Embed Size (px)
Citation preview
1
Personal Finance and Money
Management (Basics of Savings, Loans, Insurance and Investments)
2
Personal Finance and Money Management (Basics of Savings, Loans, Insurance and Investments)
Module-1: Introduction to Personal
Finance
Learning
Objectives
By the end of this module, the reader should be able to:
Recall the purpose of undertaking personal finance
Categorize various financial products according to their type
and recognise various sources from which loans are available
and match them to needs
Distinguish between cash management and money
management and align money management tasks to appropriate
financial products
Recall the purposes served by creating a budget and recall how
a budget can be used under various financial situations
3
1.0 Introduction
Arvind is sitting alone outside the crowded village tea stall, sipping a cup of special tea and
looking rather thoughtful. Pareshbabu, the school headmaster, strolls up to him and after
exchanging greetings asks him why he is looking so gloomy. “Oh nothing very serious,”
replies Arvind. “My wife’s sister lives in Dubai and has been inviting us to spend some time
with her for years now. She called again today and spoke to my wife...”
“That doesn’t sound like something to be sad about,” says Pareshbabu. “Why don’t you take
your family to Dubai this summer, once the harvest season is over?”
“The problem is that everyone, including my wife, thinks that I am rich because I own so
much land and seem to be harvesting good crops in most years. But only I know how difficult
it is to manage my money. Every year, after the summer harvest, I have to set aside enough
money to pay-off all my workers for the year ahead and even give them bonuses in good
years. Then I have to pay back all the loans that I have taken from family and friends…you
know how they talk if we have a good crop and still hold on to their money!
“But surely you must have saved up enough to go on one expensive family holiday after so
many years…” interrupts Prakashbabu, who is truly a well wisher of Arvind and his family.
“I don’t have any savings,” replies Arvind sadly. “Whatever is left over after paying off the
workers and my debts and purchasing new raw materials and taking care of my home
expenses goes into buying something new for my land – a tractor, a pump, a truck – or
buying gold for my wife and my mother. To be honest with you, there are times when I
myself don’t know where all my money has gone!”
“Aah, my friend! I have finally understood your problem,” says Pareshbabu, with a small
smile on his face. “You need a lesson or two in financial planning… But if you are able to
spend just a little time on personal finance planning, you will certainly be able to take your
wife for that holiday in Dubai!”
“You think so?” asked Arvind, his mood improving at the thought of being able to give his
wife something she has always wanted. “What do I have to do? What does personal finance
planning involve? Am I capable of financial planning? It sounds a bit scary…”
“Oh don’t worry. Financial planning can be made very simple. It involves understanding
how much you earn and spend and save; then setting goals – like your plan to go to Dubai
and then deciding how to save and invest so that you can meet your goals. But most
importantly, it involves putting into action your plan…that means actually saving and
investing as per your plan. Lastly, it involves checking from time to time if your personal
finances are going as per the plan and modifying the plan, if necessary…”
“Oh Pareshbabu, will you help me creating a financial plan and putting it into action? I really
want to take my family on a trip to Dubai….”
“I will be most happy to help you. Shall we meet tomorrow at your house at 11 am to start
our personal finance planning exercise?”
“That will really be so kind of you!” replied Arvind, quite excited with the thought.
4
Personal Finance and Money Management (Basics of Savings, Loans, Insurance and Investments)
------------------------------------------------------------------------------------ Module 1 Topic-1
------------------------------------------------------------------------------------
1.1. Financial Products
Introduction The next day, as promised, Pareshbabu dropped in on Arvind. He was given a warm welcome
not only by Arvind but by his wife, Vimla, too. She had great respect for the school
headmaster and now more than ever, as her husband had told her how he offered to help them
plan their personal finances so that they could meet goals – such as their trip to Dubai.
“Before we begin, we need to gauge how much money you already have saved up in various
financial products such as bank and post office deposits, stocks, insurance, etc …” said
Pareshbabu.
Arvind and Vimla looked at each other rather embarrassed. Arvind replied, “Other than gold
and our houses and land and other equipment, we have no savings. You see, although we
have heard about banks and the share bazaar and insurance, we have not really put any
money into these, as we do not understand the need to, when we can buy gold.”
“Then let me explain why you need to invest in different financial products. Every product
has its positives and negatives, including gold. Your decision to invest in a financial product
5
should depend on your goals, the returns you expect, liquidity and the time period in
which you want your money back.”
“Sounds quite complicated,” said Vimla.
“It’s not really so, once I begin telling you about various products…they all follow a pattern
that you can easily identify with.”
With that, Pareshbabu began an in-depth explanation of various financial products.
1.1.1 Savings account
Introduction A savings account in a bank allows you to deposit and withdraw money any time you want.
The money is not only kept safe in a bank, you also earn interest on it. To open a savings
account, all you need to do is approach your local bank with proof of identity (such as your
PAN card, ration card, passport, voter ID card, etc.) and proof of residence (such as your
electricity or telephone bill, your ration card, etc.) and two photographs. After filling in a
form and signing at the right places, you will receive a number - which is called your
“savings bank account number” and you have successfully opened a savings account.
Depositing money
Any time you would like to keep more money with the bank, or deposit money into your
account –- it gets added to your account. You can deposit the money by filling in something
called a “deposit slip”. It asks for information like your name, the date, your account
number, the amount of money that you are depositing, etc. The first time you fill in a deposit
slip, you can ask a bank employee to help you. They will be happy to show you how it is to
be done.
Withdrawing money
Naturally, when you take money out of your account, or withdraw money from your account -
it gets deducted from your account balance. To withdraw money from your account, you need
to fill in a “Withdrawal slip”. Like a Deposit slip, a Withdrawal slip also asks for similar
information – your name, account number, amount that you wish to withdraw, date, etc.
Using cheques
You can also deposit and withdraw money out of your account using cheques. The benefit of
using a cheque to pay or receive money is that if the amount is large, you don’t have to worry
about it getting lost or robbed while it changes hands. Even if you lose the cheque, your
money will be safe if you have taken care to write the cheque in the correct manner.
Following is the correct way to deposit money through a cheque:
Depositing money using a cheque
When someone gives you a cheque instead of cash, it could be from any other bank. You
need to make sure that
1. Your name is written on the top most line
2. The date is recent (not more than 90 days prior to today)
6
3. The amount in words and amount in figures are the same
4. There is a signature at the bottom right hand corner of the cheque
5. The cheque has two diagonal lines across the top left corner with “A/C Payee”
written in it. The diagonal lines ensure that the bank will deposit the money only
in your account.
The amount on this cheque can be credited to your account once you fill in a deposit. The
first time you deposit a cheque, you can ask a bank employee to help you fill in the deposit
slip. It may take up to three working days for the money to reach your account after you
deposit a cheque.
Withdrawing money through cheques
When you have a certain minimum balance in your account, your bank will offer you a
cheque-book facility. This means that you will receive a booklet with 10-20 blank cheques in
it. You can use these cheques to pay other people money from your bank account. You need
to make sure that you fill in the following details:
1. The name of the person you wish to pay is written on the top most line
2. The date is filled in the top right hand corner of the cheque
3. The amount in words and amount in figures is the same
4. Your signature is at the bottom right hand corner of the cheque
5. You cross the top left hand corner of the cheque with two diagonal lines and write
“A/C Payee” between those two lines. These double lines ensure that your bank will
take money from your account and deposit it only in the account of the person to
whom you wish to pay the money.
Here again, it may take up to three working days for the money to be deducted from your
account after you issue (pay out) a cheque.
Pass-book: Keeping track of your money
When you open a savings account, the bank will give you a pass book to track your deposits
and withdrawals. So, for example, let’s say you have a balance of Rs. 5,300 at the beginning
of January 2011 and you deposit Rs. 500 on the 4th
of the month, it will appear in the credit
column of your passbook. Then, let’s say you withdraw Rs. 200 from your account on the
20th
of the month. This will appear in the debit column of your pass book.
Suppose on the 20th
of the month you deposit a cheque payment of Rs. 8,000 which has come
from your client “Agrofoods”. Also suppose that you issue a cheque for Rs. 4,000 to your
supplier, Natwarlal Bhede, on the 25th
of the month. Both these transactions will also show in
your passbook on the day that they impact your balance.
Assuming no other transactions, your balance at the end of the month will be Rs. 9,600
Sample of a Pass-book
Date Particulars Cheque
Number
Credit
(Amount
Deposited)
Debit
(Amount
Withdrawn)
Balance
01/01/2011 5,300
7
04/01/2011 Cash deposit 500 5,800
20/01/2011 Cash withdrawal 200 5,600
23/01/2011 Agrofoods 367241 8,000 13,600
28/01/2011 Natwarlal Bhede 901454 4,000 9,600
Debit cards
If you open a savings bank account and are able to sign (as against using a thumb print), most
banks give you the option of using a debit card. A debit card allows you to withdraw money
from their Automated Teller Machines (ATM) any time of the night or day, all through the
year. As a result, you can avoid making a trip to a bank branch during banking hours. To
withdraw money from an ATM, you just need to insert your debit card and type in a unique
password. The maximum amount that you can withdrawn per day is set by the bank. You can
also use the ATM to carry out other financial and non-financial transactions such as finding
out your bank balance, depositing money, getting a statement, etc. without visiting the bank
branch.
You can also use a debit card while shopping at stores such as Apna Bazaar, Sarkari Bhandar
and even some privately owned shops. When you give your debit card to the cashier at such
stores, he will run it through a machine, which is linked with your bank’s computers. The
shopkeeper types in the amount of your purchase. The bank computer debits (or subtracts) the
amount of the purchase directly from your account balance. The machine then prints out a
receipt which you have to sign. The shopkeeper keeps the signed receipt and hands you a
copy for your record. For your safety, the bank sets limits on the amount that you can pay
through your debit card per day.
Debit cards are useful as they allow you to access your account details and money in your
account any time that is convenient to you. They also protect you from the risks involved
with carrying large amounts of money while shopping.
Features of a bank account
Return: Fixed at 4% per annum. This rate can change from time to time.
Risk: Minimum risk. Your money is safe in a bank account. Even if somehow the
bank gets robbed, you will still get your money as the Government guarantees
investments in banks up to Rs. 1 lakh. Plus, banks also insure themselves.
Liquidity*: Very liquid. You can withdraw any amount, up to the total balance
available in your account, any time during banking hours.
Tenure: No fixed tenure. You can keep your money in the account as long as you
wish. This could be for years together or you could withdraw it the day after you
deposit it.
8
Taxes: The money that you receive as interest on your balance in the savings bank
account gets added to your other taxable income and is taxed at the rate of tax
applicable to you.
1.1.2 Short term savings products
If you wish to invest your money for short periods of time (up to 3 years), there are various
financial products available. Some of the more popular ones are bank deposits, recurring
deposits, some mutual fund products. All these
Bank Deposits:
A bank deposit is similar to a savings account. Like with a savings account, when you open a
bank deposit, you need to fill in a form and provide proof of identity and proof of residence
and two photographs. If you already have a savings account with the bank, you may not be
required to give these details.
The main difference between a savings account and a deposit is that in a deposit you cannot
withdraw your money as and when you please. If you need to withdraw money in an
emergency, you can do so by paying a small penalty. You also cannot keep adding to the
amount you’ve deposited (unlike in a savings account where you can do so). Your money,
which is called the principal, is kept in this account for a period of time that you specify at
the time of opening the account. The period can be a few months, a year, or a few years. At
the end of the period, the money gets automatically deposited in your savings account. If you
do not have a savings account with the bank, you can receive the amount in cash.
The interest that you receive in a bank deposit is greater than that offered on a savings bank
account. You can either receive your interest at regular intervals – perhaps every month or
every six months or once a year or get it at the end of the period as one lump sum amount
with your principal amount.
Features of a bank deposit
Return: The rate of interest is fixed in advance. It varies slightly from bank to bank.
The interest is higher than the savings account interest. Interests are usually in the
range of 6-10% per annum. The rate of interest that you receive is also linked to
period for which you plan to keep your money in the bank deposit.
Risk: Minimum risk. Bank deposits are backed by the RBI up to an amount of Rs. 1
lakh per person per bank.
Liquidity: You can withdraw your money if you need to. However, you may be
required to pay a small penalty. The penalty is usually in the form of a deduction in
interest rate. For example, if you had invested for a period of 2 years at an interest of
8% and you decide to withdraw the amount at the end of 1 year, you may earn an
interest of only 7%. The penalty could also be a small percentage of the amount of
your deposit.
9
Tenure: You can decide on the tenure (i.e. how long you would like to deposit your
money) from amongst various tenure periods offered by the bank. Most banks offer
you 4-6 tenure options to choose from. These can range from around 1 year to 5 years
and even more.
Taxes: The money that you receive as interest on your principal must be added to
your other taxable income and is taxed at the rate applicable to you.
Recurring deposits
Banks also offer their clients the option to open a deposit where you do not have to deposit a
lump sum principal amount but can contribute a fixed amount at regular intervals – such as
monthly or yearly. Just as in the case of a bank deposit, you cannot withdraw your money
before the end of the tenure, without paying a small penalty. For example, you can deposit
Rs. 500 every month for 3 years. At the end of three years, you will receive not just the
amount that you have deposited over the years but the interest as well.
Features of a recurring deposit
Return: The rate is fixed in advance. Varies slightly from bank to bank and is linked
to some standard rates used in the banking system. It could be in the range of 6-10%
per annum. The rate of interest that you receive is also linked to the amount of time
for which you plan to keep contributing to the recurring deposit.
Risk: Minimum risk. Recurring deposits along with the amount in your savings
account and bank deposits and are backed by the RBI up to an amount of Rs. 1 lakh
per person per bank.
Liquidity: You can certainly withdraw your money if you need to. However, you may
be required to pay a small penalty. The penalty usually means that you may lose some
part of the interest that you would have been due, if you had kept your deposit with
the bank for as long as you had originally decided to. Alternatively, this could be a
small percentage of the amount of your deposit.
Tenure: You can decide on the tenure (i.e. how long you would like to deposit your
money) from amongst various tenure periods offered by the bank. Most banks offer
you 4-6 tenures to choose from and these range from around 1 year to 5 years and
even more.
Taxes: The money that you receive as interest must be added to your other taxable
income and is taxable at the rate of tax applicable to you.
Mutual fund products
Very often, people would like to invest in certain financial products, such as stocks or bonds.
However, due to lack of knowledge or time they avoid doing so. Sometimes, the amount of
money that they would like to invest is not enough to allow them to purchase a significant
amount of units.
10
A mutual fund is a financial product that allows individual investors to buy such products
indirectly. With mutual funds, money is collected from thousands of investors. The money
collected is then invested in some financial products according to a pre-stated objective. For
instance, the objective may be to invest only in government bonds or it may be to invest in a
mix of stocks and bonds in a particular ratio. Some mutual fund schemes may have the
objective of investing in certain sectors only, for example, banking, pharmaceuticals,
software, etc. There are plenty of schemes from different mutual funds with different
objectives. You can invest in a mutual fund scheme whose objectives suits your investment
need best. In order to keep a track of how much each investor has contributed to the fund,
each investor is given a number of units. Each unit represents Rs. 10 invested in the fund. If
you invest Rs. 1000 in the fund, you will be allotted 100 units of that fund.
The value of your mutual fund units may vary from day to day. This is because the values of
the products (shares of different companies, interest rate on bond, etc.) that the fund has
invested in vary. Accordingly, the value of the whole fund varies. Once a year, it may pay
you some part of the profit, if it has made any. This is called a dividend. Alternatively, you
can choose an option where you do not receive any dividend, but the value of the fund, and
therefore the value of your units keeps increasing. You can make a profit by selling your
units at a higher rate than what you bought them for.
You can find out the value of your units by checking the Net Asset Value or NAV of your
scheme on the website of the mutual fund house. You can buy mutual fund units from a
mutual fund company and sell them on any working day. The price that you have to pay will
be the NAV. When you sell your units, you will receive the NAV per unit. Here you may
need to pay a small percentage of the total value as an exit load.
Features of mutual fund
Return: It is not fixed in advance. It varies from scheme to scheme and depends upon
the performance of the products in the particular scheme. Short term schemes that
invest in government backed products usually offer a return of anywhere between 3%
and 8%. Sometimes, it could be more or less than that. Performance of mutual funds
that invest in shares can give returns above 15% in a good year or fall more than 15%
in a bad year.
Risk: There is no security of the amount that you invest. It could increase or decrease
depending on the performance of the products in which the fund invests.
Liquidity: You can sell off your units on any working day and you will receive the
amount due to you within 3 working days. This is true for all mutual funds except
Equity Linked Saving Schemes (ELSS) funds. With ELSS schemes, you get tax
benefit under Section 80C, but at the same time, you can only sell them after 3 years
of buying them.
Tenure: There is no fixed time frame for which a scheme lasts. Investors have the
freedom to buy or sell units to the mutual fund company anytime they would like to.
11
Taxes: The money that you receive from a mutual fund company in the form of
dividend or profit once a year is tax free. The tax payable on the profit you make
when you sell your funds, if any is treated as capital gains and taxed depending on
how long you have held your mutual fund units. If it is for less than 1 year, you have
to pay short term capital gains tax. If it is for more than one year, you have to pay
long term capital gains tax.
1.1.3 Long term investment products
We need short term savings products to match our short term goals. We also use short term
savings products to keep our money safe when a long term goal is fast approaching and we
have saved up enough to achieve it. However, when we begin planning for a long term goal,
we need long term investment products to help us grow our money. Here are some long term
investment products:
Post office savings schemes
Post office schemes are also called small savings schemes. These are designed to provide safe
and attractive investment options to the public and at the same time to mobilise resources for
the postal department.
Post office savings accounts
These accounts are very popular as they can be opened at any post office in India with
a minimum of Rs. 20. On the outer limit, a maximum of Rs. 1 lakh can be deposited
per single holder (across all post office accounts held in that name) and Rs. 2 lakh for
joint holders (again Rs. 1 lakh per person across all post office accounts held).
Maturity period: There is no lock-in/maturity period, just as in the case of a
savings bank account.
Withdrawals: Any amount can be withdrawn as long as the account holder
keeps a minimum balance of Rs. 50 in simple account and Rs. 500 if he/she
opts for the cheque facility.
Interest: Interest is paid at a rate as decided by the Central Government from
time to time. It has been is 3.5 per cent per annum since March 2001.
Pass Book: As in the case of a bank deposit, depositors are provided with a
pass book with entries of all transactions duly stamped by the post Office.
Tax: Income tax relief is available on the amount of interest that you receive
in this account.
Post office time deposit accounts
These deposits can be compared to bank fixed deposits and like the post office
savings accounts, they can be opened at any post office in India.
12
Types of Accounts: Accounts of different maturities are available - 1 year
maturity, 2 year maturity, 3 year maturity and 5 years maturity.
Deposit amount: A deposit can be opened with a minimum of Rs. 200. There
is no maximum limit.
Maturity period: The deposited amount is repayable after expiry of the
period for which it is made viz.: 1 year, 2 years, 3 years or 5 years. The money
in the deposit can be withdrawn 6 months after the deposit is made, if
necessary (with certain conditions).
Interest: Interest is payable annually. At present, since March 2003, the rates
are as follows:
1 year deposit - 6.25
2 year deposit - 6.50
3 year deposit - 7.25
5 year deposit - 7.50
Pass Book: Depositors are given a pass book with entries of the deposited
amount and other particulars, duly stamped by the post office.
Tax: Income tax relief is available on the amount of interest that you receive
in this account.
Post office monthly income accounts
This account is somewhat like a bank fixed deposit too. Only one deposit can be
made.
Maturity: 6 years. The deposit can be closed after one year, subject to
conditions.
Deposit limits: A minimum deposit of Rs. 1000 has to be made. The
maximum amount is Rs. 3 lakh in case of a single account and Rs. 6 lakhs in
case of a joint account. Deposits in all accounts taken together should not
exceed Rs. 3 lakh for a single name and Rs. 6 lakh for a joint account.
Interest: Interest is paid at the rate of 8 per cent per annum, every monthly. In
addition, a bonus equal to ten per cent of the deposited amount is paid at the
time of maturity.
Pass Book: The depositor is provided with a pass book with entries of the
deposited amount and other particulars, duly stamped by the post Office.
Tax: Income tax relief is available on the amount of interest that you receive
in this account.
National Savings Certificate
National Savings Certificates are available for purchase at Post Offices.
13
Maturity: Period of maturity of a certificate is six Years.
Deposit limits: Certificates are available in values of Rs. 100, Rs. 500, Rs.
1000, Rs. 5000 and Rs. 10,000. There is no maximum limit for purchase of the
certificates.
Interest/maturity value: The maturity value of a certificate of Rs. 100
denomination is Rs. 160.10 and certificates of other maturities are calculated
at a proportionate rate. On maturity the certificates can be encashed at the post
office where it is registered or any other post office.
Tax: An income tax rebate is available on the amount invested and interest
received every year.
Kisan Vikas Patra
Kisan Vikas Patra are available for purchase at Post Offices.
Maturity amount / period: The invested amount doubles on maturity after 8
years and 7 months.
Deposits: You can invest in KVP in values of Rs. 100, Rs. 500, Rs. 1000, Rs.
5000, Rs. 10,000 and Rs. 50,000. There is no maximum limit for purchase of
the certificates.
Tax: No income tax benefit is available under the scheme.
Public Provident Fund Scheme
Public Provident Fund schemes can be opened at certain designated post offices
throughout the country and at certain designated branches of Public Sector Banks
throughout the country.
Maturity period: The account matures after 15 years. It can be continued
with or without subscriptions after a block of five years.
Deposit limits: A minimum deposit of Rs. 500 per financial year is required.
The maximum deposit limit is Rs. 70,000 in a financial year. The maximum
number of deposits in a financial year is twelve
Withdrawal: Premature withdrawal is allowed every year after 5 years from
the end of the year of opening the account.
Interest: The interest rate payable is notified by the Central Government from
time to time. At present it is 8% per year
Tax: An income Tax rebate is available on the deposits made and the interest
credited every year is tax-free.
14
Equity
All the products that we have looked at so far offer a fixed rate of interest. Some have a fixed
maturity, some do not. But in general, we know more or less how much money we can expect
to get from such products. That’s why those products are called fixed income products.
Equity or shares is different from such products. In the case of fixed income products, you are
lending your money to some organisation or depositing it with an organisation. They pay you
a fixed amount of money, called interest, for allowing them to use your money. In the case of
equity, instead of loaning the money, you are actually purchasing a part of the business.
That’s probably why what you own are called “shares”.
When the company whose shares you hold makes a profit, it shares some of this profit with
you and the rest of its share holders. The amount that is given to share holders is called
dividend.
The share price of a company will move up and down on a regular basis depending on how
well it performs. You can sell the shares at a price that is higher than the price at which you
bought and make a profit. As the years go by, companies that do well will see an increase in
their share price. The amount of profit that a company distributs to its share holders may also
increase. It is for this reason that investing in well chosen shares can give investors a very
good return over the long run. Studies from across the world and across different time frames
show that shares give the best return from all investment products, when kept for a long
period of time – 7-10 years.
People are advised to keep shares for a long period of time because
It takes time for businesses and companies to grow. So investing and expecting
good results immediately is not possible
The prices of stocks are affected by factors other than the performance of the
company. Political events, economic performance of the country, natural
calamities, international happenings, etc. All make the price of shares go up or
down. So investing for the long run usually insures that though prices may move
up and down due to other factors in the short run, they will reflect the value of the
company in the long run.
Cautions while investing in shares:
If somehow, you purchase the shares of a company that does not do well, the
value of the share may fall and although you invested Rs. 50 to purchase one
share you may get back only Rs. 20. Worse still, no body may want to
purchase your shares when you need the money and want to sell them. This is
a rare case... but it is possible.
When you need your money urgently, you may be able to sell your shares but
you may not get a good price for them, simply because you sold during a
down market.
Make sure you are truly convinced that the company will do well. Learn about
its management and how they plan to grow the business. Take interest in every
little aspect of the company. It is, after all, partly your company.
15
Stay invested for the long term but keep a track of the performance of the
companies that you have invested in from time to time. Don’t panic and sell
your shares if the price of the stock is falling – especially if the prices of most
stocks in the market are falling. Don’t be greedy and sell off your shares if you
find that the price of the company you have invested in has risen a little. Sell
only if you feel that the company does not show any future promise.
Insurance
Whenever you hear the word insurance, “protection” and “financial security” are the ideas
that come to mind. Fundamentally, that is what insurance is all about. It involves paying a
small fixed sum of money (premium) for a specified number of years (term of the plan) and
then receiving a lump sum payment in the event of the death of the insured (sum assured). If
the insured lives beyond the term of the insurance policy, you get back nothing. Such
insurance plans are called term plans.
However, insurance has changed over the years. Insurance products which help you to meet
long term goals have developed. These goals could be anything from giving your children an
expensive post-graduate education to funding your retirement. At the same time, they give
you the traditional insurance protection and financial security in the event of the death of the
insured.
In such cases, insurance companies still collect a fixed amount from the insured. Then part of
the money goes towards the basic insurance protection and the remaining is invested on
behalf of the insured person. Let’s look at some of the most popular types of insurance plans
which act as a long term financial product in addition to fulfilling the basic function of
insurance.
Moneyback plans: In such plans, you pay a regular premium. Part of the premium is
invested on your behalf and the rest pays for your insurance. Then, at fixed intervals – for
example every 5 years, for the next 20 years - you will receive lump sums of money. If you
die during the term of the plan, your dependents will receive the sum assured. If you do not
die, you will still receive the payouts at regular intervals.
Such plans are ideal for those who would like to match the incomes from the plan to
milestones in their children’s lives. For instance, let’s say you purchase a moneyback plan
when your child is 10 years old. Suppose this plan promises to pay out lump sums of money
every 5 years for the next 20 years. When you child is 15 years old and ready to go to college,
you will receive money. Then, when your child completes his graduation and is ready for
post-graduation, you will receive money. After 5 years, you can gift your child a lump sum of
money to help him settle in his career. When you receive the last lot of money from the
policy, it may contribute to your child’s marriage expenses.
Endowment plans: These plans require you to pay a regular premium. If you expire during
the term of the plan, your dependents will receive the sum assured; if you survive the plan,
you will receive a lump sum.
16
Such plans are made for those who would like to receive a large amount after a fixed number
of years. This could be used towards paying for a home or as a retirement kitty.
Unit Linked Insurance Plans (ULIPs): When you purchase a ULIP, you will have to pay a
regular premium as is usual with insurance products. Part of your premium is used to
purchase insurance and the other part is invested. In the case of ULIPs, you decide how the
money has to be invested –by choosing a fund or combination of funds presented to you by
the mutual fund company. These funds work in a similar manner to regular mutual fund. You
are allocated a number of units, based on how much of your money is channelled towards
investing. If the fund does well, the value of your units increase.
Such plans enable you to shift your money from one fund offered by them to another. They
also allow you to withdraw some part of your money by encashing your units, subject to
conditions. And, as in the case of other insurance plans, if you die during the term of the plan,
your dependents will receive either a sum assured or the value of your units, depending on
the plan you have chosen. If you survive the term of the policy, you receive the value of your
units when the plan matures. You can use this money to meet a long term goal.
There are many variants of the above mentioned plans. They are given different names and
packaged as solutions to meet different goals. But one thing remains common, they have
become financial products which could help you to meet your goals.
1.1.4 Life Insurance – a basic financial necessity
Let’s suppose you plan for your goals and invest in various long and short term financial
products. Let’s also say that all’s going as per your plans and you are contributing to these
products as per your financial schedule. What happens if you are suddenly not around
anymore to ensure that the money keeps flowing into these products? Should the dreams that
you had for your loved ones suddenly disappear? It should not. If you have purchased
adequate insurance, it will ensure that your loved ones continue to live the dreams that you
planned for them.
Insurance is a very important foundation which all earning members of a family must have
before they invest elsewhere.
An earning individual must pay a certain amount of money each year (once a year or every
month or every quarter) called premium for the term of the policy. The term of the policy is
the time span during which, if the individual dies, the family will receive a large lump sum
amount. This lump sum amount is called the sum assured. Some insurance policies called
Unit Linked Assurance Plans or ULIPs offer individuals a chance to invest and grow their
money. Other insurance products, such as Money back plans and Endowment plans return
some amounts of money at pre-determined times. The most basic type of insurance does not
pay back any amount if the insured individual lives past the term of the policy. However, it
pays out a large amount if the individual dies during the term of the policy.
Features of insurance
17
Return: The return from different insurance products differs. Term plans offer a fixed
sum assured only if the insured individual dies during the term of the plan. Other
insurance plans, like ULIPs offer returns that are linked to financial products as they
invest part of the money in such products. Still others pay out predetermined sums of
money and different intervals. Some policies also pay out unexpected bonuses.
Risk: In a pure term policy, if you live beyond the term of the policy, you will get
nothing back. In the case of ULIPs, the investment portion of your insurance product
depends on the investment options available to you. It also depends on how these
products perform.
Tenure: Usually long term.
Taxes: The government allows you to get a deduction from your income for premium
payments that you make towards your insurance policies.
1.1.5 Cautions while investing
While there are many options to invest, be aware that there are recognized, legitimate
financial products and fake ones. The genuine ones give you returns based on how they use
the money you invest. For example, when you lend to a bank for a fixed period of time, the
bank further lends that money to someone else. The rates that banks offer and charge are
fixed by the RBI and the banking system and your money is very safe with them. Similar is
the case with post office savings and other recognized organizations that we have covered so
far.
However, you should be careful about investing in schemes offered by people or
organizations that are not recognized by a regulator like RBI, SEBI, IRDA, etc. The schemes
promoted by unrecognized companies may look very attractive when you first hear about
them. One such example of a fake financial investment scheme is a Ponzi scheme.
This is how Ponzi schemes work: You will be approached by an individual or an organisation
that promises to give you extremely high returns on your investments. When you invest with
them, they will give you unbelievably good returns at first. For instance, if you invest Rs.
1000, you may be given Rs. 500 as interest, in the first 6 months itself. Sometimes, they may
return double your initial investment in a short period of time. This will encourage you to
invest more and also tell your friends and relatives about the scheme.
How do they give this kind of returns? What they actually do is take your money and give it
to someone else without investing anywhere. Similarly, what they get from someone else,
they give it to you. When you tell your friends and family, they also invest in the scheme.
The firm then just pays circulate the money until a very large number of people start
investing with them. As an investor in such a scheme, once you start receiving very high
returns regularly, you will be tempted to invest even higher amounts to get more returns.
Once a sizeable number of people invest huge sums of money, they will disappear with the
money. Since they have not registered with any regulatory body, you will not be able to track
18
them down. The documents, contact numbers, etc. will all be invalid and you would have lost
a huge sum of money.
There can be many complicated variants to this scheme. The main indication that you must
look forward to is that if the returns seems to be too good to be true, study it further. Ask a lot
of questions about the scheme and consult people whose financial knowledge you trust before
you invest. If you fall for such a scheme, it can wipe out years of efforts that you or your
loved ones would have made to save money. So be careful. Don’t be greedy when it comes to
investing. There are no shortcuts to investing. Always be patient.
1.1 Summary
The first step in financial planning is to understand how much money you already
have saved up in various financial products.
Your decision to invest in a financial product should depend on your goals, the
returns you expect, liquidity and the time period in which you want your
money back.
Overview of short-term financial products
Savings bank account: It allows you to deposit and withdraw money any time
you want.
Bank Deposits: The main difference between a savings account and a bank
deposit is that in a deposit you cannot withdraw your money as and when you
please. The benefit is that you receive a higher rate of interest.
Recurring deposits: In a recurring deposit, you do not have to deposit a lump sum
principal amount. You can contribute a fixed amount every month for a fixed
tenure. Here again, you receive a higher rate of interest than you do on money in
a savings account.
Mutual Funds: A mutual fund is a financial product that allows individual
investors to buy financial products indirectly. With mutual funds, money is
collected from thousands of investors and invested in financial.
Overview of long-term financial products
Post office savings: These saving and investment products are designed to
provide safe and attractive investment options to the public. They are also
convenient as they can be accessed at any post office (except for PPF).
Shares: Shares actually mean an ownership or share in a company. As a result,
over the long run, this financial product can deliver a very good return, if the
company does well. However, the performance of shares is not guaranteed.
Insurance: Traditionally, insurance has been used as a means of financial
protection. However, over the years, insurance products have developed to help us
meet our long term goals.
19
Overview of insurance as a basic financial necessity
Insurance is the foundation on which sound investing is built on. It is a must for every
earning member of the family. Various types of insurance products include term plans,
money back plans, endowment plans, ULIPs, etc. You should buy the insurance that best
suits your family needs.
