their finances are their life insurance policies. Out of total life cover of Rs 17, lakhs, Rs 5 lakh cover is provided by the employer. For the rest, the premium being paid annually is Rs 2 lakhs.
Instead, if he had opted for term cover, then annual premium for Rs 12 lakh cover would have been Rs 5,000. Balance Rs 1.95 lakhs invested in a pure investment product would yield higher returns. It is the most common mistake people make-confusing insurance and investment.