Personal Finance: A Primer

The Feng Shui money tree

Introduction

The purpose of this post is to give a general set of guidelines on how to best manage personal finances. A lot of this has been gleaned from books like Let’s Talk Money by Monica Halan, The Richest Engineer by Abhishek Kumar, and following people with humble beginnings but extraordinary investing profiles.

It is not meant to be a dry course on how to do technical analysis of stocks or how to chart yield curves on 10 year bonds. Of the lot, I like Halan’s approach the best because it’s super practical, so I’m outlining major takeaways from her book and following her structure.

If you’ve read her book already, this may even be redundant (think of this as a tl; dr version of it — the irony of a tl; dr being 7,000 words long isn’t lost on me). This document aims to be a quick guideline for lazy people on how to start thinking about personal finances, without worrying.

What to Invest

Naturally, your income needs to be split into two parts: one which you spend and one which you save. The fundamental is that you live below your means and can save at least 30–40% of your monthly income. If you don’t know what your monthly spends are, start tracking that — there are apps that let you do that (like Walnut, etc.) but I recommend having an elaborate spreadsheet where you can track spends.

Obvious Point: If you’re already net negative on a monthly basis, curtail your spending. If you’re neck deep in credit card debt, first bring that to zero. If you need to rely on your credit card for your monthly cash flow, you are doing something wrong at a very basic level. Figure out what that is and fix that — this entire document assumes you have a surplus left over after your scheduled monthly spends.

Before Investing

Emergency Cover

One of the biggest reasons why people are scared of investing is “What if I need the money immediately for an emergency?” It’s a legit worry and I’d be lying if I said that this hasn’t been a deterrent for me when it comes to investments. I used to invest without worrying about emergencies till it bit me. Having learned a lesson, I now believe that the first step in organizing your personal finances is to have an emergency cover. There are many kinds of emergencies we need to prepare for: loss of a job, a sudden medical expense, death of a loved one, etc. We need to prepare for these contingencies and an emergency cover would really help.

What is an emergency cover?

• It is a sum of money that is equal to 6–12 months of your monthly expenses (including EMI, fees, groceries, etc.). If you’re a DINK (double income, no kids) household, you can take a chance and keep this at 3 months, but in any case 6 months would be an ideal minimum.
• This money will be in multiple safe, immediately liquefiable deposits (mostly bank FDs). Why multiple? So that you don’t have to break out the entire FD in case an emergency requires only a fraction of the amount. If you want slightly better returns than FD, you could go for Liquid Funds or Ultra Short Term Bonds, but I’m risk averse when it comes to this money, so I’d rather stick to FDs
• This money is only to be used in case of a real emergency. Treat this like a Break glass in case of fire kind of money. You should not use this money to buy that shiny new iPhone XS during Prime Day sale.

This is the first corpus you need to save, before you even start investing.

Medical Insurance

The other expense that acts as a deterrent for most people is the probability of a humongous medical expense. Once emergencies are covered, we need to set ourselves up with comprehensive medical insurance. Unfortunately, finding a good medical insurance is so exhausting that it may require a hospital visit to recuperate. Halan recommends looking up policies in SecureNow Mediclaim Rankings. I’ve found it pretty good and I recommend you pick one from the list of recommendations from SecureNow.

How do you pick a policy and how much cover do you need? Good questions. There are a number of factors you need to look at while picking a medical insurance cover.

1. How much does it cost? You need to look at how much it costs today versus how much it costs 10 years later (medical insurance becomes more expensive as you age). You need to compare year-wise price across policies. A policy that’s cheaper than another today may be more expensive in the future.
2. Does it have a co-pay clause? Co-pay is simply the percentage of medical expenses you agree to pay. Let’s say your hospital bill is 1,00,000 and your co-pay is 10%, you need to pay 10,000. Ideally, you need a plan that doesn’t have a co-pay clause or at least one with as less a percentage as possible. You need to have this in writing.
3. What is the pre-existing diseases limit? Typically, insurance policies don’t cover diseases that you’re diagnosed with, before you take the insurance. Let’s say you’re diagnosed with a disease today and you take an insurance policy 11 months later; this disease won’t be covered. The number of months between the diagnosis and it not being covered is well-defined (typically 48 months). You need a policy that has a reasonable limit on this.
4. Does it have a limited diseases waiting period? This allows the insurer to impose a cool-off period before you can seek treatment for certain diseases like cataract, etc. Ensure what diseases come under this limit and what the cool-off periods are.
5. Does the policy have sub-limits? This is super important. Many policies have sub-limits in terms of what percentage of the policy can go towards specific expenses like rooms in hospitals, etc. If the cover is 2,00,000 and there’s a 1% sublimit on room, you can only take a room for 2,000. Make sure your policy does not impose sub-limits or at least be aware of what the sub-limits are.
6. What are the exclusions? Standard exclusions include dental treatments, cosmetic procedures (nose job, Lasik surgery, etc.), and pregnancy (although some group insurance policies do cover pregnancy now). Diseases like AIDS are not covered either. Make sure the number of exclusions doesn’t go beyond these standard sets. However, IRDAI allows an insurer to change this list of exclusions later on; that’s not something you can do much about.
7. How much before and after hospitalization expenses are covered? Most insurance policies cover stuff like doctor’s visits and diagnostic tests up to 30 days before and 3 months after hospitalization. It’d be good to understand what your policy offers here.
8. What daycare procedures are covered? Earlier, insurance companies required you to be hospitalized for at least one night to be eligible to claim a sum, but now about 130 daycare procedures like cataract surgery are covered by most insurers. Seek this list before picking a policy.
9. What is the no-claim bonus structure? Most individual insurance policies have a no-claim bonus feature wherein your insured sum increases by 10% for the same premium, if you haven’t made a claim in that year. There’s typically an upper cap on how many such increments can be made; know what it is.

Making claims:

1. How easy and transparent is the process of making a claim? Ideally it should be just a phone-call.
2. How many claims are settled by the insurer? Must be > 95%.
3. How many claim complaints are found online? Must be less than 30 for every 10,000 claims.

While some of the answers to the three questions are available in the brochures, insurers fudge this data; for instance, they give you info on number of complaints as a percentage of number of policies sold (which is meaningless).

Many financial advisors also seem to recommend that you have a separate critical illness cover and personal accident cover. I find that unnecessary. There are add-ons for these which serve as pretty good covers. Critical illness covers diseases like cancer, which can be expensive to manage — so it’s important to have. And personal accident cover comes in handy in case an accident leaves you unable to work for a few months or so.

How much should your cover be? Ideally, if you live in a large metro, you should have a cover of as much as INR 15,00,000 in a family floater, if you want top-of-the-board healthcare is extremely premium hospitals. If you’re in a small town, a cover of INR 5,00,000 should do. (I’m assuming you’re young; if you’re older, please consult a financial advisor for best suggestions on topping up your existing mediclaim policy, etc.)

Life Insurance

Life insurance has got to be one of the most abused financial products in the country. People sell dud products to earn a commission and leave a bitter taste in the buyer’s wallet. There are a number of products in this category that you need to absolutely stay away from: money back plans, endowment funds, ULIPs (oh God, ULIPs).

There is only one life insurance product you must buy: a term plan. A term plan basically makes you pay a predetermined sum for N years and if you die before a stipulated age, your family gets X rupees. What if you don’t die before that age? The amount you spent is gone. But that’s OK because you must wish for this amount to be ‘wasted’ and die of old age.

Many people aren’t okay with this amount being wasted and buy products like ULIPs that promise a life insurance + money back + some return. They’re crap. Do not buy them. Please do not buy them.

How much should you buy a cover for and when should you buy? This is a little tricky because insurers calculate this as a function of your age and annual salary. Most people start earning a lot in their later years but by then premiums become too expensive. At younger ages, premiums may be cheaper but your assured sum may also be lesser because you aren’t earning enough. The age of 30 is a good balance. By this time, you’re likely to have hit some kind of stability in your job, you’re likely to have dependents, and the premiums won’t be crazy expensive.

The assured sum must be greater than or equal to 10–12 years of your annual take home income.

This way, if you die, your spouse and family would be covered for at least a few years. Assume there’s no other savings, your spouse can simply put this in a long term bond and earn a monthly dividend that would be close to your monthly income.

Most people who buy into Money Back Life Insurance plans look at 2 lakhs becoming 6 lakhs in 20 years. That’s a measly 5.6% annual return. Plus, imagine this. Assuming you die and your spouse gets INR 6 lakhs, but your monthly expenses are around 1 lakh, the sum won’t be enough for even 6 months.

Get a term plan and hope you waste that money. Don’t buy any other life insurance product. Period.

With all of these safety nets, your finance table would look something like the following:

• Emergency Fund: 6 to 12 months of your monthly expenses
• Medical Insurance: INR 15 lakhs in family floater if you live in a large metro
• Critical Illness: INR 10 lakhs (many recommend buying a separate critical illness cover)
• Personal Accident Cover: INR 5 lakhs (10 lakhs if you are risk averse)
• Life Insurance: Greater than 10–12x your annual take home income

Investing, Inflation, and Asset Classes

Now, we are ready to start investing. Before we dive deep though, we must first understand two things: a) inflation, and b) what asset classes exist for us to pick from.

What is inflation? Inflation means your money’s worth keeps reducing every year. All countries have something called an inflation index wherein they measure the prices of different items like milk, fuel, rent, etc. and compare how much it has increased since the last year. India’s inflation rate is currently around 3.75%. That is, an item that costs 100 rupees today is likely to cost 103.75 rupees next year.

What does this mean for your money? Currently, savings accounts give an interest rate of 3.5%. Which means if you just keep the money in your bank account at current inflation rates, your money will decay. 100 rupees in the savings account would become only 103.5 rupees next year. Therefore, you won’t be able to afford the item that costs 103.75 rupees next year, even though you can afford it today at 100 rupees. This is what inflation does to money.

So what should be our goal? Simple, beat inflation every year. If there is a way to invest your money with returns greater than that of inflation, we are good. Bank fixed deposits give around 6% annually. And banks constantly keep tweaking this number in tandem with inflation (and something called repo rates, but that’s not something we need to worry about now). All we care about is what’s the real rate of return? That is, what is the rate of return minus what is the rate of inflation?

OK so, if fixed deposits give returns why think about anything else at all? Because over the long term, keeping money in just FDs would mean that you’ll more or less be at the same place where you started, after accounting for inflation. Not much growth. Each asset class comes with its own set of pros and cons, and will work for different investment horizons.

Asset class, investment horizon, new words.

Investment horizon simply means how long are we willing to stay invested in this — what’s our goal? Most financial advisors recommend you to map an investment plan to a goal — a vacation in Maldives, kids’ higher education, wedding, anything. How far away from the goal you are determines what’s the best asset class to invest in.

I recommend splitting them into three components:

1. Short term goals (within 3 years)
2. Medium term goals (between 3 and 7 years)
3. Long term goals other than retirement (more than 7 years)

Now would be a good time to whip out a pen and paper and jot down the major expenses you anticipate in the aforementioned time periods.

An asset class is just something you invest your money in, to generate a return on the investment. As Indians, most of us are conditioned to think of fixed deposits, gold, and real estate as the only ‘reliable’ asset classes. We are typically against equity and the world of bonds seem too esoteric for our taste. Each asset class comes with its own set of pros and cons. I’ve listed some of them below.

Equity, Real Estate, and Gold are the only three asset classes that can deliver positive returns with good margins over the long term. However, I’m personally against real estate because of the high upfront costs, inability to liquidate on short notice, and ongoing maintenance costs. So I’d prefer sticking to Equity, with a small portion of my portfolio in Gold.

Equity (Stocks)

Simply put, if we want to grow our money, we must start thinking about giving our finances an equity exposure. Equity has earned a bad name in India, probably because of the Harshad Mehta scam or for whatever other reason. People often compare it to gambling, without realizing that the stock market is a tightly regulated place with checks and balances in place to prevent fraudulent behaviour. SEBI is a watchful protector of retail investors and it is ‘safe’ to invest in the market.

What do I mean by ‘safe’? Aren’t stock markets risky? Yes, stocks carry market risk. By safe, I mean that no one is going to run away with your money. If you’re getting poor returns, it’s probably because the stocks you picked were poor, not because the odds were stacked against you in a casino called the Bombay Stock Exchange.

How to pick good stocks is beyond the scope of this document, and I’m not going to get into that. However, I’m going to introduce a few concepts related to equity you may already have heard of but may not have understood.

What is equity?
Equity means ownership in a company. Assuming you buy 1 share in a company that has 100 shares, you own 1% of the company. Let’s say you buy this 1 share for 10 rupees and the company does well. In one year, if someone wants to buy this 1 share from you for 20 rupees and you sell it, you have made a profit of 10 rupees. What if the company doesn’t do well and you want to ‘exit’ the holding; people are willing to pay only 7 rupees for the share and you agree? Well, you’ve incurred a loss of 3 rupees. That’s all there is to know about equity as a beginner.

How do I buy equity?
For regular investors (that is you and me), there are two ways to buy equity: a) buying stocks directly on the stock exchanges (BSE and NSE which are just markets to buy these stocks much as Flipkart is a market to buy Xiaomi phones), and b) buying mutual funds that hold equities as part of their portfolio. To buy stocks directly, you need a demat account, but not for buying mutual funds.

What do Sensex, Nifty, etc. mean?
Similar to the inflation index I introduced to you earlier, the stock markets also have indexes that track how the market is doing. Sensex and Nifty are just two such prominent indexes in India. Just like how inflation index looks at prices of various items like milk, rent, etc. that represent a regular person’s life, Sensex and Nifty look at companies that represent the economy.

The list of such companies and how much importance is given to them in calculating the number that defines Sensex or Nifty, is arrived at by a formula. Sensex has 30 such companies and Nifty has 50 such companies. Sensex, the more important index in India, has a base value of 100 as on April 1, 1979. Similar to how there is Sensex to represent the overall economy as a whole, there are sector wise indexes as well — pharma index, mid-cap index, etc. that take just the companies that represent those specific sectors and track them.

What do large-cap, mid-cap, and small-cap mean?
Cap is short for market capitalization, that is the number of shares a company has multiplied by the price of each share. This is also called the valuation or value of the company.

TCS or Reliance typically holds the title of largest company by market cap, in India. Globally, technology companies like Amazon, Apple, etc. would top the list. Now let’s say you rank companies in descending order of market capitalization. We call the top 100 companies Large Cap Companies, the next 150 companies Mid Cap Companies, and the ones after 250 as Small Cap Companies. That’s all! It just sounds fancy.

Can I invest in equity even if I don’t understand it?
In a growing economy like India, equity will give the best inflation-adjusted returns. But, it’s not at all recommended to buy stocks directly if you don’t know how to evaluate companies from that perspective.

However, a hack is to be invested in equity even if you don’t understand it is to simply buy the index like Sensex or NIfty and just staying with it. You won’t get the outsized returns people brag about at parties, but you will very likely be much better off than your friend who just stuck with Fixed Deposits. (Note: This is not to say that you’re de-risked completely; you’re still subject to market risks, but long term growth, over say 10 years, is likely to be significantly positive.)

Now, you can’t buy Sensex or Nifty on the stock exchange, but there are mutual funds that just buy stocks in the same proportion as the Index holds them. These mutual funds are called Index Funds and are some of the cheapest categories of mutual funds. This is a great category to test waters if you are just getting started with mutual funds. You can also buy the index via something called ETFs (Exchange Traded Funds). What is an ETF? An ETF is similar to a mutual fund, tracks an index, but traded on the stock market like regular stocks. That’s all you need to know right now.

Can I invest in equity even if I can’t track it on a daily basis? The best investors don’t keep tracking their portfolio prices on a daily basis. So yes, you can invest in equity even if you can’t track it on a daily basis. If you buy something like an Index Fund, there’s literally nothing for you to track if you’re going to stay invested for 5 years or so. I typically look at my portfolio once every couple of months.

How long do I need to stay invested? This is an important question. For best returns in equity, you should stay invested for at least 5–7 years. Anyone promising to double your money in 2 years by investing in equity is selling you snake oil. Stay away. And if you need the money next year, do not put it in equity. I repeat, do not put the money you need next year, in equity.

Debt

It’s very easy to understand debt at a personal level, but when it comes to bonds, people think it’s something more complex. But it really isn’t. A company promises to take money from you as debt and repay with interest over a time period (called the maturity period). Sometimes even governments do this. This agreement to repay your money with interest over a certain time is called a bond. When companies or governments say they are issuing bonds, they mean they are taking a loan. That’s it.

Debt is considered more stable than equity but comes with its own set of risks. What if a company or entity defaults on the debt? It’s possible. That’s why you need to look at the quality of the debt paper. Different credit rating agencies like CRISIL, ICRA describe the quality of a bond with a jumble of alphabets like AAA+, AA+, BB-, etc. Government bonds are the safest, but also offer the lowest returns. In debt, like in equity, returns are proportional to risks. You must look at what the risk profile of a borrower is before you buy a bond.

The best way to buy bonds is via mutual funds.

Mutual Funds

Almost all of us have heard of this beast from the Mutual fund investments are subject to market risks. Please read the offer documents carefully before investing rap. I briefly touched upon Mutual Funds in the equity and debt sections as a way to have equity/debt exposure in your portfolio. I love mutual funds because it is super easy to setup and get going. They’re also fairly easy to redeem (most of them are) and you can have your money back in 1–2 days.

So what are mutual funds? Mutual funds are basically entities that pool money from a large number of investors, collectively invest them in a set of assets (equity, debt, gold, etc.). A large company like Reliance or ICICI acts as a sponsor to setup an Asset Management Company, which in turn issues different Mutual Funds. It’s like an ice cream chain working with a local entrepreneur to set up a franchise and offering different flavours like chocolate or butterscotch.

The very basic element of a mutual fund is a unit. A unit is just what it sounds like — a single, atomic entity of a mutual fund. Like you typically buy 1g, 2g, 5g of gold, you buy 1 unit, 2 units, 5 units of mutual funds. Each unit has something called the NAV (Net Asset Value). This is the value of 1 unit after accounting for costs of the mutual fund (we will come to the costs later). Now that you know the basic elements of a mutual fund, you need to understand the different flavours of MFs.

Well, what are the different flavours of mutual funds? Typically, mutual funds invest in a combination of equity, debt, gold. Of course, there are funds that are purely one of the above, but typically you get a mix of debt + equity.

Debt Funds

Debt funds are those that put almost all of the money in debt. These are better than buying bonds directly because you would diversify your risk across multiple bonds (even if one defaults, only a small portion of your investment gets affected). Debt funds are less susceptible to volatility and therefore produce only modest returns.

While buying debt funds there are two things to note: one is the holding period. Debt funds come with varying maturity periods, ranging from 25 days to 10 years. You must match the maturity period with your investment horizon. Debt funds typically pay a periodic interest and the principal is paid at the end of the maturity period. Obviously, do not buy a 10 year bond if you need the money in 3 months.

The other thing to consider is the quality of paper. Sometimes, less-than-scrupulous fund managers buy low quality, high risk debt paper to show better returns. If a debt fund is showing extraordinary returns compared to its peers, be sure to check the ratings of the bonds / borrowers that are part of the fund.

There are two main kinds of debt kinds that are important:

1. Liquid funds
2. Ultra short term debt funds

Liquid funds offer instant redemption upto INR 50,000 and offer slightly better returns than Fixed Deposits. It makes liquid funds an excellent choice for storing (at least a part of) your emergency funds.

Gold Funds

There are some funds that exclusively buy gold. Typically they are ETFs, for which you need a demat account. Buying a gold ETF is cheaper than buying physical gold (you don’t have to worry about purity, storage, redemption, etc.) 1 unit of ETF corresponds to 1g of gold.

To make gold buying cheaper and easier on foreign exchange reserves, the government of India launched a Sovereign Gold Bond scheme which are way cheaper than even gold ETFs. Additionally, the government also pays you an interest on the amount you have invested in SGBs. Gold is an excellent hedge (hedge is finance speak for an investment you make to reduce risk) against inflation. I recommend SGBs if you want to buy gold, but don’t recommend having more than 10% of your portfolio in gold.

Equity Funds

Most regular investors should prefer getting an equity exposure in their portfolio via equity funds. However, there are a gazillion varieties of equity mutual funds — active, passive, growth, dividend, large/mid/small cap, etc. This makes picking a mutual fund quite hard. I’m going to try and break down the different kinds of mutual funds.

Active/Passive Mutual Funds

An Active Mutual Fund is one where a bunch of people, called fund managers, sit and decide on how best to deploy your money. Because there is a lot of work that goes into such decisions, active MFs are generally more expensive than Passive ones. The returns are also higher (but remember, risk goes up too as returns go up). A passive fund is like that student who goes through the professor’s slides a day before the exam. It just mimics an index like the Sensex, buys stocks in the same proportion as the index, and just stays put. This way, in a growing economy, you get the benefits of growth with a lesser amount of risk. Passive funds are cheaper too! Passive funds (also called Index Funds) are a great way to get started with investing in equity.

Growth/Dividend Funds

Growth funds are those that keep reinvesting your profits to buy more units. As the name suggests, if you are not looking for a regular source of income via mutual funds, growth is a good option to stick to. Dividend funds give back your profits. Dividend funds are good for old investors who generally look to augment their income.

Open-ended/Closed-ended Funds

This is a very simple distinction. Open ended funds allow you to exit at any time (if you exit within a year of investment, there is generally a charge of 1%). Closed ended funds don’t allow you to exit before the lock-in period of a mutual fund is over.

Large/Mid/Small Cap Mutual Funds

The other common differentiator between equity funds is in the specific market cap size the fund invests in — large cap funds invest in large cap companies, mid cap funds in mid cap companies, and small cap funds in small cap companies. Naturally large cap funds (a specific category of large cap funds are also called Blue Chip funds, which represent the best companies) are less risky, compared to mid and small cap companies. They are mature and stable. But remember that most of the growth comes from mid and small cap companies.

Sector/Thematic Mutual Funds

There are also funds demarcated by sector, called Sector Funds. Some funds focus on specific sectors like Infrastructure, Telecom, Power, etc. Sector funds are significantly risky, and should not be part of your portfolio when you are just starting out. Unfortunately, sector funds are the ones that you see with 25%, 30% returns which make it very appealing at a surface level. Please stay away till you have a better understanding of how to evaluate companies.

ELSS

Equity Linked Savings Schemes (ELSS) are a great category of mutual funds that offer tax savings. They are typically comprised of blue chip stocks and have a fairly stable outlook. However, the downside is that there is a lock-in of 3 years in this category of funds. Investments made in this category count towards Section 80C that offer income tax savings (if you are in the highest tax bracket, you could save up to INR 45,000 per year by investing in these funds).

Hybrid Funds

These are one of my favourite categories of mutual funds, because they don’t come with the boring returns of a pure debt fund nor the risks of a pure equity fund. Hybrid funds, as the name suggests, put their money in both equity and debt. There are three kinds of hybrid funds: conservative, balanced, and aggressive. Conservative hybrids typically have 15–25% of their portfolio in equity, balanced have 40–60% in equity, and aggressive have 60–80% in equity.

Costs Associated with a Mutual Fund

When I spoke about Net Asset Value, I said that it was the value of 1 unit of the mutual fund minus the costs associated. What are the costs associated with a mutual fund? There are two costs: (entry and exit) loads, and management expenses.

Entry load is what it costs to buy a mutual fund. Nowadays, most mutual funds have their entry loads as 0. Exit load is what it costs to sell a mutual fund. Generally, this is 1% of the value if you exit within a year and is nil if you hold on for more than a year (this is just a general case, please check the specifics of the fund you pick). Management expense is counted as a percentage called the expense ratio.

You must make sure that you don’t spend too much money in buying, exiting, or holding your mutual funds. This is another reason why index funds and ETFs are good choices — their costs are much, much, much lesser.

There is another category of mutual funds called Direct Mutual Funds that are sold directly by an AMC without distributors — because there’s no distributor commission, they are also significantly cheaper to buy. Apps like Coin by Zerodha, Paytm Money, ETMONEY, etc. allow you to buy Direct Mutual Funds (disclaimer: I don’t work for any of these guys).

Picking a financial product

There are a number of things to consider when you pick a financial product. The following are the most important criteria:

Cost

1. What does it cost to buy a product? This is the entry load or front load. Imagine you’re buying a house. The front load on that is huge. But buying a bank FD may cost you next to nothing.
2. What does it cost to hold a product? This is the expense ratio, etc. Don’t assume bank FDs don’t have an expense ratio; banks factor that in while specifying interest rates. In physical items like gold or real estate, this is the storage or maintenance cost.
3. What does it cost to exit a product? This is the exit load. Things like endowment plans or ULIPs come with huge exit loads, which is what make them such terrible investments.

Return

1. What is the annualized return after accounting for all costs and inflation? This is a super important metric. A savings account is the safest place to put your money but the annualized return after accounting for inflation is negative, which makes it a bad investment vehicle. But also remember that risk goes up in proportion to return.
2. How does it compare to a bank fixed deposit? It’s a great metric to compare your returns to. The house you bought has appreciated in value from INR 20 lakhs to 40 lakhs in 20 years? That’s just a 3.5% annualized return. Heh, that fares way worse than a Bandhan Bank FD which is almost at 8%. (This is also the problem with comparing absolute numbers like 10 lakhs, 20 lakhs, etc. — always try to distill the number to annual percentage growth)
3. What has been the average return over 1, 3, 5, 10 years? Be very very careful about finding this info if you’re being sold mutual funds by an agent. Look up websites like Value Research online or Morningstar for reliable information on this. A fund has to be consistent (particularly active funds carry this risk).
4. What are the returns of other products in the same category? If a debt fund promises 9.5% return when other products are only at 7%, something is fishy. At the same time, you don’t want a mutual fund delivering 6% return when comparable products (same type of companies, same sector, etc.) are returning 10% returns. Again, VRO and Morningstar are your friends here.

Lock-in

1. Is there a lock-in? Many mutual funds don’t come with a lock-in these days, but there are other products that do. Bonds, ULIPs, ELSS etc. all come in with specified lock-in periods. Even fixed deposits come with lock-ins.
2. Can I exit the locked-in product early? Typically, no. But some products like FDs allow you to exit the investment before a lock-in is over. Be sure to understand the exit modalities in case you want to do so before the lock-in expires, before you make the investment.
3. What does it cost, in case I do? In case of products like FDs, the penalties are quite low. But there are products with extremely significant costs to exit before lock-in expires. Please, please be careful of such products. They can put a severe dent on your returns (some products don’t even return the capital).

Holding period

1. What’s the best/recommended holding period for this category of products? Some come with defined holding periods (like bonds) of 1y, 3y, 5y, etc. Some perform well over time, like equity MFs that do well over 5y. Some need you to stay invested for over a decade (like a real estate investment). Be sure to understand what the recommended holding period for the category you’re buying into.

Taxes

1. What is the tax treatment on the profits realized from this product? Here’s a quick primer: FDs are taxed at your income tax slab rates. Dividend from debt MF is taxed at 38.83% (reflected in your NAV). Short Term and Long Term Capital Gain taxes are applicable on debt MF profits. Short Term and Long Term Capital Gain taxes are applicable on equity profits.

What should be your asset allocation?

Almost all financial planners will tell you to allocate 100 minus your age in equity, 5–10% in gold (not physical gold), and the rest in debt. It is a bit overly simplistic because I like to tie my investments to what I’m saving them for. I argue that, if your goal is something like retirement that’s 20–30 years away, 100% of asset allocation for that goal must be in equity. Whereas for a sibling’s wedding that’s 2–3 years away, it may be prudent to have 70% in debt and 30% in equity. Basically, the closer you are to a goal, lower the percentage of equity allotted in that investment.

What financial products to buy?

As I mentioned above, different investment horizons require different styles of financial products. We earlier spoke about having three investment horizons: short term (less than 3 years), medium term (3 to 7 years), and long term excluding retirement (more than 7 years). In addition to your investment goals, there are emergency funds, medical and life insurance, and well, your regular cash flow.

• For your monthly cash flow, a simple bank account that has excellent apps, net banking options, very rewarding debit and credit cards, decent savings account interest rates, should do.
• For your emergency funds, 6 to 12 months of your monthly expenses must live in bank Fixed Deposits, Ultra Short Term Mutual Funds, Liquid Funds, or Conservative Balanced Funds (in decreasing order of recommendation).
• Your medical insurance must be a family floater with coverage of INR 10 lakhs if you are living in a metro and want excellent, top-of-the-market healthcare. You must also have critical illness and personal accident covers.
• Your life insurance must be one or more term plans that have an assured sum of 10–12x your annual income. You should also have term plans on all your loans. You should not, and I say this at the risk of sounding like a parrot, you should not buy ULIPs, money back plans, endowment plans, etc. under this category.
• Your short term investments must be in bank Fixed Deposits (for goals < 1 year), Ultra Short Term Mutual Funds (for goals between 1 and 2 years), and Conservative Hybrid Funds (for goals between 1.5 and 3 years).
• Your medium term investments must live in Conservative Hybrid Funds (for goals around 3 years), Aggressive Hybrid Funds (for goals between 4–5 years), and Diversified Equity Funds (for goals between 5–7 years).
• Your long term investments must all be in one form of equity of other. I recommend Diversified Equity Funds (for goals around 10 years) and significant exposure to small and mid cap mutual funds (for goals more than 10 years away).

Monica Halan and a bunch of other financial advisors recommend that your retirement fund be equal your Age Percent of your annual income, every year. If you’re 30, save 30% of your annual income for retirement. But I find this slightly aggressive and sorta impractical. So I recommend sticking generating multiple 10 year goals for your retirement corpus.

If you’re 40 and have about 3x your annual income in your retirement corpus, you’re doing well. At 60, you need to have about 8x your annual income in this corpus. As you age, you can increase the proportion of your investments towards retirement. If you’re young, this can be a lower priority (preferably nothing other than PFs and PPFs). I recommend the National Pension Scheme, even though it allows only 60% of the corpus to be withdrawn at maturity, because of the tax benefits it offers.

Edit: I had earlier written that I don’t recommend the NPS. It seems I was slightly misinformed about the tax treatment of the withdrawable 60% in NPS. It’s a way better improvement than earlier, and given the tax benefit it offers (particularly if you are in the 30% bracket), it is a good option.

Many planners recommend that your real estate investment should be only one — the house you live in. I’m against even that (I don’t want to get locked into one house; we have dynamic lives where we change jobs frequently and even move across countries.)

Many, many well-pff upper middle class people I know attribute their financial success to one thing — not spending 50% of their monthly income as EMI to a house that’s more of a liability than an asset. I really do not understand the Indian obsession with real estate and probably never will. If you’re contemplating a real estate investment, please do the math on an Excel sheet and be realistic about how much the area would grow in the next 15 years. Do not be fooled by the argument that the income tax saving and rental income will offset the EMI cost unless the math adds up.

Well, that’s about it. Just short of 7,000 words. I hope this helps you think better about personal finances, and if it does, please share the post with your friends. Would highly appreciate that! Also, don’t forget to thank Monica Halan whose structure/thinking I condensed in this post. :)