4 Hygiene factors to be in place prior to entering the world of Investing.

April 26, 2020

As many of you would be aware , I follow Muthu sir , one of the well known handles on Twitter for his sensible approach towards Investing .This blog post is my humble attempt at creating Financial literacy on 1 of his tweets.

We often come across stories of people from "Rags to Riches" in markets and become so enamoured by it. Who wouldn't ! Afterall , we all wish to earn easy money and lead a comfortable life. What we don't focus on is the reverse " Riches to Rags" story (which happens a lot ) and is of utmost importance as we get to learn from the mistakes of others*( More on this in my upcoming blogs !)

However before we begin the journey of investing in markets there are a few things we need to have ticked off from our financial checklist to ensure we sail through turbulent times of illiquidity, smoothly.

In this blogpost I shall throw light upon the areas which need our focus prior to investing in markets. These shall serve as a precursor to all aspiring investors out there .

Once we ensure we have liquidity, life becomes tolerable even during a catastrophe!

WITHOUT THESE ONE SHOULD NOT BE ENTERING MARKETS IDEALLY .

Savings

One must inculcate the habit of saving , early on in life. ONLY if we save, we shall have SURPLUS.

Once we enforce this, we can ensure we have a surplus at our disposal by the time we turn say 25-27 years old . With good planning we can use the surplus judiciously for one's marriage without having to take any type of personal loan . A simple wedding without causing any undue stretch on our purse strings should be opted for . The money saved here can be utilised for post marriage expenditure. Believe me when I say the expenses shoot up a lot !! :)

1) Term Insurance
Once our Education loan is repaid and Marriage expenses are done with , one must ideally start planning for a good Term Insurance . Our spouses may / may not be financially independent . Regardless, one must get this done ASAP.

What is Term Insurance ?

It is a life insurance product which offers financial coverage to the policy holder for a specific period of time. In case of death of the insured individual during the policy term, the sum assured is paid by the company to the beneficiary(nominee).

The purpose of taking life insurance is to provide life cover to the policy holder and financial security to his family.

A few pointers here :

i) Think about your life stage ( which point in life are you currently - Married , Married with children etc) and number of family members when determining the cover amount.

ii) Estimate how much monthly expenditure would be required to run the family affairs smoothly . Include the amount outstanding on all your loans ( 4 wheeler , 2 wheeler , housing loan etc)

iii) Cover amount should be in totality . A sum total of entire family's needs .

iv) Premiums paid towards a Term Insurance plan qualify for tax benefits under 80C.
v) The maximum permissible cover depends on the earning span of the individual. Hence its subjective.

In the event one has purchased a house on loan recently , it becomes mandatory to take a Term Insurance cover which includes the outstanding home loan amount . WHY SO?

In the event something untoward happens , the house will be safe and will not be taken over by authorities for non payment of EMI'S.

2) Get a good Medical cover .

What is Health Insurance ?

Health insurance is a type of insurance coverage that covers the cost of an insured individual's medical and surgical expenses . One can opt for a good cash less insurance policy for a hassle free experience. Medical expenses at good hospitals are sky rocketing and it makes lot of sense to ensure this expenditure is kept at a minimal by opting for a comprehensive health cover policy.These days many employers provide Group Insurance.However it is prudent to have a personal cover as well .

A few pointers here :

i) Go in for a reputed provider once you decide your requirement .

ii) Assess the requirement , whether you need an individual plan , or a family cover or a floater policy or even a maternity insurance ! The need shall determine the selection .

iii) Keep increasing the cover with increase in age.

iv) Health Insurance policy offers tax benefits under 80D.

3) Accident and Disability cover

As the name suggests it would keep you financially secure in the event of an accident or a disability. But why is there a need for a separate accident cover ?
Now while Term Insurance covers death by accident, it doesn't include total / partial disability due to an accident .
The standard insurance does not cover disability. So imagine the ramifications financially , if one gets hurt in an accident and is unable to work a while or gets permanently disabled ! Moreover the recurring cost of rehabilitation would completely cripple the household.

This is an often over looked concept and to be absolutely secure one should opt for an Accident and Disability cover as well despite the fact that there are no tax exemptions on premium paid here.

4) Emergency Funds.

We all are aware of this as the name itself is self explanatory .These funds are to be used in the event of an EMERGENCY ONLY . Today's world is extremely unpredictable given the pace of globalisation and obsolescence. Add to it the current pandemic and the effects of it on global economy !

A few pointers here :

i) We often tend to under estimate our requirement .The fund requirement depends totally on the stage of life we are in and it can only increase as we grow old !

ii) Setting aside a month's salary IS NOT Emergency funds . One needs a sizeable corpus. A year's worth savings at the least.The recent lay offs should be an opener for many .

iii) DO NOT park the funds in Equity (be it even Blue chip companies) and say it shall be withdrawn when required. Meanwhile let it earn some money ! The prima facie reason one keeps Emergency funds is for sudden requirement !

The recent fall in markets should be a great lesson if one has any such plans .(Remember Yes Bank? )

iv) INCREASE the fund amount annually in sync with inflation or any additional lifestyle changes to suit your comfort level.

v) One can park these funds in a Fixed Deposit. Ensure you make different F.D's of varying amounts so that in times of requirement the entire F.D amount need not be broken. Given the current circumstances , it is recommended to park funds only in banks insured by DICGC . Also since the maximum deposit amount insured by DICGC ( includes Interest also) is only 5lakhs , it makes more sense to spread out the funds in excess of 5lakhs in different banks to ensure maximum safety .

vi) NEVER compromise on security of your principal amount just to earn 2-3% more interest in Co-operative banks . ( Remember PMC bank ordeal ?)

vii) Never take an insurance policy for TAX BENEFITS purposes ONLY !

Key Takeaways

Be Debt free
Save wisely .It is a continuous process.
A Term Insurance and a comprehensive Health Insurance are equally important and are mutually exclusive. Opt for both.
Emergency funds are to be parked safely and used only during times of illiquidity. It should provide for accidents as well.
Review yearly and increase allocation as per needs.

To sum up, The journey to Financial Independence is akin to laying plinths for constructing a sky scraper . The building shall stand unaffected during a calamity only if the plinths go deep inside the ground and there are shock absorbers installed in critical places . Financial literacy is our plinth in this journey with Liquidity as our shock absorbers as we go about to build our sky scraper of compounding wealth via Investing to attain our ultimate goal of Financial Independence!