In this choice, he can take some tough decision and restructure things. Let’s see what he can do here.
Let’s first work on the life cover of Ajay, because in choice 1, his life insurance was really low and was not up to the mark. The primary thing is to get a decent life cover, so Ajay take a term insurance plan for Rs. 50 lacs for next 23 years. This should cost him not more than Rs. 5,000 as of today’s standard (assuming his health is normal and he is not a smoker).
So out of Rs. 40,000, Rs. 5,000 goes towards his pure life cover; now he will be left with Rs. 35,000 per year after paying Rs. 5,000 for his life insurance.
Assume that he invests this Rs. 35,000 in a PPF or fixed deposit account for the next 23 years. For simplicity sake, assume a return of 8% on PPF or equity mutual funds (current rates for PPF is 8.8% and equity mutual funds have given 15-20% returns over the long term like 15-20 years). We have chosen PPF and equity mutual funds, so that the maturity amount is also tax- free just like insurance policies. This is a fair comparison.
In this situation, the overall final value from his investment would be Rs. 23 lacs (Rs. 35,000 paid each year compounded at 8% for next 23 years). So at the end of 23th year, he will get Rs. 23 lacs and his life cover through the period would be Rs. 50 lacs. Now if you see:
Loss from Phase A (first 2 years) = Rs. 80,000 Profit from Phase B (next 23 years) = Rs. 23,00,000
Total Profit (Phase A + Phase B) = Rs. 22,20,000 with Rs. 50 lacs of life cover
However, in Choice 1, the overall gain was Rs. 20 lacs with a life cover of just Rs. 10 lacs. Now, numbers can be up and down a little and depending on future changes, one situation can better or worse than the other, but let’s see what advantages Choice 2 has over Choice 1. In this example:
Criteria Continue the policy as it is
Dump policy, take a term plan and reinvest the remaining money in
PPF/fixed deposit How much
will Ajay’s family get in case of death before 25 years
Rs. 10 lacs only Rs.50 lacs + Value of his investments in PPF/mutual funds/FD
How much will Ajay get at maturity
Rs. 20 lacs approx. Rs. 22 lacs approx. (this can change based on the interest rate on PPF or performance of mutual funds)
How much will Ajay’s family get if they want their money in 15th year
Surrender value as per 15th year along with reduced bonus amount, should be somewhere close to Rs. 7-10 lacs.
Close to Rs. 10 lacs
What happens if Ajay wants to discontinue his life
insurance cover in between
Not possible; he will have to either close the policy itself, which will impact his investment part. Or he can make the policy paid up. Both insurance and investments are linked here.
Just terminate the term plan. Because investments are not linked to insurance, the insurance premium money can be diverted to investments now.
What happens if Ajay wants to partially withdraw
He can take a loan on the policy, but there are limits and restrictions.
If invested in PPF, he can partially withdraw after 7 years. If invested in FDs, he can break the FD and take
money from his policy and keep the
policy in force too?
the amount. If invested in mutual funds, he can
redeem the units anytime he wants.
Effort Needed Nil - Just continue what is going on. Looks
extremely tempting
High - Effort required to take a term plan, start the investment and get out of your comfort zone. Not for everyone!
Note - The alternate investments taken was PPF/fixed deposits/equity mutual funds. If invested in equity products, the results can be much better in Choice 2 as returns from equity in the long term are very good.
You will realise that this comparison is valid only when a person is in the initial phase of his traditional insurance plan. If a person is at the last phase of investment tenure and a big part of his policy tenure is over, it would make sense to make the policy paid up or just continue the policy, because the initial time is lost and the remaining time is not much (phase B). And it will be really tough to find out an alternative that will deliver enough returns to offset the loss by surrendering the policy (phase A).
So if you are doing this comparison, better do the math and find out which situation works in your case. Focus on other aspects also like liquidity, partial withdrawal aspect and simplicity. Returns are just one aspect and a much overemphasized factor by product sellers, but in real life, many things matter.
Coming to the point, here is an indicative action item table that you can use, but make sure you do the calculations yourself before taking any action.
Paid very few premiums (1-3) for the policy
Stop the policy
Paid 4 - 7 premiums Make it paid up and don’t make further premium payments
Near to maturity Continue the policy
So coming to your personal case now, you have understood how to think about the life insurance policy and what factors to look at while cleaning up.
List your policies and make a note of which policies you would like to discontinue and not pay further premiums.
Bad policies are an opportunity
When we do this exercise with our clients, some of them feel very sad that they took such a wrong decision and wasted so much time and money on bad policies. But then we tell them that they should look at them as opportunities.
They have to look at the scenario after they stop the bad policies. We tell them how the premium they were paying for their policies will suddenly be
“available” for them, and they will now have additional money (which they were putting in these policies), which can be used for other meaningful purposes like funding their financial goals. If one was struggling to generate those premiums, at least now he will not have that pressure in his life.
Your situation vs. your parent’s situation
The world today vs. your parent’s world is very different. There was a time when there were only traditional life insurance policies, there was a time when life was not that complex, there was a time when you had enough people to take care of your loved ones in case you weren’t there, and there was a time when a small cover was enough for your family.
Not anymore!
Times have changed and what looked like a good product to your parents might not fit you! Traditional life insurance policies were at one point of time the only option to invest for a common man, but not anymore. There are numerous alternatives and much better ones at that. So don’t get the notion that a product is always bad or always good. It depends on the time and the situation.
Now let’s move to the final task.
After most people start their career, in a few initial years, their net worth is not more than Rs. 5 lacs, Rs. 10 lacs or at best Rs. 20 lacs, so these kinds of numbers look good to them. When they buy a policy, these numbers look big enough, because they generally look at the return from the policies.
But is it big enough to replace you?
This person does not look at the life insurance number deep down, nor does he question how much help it will extend to his family for their whole lives.
Note, you will never come back, and your family will be there for next 30-50 years at least. Other than having food 3 times a day, is there not much to achieve in life? Assuming that Rs. 10-15 lacs will be enough for them is a joke in today’s world. I am assuming you still have a home on loan or don’t have a home at all and you also don’t have a great bank balance to show off.
So “how much life insurance to have?” is a simple function of what all you want to make sure for your family. Your ideal life insurance should be a number that can:
1. Meet your family expenses for several years.
2. Pay off your liabilities + loans, so that your family can concentrate ahead and not get tangled in these issues.
Now one way of doing this is through mathematical calculations; but do you want to really reach that perfect number? Do you want to be too precise?
Because that would call for some calculations, but a more simpler way of doing it is to approximate. The best thing about life insurance approximation is that the approximate numbers are as powerful as the perfect numbers.
Think about It, with calculations your life insurance number was Rs. 1.43 crores. Now suppose you take a life cover of Rs. 1.5 crores or Rs. 1.2 crores, do you really think that’s a blunder? Do you think that’s wrong planning?
No!
The whole idea is to get “decent” life cover”. Rs. 1.43 crores, Rs. 1.2 crores and Rs. 1.5 crores are all decent numbers and any of them is fine. It should just make sense and justify your case. So let’s approximate using this table assuming your situation.
We will assume 3 things.
1. E = your family yearly expenses in your absence (because you are not around)
2. Inflation you want to assume in long run (depends on how pessimistic you are about future inflation)
3. Returns earned by the insurance money that your family would put in some investments (preferably a fixed deposit most times).
Let’s assume that you want to plan for next 30 years. Hence, the life insurance requirement would be:
Insurance Requirement Table
all the numbers are approx
Now calculate the life insurance amount you need from this table. The best thing is that this number also takes care of inflation. So, the assumption is that your family will invest the money and expenses will be withdrawn from the pool of money each year, as the expenses will also increase as per inflation.
Example
Ajay’s family’s monthly expenses in his absence are Rs. 30,000 per month or Rs. 3.6 lacs per annum. He also knows that his family would put the insurance money into a fixed deposit, which will have an average return of around 8% per year. He also wants to factor in inflation of 8% over that period. Now if you see the table and match the returns (8%) and inflation (8%) column, you can see that it’s 30 times. So it would be 30 X Rs. 3.6 lacs
= Rs. 1.08 crores.
Ajay also has a liability of Rs. 20 lacs of outstanding home loan, and Rs. 40 lacs worth of investments in FD and cash in the bank. So his final life insurance would be Rs. 1.08 crores + Rs. 20 lacs - Rs. 40 lacs = Rs. 88 lacs.
Now this is a good enough life cover covering different aspects of his financial life. He can safely get this cover in Rs. 10,000-20,000 per annum.
Higher the age, higher the premium.
If you see carefully, this Rs. 88 lacs figure is just a number, which is a “good number”, though we tried to reach it using some logic. Still, if I were to tell his situation to you, you would say around Rs. 1 crore is a good amount of life insurance for him. Truly speaking, a person can just choose a number out of Rs. 50 lacs, Rs. 1 crore, Rs. 1.5 crores and Rs. 2 crores. Choose the one which looks logical to you and that you can mentally justify will help your family if you are not around. Don’t look for perfection; it leads to delays.
This table is so simple that you can instantly do your planning.
Don’t focus too much on the perfect number. All you need is a decent life insurance cover, which can deviate a little
here and there. Don’t pause your actions because of this.
Checking your life insurance
Your family’s current yearly expenses (E) Inflation you want to assume (6%, 8%, 10%)
Return on Investments assumption (6%, 8%, 10%)
How much times you need Life Insurance based on table above (F)
times
Insurance requirement (I) - E x F
Your current liabilities (L) (all outstanding loans)
Existing life insurance, which you will continue further (A) Existing Assets and Different Investment which can be used by family (better not include the house you live in) (B)
Final Insurance Required (I + L - A -B)
Final Outcome
Now let’s see the results of this chapter and what changes happened in your life insurance.
Criteria Before this
Chapter
After this Chapter Total Life Cover
Premium Paid
Premium Paid per Rs. 1 lac cover
Number of Insurance Policies
Bonus Tips
• Most term plans give a premium incentive for higher sum assured policies, so the premiums are generally cheaper for more than Rs. 50 lacs of sum assured. So, it makes sense to go for higher cover like Rs. 50 lacs or Rs. 75 lacs. At times premium for Rs. 40 lacs of term cover is higher than Rs. 50 lacs. So do check it out.
• You can surrender your policies by sending a surrender letter through post, which most companies accept. This will be helpful if your original branch is not in the same city where you currently live.
• In case of LIC policies, you can also get some information by SMS itself.
All you need to do is SMS “ASKLIC <Policy No>
PREMIUM/REVIVAL/BONUS/LOAN/NOM” to 56677 and you will get an SMS back with the relevant Information.
• When you buy online term plans, most companies give an option to do medical check-ups at home and this way you won’t have to personally visit any place.
• You can divide your cover into two companies (suggested if both of them are above Rs. 50 lacs). That way if you want to decrease your cover after some years, you can just stop one of them, it’s as simple as that.
The second step in your financial life is to clean up your other investments. In the first step, we cleaned up your traditional life insurance policies. In this chapter, we will talk about optimizing your other investments like Stocks, Mutual funds, ULIPs, Bank accounts, Credit cards, and Other Investment Products. Once this step is complete, you will have a much simpler financial life, after
which we move to more planning actions.
What happens if you are given a plain sheet of white paper and asked to draw something beautiful on that paper? You will first decide what to draw and then start the actual drawing, you will make sure what comes on paper is great and you will give your best. All your energy would focus on what you are drawing; your creativity will be at its best. Correct? That’s because you ONLY have to deal with the blank clean paper and apply your creativity.
Now imagine I give you the same sheet of paper, but it’s dirty, crumbled, and it’s torn a bit too. And a small kid has also scribbled all over it with black ink.
I give you that paper and ask you to draw something beautiful on that. Can you imagine the situation now?
How easy is to come up with something nice on that piece of paper? Not that easy, because now you need to clean it first! You need to work on the paper first; at this point, all your focus will first go in cleaning up the paper. You will also not be too happy about the whole thing; even if you are great at drawing, the fact that you have a rough, bad sheet of paper will kill all the excitement you have as a painter. The more dirt and scribbling on paper, the higher the chances you will spend more time in cleaning it, rather than imagining how to make a beautiful picture.
Your financial life is like that sheet of paper
Your financial life is very much like that sheet of paper. And each BAD decision is every single scribble and bit of dirt on that. Bad decisions mean DIRT! More bad decisions mean more dirt. I have seen so many people who carry such a bad financial life that it’s almost impossible at times to work on it. It really gets tough to give them any good suggestions. These people are amazing at their respective jobs, their area of work and they can really do very well in their financial lives too. But due to their past mistakes, they have really lost that charm in their financial life. They are full of messes! Now if these people have to do some kind of planning ahead, the first step is to clean their financial life.
How does your Financial Life look like!
The first step is to get rid of clutter and dirt from their financial life. The first step is to simplify it to some level first. In the previous chapter, we optimized the life insurance part because that’s one big area people mess up in a big way. So this chapter is all about cleaning up your messes and looking at how you can optimize your portfolio. We will look at mutual funds, stocks, bank accounts, credit cards and other kind of investments one by one.
Clean up 1 - Optimize your Stocks
The first area we will touch is stocks. Many people have some stocks in their portfolio. They may have bought it with or without analysis, but it is a part of many people’s lives and might be potential clutter. Now you can fall into one of the following two categories:
1. Serious investors looking for wealth creation
These investors have a serious interest in making money through stock market investments and they are very clear about the rules of stock investing.
They are not looking for quick gains and free tips that will make them fast money. They know that it’s not possible because of the simple reason that life is not that easy and making money can’t be that easy. These people study the tricks of the game, have a deep vision on how stocks and stock markets function, have controlled their emotions over the years and know how to make money over the long term. If you fall in this category, your stock portfolio does not need cleaning and you are in the right direction. You probably know better than me on this subject.
2. Investors looking for quick gains and excitement
The second category of investors actually forms 99% of the stock investor population. Their mind-set is to make some quick gains from stock market in a matter of weeks or months and sell their shares as and when they feel it’s a
“great profit”. I have seen many people who just after their first job, start buying and selling stocks in the hope that they would make some money.
They look at charts, stock prices, some analysis, but all their focus is on
“quick profits” and to be excited about trading in stocks.
These investors are those “who feel”, I repeat, “feel” that they can make a lot of money from direct stock investments “somehow”, but they do not do enough homework. They buy on tips from friends, on hearsay, randomly, and every other way you can imagine. They subscribe to several “SMS subscription” services and stock recommendation channels are their favourite channel. Many of these people keep on buying and selling stocks in the hope that someday they can label their “luck” as their “talent”.
I recently met a very senior head of one of the largest stock broking firms in India, who shared with me how small investors are taken for a ride by brokers and the tactics played by brokers to engage common public into direct stock investing, even when they know it’s only destroying most of them.