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Will Debt Funds help you create wealth?

debt fund and wealth creation

Debt funds are good investment vehicles to protect your capital and still earn more than your bank interest, but they may not sufficient to help you generate enough wealth to achieve financial independence.

Let us understand this by an example.

Assumptions:

  1. A 30-year-old salaried employee has a current monthly income of INR 1.5 Lacs
  2. Annual Salary increment: 8%
  3. Annual Expenses: INR 1.15 lacs (Rent: 60K, Grocery: 20K, Child Education: 20K, Medical: 5K and Travel: 10K). The inflation rate for each is as follows: Grocery: 6% | Rental: 10% | Medical: 12% | Education: 10%
  4. The balance is saved in a combination of debt instruments which give the returns as follows: PPF: 7.6% | Bank Savings: 3.5% | Debt Funds: 7.0%
  5. The weighted average rate of return is around 6.7% annually
  6. Annual compounding of returns assumed
  7. Assumed no taxes on gains on investment

So let us see how your expenses increase for the next 30 years vis-à-vis your debt investments.

When will you run out of money?

As you can see, your expenses will outlive your income from Year 22 onwards and that is when you will start dipping into your debt savings which will start declining thereon. And this happens while you are still working. You can well imagine what should happen once your recurring income drops or becomes negligible post your retirement.

We often ignore the impact of inflation on our lives and hence, the above is a very common “kahaani ghar ghar ki”. Therefore, even in the best case scenario, debt funds will perhaps help us match inflation but not create additional wealth that can make us live through our retirement comfortably. And this is the reason the majority of retired or nearly retired Indians are working out of compulsion. A lot of such people would have ideally wanted to spend their time reading or travelling or just basking under the sun on a chilly winter morning. But even after 40 years of working, they are striving to make ends meet just because our normal income flow cannot live up to the increase in expenses.

We, therefore, need to invest our savings in instruments which can considerably beat inflation. This is where equity comes into play. You may not like it but you may still have to consider it for a comfortable future. However, equity is a challenging subject for most and we tend to have an increased the fear of loss because of our own lack of understanding of which funds to invest in. Therefore, for a person who is new to equity investing, choosing the SIP mode of investing through a trusted advisor is the best route to choose.

But then why do people still invest in Debt? And where exactly should you be investing? Read here to find more.

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Should I invest in Debt Funds or Equity Funds?

Which fund to choose

Both Debt and Equity Mutual Funds are thriving in the Indian Financial Market. But which one should you as an investor choose between the two?

When are Debt Funds suitable?

  • When you want to park some surplus cash for using it within 3 years
  • For creating your Emergency Fund
  • From an asset allocation perspective (when your risk appetite requires you to invest in low volatility instruments)
  • You want to invest funds for a long period of time but the safety of capital is most important (Example: Funds of your retired parents who may need it any time)
  • You have a lot of FDs on which you are paying significant taxes

When are Equity Funds suitable?

  • When you want to create a fund for a goal which is more than 5 years away
  • When you have surplus funds which you do not need to deploy in the next 5 years
  • When your preference is to generate inflation-beating returns and you think you have the ability to survive the volatility

In short, every investor should have some debt and equity components as part of the overall portfolio. For a lot of people, the debt exposure is taken care of through PF, PPF, FDs, NSCs and other such low return instruments. But for those who are investing for the first time and do not have a certain percentage of their wealth in the debt instruments, they can look to start investing in both debt and equity funds.

How does CAGRfunds help?

At CAGRfunds, we seek to make investing simple for you. So we do not clutter your mind with complicated technical financial terms. We just ask you your objectives of investments and suggest the suitable solutions to you. We believe in developing long-term relationships with our investors and hence our focus is solely on helping you meet your financial goals. For more information, feel free to contact us on +91 97693 56440 or drop us an email on contact@cagrfunds.com

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Company health insurance or Separate health insurance?

Health Insurance vs Corporate Insurance

“At CAGRfunds, we do a weekly session of knowledge sharing within the team. Last week, we had a rather long discussion on whether a separate health cover is required if the employee is covered by his or her company health insurance (Mediclaim) policy.

So we started digging into the various critical reasons as to why we need health cover at all. We realized that depending solely on the health insurance provided by our companies can land us up in the following situations:

Corporate Health Insurance coverage is the same for all

The employer decides our coverage amount. So, if your coverage amount is 5 lacs and your hospital bills amount to 7 lacs, the balance comes out of your pocket. Therefore, you need to ascertain the adequacy of the coverage as per your own health conditions.

You may not be rewarded for being healthy

Most companies (especially the small and midsized ones) deduct insurance premiums from our salaries. For people having the same coverage amount, the premium is also the same year on year, irrespective of how healthy or unhealthy an individual might be. So, if you are a healthy non-smoker individual, you are perhaps paying the same premium as your colleague who is slightly unhealthier than you are.

Also, in an individual health insurance, a lot of policies give either “no claim bonuses” or discounts on subsequent premiums for claim free years. That means you have more security and you save more money if you take care of your health.

You do not have the flexibility to prioritize the features you want

Corporate Insurance is a general insurance that covers a group of employees. So, the features are generic and may not be completely in sync with what you prefer. For example, if there is a history of cancer or diabetes in your family (which puts you at risk for the same), there is a chance your corporate insurance will not cover it. Or, your corporate insurance may be capping your room rent to a small % of sum insured which is unlikely to cover even half of your actual room rent.

You will have zero health cover just when you need it the most

Corporate Insurance will only cover you till you are employed with the company. So, if you are currently depending on your corporate health cover, you will have none on retirement. If at that point in time, you decide to take a private health cover, it will cost you significantly higher than what it would cost if you take a policy when you are young.

You might face several issues on changing your employer

Drop in coverage amount

Your new employer may offer you a lower coverage than your previous employer. You might want to go for a separate health cover when that happens, but do take into consideration the increased premium that you will have to take at a higher age. Also, every new policy has a waiting period for pre-existing diseases. This means that the Insurance service provider will not sanction any claim arising out of any pre-existing disease during the tenure of the waiting period. In most cases, this period ranges between 2-4 years. The older you are, the longer it is.

Lesser Dependents

Many companies today offer health insurance for not only you but also your spouse, children, parents and (occasionally) your in-laws. But, not all companies offer the same protection. If you change your company, your new employer may only support you, your spouse and your children. Having your dependants not covered in future can lead to a considerable risk of an unforeseen medical expense.

But, what should you do if your corporate health cover seems to be adequate?

Well, it is certainly possible that your company adequately covers you and your family and also provides you with the features that you prefer to have. You can choose to adopt any of the following routes:

  1. Secure your cover for post-retirement: You can take a small cover separately so that you do not have to shell out a huge premium for taking a new policy post-retirement. A new policy at retirement will also subject you to the long waiting periods for pre-existing diseases which of course defeat the purpose of the policy at that age.
  2. Secure the possibility of a massive medical emergency: Corporate covers are at best, generally adequate for normal medical situations. In case of a massive unforeseen emergency, the chances of incurring a huge expense are quite likely. Therefore, you might want to secure that eventuality and take a large health cover separately to take care of the same.

Want to know more about health insurance? Contact us on +91 97693 56440 to know more about the suitable plan for you.

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The debate between Term Insurance and Endowment Plans is finally over!

Buying Life Insurance right

Yesterday, I was scrolling through Facebook and chanced upon this really funny ad starring Akshay Kumar and Sumeet Vyas. While the deceased Sumeet pleads the new age Yamraaj (aka Akshay) to give him another life in lieu of “behen ki shaadi, beti ki padhai, ghar ka kharcha, gaadi ki EMI”, he is asked a very simple yet daunting question – “Term Insurance nahi liya tumne?” To which comes the aptest reply – “Bhul Gaya”.

Term Insurance

See the ad here

I did some research and the statistics shocked me. Although the insurance industry in India is growing at a fast pace, only 4% of our population has insurance coverage. Which means that 96 out of every 100 people have not safeguarded their dependents in an unfortunate eventuality of their death. I shudder to think of a family where the father is the sole bread earner and should anything happen to him, what was to be the future of his wife and kids. Add to that, cases where several liabilities in the form of a home loan, vehicle loan etc. are ongoing. Indeed, our priorities are completely misplaced.

But let us not blame the tendency to procrastinate as the only driver behind the low penetration. While a lot of people understand the importance of Term Insurance, they often struggle to figure out which plan is apt for them.

So I decided to do a mini survey. I went around asking 22 of my neighbours as to what had they done about Life Insurance? Well, 6 of them had not thought about it, 8 of them had thought but

got confused between the available options, 7 of them were covered by Endowment Plans and ULIPs and only 1 person was covered by a Term Insurance Plan.

Let me try and focus on the people who are covered or the ones who are thinking about coverage but are not fully aware of all the alternatives. Therefore, let us first understand what Endowment Plans and Term Insurances are.

Endowment Plans

Endowment plans, a bulk of which are sold by LIC, are a mix of Insurance and Investment. This means that you get some life insurance coverage in exchange for an annual or quarterly premium and after a certain maturity period, you get your premiums back, and maybe some bonus amount. That sounds quite appealing. You get back what you pay for. So you get insurance for free!

That is the pitch that agents make to us and like 11 out of 10 people, we scamper for anything and everything that is marked as “FREE”. Let us analyze them in more details a little later.

Term Insurance

Term Insurance is pure insurance. You pay only what is required to pay for Insurance. In case of death, the nominees get the full insured value. But you get nothing for staying alive.

Why are we even talking about Term Insurance then?

Let us see a small comparison.

Endowment Plan Term Insurance
Insurance Cover 1,00,00,000 1,00,00,000
Policy Period 30 years 30 years
Annual Premium 3,24,734 8,279
Total Amount Paid 97.4 lacs 2.5 lacs

Note: The above details are for a 30 year old, male, non-smoker.

Term Insurance Benefit 1: You pay only for Insurance, the cost of which is quite low. When compared to an Endowment Plan, everything being paid over and above the cost of Insurance is either getting allocated towards charges or are being invested.

Now when you are paying for investment, you ideally should also expect some return on the money getting invested. Historically, Endowment Plans have not given more than 4-6% annual returns. And this is true for a period when Fixed Deposits in Bank were giving around 7-8% annual returns and equity surpassed 15-16% annual returns. So basically, had you taken a plain Term Insurance and left the remaining money as a fixed deposit every year, you would have still made more money than your Endowment Plan did.

Therefore, Term Insurance Benefit 2: You can separate your investment objective and get better returns by following the right investment strategy.

So what do people do?

In most cases, we do not witness people taking an endowment plan with an insurance coverage of more than 10-20 lacs. This is because, for a vast majority of the middle class, an annual premium of approximately 50-70K towards insurance is a big amount. And if this is true, then let us revisit our objective of Insurance. If something were to happen to the bread earner of the family today, will a Life Insurance coverage of 10-20 lacs be sufficient to safeguard the family? In most cases, that is highly unlikely.

So, Term insurance Benefit 3: Get adequate coverage for a low premium.

But if that is so straightforward, why don’t people take Term Insurance?

  • Comfort with familiarity: A lot of people have seen their parents and grandparents taking endowment plans. It feels like home to them. Change results in resistance.
  • Affinity for “FREE”: We seldom do the math to figure out how much are we giving up over a period of time to get something for free now. Endowment Plans demand much higher premiums as compared to term Insurance but at some point in time, we get it all back. However, what we do not take into account is the time value for money. A 4-6% return over premiums paid is essentially capital destroyed. With that kind of return, you really did not generate any additional wealth, thereby defeating the whole concept of investing.
  • Dislike for “Expense”: We don’t like anything that we don’t get back. Term Insurance premiums albeit low are an expense. If we don’t die, we don’t get back anything. And this is one of the most prevalent reasons why people stay away from Term Insurance. Even though it makes no logical sense for them to manage their hard earned money in this way. If you want to experience this in real, next time someone sells you an Endowment Policy, ask him or her the annual return that you will make.

Our Recommendation:

Insurance shouldn’t be used as an investment vehicle. One should always go for a plain vanilla Term Insurance Policy and plan out his investments separately. Mixing the two creates a lack of transparency towards allocation to charges and leads to lower potential returns.

If you have any further queries, feel free to call us on +91 9769356440 or email us at contact@cagrfunds.com .