We all know that Paracetamol is used for treating fever and it brings down the temperature. But, what happens if we use it for a Stomach infection? It will only aggravate Stomach infection. It is important to use right medicine.
Similarly, it is important to use right financial products. We often get confused and use wrong financial products. This leads to huge losses in the long term for us, we are not able to achieve financial goals.
This article is written to help working professionals to select right product for right purpose.
There are only 4 reasons why we need to buy financial products. These 4 reasons are:
- Transacting Money
- Protecting my family from Financial Loss
- Borrowing for Building Assets
- Invest to grow wealth
Let’s now understand, what are the products that help us meet above needs
Every day we get money and we spend money. We need a financial product to receive money and spend money. This is achieved through our Bank A/c, which we normally call as Savings A/c, but actually it does not help us save any money, it only makes us spend. Hence we should call it as Spending A/c. Spending A/c allows us to spend money by way of withdrawals through ATM, transfers through IMPS, NEFT, RTGS. The old ways of Transfers through Cheques and Demand Drafts are rapidly being replaced by NEFT.
Last few years we have seen rise of wallet transactions like PAYTM etc. It is estimated that number of transactions done by PAYTM every day is more than all banks put together, although value of transactions may be very small. Hence for small transactions, these wallets are required. Today we are forced to use many wallets, but RBI is working on regulations to make Wallet to Wallet transactions. Soon we may be able to transfer money from PAYTM to JIO MONEY or vice versa.
Which bank is good or which wallet is good?
We think all banks are equally good these days and all wallets are. More important question is how many bank accounts or how many wallets we need to have or how much to keep in Spending A/c or wallet?
It is better to limit Bank Account to maximum of 2 and Wallet to 1. Further it is recommended that Spending Account Bank Balance should have only minimum balance as prescribed by the bank. If it is more than minimum balance then we are not growing our wealth, as soon as it exceeds minimum balance, transfer to a Liquid Mutual Fund. This will not help in getting higher returns on our money but more importantly will help us in cutting down unplanned expenses. If we keep money in Spending Account, unplanned expenses will eat away our money.
Similarly, do not keep more than Rs. 500 in wallet. We never know if wallet companies will survive. There are instances of many wallets shutting down their business.
Purpose – Transactions – 2 Spending A/c (with minimum balance only), 1 wallet (Max of Rs.500
|Protecting Family from Financial Losses
We face lot of risks in our life. Examples of Risks are – Hospitalization, Accidents to Vehicles, Death etc. These risks if they happen to us will lead to Financial Loss and emotional loss for the family. While emotional loss cannot be compensated, financial loss can be compensated.
For example, if we incur financial loss because of hospitalization, that loss can be reimbursed by Health Insurance Policy. Purpose of Health Insurance Policy is to help us overcome Financial Loss due to hospitalization.
The purpose of Insurance Policy is to help us cover Financial Loss. Following are the financial loss that may are may not happen
While we can easily estimate or quantify in financial losses in 4 of the five mentioned above, it is difficult to estimate financial losses due to loss of life. However a thumb rule can help us arrive at approximate loss if loss if life happens.
If someone earning Rs. 1 Lakh a month suddenly dies what is the financial loss to the family? Financial loss is Rs.1 Lakh month income. Monthly income to the family is stopped. So how can this loss of Rs.1 Lakh be compensated. Let’s assume that if the person had taken Life insurance which is 150 times is monthly income – 150 X 1 Lakh = Rs.1.5 Cr.
If family gets this Rs.1.5 cr and invests at 8%, annual interest is Rs.12 Lakh and family can continue to receive Rs.1 Lakh income every month. Thus the financial loss can be reimbursed.
So whenever we are buying insurance – Most important factor to check is sum assured, but we all look at how much I get If this is purchased. Only thing matters are how much is the insurance cover.
Insurance is like Fire Extinguisher – image 100 Story building having just 1 fire Extinguisher– If fire happens that 1 Fire Extinguisher will also become a waste – or imagine 1 story building having 100 fire extinguishers – 99 of them will never be used and it will be waste of money.
Treat Insurance has a fire extinguisher. If we don’t have to use the fire extinguisher it is good for us, but if fire happens in our family and not enough Fire Extinguishers, then we are putting our family at lot of risk.
Summary: Insurance Helps us to avoid Financial Losses. Most important question is how much insurance is adequate
Life Insurance – 150 times monthly income (but maximum Rs.2Crore)
|Borrowing for building Assets
We all feel loans are bad. But not all loans are bad. Some loans are good and they are too good. Different types of loans are – Personal Loan, Car Loan, Home Loan, Credit Card Loan, Educational Loan etc.
Is there a difference between CAR LOAN and Home LOAN?
There is a very big difference. After we finish of the car loan, the value of the car that we will have will be very close to 0, but when we finish paying of our home loan the value of home we bought through loan will be 10 times worth. Can we then call Home loan a GOOD LOAN?
Take only Good Loans – Home loan and Educational Loan. They not only make us rich but also helps us in saving lot of taxes. Because it is good, do not take more loans, limit EMI to 25% of monthly income.
|Investment Products for Growing Wealth
The purpose of investment products is to help us beat the inflation. The returns we get from Investments should be more than Inflation. But Returns depend on Risk. If we want high return, then we must take high risk. But taking high risk does not guarantee high return. So, what should we do with Risk
If we avoid risk, we will also be avoiding returns. For example – Fixed deposit is ZERO RISK Investment, if choose Fixed Deposit, we have successfully avoided RISK. But, what is the return – 6.5%. But is 6.5% is it a real return? Inflation is 7% and our return is 6.5% so, we have got -0.5% – NO RISK – NO RETURN.
We can ignore risk and go for – Crypto Currencies and Gambling. In this case we can even loose the capital.
We can only get returns above inflation if we manage risk. What are the investment products available for us?
How to manage Risk?
Risk Management is very simple. Invest in 3 buckets –Short Term, Mid Term, Long Term
Here is the matrix that can make your financial decisions easier!
||Invest in 3 Buckets
||Take only good loans
Limit EMI to 25% of monthly Income