Month: October 2020

How a family can plan its finances holistically

Personal Finance

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The necessity of having a good plan to manage family money cannot be overstated. Having a holistic plan is necessary but not sufficient condition to preserve and grow wealth and achieve family goals. At best, it should act as a guard rail and guiding post for the next turn and not the entire journey.

Also read: How a senior citizen can generate more income amid low interest rates

A holistic plan is one which is prepared for most possible outcomes (internal and external) and considers both behavioural and analytical aspects of decision making.

Nassim Taleb puts it brilliantly: “If you want to figure out how a thing works, first figure out how it breaks.” If we study the reason for wealth destruction in families, mostly it is internal rather than external. Greed, hubris, imprudence create more harm to family wealth than war, inflation or recession.

Need for clarity

Primium non nocere – First, do no harm. The first step towards a holistic financial plan is having clarity on what is really needed for the family. Both the family and planner have to work hard to get their thinking clean and make it simple. A few goals such as children’s education and marriage, and retirement are common to every one’s life and should be part of the plan.

Also read: Things to keep in mind while exchanging your old gold jewellery

Other goals such as vacation, second home, starting a new business, early retirement etc are very personal and need to be really thought through. In essence, beyond some technicality, financial planning converges with life planning and becomes a sub-set of it. Amazon founder Jeff Bezos said: “Focus on what will not change in 10 years rather than thinking what will change.” This is a great piece of advice for anyone who is taking the first step to create a plan.

Risk and volatility

Another important aspect of holistic planning is the concept of uncertainty, risk and volatility. It applies greatly to financial planning. Investing in markets is dealing with a complex system where everything affects everything else and the systems are in perpetual motion. Also, global markets are linked with each other due to financial integration. All this make investing challenging.

Hence it is important for the family to know the following things. Volatility is an expression of risk and not risk by itself. Risk is something you can put a price on. Odds are known and one can budget for it. Uncertainty is hard to measure and cannot be budgeted or accounted for.

The important thing to note is that risk can be budgeted but uncertainty can only be embraced or hedged. To start with, a family should assess how much risk capacity the plan allows for and how much risk tolerance it has.

Also read: Your Taxes

For instance, if one of the goals is to buy a car in the next six months, the risk capacity permitted by the plan is the least. Also if the family is really uncomfortable seeing 5 per cent erosion of capital on a temporary basis, the risk tolerance is very less. There are a lot of tools available to help families/planners with psychometric testing to determine risk profile.

Investment framework

Once the financial objectives are defined and risk assessment is done for the family, the next step is to create an investment framework. In essence, an investment framework should help realign long-term capital to long-term assets, after budgeting for short-term liquidity requirements and contingencies. This is an important decision making node for the family/financial planner where they have to decide on asset class participation, allocation and its location.

Also read: How work from home can impact your tax outgo

Asset class Participation: Often it is asked as to why one should have diversification across asset classes. Quoting Warren Buffet, “Diversification is a price we pay for our ignorance.” Uncertainty cannot be budgeted for; it can only be hedged or embraced. Hence diversification across various asset classes helps a family to hedge future uncertainty and prepare the portfolio for various economic outcomes.

The important pillars of asset class participation are real estate, equity, gold and debt (not in any order). There are other asset classes such as private equity, art and passion investments. These asset classes should be evaluated if one has expertise of subject matter and time on hand. Also, most of these other investments have liquidity constraints and hence one should think very prudently before making them a core part of the investment allocation. An important objective of any plan is not to be asset rich and cash poor.

Asset Allocation: Deciding on the percentage of capital to be allocated to an asset class is a function of risk assessment done for the family. Analytically it is a very simple exercise but is the most difficult concept to execute in practice. Studies suggest if one does attribution analysis for investment gain from a diversified portfolio, 91 per cent of the gain can be attributed to asset allocation. Right execution of asset allocation is one of the cornerstones of any financial plan and its success.

One of the observations is that if any asset class does not give par return for 3 to 5 years, ownership in the portfolio goes down significantly or becomes zero. The recent example is having gold in a portfolio as a protection asset. Since gold didn’t perform well from 2011 to 2017, it had a negligible presence in most of the portfolios. A practical hack to this problem is to stay away from narrative and stories. The human mind is more susceptible to stories than facts. Most of the narratives and stories are post facto and after price performance.

Asset Location: Deciding on ownership of assets and how it is located is also very important. We believe one should be open minded and do the full spectrum of analysis on available opportunities. In each asset class there are multiple choices available to align investments with financial objectives. If the portfolio is in need of regular income, maybe bonds are a better option but if liquidity is required debt mutual funds will serve the purpose.

If one wants to build long-term annuity, options such as REIT and InvIT should be explored. Direct equity ownership can be explored if one is building a long-term intergenerational portfolio and has active involvement. The point to ponder is what choice will help you opt for simplicity over sophistication and still achieve your objective.

Maintenance matters

It is a fact that disproportionate energy goes in building something rather than maintaining it. Maintenance is underrated and building is overrated; hence, the key to success is maintenance. After the creation of a financial plan and investment framework, regular diligence (at least quarterly) with your advisor and rebalancing prudently is perpetual work-in-progress. It is very difficult to re-balance the portfolio in panic and mania. About 90 per cent of investors failed to re-balance portfolios in favour of equities in March 2020; reason: Fear.

Today it is equally difficult to re-balance to reduce allocation to Nasdaq if it has become overweight; reason: Greed. These are a few examples of how behavioural aspects impact portfolio outcome more strongly than external events. In times of crisis or euphoria only framework works; willpower gives up.

As in other aspects of life, the key to success lies in execution. There are some time-tested principles and learnings which can help execute plans better:

  • Have a long time preference – The only sustainable and real big edge that families have against big institutions is long-term investment horizon.
  • Distinguish between desirable and attainable. Most investment success also depends on initial conditions and hence this distinction will help family set realistic goals.
  • Do not underestimate liquidity. Having assets which provide liquidity during tough periods is a game changer.
  • Wu Wei is a philosophy of passive achievement. Often, in investing, a bias for inaction — rather than constant churning — helps.
  • Often decision making will happen between ignorance and knowledge, hence thinking probabilistically will be of immense value.

Holistic financial planning in essence is about finding your own equilibrium. This will protect the family from internal and external headwinds and help creating wealth in good times.

Lastly, festina lente — make haste slowly

The author is CEO and MD of TrustPlutus Wealth Managers (India)

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Readers’ Feedback – The Hindu BusinessLine

Personal Finance

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I read the article ‘Will employees gain if gratuity rules are tweaked?’ that appeared on BusinessLine sometime back. If you serve more than six months in the last year of employment, it is considered as a full year of service. So, if a person completes four years and 181 days in the fifth year, will the person be eligible to claim gratuity? Is 180 days considered six months?

John

Our response: In general, if you stay on with your employer continuously for five years or more, you are eligible to get gratuity.

But there are exceptions and legal rulings that relax the five-year continuous service rule to be eligible for gratuity. One, the rule is waived if an employee dies or is disabled.

Next, the Madras High Court in the Mettur Beardsell case had ruled that if an employee completes four years and 240 days in service, he will be eligible for gratuity.

So, to your query, if a person completes only four years and 181 days in the fifth year, he would not be eligible for gratuity.

But once a person becomes eligible for gratuity as per the above rules, the number of years of completed service to determine the gratuity amount as per the Payment of Gratuity Act takes into account the service of more than six months in the last year of employment. So, if you serve more than six months in the last year of employment, it is considered as a full year of service to determine the gratuity amount. For instance, service of 20 years and seven months will be considered as 21 years.

This is in the context of the article titled ‘Why the stock of Muthoot Finance is a good buy’ that appeared on BusinessLine on October 19.

It could be a perfect buy in this situation — very less risky counter. It can be averaged at various levels for the long term. Good point, Ms Keerthi.

Bala Krishna

‘All you need to know about IPO allotment’ that appeared on BusinessLine on October 20 was well-articulated. I stopped applying to IPOs long back, after several bitter experiences of non-allotment.

TS Thiruvenghadam

Regarding the ‘buy’ call on Muthoot Finance, gold loans picking up does correlate to rising gold price, but the after-effects are disastrous if the gold price falls.

Shailesh Desai MD

Our response: Muthoot’s average loan-to-value is at 54 per cent. Additionally, the loans are of shorter tenures, which should provide sufficient cushion during a falling-gold-price scenario.

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Things to keep in mind while exchanging your old gold jewellery

Personal Finance

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When purchasing gold, we often exchange our seldom-used ornaments to reduce, at least to an extent, the total spend. If you have plans to exchange your old gold for new this festival season, here are some factors you should consider before you take the plunge.

No right time

If you think you will get a better deal if you exchange your old gold (in the form of jewellery or bar) when the gold prices are high, you are mistaken. This is because the gold you are exchanging and the new gold will buy are valued at the same price, which is the prevailing market price.

Whether the gold price is at ₹4,000 per gram or ₹5,000 per gram, you can always exchange your old gold ornament for the same quantity of new gold ornament at no additional cost (except making charges and taxes).

Having said that, we usually tend to buy more gold (in weight) than what we exchange. Thus, you will be better off buying gold (with or without exchange) when gold prices are lower.

Purity check

While exchanging gold, the timing of exchange doesn’t matter much. What matter is the weight and purity of the gold you are trading off.

Jewellers use a jewellery weighing machine and an assaying machine to determine the weight and purity of the gold you offer, after removing any stones and other embellishments.

If you would want to cross-verify if these metrics are assessed correctly by the jeweller, you can do so, if you have the invoice of the gold you are exchanging .

Of course, if your old gold is hallmarked, the details of the purity of the gold would be mentioned on the item itself. Hallmarking of gold is done only for three levels of purity — 22 karat gold (22K916), 18 karat gold (18K750) and for 14 karat gold (14K585).

A pure gold bar would be of generally 24 karat purity.

N Anantha Padmanaban, Managing Director of Chenna-based NAC Jewellers, says there is no need for customers to test the purity if the gold is hallmarked and brought from a reputed gold showroom.

Say, the gold you want to exchange is not hallmarked, you can request the jeweller to display the purity test results.

GR ‘Anand’ Ananthapadmanabhan, Managing Director of GRT Jewellers, another Chennai-based player, says the gold given for exchange with his firm will be melted and tested using an XRF machine right in front of the customers, if they request for it.

Following the acceptance of terms of the weight and purity of the gold exchanged, take a moment to notice the gold rate used to value your old gold.

If the gold being exchanged is of 18 karat, but the gold being bought is of 22 karat, the applicable gold rate to value the old gold should be the gold rate for 22 karat x (18/22).

For example, if the rate charged for the 22 karat gold you are buying is ₹5,000 per gram and you are exchanging 18 karat gold, your old gold should be valued at a minimum of ₹4,090 (5,000 x 18/22).

But if you are exchanging gold of 22 karat purity, it should be valued at the same ₹5,000 per gram.

Wastage on total value

Note that while the value of exchanged gold will be deducted from the cost of your new ornament, the making and waste charges (otherwise called ‘value addition (VA)’) and taxes (SGST and CGST — each of 1.5 per cent) shall be calculated as a percentage on the original vale of the new ornament and not on the deducted value.

For instance, say the value of the gold in the old ornament exchanged and the new ornament is ₹1 lakh and ₹2 lakh respectively. Your total cash outflow would be ₹1 lakh (₹ 2 lakh – ₹ 1 lakh) plus VA of ₹20,000 (say, VA is 10 per cent-then 2 lakh x 10 per cent) plus taxes of ₹6,600 (GST of 3 per cent on new ornament value plus VA). That would be equal to ₹1,26,600.

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How a senior citizen can generate more income amid low interest rates

Personal Finance

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Mr Ramesh is 70 years old. He is retired and has no financial dependents. He has been a very conservative investor and has never invested beyond bank fixed deposits, provident fund or insurance policies.

His total portfolio is about ₹1 crore. From this portfolio, he has maximised investments in Pradhan Mantri Vaya Vandana Yojana (PMVVY) and Senior Citizen Savings Scheme (SCSS). He has invested ₹15 lakh in each of these schemes. The remainder of his portfolio (₹70 lakh) is in bank fixed deposits.

The SCSS and PMVVY schemes give him an annual interest income of about ₹2.25 lakh per annum. His requirement is about ₹50,000 per month or ₹6 lakh per annum.

Until now, the interest rate from bank fixed deposits was comfortable enough to bridge the deficit amount (about ₹3.75 lakh). In fact, Ramesh was able to save some money from his interest income, which was also helping his portfolio grow. He hoped this slow growth in portfolio could at least match the inflation in expenses to some extent.

The bank fixed deposit rates have gone down in the recent past. This means his bank fixed deposits will be renewed at lower interest rates, resulting in reduction of income.

Ramesh is worried that he may not be able to sustain on such low interest income and his portfolio may start depleting. Smaller portfolio means lesser income and greater deficit, which needs to be funded by breaking fixed deposits. This can become a self-reinforcing cycle and his portfolio can deplete fast.

Ramesh is looking for a high-income product with low risk.

Recommendations

Let’s look at the options.

Ramesh can go with corporate fixed deposits that may offer a higher rate of interest than bank fixed deposits, but he is not comfortable with credit risk of corporate fixed deposits. Debt mutual funds won’t suit him for the same reason. Moreover, at his level of income, tax efficiency of debt funds does not come into picture either.

Another option is to go with potentially higher-return products such as equity funds, but such products come with higher risk of capital loss. Moreover, since Ramesh needs to withdraw from this portfolio, adverse market movements can make rupee-cost-averaging work against him. Thus, at his age and with his risk appetite, this may not be a good choice. Also, Ramesh is not comfortable with this option.

A third alternative is to open bank fixed deposits with newer banks that are offering a higher rate of interest, but Ramesh is not comfortable with this option either.

Given this background, in our opinion, Ramesh must explore purchasing an immediate annuity plan without ‘return of purchase price’. In this variant of annuity plans, the insurer does not return the investment amount or the purchase price to the investor’s family in the event of investor demise. Thus, the insurance company can afford to pay a much higher rate of interest.

For instance, even during these times of low interest rates, the annuity rate for a 70-year-old will be 10-10.5 per cent pa. To cover the deficit of ₹3.5 lakh, Ramesh would need to invest only ₹35 lakh. And this interest rate is guaranteed for life.

When his PMVVY and SCSS mature, this money can either be put back into the respective schemes or into an immediate annuity plan. The immediate annuity plan without return of purchase price will likely generate much higher income than PMVVY and SCSS, at his age.

In fact, the annuity rate for a variant without return of purchase price increases with age. Hence, the annuity rate for the entry age of 75 will be much higher than the annuity rate for the entry age of 70.

To counter inflation, Ramesh can stagger annuity purchases for small amounts in the future.

The caveat with an annuity plan without return of purchase price is that, in the event of early demise, it might look like a waste of money. His family won’t get anything. Therefore, this approach would have been a problem if he had financial dependents or if he wanted to leave this money as legacy. Since he does not have such limitations, an annuity plan without return of purchase price is a good way to maximise income at very low risk.

He will also lose access to this money. This could have been a problem, but he has investments outside of this annuity plan, too.

Another point to note is that GST at 1.8 per cent of the purchase price will be applicable. So, that has to be taken into account while arriving at the purchase price, based on the annuity requirement.

Since Ramesh does not have to worry about income generation now, the remaining ₹35 lakh (₹70 lakh minus ₹35 lakh) can be invested freely. He can consider keeping a portion of this money as an emergency fund. He can even take some risk with this money for growth and build legacy for his family.

Alternatively, he can simply put the remaining ₹35 lakh in bank fixed deposits. His portfolio will gradually keep growing. As his income requirements grow, he can take some money out of FDs and buy an annuity plan to bridge the income deficit.

The writer is a SEBI-registered investment advisor at personalfinanceplan.in

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All you need to know about health insurance waiting periods

Personal Finance

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Insurance regulator IRDAI has mandated that the waiting period for pre-existing diseases should not go beyond four years (48 months) in any health policy, effective October 1. But this is not the only waiting period component in a health policy.

For instance, if you sign up for a new health policy, you will have to wait for a minimum period before your health cover starts.

Maternity covers and some other specified diseases also have a waiting period before claims can be entertained.

Waiting period ensures that insurers do not cover for claims that are certain and predictable. The clause helps prevent their losses. Waiting period is an important clause and every policyholder should be aware of its nuances to avoid unnecessary hassles at the time of claim.

Waiting period, which is applied from the date of policy commencement, varies depending on the ailments, and differs from one insurer to another.

Varying time-frames

If you buy a health plan, you have to mandatorily wait for a period of 30 days, known as initial waiting period, from the date of commencement of the policy. During this period, the insurance company will not admit claim for diseases or hospitalisation except for accidental injuries, provided the policy covers such accidental injuries.

Now, if an individual has an existing medical condition (known as pre-existing medical condition) before the commencement of health policy, he/she has to wait for a few years before the cover begins. However, excluding that particular medical condition, the policyholder will be covered for other illnesses/accidents, post initial waiting period.

The ‘pre-existing waiting period’ is usually 48 months among most insures but some insurers have only 24-36 months as pre-existing waiting period.

For instance, for Optima Restore policy from HDFC Ergo Health, the pre-existing waiting period is 36 months.

There is another type of waiting period for specific diseases or specified procedure and this, too, varies from one insurer to another. Insurers usually have a common list of specific diseases or a list of medical treatments for which this waiting period will apply.

For instance, ManipalCigna’s ProHealth policy has a disease/procedure-specific waiting period of 24 months (two years), after which the expenses for the same will be covered. The list of specific diseases/procedures includes cataract, knee replacement surgery (other than caused by accident), and varicose veins or ulcers.

But keep in mind that if these diseases exist at the time of taking the policy or it is subsequently found that they are pre-existing, the pre-existing diseases waiting period will apply.

Insurers usually have a waiting period of 90 days (from the date of commencement of policy) in case of critical illness or lifestyle-related diseases, including cancer, hypertension and cardiac conditions.

Health policies that offer maternity covers also have waiting period (for mothers and new-borns). Any treatment arising from pregnancy to childbirth including Caesarean sections will be covered under a policy only after the expiry of the waiting period. For instance, ProHealth policy from ManipalCigna covers maternity expenses only after expiry of 48 months. Similarly, Digit Insurance’s health policy, too, has a two-year waiting period for maternity cover.

Lastly, most insurers have personal waiting period which may be applied (from the date of policy commencement) to individuals depending on the declarations made by him/her at the time of taking the policy and the existing medical conditions. Factors including medical history, pre-existing medical conditions, medical test results and current health status will be taken into account by the insurer for applying this waiting period.

In Max Bupa’s ReAssure policy, for instance, personal waiting period is applicable for a maximum of 24 months, while in ProHealth policy (ManipalCigna), it is applicable for a period of 48 months. Personal waiting period will be specified in your policy document and will be applied only after you give your consent. If you decline, your application will be cancelled and premium, if any paid, will be refunded.

But most of the time, personal waiting periods are not applied by the insurers.

Points to note

There are a few points to keep in mind about the waiting period clause in health insurance.

One, you can reduce your waiting period. If you feel the pre-existing or disease-specific waiting period is too long, some insurers let you reduce the same.

But you might have to cough up additional premium.

For instance, in the case of ICICI Lombard’s Complete Health insurance policy, you can reduce the pre-existing waiting period if you opt for sum insured (SI) over ₹2 lakh.

The waiting period comes down to 24 months from 48 months. Similarly, in ProHealth policy (ManipalCigna), you can reduce your waiting period if you opt for a higher variant of the policy.

The pre-existing waiting period is reduced to 24 months in ‘Plus’ and ‘Accumulate’ variant while it is 36 months for the ‘Protect’ variant and 48 months in other variants.

Two, if you renew your health policy without any break in premium payment, the policy continues to cover you.

But if you renew your policy after a break, you may have to undergo another waiting period similar to what a new policy entails.

At the time of porting, too, if you continue the policy without any break, your waiting period will be as per the new policy or as per your health status at the time of porting.

However, if you enhance your SI (at the time of porting as well as in an existing policy), the waiting period shall apply afresh to the extent of increased SI.

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New health insurance guidelines and what they mean for you

Personal Finance

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In the recent past, insurance regulator IRDAI came out with standardised, customer-friendly guidelines for health insurance policies. These changes are implemented from October 1, 2020 and are largely expected to benefit the policyholders. Here’s more :

 

Definition of pre-existing diseases

One of the important amendments is the change in the definition of pre-existing diseases (PED) in health policies. This is because the old version had ambiguity in terms of what constitutes a pre-existing disease. Also, all conditions for which the person had signs/symptoms in the 48 months before taking the policy were considered PED.

IRDAI has changed this definition and has offered more clarity. As per the new definition, pre-existing disease means any condition, ailment, injury or illness that has been diagnosed by a physician/doctor within 48 months prior to the effective date of the policy issued by the insurer or its reinstatement; Or for which medical advice or treatment was recommended by, or received from, a physician within 48 months prior to the effective date of the policy or its reinstatement.

Changes in proportionate deductions

Liability of a health insurer is limited to the extent specified in the policy, and these are termed as sub-limits. The sub-limits are applicable mostly in cases such as room rent for hospitalisation, ICU, OPD (out-patient department) and ambulance cover. So, if you exceed the limit prescribed, the extra amount has to be paid from your pocket. That is, based on the type of room you occupy at the hospital, the cost of associate medical expenses also changes.

Higher room cost would mean the cost of associate medical expenses will also be higher. For instance, due to an emergency, assume someone is hospitalised in a room with a rent of ₹6,000 per day (while it a ₹4,000 a day limit in his policy). This increase of ₹2,000 in room rent will be applicable proportionately on associate medical expenses as well, such as doctor’s fees and nursing charges (in the ratio of room rent eligible to actual room rent). So, if the proportionate increase in medical expenses works out to ₹80,000 and the total hospital bill works out to ₹3 lakh, then the insurer will settle ₹2.2 lakh.

So to standardise the claim settlement in health policies, the regulator has established that associate medical expenses – the cost of pharmacy, consumables, implants, medical devices and diagnostics – cannot be subject to the proportionate clause. Insurers are not allowed to apply proportional deductions on ICU charges as well.

On claims

Health policies, sometimes, get rejected on the grounds of non-disclosure of medical issues (by mistake) even though the policyholders would have paid the premium for an extended period. This is because, during the issuance of a policy, many are not aware of certain pre-existing conditions, on the grounds of which the insurers reject claims later. Therefore, the regulator has ruled that health insurers cannot contest claims, citing non-disclosure, by clients who have continued with their policies for eight years. That is, after the expiry of moratorium period (the period of eight years during which the policyholders have continuously renewed their policy) no health claim shall be contestable, except for proven fraud and permanent exclusions specified in the policy contract. Policies would, however, be subject to all limits, sub-limits, co-payments, and deductibles based on the policy contract.

Other major changes

Generally, people with serious illnesses such as Alzheimer’s and epilepsy were not given coverage at all under a health policy previously. Insurers now have to provide individuals with such diseases, coverage for at least other diseases (specifying pre-existing conditions such as Alzheimer’s and epilepsy as permanent exclusions).

Also, the scope of coverage of health insurance policy is widened to provide cover for various illness including behaviour and neuro development disorders, genetic diseases and disorders and cover for puberty and menopause-related disorder. This was previously not covered by all insurers. Modern treatments too will be covered by a health policy including deep brain simulation, oral chemotherapy, robotic surgeries and stem cell therapy.

Waiting period (time period an insured has to wait before the insurer provides coverages) related to a specific disease has been standardised as well. While the standard waiting period is for 30 days, the disease-specific waiting period varies with each insurer, usually 2-4 years; for older policies, it went to over four years as well. The regulator has said that disease-specific waiting period cannot exceed four years. Similarly, the waiting period for lifestyle-related illnesses such as hypertension, diabetes and cardiac conditions cannot exceed 90 days.

Now, policyholders can pay their health insurance premiums in instalment in addition to lump-sum payments. Another change is that insurers have been advised to allow claim settlement for telemedicine consultation.

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