Unit Linked Insurance Plans - Good or Bad?

I was having a discussion with a colleague last week about Unit Linked Insurance Plans. The discussion was mostly focussed towards the returns from such plans and the Mutual Funds. He was emphasising on the fact that you get both insurance coverage and market linked returns. All I told him was one line - 

"Insurance is not an investment. It is expenditure."

I am going to tell you guys what ULIPs are and how do they work.Will keep it as short as possible.

What is a Unit Linked Insurance Plan (ULIP)?

A ULIP is basically a combination of insurance as well as investment. A part of the premium paid is utilized to provide insurance cover to the policy holder while the remaining portion is invested in various equity and debt schemes. The money collected by the insurance provider is utilized to form a pool of fund that is used to invest in various markets instruments (debt and equity) in varying proportions just the way it is done for mutual funds. Policy holders have the option of selecting the type of funds (debt or equity) or a mix of both based on their investment need and appetite. Just the way it is for mutual funds, ULIP policy holders are also allotted units and each unit has a net asset value (NAV) that is declared on a daily basis. The NAV is the value based on which the net rate of returns on ULIPs are determined. The NAV varies from one ULIP to another based on market conditions and the fund’s performance.

Fact - Most of us buy such products because one of our Uncles or Aunts is an insurance agent and we cannot say no to them. Has happened with me too. I am no exception.

What is the difference between a ULIP and a Mutual Fund?

Both ULIP and MFs are similar. However they are not the same. When we buy equity linked mutual fund units, our money is used to buy direct stocks. But when we buy equity-ULIP our money is used to buy mutual funds units which in turn buys stocks. So in ULIP, buying stocks is like a two step process, but in mutual fund it is a one step process. Moreover ULIP also provides insurance benefits. In addition to investment benefits ULIP provides life cover. Benefits of ULIP can be in either of the following ways:

• In case of death or maturity the insurance cover is paid to the beneficiary or,

• In case of death or maturity  the fund value is paid to the beneficiary or,

• In case of death or maturity both cover and fund value is paid to the beneficiary. So before finalizing on ULIP one must ask what type of benefits it offers

• In the form of tax deductions under section 80C of the IT Act

Now that we have discussed the benefits of ULIPs, let us see the disadvantages as well - 

1. In the initial few years, the costs of servicing your ULIPs are very high. They vary from 15 per cent to 65 per cent depending on the scheme and company chosen by you. What this means is that, if you invest Rs 100,000, only Rs 35,000 (65 per cent cut) to Rs 85,000 (15 per cent cut) will remain for actual investments after deducting charges

2. The cost of insurance keeps increasing every year as per your age. For example, if you are paying a mortality charge (that part of your premium that goes towards covering your life) of say Rs X when you are 30 years old, this figure can go up to Rs 2X by the time you are 40. And it keeps going up. The worst part is, since these amounts are deducted from the units, you do not see the impact of these charges on your NAV. Which is why a lot of people don't realise this happens.

3. You should read - http://www.rediff.com/getahead/2007/mar/23ulip.html

4. In any equity linked insurance product, fund management skills play a very important role. But the best fund managers in the Indian investment industry and in the world are found either working for mutual fund houses and not in insurance companies.

5. When investing in insurance, investors do not have a choice to change funds mid-way if the investments don't do well. In other investment options, investors can sell and move to a different investment.

6. Beware before you buy such bundled products (a mix of insurance and investment) like ULIPs. Ask yourself would it help if you keep your insurance and investment needs separate. While investment needs primarily seek decent returns, insurance needs are meant to protect your family or dependents in case of your death or permanent disability.

7. Remember, your insurance needs go down as your wealth increases. It helps to have a term plan that you can quit at any time without worrying too much about surrender charges and how much will you lose if you exit later. If you stop a ULIP plan in between, you pay a part of your accumulated money as charges for stopping the premiums. This is known as the 'surrender charge

Hence I would like you to focus on the following points -

1. If you want insurance, go for a term plan.

2. ULIPs can give you 12-15% returns over a longer period. However, mutual funds can give returns more than 15%.

3. There is flexibility of moving from one funds to another but that wont be the case for ULIPs.

Emergency fund – savings for that rainy day!

The one thing we can all be sure about life is to expect the unexpected. And the best you can do is be prepared for those unexpected emergencies. Continuing my last article, let us talk about financial emergencies.

How does a financial emergency arise?

Financial emergencies can come in the form of a job loss, significant medical expenses, home or auto repairs or something you’ve never dreamed of. The last thing you want to do is be forced to rely on credit cards or a loan which could simply compound the problem.

How to protect ourselves from such emergencies?

The answer is simple. Create an emergency fund.

What is an emergency fund?

In simple words, emergency fund is the amount set aside to meet all your financial requirements during emergencies.

Where is your current status of emergency fund?

As far as my experience goes, most of you working people are not setting aside money in a systematic manner. Hence, most of your salaries would be lying idle in your savings account or fixed deposits at the max. This means you’ve already created your emergency fund. Congratulations!

How much is enough?

The rule of thumb is to park your 3-6 months of your salary. And if the number of dependents are more, park more than 6 months of your salary according to your requirements.

Where should you park the money?

Emergency funds should be easily accessible and be easy to withdraw. Hence, it should be maintained in cash or cash equivalent form which could be in the form of Fixed deposits or in a liquid fund account in mutual funds. Savings account is not advisable since the amount of interest rate is low.

How to create?

Once you have decided on the amount, do not try and save everything in one month. Do it gradually. Start saving monthly. You could park it in savings account or in a recurring deposit to meet your required emergency fund. Recurring deposit is advisable for greater returns.

Final words

The best way to maintain a healthy emergency fund is not to touch it until you have an emergency. Don't withdraw cash from your emergency account to fund your unnecessary expenses or for buying something which you like. Never allow your instant gratification instincts to play a part in withdrawing from your emergency fund you accumulated over the years. If you have any major expense, see if you can postpone it to the next month rather than funding it with your money set aside for emergencies.

Further, Monitor your budget periodically and make sure that your emergency fund is always at the optimal levels. Whenever there is a change in your financial situation, make sure you revisit your emergency fund requirements and make the required changes. This helps in maintaining a healthy fund to counter unnecessary debts during emergencies.

Feel free to ask any questions. I would be glad to answer. Cheers!

Six steps to financial planning

In this post, I am going to list down the steps all of you must take to secure your finances no matter how much you earn. It won't be elaborate. Very precise and to the point. Following are the few steps you should take -

1. Find out where does all your monthly income go?

Make weekly expense charts under different heads such as conveyance, entertainment, food, rent etc. Track your expenses for at least three months and see the pattern of your expenses.

Here, do not worry. You only need to track your cash outflows and not get rid of them. But one thing you must do is segregate your necessary vs. unnecessary expenses and calculate how much you can save each month and in the next 12 months.

2. Assess your current financial situation. Create a list of your assets and liabilities. This will help you in your financial planning and goal creation.

3. Now that we have identified the cash inflows and outflows, ask yourself the following questions -

a. Have you set aside an emergency fund?

b. Do you have adequate health insurance?
c. Do you have adequate life insurance?
d. Have you planned for your retirement? (you might wonder who plans for retirement in 20's right? Trust me, start saving early, compounding does wonders in the long run. There is a reason why it is called the eighth wonder of the world)
e. Have you planned for your other goals in life? For example - your wedding, your car, your children's education, your first home etc.)

4.The  important question is how much is enough. I will write detailed posts on each of the above. However, for you to begin with -

a. Emergency fund - six months of your salary
b. Health insurance - this would depend on various factors. Depends on your ability to pay premium, your medical expenses in the past, medical conditions, age etc.
c. Life insurance - generally 10 to 12 times of your annual earnings. Remember, when we talk about insurance, its strictly term insurance and not any other form of insurance.
d. Retirement and other savings - This would depend on your goals. set those goals, there are plenty of calculators available online to help you. But please remember to set achievable goals. How can you achieve these goals? There are plenty of routes depending on your tenure. Direct equity and Mutual funds for long term, mix of equity and debt for medium term and debt for short term.

5. This is the most important step. This is the time to execute and implement. The steps listed above are basic minimum steps towards financial freedom. Don't be lazy and start working towards it.

6. Monitor your goals. This step must be performed annually and hence would come much later.

Read this post for more than one time. Understand the requirements. You may also do a Google search for the importance of each item in the financial planning process.

My following posts would be why we need all the above, how to proceed and where to go. Each one of them would be discussed individually.

Feel free to give suggestions / improvements.

Cheers!

How to check EPF balance online?

A lot of us do not have even an idea on how much money we have in our Employee Provident fund account (EPF) and how to check EPF Balance online or offline. So in this post we will see how one can check his EPF balance online and get the details back through sms. 

How to check your EPF balance online ?

Go to this EPFO website link

There will be a link below the page to check your EPF account balance status online , click on that (direct link)

You will see a drop down there to select the PF Office State ( like Maharashtra, Karnataka , Delhi etc) . Select your PF office .

Once you select the State , you will see a list of different cities office, like for Karnataka , you can see one of the options as “Bangalore” along with the “data available upto” date , so you can get your PF balance till that date only .

Choose the city office

You will be taken to the page where you will have to fill in EPF account number , Your Name and mobile number and Submit.

How to enter your EPF account detail ?

For an example lets say Manish Chauhan worked in Bangalore and had a  Employee Providend Fund account with number KN/62345/876 . This name “Manish Chauhan” is the name appearing in EPF slip .

In that case 62345 will be the Establishment Code (which will be first blank column) and 876 will be the account number (third column) . The second column will be blank in most of the cases , it’s actually the sub code or extension of the establishment code.

Important Points

Note that the name should be exactly same as it appears in EPF slip

The office and state have to be selected properly , In a single start there can be many offices , make sure you choose the right one.

The SMS can come a little late , so please be patient

The amount can be only upto a certain date which will be mentioned in the SMS.

Auto Sweep Account – Enable it in your Saving Bank Account

Do you have a Bank Account? Off-course you do! How much money do you have in your account? 5,000? 20,000? or a few lacs? If you have a lot of cash, lying idle in your Bank Account, and at the same time you don’t want to commit to long-term investment, you need to enable the Auto-Sweep facility in your Savings Bank account. This will make sure you earn good interest on a major part on the cash lying in your Savings account.

What is Auto-Sweep Account ?

“Auto Sweep” is a facility which provides, the combined benefits of a Savings Bank account and Fixed Deposits. Auto-Sweep facility interlinks your saving bank account with a Deposit account and makes sure any extra amount lying in your bank account above a threshold limit is automatically transferred to Fixed deposits and you earn better interest on your money.

How ‘Auto Sweep’ works?

This is how Auto-Sweep works. You define a “threshold limit”, and money up to that limit will be in the form of cash in your savings account and any amount above this, “limit” will automatically be converted into a Fixed Deposit and you will start earning normal FD returns on that part of the money. At any point in time, if you need money more than is lying in your bank account, the money lying in the Fixed Deposits is Reversed-sweeped into your savings account and you can withdraw the amount you wish.

Example

Ajay opens a new Savings Bank account with SBI. He enables Auto-Sweep facility on his savings bank account and defines the threshold limit of Rs 30,000 . Now suppose he has Rs 10,000 lying in the bank, He will be earning normal 3-3.5% interest on this money. After that if he deposits Rs 60,000 in his account, his total balance would be 70,000. But as this is above his “threshold limit”, the extra amount of 40,000 will be converted into a fixed deposit automatically and start earning returns equal to normal Fixed deposits with SBI (for example 8%). This way he always has 30,000 in his account for his daily requirements, and he has 40,000 converted into Fixed deposits which again is available to him incase he requires it.

Now suppose he has to withdraw 10,000 from his account, he will actually withdraw it from the cash lying in saving bank , and his balance will reduce to 20,000. However on the other hand if he wants to withdraw Rs 50,000 . then in that case, as his account balance will be just 30,000, an additional Rs 20,000 will be auto-reversed from his Fixed Deposit and he can withdraw total 50,000 .

Opportunity cost

A lot of us don’t bother about how much idle money is lying in our account and for how long. This happens because we think “I might need it soon, so lets not commit to any investment.” But then, the money keeps lying in the bank for months and months and sometimes even years.

Suppose your account has Rs 1 lac for 1 year, it will earn 3.5% interest on it, which is Rs 3,500 for a year. However if you have auto-sweep enabled in your savings account with threshold limit of Rs 20,000, the additional 80,000 will actually be in form of a fixed deposit and it will earn an interest of 8% (assumption). In this, you will earn 3.5% of 20,000 which turns out to be Rs 700 and 8% of 80,000 which is Rs 6,400 , a total of 7,100 , which is almost 100% more than the first case .

A lot of people have much more than 1 lac in their accounts, not just 1 lac. You can earn some extra returns if you just enable auto-sweep on your saving account . So find out if your bank provides the facility, just do it, and get it right away!

Also note that different banks have different names for this facility. For eg., ICICI Bank calls it ”Auto Sweep” , HDFC Bank calls it “Sweep-In” account , and SBI calls it “Saving Plus.” . Here is a list of other banks and the name by which they call this Auto-Sweep facility (thanks for Gopal Gidwani for the info)

IDBI Bank – Sweep-in Savings Account

Axis Bank – Encash 24

Union Bank – Union Flexi Deposit

HDFC Bank – Super Saver Facility

Bank of India – BOI Savings Plus Scheme

Oriental Bank of Commerce – Flexi Fixed Deposit Scheme

State Bank of India – Multi Option Deposit Scheme

Allahabad Bank – Flexi-fix Deposit

Bank of Maharashtra – Mixie Deposit Scheme

Corporation Bank – Money Flex

United Bank of India – United Bonanza Savings Scheme

Disadvantages of Auto-Sweep Account

Auto-Sweep has some disadvantages too. In general the interest rates of normal fixed deposit and FDs under Auto-Sweep are same, but some banks charge a penalty if the FD under auto-sweep accounts are broken before some duration like 1 yr and 1 day . But I think that’s fine.  If not 8% , you will at least get 7%, still better than 3.5% .

Some banks are also known to give simple interest on the Auto-sweep Fixed Deposits and not compound interest as in case of normal fixed deposits .

Don’t over do it

While Auto-sweep is a wonderful thing for salaried class people who want to maintain liquidity, as well as want to earn more interest on their unused money, one should not over do it. If you are very sure that the money lying in your account will really not be used for long, better to use the normal Fixed deposit or Debt funds. Only if you are unsure of your money lying in bank and when you might need it, you should be using Auto-Sweep facility.

The way auto-sweep works, it makes it an ideal place to park emergency funds . So if you have kept 6 months of expenses as your emergency fund in Saving Bank, then you can enable auto-sweep facility and set threshold limit as 2-3 months of expenses, so that rest of the money can earn a better interest.

Cheque Truncation System – New Benchmark for Cheques in Banks

It might happen that your cheque’s start bouncing and do not get accepted from Jan 1, 2013 . There is a new standard in banking called as Cheque Truncation System or CTS 2010 , which all the banks have to follow now. RBI has issued a cricultelling all banks that they should only process and accept those cheques which follow CTS guidelines.

What is cheque truncation system or CTS?

Its just a new improved structure for chqeues and a set of guidelines which will change the way cheques are being processed and cleared. Right now, all the cheques are sent directly physical to the other bank for clearance, but with this new Cheque Truncation System guidelines, the banks will send the digital version of cheques (read scanned image) to the other bank and the clearance will happen almost same day or very fast. Some of the features of CTS cheques would be

·         It would have the wordings “please sign above this line” at right bottom

·         All CTS-2010 cheques will have a watermark with the words “CTS INDIA”, which can be seen against a light

·         A bank logo will be on cheque with a Ultra Violet Ink , which can be seen only under UV Scanners.

·         The Cheque Truncation System 2010 enabled cheques will not allow any alterations. If there is any mistakes, the cheque will be invalid

·         “payable at par at all branches of the bank in India” text will be at the bottom of all the cheques

·         There will be IFSC and MICR code on the cheque

·         You will have to sign the cheque will a darker ink, so that your signatures are valid for scanning.

If you look at these features, you can simply see that these are required for digital processing and once these Cheque Truncation System enabled cheques arrive , the whole banking system will start clearing the cheques in a must faster time. This will improve banking and save paper . 

You already have CTS compliant cheque books?

Note that RBI has directed all banks to issue Cheque Truncation System 2010 enabled cheque books already from last many months. So it might happen that your cheque books are already complaint with those standards . So please check it once and dont rush to bank to issue you new cheque books . 

Exchange Traded Funds

Exchange Traded Funds (ETFs) have been in existence in India for quite some time now. But so far ETFs have not enjoyed the kind of popularity that the conventional Mutual Funds enjoy. One reason could be the lack of understanding of the concept of ETF amongst the general investor and also most people lack the awareness about the existence of such funds. In this post, let us understand what are exchange traded funds, how they work, their pros and cons.

What are ETFs?

As the name suggests, ETFs are a mix of a stock and a MF in the sense that 

·         Like mutual funds, they comprise a set of specified stocks e.g. an index like Nifty/Sensex or a commodity e.g. gold; and

·         Like equity shares they are traded on the stock exchange on real-time basis.

How does an ETF work?

In a normal fund we buy/sell units directly from/to the AMC. First the money is collected from the investors to form the corpus. The fund manager then uses this corpus to build and manage the appropriate portfolio. When you want to redeem your units, a part of the portfolio is sold and you get paid for your units. The units in a conventional MF are, therefore, called in-cash units.

But in ETF, we have something called the authorized participants (appointed by the AMC). They will first deposit all the shares that comprise the index (or the gold in case of Gold ETF) with the AMC and receive what is called the creation units from the AMC. Since these units are created by depositing underlying shares/gold, they are called in-kind units.

These creation units are a large block, which are then split into small units and accordingly bought/sold in the open market on the stock exchange by these authorized participants

Therefore, technically every buy and sell need not change the corpus of an ETF unlike a conventional MF.

However, as and when there is more demand, these authorized participants deposit more shares with the AMC and get more creation units to satisfy the demand. Or if there is more redemption, then they give back these creation units to the AMC, take back their shares, sell them in the market and pay the investor. 

All this may seem to be a bit complicated and time-consuming. But, in effect, it is all system driven and hence happens on real-time basis with minimal effort & cost.

Benefits of investing in ETFs

·         Convenient to trade as it can be bought/sold on the stock exchange at any time of the day when the market is open (index funds can be bought only at NAV based on closing prices)

·         One can short sell an ETF or buy on margin or even purchase one unit, which is not possible with index-funds/conventional MFs

·         ETFs are passively managed, have low distribution costs and minimal administrative charges. Hence most ETFs have lower expense ratios than conventional MFs

·         Not dependent on the fund manager

·         Like an index fund, they are very transparent

Disadvantages of investing in ETFs

·         SIP in ETF is not convenient as you have to place a fresh order every month

·         Also SIP may prove expensive as compared to a no-load, low-expense index funds as you have to pay brokerage every time you buy & sell

·         Because ETFs are conveniently tradable, people tend to trade more in ETFs as compared to conventional funds. This unnecessarily pushes up the costs.

·         You can’t automatically re-invest your dividends. Secondly, you may have to pay brokerage to reinvest dividends in ETF, whereas dividend reinvestment in MFs is automatic and with no entry-load

·         Comparatively lower liquidity as the market has still not caught up on the concept

It may, therefore, be concluded that if an investor is looking for a long-term and defensive investment strategy in equities by backing the index rather than looking at active management, ETF offers an alternative to index-based funds. It offers trading convenience & probably lower costs than index funds. A case-to-case comparison is, however, important as some index-funds may be cheaper. Also for SIPs, index-funds may prove better than ETFs.

However, in the absence of conventional MFs like in Gold, ETFs is but a natural and better choice than buying/selling physical gold.