Thanks to the 2004-2007 stock market boom, it become very easy to show the returns at 20% and 30% assumptions and show people how they could generate wealth by contributing a small amount of money each year. It was very easy to show the different funds under a ULIP and how people can switch between equity and debt funds and control the growth and reduction of their money. It was illustrated in a way that it’s like child’s play and any one can do it; for those who don’t want to be active, there was an automatic plan also where the switch happens automatically based on some “research”.
The higher the complexity, higher the chance of high returns-that’s how people look at things and that was one reason why the complexity of ULIP helped its sales. Somewhere, buyers trusted that complexity beyond what was prudent.
ULIPs are a long term investment product
ULIPs are really a long-term financial product, because the underlying investments are done in stocks. Also, it’s not a suitable product for the common man who does not understand various features and switching options in ULIPs and when to do the switch. Most investors look at them as
“pay the premium and wait for years for it to perform”, but the various charges make sure that the returns come down over time. It’s not a suitable product for most people.
How to clean up your ULIPs?
In September 2010, there were some major changes made in ULIPs that made the lock-in period 5 years and lowered the charges, at least apparently. But they are still not simple products. Someone who does not have the time to look at its various features or switch between the various plans under the ULIP should stay away and take the route of mutual funds. This is purely from the complexity point of view.
If one can utilize its benefits, only then does it make sense to continue. So talk to the customer care of your ULIP company and check how much money you will get back if you surrender the policy right now. Most policies give back the 100% of your current worth in ULIP after the 5th year. So if you have completed the 5 years, better take the money back and think of a suitable use of your money and future premiums.
Clean up 5-Optimize your credit cards
I am counting “credit card” as one of the financial products, because it’s an important addition to someone’s financial life and it has a big impact on your financial life. If you don’t handle them in right way, it can literally create havoc in your financial life. We will go over this in detail in Chapter 8.
Many people have many credit cards. The higher the number of cards, the higher is their combined credit limit. Also, different kind of credit cards offer various benefits and offers in terms of cash back, bonus points etc. This makes many people apply for different credit cards. But credit cards are like double-edged swords. While there are many benefits, there are various kinds of problems with credit cards.
It can make you a spendthrift and entice you to spend on those things that you do not really need. Because of easy availability of credit and the feeling of “I can always pay it back later”, many people get into a debt trap. They overspend, they do not pay money on time, they panic when the debt keeps piling up and it’s almost impossible to pay off the entire amount. Then they just run off and don’t pay anything or pay a partial amount and settle the debt. Finally, it takes a lot of time and effort to come out the debt trap successfully.
Myth of minimum payment in credit cards
I was so surprised to hear from lot of people that they do not understand how minimum balance works and what exactly it means! Most people feel that minimum payment is some kind of favour that credit card companies do for their customer and that it’s totally fine to pay minimum balance each month and keep on increasing the debt on credit card. It’s totally untrue! Here is a real life incident shared on my blog, where this guy didn’t know how minimum payment in a credit card works.
I just can’t believe myself when I preached the concept of paying Minimum Balance to my wife and brother. In spite of my wife suggesting to pay off the entire amount outstanding, it was foolish of me to brainwash her to pay the minimum due and get away with that.
The minimum amount is the amount that you need to pay on your credit card bill, just to avoid the penalty charges that are charged for non-payment, but
the interest is charged on your dues when you do not make the full payment.
So if your credit card bill i Rs. 20,000 and your minimum payment is Rs.
1,000, you can do 3 things:
1. Make the full payment of Rs. 20,000 - This means you are paying back your loan on time (a credit card bill is just another short-term loan, which was given to you for few days)
2. You do not pay anything - In this case, a penalty will be applicable and it will be added back to your dues, and then the interest will be charged on your dues, unless you pay everything back. This interest is generally calculated on a monthly basis and can be as high as 3.5-4% depending on the credit card company.
3. You make a minimum payment of Rs. 1,000 - In this case, you will not be charged the penalty amount, but the interest will still be charged on your total debt.
There are many cases where a person has kept on paying just the minimum balance and the debt kept growing exponentially over the years. And later a person thinks that the credit card company has over-charged them, which is generally not the case.
So to summarize, having too many credit cards is not the right thing if you cannot control your spending behaviour. What really matters is your total credit limit when all the cards are combined. If you have 6 credit cards with the limit of Rs. 20,000 each, your total limit is Rs. 1,20,000. You can’t spend more than that. There is a high chance that you can get 2 credit cards with limit of Rs. 60,000 each and achieve the same thing, then why carry 6 cards!
What can go wrong with high number of credit cards?
• You have to take care of all 6 of them; you have to worry about their maintenance, check if they are safe and not fallen in wrong hands.
• You have to pay bills on most of them and if you forget or miss to pay the bills on time, you will be charged interest and penalty. There is a higher chance of forgetting if you have high number of cards.
Clean up 6 - Optimize your other investments
Apart from mutual funds, stocks, and bank products, there are several financial products you must have invested in like PPF, NSC, other Post Office products, infrastructure bonds and real estate. While we can’t cover each of them here and talk separately about them, the whole point is that you need to optimize it, list it and ask yourself what purpose it serves in your financial life. Why did you buy it? Does it add meaning to your financial life or is it just a random addition due to some kind of pressure or your impulsive buying decision sometime in the past?
Check if you can minimize them and reduce the number or not, without compromising your other parameters like returns, simplicity etc.
Collector vs. Investor
In his amazing book “11 Principles to Achieve Financial Freedom”, by Nandish Desai (disclosure: we are partners and work together), a coach shows a person coming to him about how to lead a great financial life. The coach distinguishes between an “Investor” and a “Collector”. The coach talks about people who live in the myth that they are great investors, whereas they are just collectors. They collect whatever they encounter in their financial life. They keep accumulating things, different policies that hit the market, any mutual fund making the headlines. They don’t go with any informed rational
decision. Here are excerpts from the book, where the coach is talking to his disciple.
“I want you to play the role of an investor and not a collector who keeps collecting different financial products. If you are a collector, you just need one reason and you will become ready to invest. Some advisor will say this product will help your child or will help you save tax or will give you high returns and you are ready to dive. As a collector, you are stuck in the financial products that you bought. It is as if you are stuck in a traffic jam where every car is owned by you. - Financial clutter leads to Product JAM.
Here are the differences between a Collector and an Investor Traits of a collector Traits of an investor Looking for what’s new in
market
His primary goal is always simplification
Always busy collecting information
Invest in products with understanding
They always have complex portfolio
Focus is on ground rules
Always on a crossroad A big NO to instant gratification Collectors lack focus Investors are focused on what they
want Collectors are fear and greed
driven
They follow a strategy
Your financial life complexity depends on what you are-an Investor or a Collector. If you are an investor, try to be a better investor and if you are a collector, try to first play a role of an investor.
Conclusion
The whole idea of this chapter was to make sure you get rid of unwanted and low value providing financial products from your life. More products means more looking after them, more documentation, more tracking and at times it does not add any value, none at all.
Action time
So now take this action and identify how much of your financial life is
“duplication” and it can be removed. Write your results:
Products How many do you have right now?
How many will you have after clean up?
Stocks
Mutual Funds Fixed/
Recurring Deposits
Bank Accounts Other Financial Products
Credit Cards
Anything Else
Bonus Tips
• To get the maximum out of your credit cards, keep two credit cards with a 15-day gap between the billing dates, so that you can use the credit card whose billing date is later. This way you can get the maximum credit.
• If you are a serious stock investor, ask yourself if you are ready to hold a stock for next 10 years if the markets still do very badly. If the answer is NO, it should not be in a serious investor’s portfolio!
• To redeem your mutual funds, you can just fill up a redemption form at CAMS office or your mutual fund’s AMC office and the money will be back in your bank account in 3-5 working days.
• Tell your credit card company that you are planning to increase your expenses through credit card and if they can increase your limits on the card. Mostly they will accept your request and once they do it, you can reduce the other cards if it makes sense.
• If you have too many credit cards and debit cards, you can also buy Card Protection insurance. Just search for CPP protection on the Internet and you will get more information. It’s a good way to protect yourself from loss and misuse of credit and debit cards.
The third step in your financial life is to tackle Health Insurance.
It’s a vital part of your security and before you move to investments, it makes sense to take adequate health cover.
I want you to imagine this scenario!
A person is admitted to a hospital after an accident/due to some illness/for some major surgery. Who will pay the bills? Obviously, the patient! Will he be able to afford it? Does he/she have so much money in case of this kind of emergency? For most people, this kind of sudden expense is unplanned and comes as a surprise.
If you look at this example and try to imagine this person’s life, you will see that before being admitted to the hospital, the patient had to spend nothing on medical expenses for many years because nothing happened to him. He never had to imagine a situation where suddenly so much money would be needed for a medical emergency! This is exactly how most people’s lives are going on and when this surprise expense appears, this sometimes put a big break on so many plans! A person might have saved money for his house down payment, or a wedding at home, or just for higher education and suddenly one day all the money is wiped out! It’s a situation no one wants to get into.
Now consider another scenario!
Now let’s reverse the process, where each year you keep aside a small amount for a big future medical expense that might arise. How much will you have to save each year for a goal of that type? It can be a small or big amount depending on how well you want to plan and expect the future situation to be.
So you start this plan and now suddenly after 2 years, some medical emergency happens and you still won’t have enough money. You will be able to save a respectable amount only after maybe 20-25 years, but by that time medical costs might be very high due to inflation. So then, how do you deal
with this situation? How do you ensure that you can deal with such unexpected expenses?
Look at Health Insurance Premiums as advance payment for a big future expense
in small parts. This will help you psychologically be more comfortable
This is where the concept of Health Insurance comes into play!
What if you can pay someone a small fee, which will be part of a large pool of money, and whenever something happens to you and if it fits the agreed terms and conditions, the expenses can be borne out of that big pool of money? You don’t have to shell out any money from your pocket, so the small amount you keep aside Is like the cost of being insured for your health expenses in the future. That’s Health Insurance.
This sudden surprise can come in 2 years, 5 years or 10 years; it does not matter because health insurance will cover you from the day you start paying your premiums for health insurance.
Now let’s understand two important points about health insurance policies.
Indemnity based policies vs. Lumpsum benefit plans
There are broadly two kinds of health insurance plans in market, and you should be very clear what each offers.
The first kinds of policies are those plans that reimburse you the actual expenditure up to a limit. Most plans in the market are of this type. If
someone is hospitalized, they could incur different kind of expenses like:
1. Room charges 2. Nursing
3. Surgeon/Consultant/Anaesthetist fees 4. Cost of blood/oxygen
5. Operation theatre charges
All these kinds of expenses are covered in these indemnity-based policies.
You should be very clear about the rules and regulations by reading the policy document of the plan in detail.
The other kind of health insurance plan is based on lump sum benefits. These policies provide a defined amount of money irrespective of the actual amount spent! The examples of these kinds of policies are:
Hospital Cash Benefit Plans - these kinds of plans provide a fixed specified amount of money for each day of hospitalization. Your actual expenses might be more or less. How much will be provided for per day of hospitalization is clearly defined as per the plan. The benefit is given only after the discharge and on showing the proof on the number of days spent in the hospital.
Critical illness Plans - These plans are another example of defined benefit plans. These policies provide a specified lump sum amount if you are detected to have a particular illness covered under the policy. Some of the major things covered under these kinds of plans are:
• Heart Attack
• Stroke
• Kidney Failure
• Multiple Sclerosis
• Coronary Artery Bypass Surgery
• Cancer
• Major Organ Transplantation
• Paralysis
Individual vs. Family Floater Health Insurance Policies
Now we will talk about those policies that provide you the actual reimbursement of money, not a fixed amount. But before we move ahead, a critical point to understand very clearly is that these types of health insurance policies cover only in-patient hospitalization expenses not cover outpatient or dental expenses. An in-patient treatment is treatment that requires an overnight stay. There are several things like x-rays, normal check-ups, blood tests etc. that require only a few hours to complete and hence they are not covered in a health insurance policy, unless specified. So make sure you don’t assume that once you buy a health insurance policy, it will cover you for every small illness and medical treatment.
There are broadly two types of policies:
• Individual Health Insurance Policy
• Family Floater Policy
An individual health insurance policy just covers one person and the premiums are totally dependent on his health and past history. However a family floater cover is like a joint cover by many people—husband, wife, children and at times parents too. The whole sum assured is shared by all and can be utilized by any number of people in the group with upper limit as the sum assured. The following tabular comparison will help you understand it in detail.
Feature Individual Cover Family Floater Cover
Covers Covers the insured Covers Self + Spouse + Kids + Parents
only (some policies) Eligibility Must be above 18
years
The primary insured needs to be above the age of 18 years
Cost of insurance
High compared to Family Floater
Little low as the Sum Assured floats between 2-3 (or more) members
When to buy health insurance - when healthy vs. when unhealthy
Health insurance depends on your age. The older you are, the higher the cost of health insurance because an older person is always more prone to illnesses, and has higher chances of having a pre-existing disease. This is one big reason why a person should take health insurance early in life. With each year of delay the chances of paying higher premium increases. It also gets more difficult to get a policy later as time increases.
There are two important age milestones that you need to look at: these are the points where your health insurance premiums take a huge turn and it gets more difficult to get health insurance.
Age 45: When you cross 45, generally the premiums shoot up pretty fast as the amount of appreciation is very high.
Age 60: This is another milestone you should watch where you are labelled as a “senior citizen” and the premiums increase to astronomical levels when you cross this age. Let me give you one example.
Example