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(Done) Let's Talk Money - Highlights

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Highlights

  • I do this using three boxes for the three functions of money. These are income, spending and saving. (Location 302)

  • Once your salary hits your Income Account, within thirty minutes (OK, take a day – but do it) move out your monthly expenditure to your Spend-it Account. And whatever is left, move it to your Invest-it Account. (Location 308)

    • Note: Its okay to leave some money in the Income account

  • Use your Income Account as the sump for all kinds of money inflow that we get. You may quickly say: ‘Oh, but I get only a salary.’ But there is always some other cash that flows into your life. Cash gifted by parents or relatives, a bonus, a refund from work, a matured insurance plan, rent from a property you own, dividend on stocks or mutual funds, return of money borrowed. Other than interest earned in the other two accounts, rest of the inflow into your life falls into one account – your Income Account. (Location 316)

  • You and your spouse must have your individual Income Accounts. The Spend-it Account is a joint account into which both credit equal amounts for the monthly spending. (Location 332)

  • Moving money from Invest-it to Spend-it (Location 341)

  • When we use mental accounting in the cash flow system, we are using the principle of mental accounting to work for us. When we label the account Invest-It Account, we will be loath to touch it for our current spending needs. (Location 355)

  • your EMI payouts are no more than 25–30 per cent of your take-home income; (Location 363)

  • This is the piggy bank you break only when you need the money for an unplanned emergency. (Location 400)

    • Note: About emergency funds

  • A rough rule of thumb says keep aside six months’ to two years’ living costs. Include everything in it – rent, EMI, school fees, utilities, premiums, credit card charges, club memberships, whatever. (Location 412)

  • So, lower the risk to the household, lower is the number of months’ spending you need to cover for in the emergency fund. And higher the risk, higher the amount you save. (Location 420)

  • The easiest and best-understood product is a fixed deposit. (Location 429)

    • Note: Where to keep the emergency fund

  • setting up an FD with your emergency money in it. If you are banking with a bank that allows flexi-FDs that allow you to sweep out just the amount you need, rather than breaking the entire deposit, go for that. Else split your emergency fund into smaller FDs so that you don’t have to lose the interest on the entire deposit. (Location 431)

  • People familiar with mutual funds can use what are called short-term debt funds to build an emergency fund. (Location 434)

  • There are several advantages to this product. It earns you a better return, is more liquid than an FD and can have a lower tax incidence than an FD if you plan its use well. The higher post-tax return as compared to a bank FD makes a debt fund a great choice for an emergency fund. (Location 437)

    • Note: About short-term debt funds

  • most insurance companies will not cover your ‘pre-existing’ diseases and medical costs related to a pre-existing disease for a maximum of four years. (Location 490)

  • For a nuclear family it makes sense to get a product called a ‘family floater’ that allows the insurance cover to whichever member of the family that needs it. (Location 505)

  • Most personal finance advice on this usually begins with: ‘Research the company, its management, its hospital reach, its third-party agent (TPA) service (TPAs are firms that insurance companies outsource claims management to), its claims experience before you buy a policy.’ You need to know that some policies will not pay the full amount because you signed up for something called ‘co-pay’. Not exactly helpful! Few articles will tell you that you need to know that some polices have in-built limits to what you can spend on what part of a hospital’s service. You need to know how good the claims experience of the company is. You need to know if the TPA service is good or not. If the hospital network is large or not. (Location 513)

    • Note: It is not humanly possible to do all this

  • One, how does it perform on the metric of price. Two, how does it perform on the metric of benefits. Three, how does it perform on the metric of claims. (Location 524)

  • Unlike a life cover, where your premium gets locked when you buy a term cover, the premium of a medical cover changes as we age. (Location 528)

  • You need to look at two things in price. How does the price compare with policies from other companies right now and how does the price compare over the years? (Location 529)

  • ask him to show you the price comparison at ten-year differences. If you are forty, ask for the price of the policy as it is today when sold to a fifty-, sixty- and seventy-year-old. If he can’t do the work, find another agent. (Location 531)

  • ensure that you have a policy that does not have something called a ‘co-pay’ clause. (Location 539)

  • Ask your agent to mail you the policy document and then do a search on the words co-pay. Search the net to see if the policy being sold has complaints related to it having a co-pay clause. Build an email trail with the company or the agent to ensure that you have something in writing that ensures that you have not been lied to. (Location 544)

    • Note: How to ensure that there is no co-pay

  • check for a ‘pre-existing’ disease clause. Insurance companies will not cover diseases that you already have when you take the policy. Insurance rules allow a company to refuse to pay for any treatment related to any condition, ailment or injury for which you were diagnosed or had symptoms when you took the policy, for four years. (Location 548)

  • Check to see how long the waiting period is in the policy you shortlist. (Location 552)

    • Note: Waiting period for pre-existing disease

  • People with any pre-existing disease find it difficult to get a cover. Some insurance companies use this clause to refuse claims for totally unrelated ailments. It is a good idea to disclose your correct present and past medical history to the insurance company when you sign up for the policy. (Location 553)

  • check if your policy has a ‘disease waiting period’. Many companies have a cool-off period of thirty to ninety days during which they will not pay any claim. Some ailments such as cataract or hernia may have a ‘waiting period’ before the company will pay. Ask the agent to list out all diseases that are covered under this clause. Look for a policy that does not have a waiting period on diseases or coverage. (Location 559)

  • check if your policy has ‘sub-limits’. (Location 562)

    • Note: Example of sub-limits: Room rent may be limited up to a certain amount

  • Your policy may say that it will pay a maximum of Rs 2,000 as room rent or it may say that you are eligible for a double occupancy room with air conditioning. (Location 569)

  • Look for a policy with no sub-limits. (Location 572)

  • check for exclusions. A policy will list out diseases, conditions and medical services that the policy does not cover. (Location 572)

  • Dental treatment, pregnancy and cosmetic surgery are standard exclusions. (Location 573)

  • What you can’t do much about is when the policy you buy excludes something at some future point in the policy. (Location 574)

  • ask how much of the costs before and after hospitalization the policy will cover. You can claim expenditure made on doctor’s fees, medicines and diagnostic tests done before a planned hospitalization and for three months afterwards. (Location 577)

  • ask for a list of ‘day-care’ procedures that don’t need you to stay for twenty-four hours in a hospital any more. Procedures and treatment such as a cataract surgery or surgery for a ligament tear (there is a standard list of 130 such procedures) are treated as ‘day-care’ procedures and are covered. Check the details of the day-care clause, what will be covered, how much will be paid and how long you have to stay to claim. (Location 580)

  • look at the ‘no-claims bonus’ feature. When you don’t make a claim in a year, you get rewarded by the insurance company. It does this by giving a ‘no-claims bonus’ (NCB). The usual way is to raise your cover by 10 per cent for the same premium. If your cover was Rs 15 lakhs, for a premium of Rs 25,000, when you have a claim-free year, you get a cover of Rs 16.5 lakhs for the same premium. (Location 585)

  • how many claims does the company settle? Out of 100, if the company’s claims history does not settle more than ninety-five claims, don’t buy from the firm. (Location 594)

  • look at the claim-complaints data and look for a policy that has less than thirty complaints on every 10,000 claims made. Be careful of firms that give data on complaints as a percentage of policies sold. What is relevant is how many people, how many made a claim, then how many went on to complain. This number should be low in the policy you finally choose. (Location 597)

  • The best way to get a larger cover is to use what is called a ‘top-up’ plan. Think of this as a policy that will pay up after a certain threshold amount has been paid by you. Suppose you have an existing policy for Rs 3-lakh medical cover. Now you buy a top-up plan that gives you another Rs 5 lakhs of cover, (Location 618)

  • Do I buy a critical illness and accident cover while I’m at it? Yes, you do. A critical illness, like cancer, is a disease where you may not spend too much time in hospital but have very large out-of-pocket expenses. The disease may also affect your ability to work for some time. Such illnesses are covered by a ‘critical illness’ cover. These policies pay a lump sum if you get any of the illness that are part of the contract. Some policies cover up to twenty such illnesses including cancer, kidney failure, heart attack, major organ transplant, stroke, serious burns and end-stage diseases of the liver and lung. A Rs 10-lakh policy should cost between Rs 3,000 and Rs 5,000 roughly. (Location 626)

  • You should be able to add a ‘rider’ to your existing policy on the policy renewal date. A rider is an add-on at a very low cost to a basic policy. Riders look attractive, but I recommend that you buy a stand-alone accident policy from a general insurer. This cover is likely to be more comprehensive and will not lapse if you discontinue your basic policy for any reason. (Location 632)

  • This kind of policy gives you a lump sum if you meet with an accident that leaves you temporarily or permanently disabled. A personal accident plan has four covers: death, permanent disability, permanent partial disability and temporary total disability. (Location 635)

    • Note: About accident policy

  • For death or permanent disability, the policy pays the entire sum assured. For permanent partial disability, the policy pays a part of the sum assured, and for temporary total disability, it pays a weekly compensation, usually up to 104 weeks. (Location 637)

  • How much insurance you buy depends on how insecure you feel about your health and the future. (Location 639)

  • The intent is not to pay. (Location 648)

    • Note: The insurance company’s intent

  • We buy life insurance for all the wrong reasons – fear, greed, pity, frustration, taxes. The real reason for a life cover, to protect your family if you die, is never explained. (Location 659)

  • You need to treat the insurance industry and those who sell the same like walking through reptile-infested waters; you need to stay on the path that is safe. They’re out to get you. (Location 679)

  • You need a life insurance cover for only one reason: to protect your family’s financial health if you die an untimely death. (Location 698)

  • Add up the cover (look in the policies you have and add up the figure under ‘sum assured’) you have in all your existing policies and see how much your life insurance cover is – not the value of the policy when it matures, but what the beneficiary gets if you die. (Location 719)

  • In its purest form, a life insurance cover should pay your beneficiary a lump sum when you die for the price of the premium. If you outlive your policy, no money comes back. (Location 723)

  • A pure life insurance policy is called a ‘term plan’. (Location 726)

  • An easy way to cut through the tyranny of being hit by large numbers is to use the Rule of 72. This is a versatile rule that we shall use many times in the book. To know the rate of return every year of a double-your-money proposition, simply ask the question: Over what time does my money double? Then divide 72 by that number. Suppose the agent says: Your Rs 1 lakh will grow to Rs 2 lakhs in fifteen years, divide 72 by 15. Your return per year is 4.8 per cent, which is near the 4.73 number that a more exact calculation will give. (Location 747)

  • If you died today, think of all the expenses that the family has ahead of them. Now think of how much they will need to put away in a fixed deposit or a tax-free bond or a mutual fund to generate a regular income? The rule of thumb is that you need eight to ten times your take-home annual income. Or fifteen to twenty times your annualized monthly expenditure. (Location 793)

  • In addition to a cover for your income, you need to buy insurance for all the debt you have. Each time you take a large loan – usually a home loan, sometimes a personal loan – buy a term cover for the full amount of the loan that you take. Suppose you take a home loan of Rs 80 lakhs. Buy a term cover of Rs 80 lakhs. Your bank may offer you a reducing cover policy whose premium is bundled with your EMI. Say no. It’s likely to be more expensive (Location 800)

  • The policy you buy is a mix of getting a cheap plan from a company that is known to honour its claims. (Location 833)

  • once you buy a policy at a particular price, you get locked into this price (Location 836)

  • The online plans are the cheapest since they remove the agent commission (Location 839)

  • When buying a term cover, check the claims experience of the insurance firm. (Location 844)

  • A claims experience of over 95 per cent is fine. This means that the company pays 95 per cent of the claims filed. (Location 846)

  • If you have no dependants on your income, you don’t need any life insurance cover. Let me repeat that. If there will be nobody to miss your income – do not buy a life insurance cover. (Location 858)

  • There is one more situation in which you don’t need a cover – when you are financially free. (Location 859)

  • When are you financially free? When you don’t need to go to work to pay your bills, EMI, fees and other living costs. Your investments are large enough to look after all your expenses – current and future. Most people reach this milestone around the age of sixty, when they retire. (Location 860)

  • The job of the life insurance cover is to serve you till you are debt-free and financially independent. The moment that happens you can stop your term insurance plan. Remember that these are annual contracts; if you terminate it, you lose nothing. (Location 866)

  • each financial product you buy must solve a problem you have. (Location 985)

  • create three more cells in the box for our investments. We name each cell: The first is called Almost There; the second, In Some Time; and the third, Far Away. (Location 995)

  • Any planned expense that will happen within two to three years is a short-term need that you put down under Almost There. (Location 997)

  • you can use this money box to suit your own personality and financial situation. If you hate taking risk and are happier with lower efficiency, you can extend three years to four, or even five. (Location 998)

  • In Some Time are planned expenses that sit between three to seven years away. (Location 1002)

  • Far Away are expenses that are really hard to imagine today. (Location 1005)

  • we need to match our financial needs to financial products. (Location 1023)

  • Each financial product has a certain time period over which it works best. A product that is very safe in the long run becomes very risky in the short term. And a product that works in the short term becomes a drag on returns if you hold it too long. (Location 1025)

  • There are three asset classes that we need to understand. Debt, equity and real assets. (Location 1066)

  • Debt is just an umbrella term for all financial products that are based on borrowing. Equity is ownership of a business and the risk that it brings, either directly (through stocks) or indirectly (through mutual funds). Real assets are those that can be physically seen. Debt and equity are called ‘financial assets’, while real estate and gold are called ‘real assets’. (Location 1067)

  • debt means the cell with products that give you an assured return – like a bank fixed deposit or a tax-free bond or a public provident fund. The core of the product is a loan. (Location 1073)

  • The higher the return it promises, the higher is the risk – even in a product you think is ‘safe’ like a company deposit. (Location 1083)

  • A benchmark is a standard you measure something against. (Location 1085)

  • They also make up the core of your long-term investments. (Location 1096)

    • Note: About debt products

  • Debt products are good for stability but not for growth. (Location 1100)

  • Not more than 5–10 per cent of your total portfolio goes into gold. (Location 1123)

  • You do not buy jewellery as investment. (Location 1123)

    • Note: With jewelry, there is making charges involved. it is about 10 - 30%

  • Your options to buy gold are coins, bars, gold exchange-traded funds (ETFs) and gold bonds from the government. (Location 1124)

  • As of 2017, the smart investment decision is to buy the bonds issued by the Government of India; these bonds give you not only the full market value of gold when you sell the bonds in the future, but also a small interest on your investment each year. (Location 1125)

  • It is a horrible, clunky, chunky investment that has lots of costs, which people forget to add to the profit maths. It is illiquid – you can’t sell in a hurry. You can’t sell one room to raise some funds – you need to sell the whole darn property. It needs periodic investments for maintenance. For society flats, there is the added cost of high charges. (Location 1156)

    • Note: Real estate

  • costs of maintenance, property taxes, brokerage and insurance. (Location 1166)

  • So unless you have illegal money (basically money on which you have not paid tax), stay well away from real estate as investment in India – the prices are inflated due to cash in the system, and if the crackdown on corruption succeeds, there is no room for price rise for another decade (as of 2020). (Location 1176)

  • you have your FDs, PF and PPF, debt funds and no other debt products, no corporate deposits, no chit funds, no AT1 bonds; (Location 1189)

  • your debt allocation is equal to your age; at age thirty, no more than 30 per cent of your portfolio is in debt products; at age seventy no more than 70 per cent in debt products; the rest is equity. (Location 1189)

  • The Suits use ‘underlying’ all the time to confuse people; all it means is the product in which the investment is made. So in an equity mutual fund, the underlying is stocks. (Location 1191)

  • The toughest learning is the one around equity, as it is misunderstood to be a gamble rather than a slow builder of wealth. Equity is a slow cook and not instant noodles. (Location 1198)

  • What is the inflation index made up of? Does it comprise all the goods and services in the country? That would be an impossible task, so the index is made up of the most representative items, such as food, fuel, clothing, housing, among others. The big spends for the consumers are included as representative of all the expenses. Each of these further breaks down into its most representative items. (Location 1250)

  • The Sensex is made up of thirty most representative companies that are listed on the Bombay Stock Exchange (BSE). The index has an initial value of 100, as on 1 April 1979. The index is made up of companies that represent the sectors they operate in. They are also companies that are most traded on the stock market. (Location 1263)

  • The Sensex and Nifty50 are broad market indices and are also called large-cap indices. (Location 1270)

  • You must have heard the term ‘market cap’ or ‘market capitalization’ – this is just the number of shares of the company multiplied by the price. If the firm has 100 shares in the market and they currently sell at Rs 50 per share, then the market cap is Rs 5,000. (Location 1271)

  • Large market-cap companies are usually the mature, established firms in the market. They are known for giving dividends rather than rapid growth. (Location 1278)

  • SEBI defines a large-cap company as one that features within the first 100 companies by market cap on the stock market. A mid-cap is a company that ranks between 101 to 250 by market cap, and small-caps are 251 and below. (Location 1279)

  • The Sensex was formally launched on 2 January 1986 with thirty most actively traded stocks of that period, with 1 April 1979 as the base year, and an initial value of 100. (Location 1282)

  • Sensex throws out the companies that are no longer the largest and bestselling, and includes companies that represent the new areas of activity in the country. (Location 1285)

  • The mid-cap index tracks only the representative mid-cap companies. These are companies that are smaller in size than the big, mature companies that sit in the Sensex. Being smaller, they have lower market cap and fewer shares out for trade. Their growth and fall both can be sharp. (Location 1296)

  • A BankEx will track the stocks of the banking sector. (Location 1299)

  • A PSU index will track the prices of just PSUs (public sector undertakings). (Location 1299)

  • A technology index will map the prices of tech firms. (Location 1300)

  • Just as a food index will be more volatile (prices will go up and down with greater intensity) than a broader consumer price index, so also the Sensex will be more stable than the changes in a mid-cap index or a sector index. (Location 1302)

  • Volatility affects those who deal in the stock market for short periods of time, but the longer you allow an index to work, the lower the effect of volatility. (Location 1304)

  • As inflation rises in the system – the input costs for the firms go up – they are passed on to the consumers in the form of higher final prices. The ‘margins’ or the profits of the firm, therefore, get protection from the effect of input price inflation. (Location 1311)

    • Note: Why are stocks the best way to beat inflation?

  • Rs 1 lakh invested in 1980 today in four different products. One, a fixed deposit. Two, gold. Three, public provident fund. Four, Sensex. Rs 1 lakh invested in each of these products and left to compound is worth a few lakhs in the FD, gold and PPF, but the Rs 1 lakh invested in the Sensex is now in crores. (Location 1315)

  • Any investment that allows you to buy the index stocks in the same proportion will give you index returns. You also get the benefit of the dividends declared and the bonus shares issued as you hold the index. Therefore the super returns over time. (Location 1323)

  • Around year seven you begin to get a very interesting result: the volatility of returns begins to reduce and the average return is about 14–15 per cent a year. Depending on a number of factors, the year at which the minimum return is positive is between seven and ten years. (Location 1334)

  • it is not market timing but time in the market that matters. Time in the market matters because it smoothens out the volatility of the market. Which is why you should not put money into the equity market if you need it next year. (Location 1339)

  • when investing in the stock market, give it the same patience you give real estate – a good equity portfolio needs five years of patience, ten years to see consistent returns, but actually will slow-cook over fifteen to twenty years. (Location 1371)

  • remember that your risk is choosing poor products and finding out after fifteen years that your fund manager has malfunctioned. (Location 1374)

  • if you find yourself frozen while choosing equity products in the market – direct stocks, market-linked products such as unit-linked insurance plans (ULIPs) and mutual funds – and don’t want to take the risk of choosing a fund manager, go with an exchange-traded fund (ETF) or an index fund linked to a broad market index or a mid-cap index. This is the safest way to get the average market returns without taking the risk of having a fund manager. (Location 1375)

  • An average equity fund costs you 2 per cent of the returns a year and the cheapest ETF costs 0.03 per cent. Over a thirty-year period, this difference in cost will be significant if your managed fund does not beat the index by more than the cost difference. (Location 1380)

  • Four, do not invest in any product that locks you into a particular company or asset manager. What we forget is that, over the long term in equity investing, the risk is not of the market, but of poor fund management. This is why I do not recommend having a ULIP in your equity portfolio, despite it being competitive with mutual funds in terms of costs. (Location 1382)

  • A ULIP will lock you in with a particular company’s asset management and shuffling is expensive. What you want is a product where exit is possible, cheap and easy. Think of it as portability –you should be able to port your money to a better fund manager for a very tiny cost, if you are unhappy with the existing one. (Location 1385)

  • Five, if you want to invest in managed funds, start learning. Read through the Mint50 coverage. Go through the Value Research data and Morningstar ratings. (Location 1387)

  • The mutual fund industry in India has a three-part structure. There is a businessman or firm who has the interest to set up a mutual fund. This entity is called a ‘sponsor’. There are SEBI rules on who can be a sponsor. The sponsor makes the investment to set up a mutual fund in the hope of making a profit. The sponsor sets up a trust and an asset management company (AMC). The money collected from investors belongs to a trust. The sponsor appoints the trustees who are the custodians of the investors’ money. (Location 1432)

  • The AMC is a service provider to the trust that manages the money for a fee – called AMC fee. The AMC must get all its plans and schemes approved by the trustees before they come to the market. AMCs will launch many schemes to attract investors. (Location 1436)

  • Today you can buy three kinds of asset classes through mutual funds – debt, gold and equity. Real estate will soon be available through special mutual funds called real estate investment trusts (REITs). (Location 1462)

  • Equity mutual funds buy into stocks of listed companies. Debt mutual funds buy bonds and debt papers issued by the government and firms. Gold funds buy actual gold. (Location 1463)

  • we must buy debt funds to match the investment horizon of the mutual fund scheme with ours. Investment horizon, or the time for which we want to invest our money, can also be called ‘tenor’. We are going to match our holding period with that of the scheme we buy. (Location 1486)

  • There are two ways to slice the debt fund market. One, according to tenor, or the holding period of the bond. Two, according to the quality of debt paper bought by the fund. (Location 1491)

  • When you think of a debt fund, ask yourself these two questions. Does the ‘average maturity’ of the debt fund match my holding period? (Location 1492)

  • Question two is – what quality of debt paper does the scheme hold? The better the quality, the lower will be the potential return. The lower the quality, the higher is the risk and the return. If you don’t want risk in your debt fund, settle for debt funds that only buy high-quality paper, and be willing to sacrifice some return for that safety. (Location 1494)

  • The bonds that a liquid fund buys are short-maturity bonds, or bonds that will mature within an average of three months. (Location 1501)

  • ‘Average maturity’ will be a term you will come across when you go to buy a debt fund. All that it means is that the average holding period of all the bonds is about three months in a liquid fund. (Location 1502)

  • Liquid funds buy short-term bonds. (Location 1505)

  • SEBI allowed funds in 2016 to make instant redemptions of up to Rs 50,000 a day from liquid funds, or up to 90 per cent of the money in your liquid fund – whichever is lower. (Location 1507)

  • But you do need to check for something called credit quality of your liquid fund – it must be high to ensure that the money is safe. (Location 1512)

  • But as the risk of non-payment of interest and principal rises, the bonds get graded lower and lower. (Location 1526)

  • conservative balanced fund. These are debt funds with a small flavour of equity. The large bond-holding takes away the volatility that equity brings in a bad stock market. But equity adds to the overall returns in a good stock market. (Location 1535)

  • Gold funds These are funds that invest in gold. (Location 1554)

  • The product is called a gold exchange traded fund (ETF). (Location 1555)

  • You buy a unit of the gold ETF at the current market price of gold and the ETF invests that money in bullion of 99.55 per cent purity. One unit of an ETF is equal to 1 gram of gold. (Location 1559)

  • You have to pay the cost of a demat account and its brokerage to buy the gold ETF. This usually costs about Rs 1 per lakh for a retail investor with limited trades. The fund house charges an annual cost called expense ratio. This is between 0.06 per cent to 1.15 per cent of your assets under management or gold ETFs as in July 2020. (Location 1562)

  • The Government of India has launched gold bonds to offer an alternative to gold buyers in the country. Gold imports are a heavy burden on our foreign exchange reserves and sometimes cause a balance-of-payment problem. To allow people to buy gold and yet not cause a loss of foreign exchange, the government has launched the Sovereign Gold Bond Scheme. (Location 1565)

  • Equity funds buy stocks of companies listed in the stock market. (Location 1573)

  • Diversification reduces the negative impact of an imploding stock. And conversely, it reduces the positive impact of an exploding stock. (Location 1581)

  • An active fund is like the taxi – you are choosing a mutual fund where the fund manager has a view on the market, chooses his stocks to fit the investment mandate, and then manages the money by trading every day. (Location 1596)

  • A passive fund just buys the index and stays with it. Passive funds don’t invest in large research desks, or brokers and dealers, since all they are doing is buying an index and sticking with it. Changes, if any, happen when the composition of the index changes – they sell the outgoing stock and buy the incoming stock. This is why passive funds cost less than active funds. (Location 1605)

  • Why do we buy active funds when passive is cheaper and less risky? Because the Indian market still has alpha left in it. What’s this alpha? Alpha is the extra return that the fund manager can generate over the index. Active fund managers have done very well in India and the higher cost of active management has been more than compensated by the higher returns these have earned. (Location 1608)

  • There are two kinds of passive funds – an index fund and an exchange-traded fund. (Location 1614)

  • An ETF also tracks an index like the Sensex but lists its units on a stock exchange, unlike a mutual fund. To buy and sell mutual funds you don’t need to have a demat account. But to invest in an ETF, you need a demat account. The other difference in index funds and ETFs is that you can buy an index fund at a price at the end of the day, but you can buy an ETF at any point in the day. This difference in price is not relevant to retail investors like us. (Location 1623)

  • ETFs come with tiny costs compared to the index funds. The average index fund costs between ten basis points to 1 per cent, or ten paise to Rs 10 on every Rs 1,000 invested. ETF costs have hit rock bottom and you can now buy them at a price as low as one basis point. (Location 1626)

  • liquidity in the ETFs may not be that good. This means that when you go to sell a large quantity, you may not get the current market price. (Location 1628)

  • the risk of a mid-cap index fund is much higher than the risk involved with a Sensex or Nifty fund. (Location 1632)

  • this is a fund that is diversified across mainly large-cap stocks. These funds aim to give returns that are just a bit higher than the index. (Location 1645)

    • Note: Diversified equity fund

  • An open-ended fund is open for investors buying and selling it forever. A closed-end fund comes to the market with a fixed time frame. Closed-end equity funds come with a fixed-year investing horizon. I like open-ended funds that have been in the market for at least five years. (Location 1648)

  • There are three kinds of options that each mutual fund scheme offers you: growth, dividend and dividend reinvestment. (Location 1657)

  • The growth option allows you to stay invested and get the benefit of long-term growth of the portfolio. Your profits are not ‘realized’, or in other words, your profits reflect in the rising price, much like a stock price that goes up. Till you sell, the profit is ‘unrealized’ or notional. The growth option works especially well for equity funds as it allows you to keep the money invested in the market. (Location 1658)

  • The profit your fund makes remains in the market and you get the benefit of compounding over the years. The number of units you buy remain the same, but the price, or the NAV, keeps going up. (Location 1661)

  • The dividend option is not really the dividend, but booked profits. This option allows you to book profits periodically. The number of units remain the same, but the NAV keeps reflecting the booked profits. Obviously for the same scheme, the NAV of a growth option will be higher than the dividend option. (Location 1666)

  • An ELSS is an equity fund that gets this tax benefit. It has a three-year lock-in period, and you cannot exit before that. Remember not to tick the dividend or dividend reinvestment option in an ELSS. Go for growth. (Location 1677)

  • Today there are three kinds of balanced funds – conservative, balanced and aggressive. Conservative funds have between 10 and 25 per cent in equity, balanced have between 40 and 60 per cent in equity and aggressive 65–80 per cent in equity. (Location 1682)

  • What is this NAV? It is the price of a unit of a scheme. The full form is net asset value. It is not ‘gross’, because the costs have been removed from the price, and you get the net value in your hand. (Location 1689)

  • Imagine there are 100 investors and each has put in Rs 1,000 in an equity mutual fund. Each bought a unit for the price of Rs 10; therefore, each investor holds 100 units. A sum of Rs 1 lakh is invested by the mutual fund in different stocks. A year later the value of the portfolio is Rs 1.5 lakhs, giving a profit of Rs 50,000. This will be shared equally by the units, but before that costs will be removed. If the cost is Rs 10,000, the profit that goes to the unit holders is Rs 40,000. This gets reflected in the NAV that goes from Rs 10 to Rs 14. Your 100 units are now worth Rs 1,400. Multiply the NAV with the number of units you hold to get the value of your mutual fund holding per scheme. (Location 1690)

  • costs don’t really matter in a fixed-return product, such as a fixed deposit (FD) or a bond. (Location 1698)

  • Bonds and traditional plans (non-participating plans only) sold by insurance companies too work on the same logic – you get a defined amount back either periodically or in one bullet shot some ten to fifteen years later. (Location 1700)

  • you need to think about costs in a market-linked product or one in which the returns are linked to an underlying asset such as stocks, bonds, real estate, gold or commodities. (Location 1702)

  • In its simplest form, a market-linked investment product carries three kinds of costs. One, the cost to enter the product, also called a front load. If you invest Rs 100, and Rs 2 from that is cut out so that Rs 98 is invested, the Rs 2 is called a load. (Location 1704)

  • A load is part of the price of the product, or is embedded in the price – it is an invisible charge because it is not usually disclosed. Mutual funds have zero loads and are an extremely investor-friendly product. (Location 1706)

  • The question to ask when buying a market-linked investment product is: How much of the money I invest goes to work? (Location 1707)

  • an ongoing cost or the annual fees that you need to pay to have experts manage your money. To take care of the running costs and profits of investment managers each year, some fees are deducted from your money. The cost to you of handing over your money to professionals is captured in a number called the ‘expense ratio’. This is the fees that a mutual fund charges investors for its costs and the profits it makes. (Location 1708)

  • Three, an exit cost, or the cost of selling the product. To take care of expenses of selling the investment you made or to act as a deterrent to frequent churning of money, funds levy exit charges. This is a percentage of your corpus and usually falls off to zero after about one or two years. (Location 1722)

  • The expense ratio has embedded in it the sales commission paid to sellers of mutual funds. (Location 1726)

  • There are two entities in the market – advisers and distributors. Distributors are supposed to just vend the product, much as a chemist vends medicines but does not prescribe them. (Location 1726)

  • In the financial sector, advisers are the doctor’s equivalent and are supposed to charge you a fee for their expertise. They are supposed to recommend a ‘direct’ plan that has a lower cost. (Location 1728)

  • Direct plans remove the sales commission embedded in the expense ratio and make the product cheaper for you to buy. (Location 1729)

  • For example, a large cap direct fund will cost 1.03 per cent and the same fund as a regular fund will cost 1.89 per cent. (Location 1730)

  • A SIP is a systematic investment plan. Think of this as a recurring deposit, but instead of putting money in a fixed deposit, you are making periodic investments into a mutual fund. (Location 1734)

  • an SIP allows you to average out your price as you invest over the year, either monthly, or fortnightly, or even quarterly. Since nobody can predict the market, making one large lump-sum investment leaves us open to the risk of a sudden market crash. Spacing out investments over the year allows our money to buy more when markets are down and less when markets are hot. (Location 1739)

  • Instead of investing it all in one go, you can put the money in a liquid fund and set up a monthly (or weekly or fortnightly) transfer into an equity scheme. Remember that you have to choose a liquid fund of the same fund house whose equity fund you want to buy through an STP. (Location 1748)

    • Note: STP - systematic transfer plan

  • A systematic withdrawal plan (SWP) is a facility to periodically redeem your units to generate an income. Yes, it works like a dividend plan, but in this case the control remains in your hand of how much money you want to take from your fund periodically. (Location 1750)

  • Each product in your money box needs to justify its space. It has to fight with other products available to claim its place in your money box. (Location 1772)

  • First, there is a cost to buy the product. Look at this as an entry ticket, a ticket that allows you to board the bus. Different products, even if they do the same thing, have different entry costs, also called loads. These are commissions that the person selling collects from the manufacturer of the financial product. (Location 1781)

  • In a ULIP the front load is about 8–9 per cent. In a mutual fund, there is no cost of entry. The front load was brought to zero in 2009. In a bank FD, PPF and PF there is no front load. The National Pension Scheme (NPS) has a front load of 0.25 per cent of your contribution, or Rs 250 on a Rs 1 lakh investment. (Location 1787)

  • Front costs reduce the money that goes to work in a financial product. These also encourage the sellers to ‘churn’ you, or nudge you to sell your old product and keep buying new ones.* (Location 1789)

  • Second, there is an ongoing cost. This is the money you need to pay each year for you to stay in the product. Also called expense ratio, this is usually a percentage of the money in the investment. (Location 1791)

  • They are low for debt-oriented products and high for equity-oriented products. (Location 1793)

  • Third, cost of exiting the product, or an ‘exit load’, which is the cost the fund manager charges to take care of the costs of exit. Most debt funds have zero exit cost, and most equity funds have an exit cost of 1 per cent if you leave before one year. (Location 1795)

  • Ask for an average annual return of the product for the last three, five and ten years. Then ask to see benchmark returns. Then ask to see category returns. Category return is the average return of the category of the product. For example, if the seller tells you that your money will go into a large-cap fund, even in an insurance plan, ask to see what the category of large-cap funds have done over the past. How does the fund being sold compare to that? (Location 1821)

  • A lock-in means that you cannot withdraw your money for a certain period of time. (Location 1828)

  • The ELSS funds are locked in for three years. (Location 1831)

  • Open-ended funds may not have a lock-in, but can have a cost of exiting before a certain period of time (Location 1831)

  • Traditional plans don’t have a lock-in, which means you can stop funding the policy whenever you want, but the policy tenure could be ten, fifteen or even thirty years. Don’t confuse the premium-paying term with the policy tenure. (Location 1832)

New highlights added March 13, 2023 at 3:50 PM

  • planners do not recommend pure equity products for financial goals that are less than three years away. (Location 1870)
  • Returns need to be evaluated taking into account the costs, inflation and taxes. Once these three big bites are taken out of your returns, most products give a negative return. Taxes can be levied at various points in a product. (Location 1877)
  • The most well-known tax break is Section 80C, which gives you a break of up to Rs 1.5 lakhs (in 2020) if you invest in the eligible products. You get this break if you contribute to your PF, PPF, life insurance premiums, ELSS mutual funds, NPS, special five-year FDs and a bunch of other expenses. (Location 1879)
  • Then there are two kinds of ‘capital gains’ that you need to be aware of. Short-term and long-term capital gains. In a debt fund, for example, if you sell before three years of holding the fund, you have to pay a short-term capital gain tax on the profit. This profit gets added to your income and you pay tax at slab rate on it. If you hold for three or more years, your profit becomes long-term and you pay a tax that is usually lower than the highest tax rate on income. (Location 1886)
  • You need a mix of assets in your portfolio. Debt gives you the stable core. Include products like your PF, PPF, FDs, bonds and debt funds in the debt part of your portfolio. Equity gives the return kicker – it is the only asset class that gives you returns that beat inflation, at the lowest cost. You can include gold in this, for diversification. (Location 1912)
  • Keep about 5–10 per cent at the most of your net worth in gold if you want to. The exact asset allocation between debt and equity will vary from person to person. The thumb rule for equity is 100 minus your age. If you are thirty years old, you should have 70 per cent of your money in equity. If you are sixty years old, you should have 40 per cent of your money in equity. Yes, (Location 1915)
  • Each of your goals will need their own allocation between debt and equity. (Location 1918)
  • the closer you are to the goal, the lesser should be the equity part of your portfolio. (Location 1920)
  • The first is the reliable FD. We know these products; we find them safe and know how to get in and out of them. Just the familiarity and the ease of on- and off-boarding makes an FD a contender for the emergency fund cell. You can pick the period for the FD that gives the highest interest from a large scheduled commercial bank – private or public. At times, the three-year FD gives more than the five-year FD. There is a cost of about 0.5 per cent of interest for an early exit from an FD. It is worth it to pay that and keep the money in an FD rather than a savings deposit that gives you an interest of 2.75 per cent, as in July 2020. You can use a flexi account that some banks offer to have the facility to sweep out the money you need from the FD into the savings deposit instantly. (Location 1944)
    • Note: For emergency fund
  • The second product is a mutual fund. I keep my emergency money in a mix of FDs and debt funds. Choose a fund that is conservative and not aggressive. This means that you shouldn’t buy a product for your emergency cell based on just high returns it has given in the past. To harvest more returns, fund managers of some fund houses take ‘credit risk’ or invest in poorer grade bonds than the others. If you are buying yourself, check that the top holdings of your debt fund is in AAA-rated bonds. (Location 1950)
    • Note: For emergency fund -
  • Finance is not just about numbers; it should work for all the people in the house and must look after individual preferences, fears and goals. (Location 1958)
  • These are investments you make for needs that are two to three years in the future. The products in this cell are similar to the ones in the emergency cell. Use either FDs, if you don’t understand funds and are not willing to take on a higher risk for your short-term needs, or an ultra-short-term debt fund or conservative hybrid mutual fund that have a maximum equity exposure of 25 per cent, and keep the rest in bonds. We don’t want a pure equity fund for this cell, because equity can be volatile and we want certainty about the availability of the money. (Location 1978)
  • For a goal closer to seven years, go fully into aggressive hybrid mutual funds and diversified equity funds. I would do a mix of aggressive hybrid funds and diversified equity funds for a goal that is seven years away. (Location 1989)
  • I am for going all the way to 100 per cent in equity mutual funds for my goals that are beyond seven years. (Location 1992)
  • Within this cell, you can have a mix of more or less aggressive equity. If your goals are around the seven- to ten-year mark, go with more of aggressive hybrid mutual funds, diversified equity and multi-cap mutual funds, and have a smaller proportion of mid-cap, small-cap and sector funds. (Location 1993)
  • For goals beyond ten years, you can hike the proportion of mid- and small-cap funds. The largest part of the equity fund portfolio must remain in lower-risk diversified equity or multi-cap mutual funds. Only if you understand funds well should you risk a mid-cap-heavy portfolio. (Location 1996)
  • Retirement fund This cell has a mix of products. The core is your PF and PPF. The rest is in equity funds. What kind of funds? The further away from retirement you are, the more risk you can take. For people in their thirties, a larger allocation to mid- , small-cap and sector funds would not hurt if chosen well. But if you are already in your late forties or early fifties, stay conservative with large-cap, diversified equity and multi-cap funds. (Location 1998)
  • Gold has its own cell. But it is tiny. No more than 5–10 per cent of your total portfolio is in gold, and that too paper gold, not jewellery. The government’s sovereign bond issue is very good and if you don’t need the money for the next seven years, you can begin to build a gold laddering system. It is useful for inflation protection at short notice (Location 2005)
  • We can work much better with real estate as a financial product once real estate investment trusts or REITs come to the market, (Location 2015)
  • Stockbrokers also churn direct stock investors because they make money each time they buy and sell. Therefore, brokers encourage people to trade, on the stock market, rather than invest. (Location 2027)
  • The first one uses your current income which I call ‘Save Your Age’. The second one – ‘Multiply Your Spend’ – uses your current expenditure to forecast what you will need in the future and how much you need to have. (Location 2058)
  • Save your age At age twenty-five save 25 per cent of your post-tax income, at age thirty save 30 per cent of your post-tax income. At age forty save 40 per cent. This formula works if you don’t have a single rupee saved towards your retirement, till you are forty. For example, if you are forty years old and have not a rupee of provident fund or real estate or gold or mutual funds then you need to be saving very hard and will need to save 40 per cent of your post-tax income for your retirement. If your take-home pay is Rs 1 lakh a month, you are saving Rs 40,000 a month at age forty, but if you are thirty years old, you are saving only Rs 30,000. Notice how the saving ratio reduces with age – the younger you are the less you need to save. (Location 2071)
  • You’ll need 70 per cent of your last working year expense in your first non-working year. (Location 2090)
  • At age sixty, you need between eighteen to thirty-five times your annual expenses at retirement to retire with the lifestyle you are used to. For example, if you are spending an annual Rs 12 lakhs at sixty, you need a retirement corpus of at least Rs 2.2 crores to retire, if you plan to eat up all the money and leave nothing to heirs. If you want to leave the entire corpus to your children, the same annual expense will need a corpus of Rs 4.2 crores. If you plan to leave half your corpus, then you are targeting a corpus of around Rs 3 crores. (Location 2101)
  • Post retirement, I use a very conservative 8 per cent return on your investment. (Location 2114)
  • At age forty, you should have three times your annual income as your retirement corpus already. If you earn Rs 15 lakhs a year at age forty, you should have Rs 45 lakhs in your retirement corpus. At fifty, you should have six times your annual income. If you have an annual income of Rs 40 lakhs at age fifty, you should already have Rs 2.4 crores in your corpus. At age sixty, or at retirement, you should have eight times your annual salary. Earning a crore at sixty, you must have Rs 8 crores as corpus. Remember, this assumes that you will burn through your entire retirement corpus and leave nothing as inheritance out of your retirement kitty. (Location 2121)
    • Note: Milestones to track retirement
  • As you age, your risk capacity reduces, and it is a good idea to rework your asset allocation, reducing equity as you age. (Location 2190)
  • If the thought of 50:50 allocation in equity and debt looked good to you when markets were low, why should that change when markets are high? (Location 2214)
  • It is usually a good idea to open the box once a year to evaluate if it needs a change. (Location 2218)
  • If you die without a will, your house, gold, car, mutual funds, jewellery will go to your legal heirs. Who the legal heirs are depend on your religion in India and which personal law applies to you. (Location 2250)
  • Look at the nominee as a caretaker of the asset, somebody to whom the money flows to for safekeeping till the legal heirs can stake a claim. In your head the nominee and the legal heir is the same person, but in the eyes of the law, the two could be different. (Location 2263)
  • What if you want to leave unequal bequests? Maybe one of the two kids has been more supportive to you in your old age. Will the prodigal child contest your unequal will? Probably. To prevent that, you can include what is called an ‘in terrorem’ clause. This is usually put in a will when a contest of the will is anticipated. This means that if any of the beneficiaries contest the will, they could lose even what has been bequeathed to them. (Location 2274)
  • you need to appoint an executor of the will. Ideally the beneficiary of the will is not the executor. This could be a family friend, your lawyer, your financial planner who ensures that the will is followed in letter and spirit in the asset distribution. You can write a will on a piece of paper, sign it with a date and place, and get two witnesses to sign as well. The witness and the beneficiary should be different people, and the witness and the executor should be younger than you. Do simple things like numbering each page, signing each page and putting down the date clearly. (Location 2278)
  • I don’t invest in things I do not understand. (Location 2386)

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