How much insurance do I need for my family?

A Sunday is a relaxing day. A late morning, sipping a cup of tea and reading the morning newspapers — especially the glossies. Love the advertisements in those — the latest gadgets, that fancy car.


Yes, the products are all very good, but we don’t end up buying most of them. Even if we are genuinely interested, we like to research, check around or talk to friends. We do not buy everything that is advertised repeatedly. But when it comes to insurance, we are pressurized by that persistent, glib-talking salesman, as we believe that the product on offer is the one made with only us in mind.


No wonder, I know more people who complain about their insurance than those who crib about their cars. Come to think of it, insurance will possibly last longer than their vehicle.


My family’s needs, not mine:
Insurance should be considered as a protection against risk, and you must focus on the sum assured of the policies you have. How much insurance do I really need? That’s an odd question to answer, as the benefits of life insurance accrue to my loved ones, and not me.


Don’t forget to rephrase the question to cover your family’s needs. If I have a home loan for the apartment I live in, I must buy term insurance for the outstanding amount of the loan right away, and, in addition, consider the regular expenses that my family is dependent upon me for.


Calculating expense & liability protection:
Let us consider a working example. You, aged 35 years, have a home loan of Rs 40 lakh with an EMI of Rs 40,000 per month for the next 18 years, and your family is dependent on you for living expenses of Rs 5 lakh annually.


The calculation of funds required by your family in the case of your demise will depend upon future rates of inflation and expected returns on the investments from the pool comprising insurance proceeds and other investments available. The assets required rapidly climb if inflation rates nudge up by 1% every year, and returns drop by an equal amount. If we were to consider requirements of the family to age 85 years in this example, the assets needed today spiral up dramatically.

Remember this does not cover other future goals (child’s education and the like) that may be aspirations of your family. Move on your life insurance right away.

Build portfolio through proper MF investment

There is always an inclination to look for good returns at the least possible risk. Many, in fact, say that they want to invest in instruments that give maximum returns at minimum risk. While that is utopian, we can strike a decent trade-off by assuming some amount of risk for good returns.

Mutual funds offer a comparatively lower risk profile compared to direct investment in equities. Funds from various investors are pooled and a fund manager manages the corpus. The corpus collected is invested in various companies, across sectors to mitigate the risk. Fund managers are specialists who are clued in on the market and also have access to information that the investor may find difficult to access – or he will get after a lag, by which time the market would have discounted the information.


Normally, equity investors go about investing based on tips, what their friend or broker advised, based on their general knowledge about some companies. This makes the portfolio a mish-mash of various stocks, which may not be diversified and may have poor fundamentals as well.


For most people who do not have a deep knowledge of finance, it would be a good idea investing through mutual funds. There are equity-oriented mutual funds, debt funds and hybrid funds, among others. But, within each of these categories there are several sub-categories, for instance, in equity mutual fund category there are large cap funds, mid cap funds, value funds, thematic fund and sectoral funds. A proper portfolio needs to be put together, taking into account the various categories and the individual schemes.


Mutual fund schemes allow one to invest even small amounts; for instance, even Rs 100 per month is possible in a scheme. Most companies permit a minimum of Rs 1,000 per month. Monthly investment through systematic investment plans is one of the best ways of investing, as many would find investing lump sums difficult. Also, since one gets income (in most cases) at the start of the month, it is easy to invest a portion of this every month.


Systematic investment plans also have the advantage of making timing the market redundant as the investor would be investing at all points in the market. This ensures that over time, the investor would get advantage of rupee cost averaging and would end up making money over time. Even if a person wants to invest one time, the money can be invested through the medium of systematic transfer from a debt fund to an equity fund over time. This will be very helpful, when markets are expected to be turbulent.


For any goal, savings in small lots is far easier than lump sums. Mutual fund investments in equity are popular vehicles to meet long-term goals as equities perform well over time. Sensex has returned about 18 per cent compound annual returns over its period of existence — 32 years.


Equity mutual funds too, have given sterling returns over their lifetime of over 10-15 years. There are many funds that have given even a 20 per cent plus returns over 10 year plus periods. For those who are a bit more conservative, hybrid funds with a preponderance of equity investments exist. The investment returns will be commensurately lower, but the risk assumed is also lower.


There are also hybrid funds that have a major portion in debt and some exposure to equity. This offers a good chance to participate in equity to some extent, to those who are averse to taking a lot of risk. Then there are full-fledged debt instruments too such as short, medium and long term funds, gilt funds and fixed maturity plans (FMPs).


Mutual funds hence, give an entire range of products to address the needs of every individual. Whatever the goals a person may have, a good portfolio can be put together for achieving them.


For instance, if a person has a short-term requirement of money say one year, an fixed maturity plan of that duration or a debt fund whose portfolio maturity coincides with the tenure, may be a good idea.


For comparatively longer periods, one could look at a mix of debt products, hybrid and equity-oriented products, to construct the portfolio. Since the mutual funds have assured liquidity and equity-oriented funds enjoy zero long-term capital gains, they are even more attractive.


In a nutshell, mutual funds lend themselves to investments for meeting the short, medium and long-term goals and that, too, at one’s pace and convenience. What is required is regularity in investments and reviews from time to time, to ensure that the funds ones have invested are still performing well.


Used well, mutual funds can work like a charm for investors seeking goal achievement.

Learn The Templeton Way

One man consistently searched for and bought neglected stocks and made a whole lot of money doing so over and over again in different markets — John Templeton. His name is now famously associated with Franklin Templeton Funds (John sold his funds to Franklin Resources in 1992). A hallmark of the Templeton way of investing was foraying into international markets at a time when doing so was not common. Constantly searching for markets that were depressed, and within them buying not the most popular stocks but those that were beaten down, was the secret of his outstanding track record spanning decades.

Point of maximum pessimism

Templeton executed his first trade in 1939 after the start of World War II. The markets had declined 39 per cent over the preceding 12 months and the outlook was gloomy. In this pessimistic environment, Templeton took a loan of $10,000 and bought as many stocks for less than $1 as he could lay his hands on. Why did he buy when the outlook was so depressing, and what was his fascination with the $1 mark?

Buying when the outlook was negative ensured that stocks were significantly undervalued. The outcome of the War, and a victory for the Allies, was by no means assured. Fear and uncertainty combined to produce an environment of “maximum pessimism”.

The market did not expect these below-$1 stocks to do well in the prevailing circumstances. Some even faced bankruptcy. Templeton recognised these problems. To counter the risk of some of his investments failing, he bought a large number of stocks: 104 in all.

Templeton was not speculating. His investment rationale was simple: during the War all companies would be expected to contribute to the “War effort”. Where others were pessimistic, Templeton realised that the War, and the massive expenditure it would entail, was just the kind of stimulus that the economy needed to pull it out of the Depression. He realised that the prospects and profitability of at least some of these beaten down stocks would improve and this would more than compensate for the losses that he would incur on stocks that failed to turn around. Templeton was proved right. Only four of the companies he invested in eventually folded up while his $10,000 investment multiplied four-fold to $40,000.

The concept of buying at maximum pessimism has been immortalised in Templeton’s own words: “Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell.”

How to identify a good bargain

To identify stocks, Templeton looked at the price that he would have to pay for a dollar of future earnings today against the company’s long-term earnings growth rate. This concept is today more commonly known as the PEG ratio. A lower PEG ratio signifies a better bargain. However, don’t go buying any stock with a low PEG ratio. You need to watch out for a few things: check whether the P/E ratio itself is justified: a bull market inflates the P/E ratios of most stocks. Look up the stock’s historic trading range. Second, consider whether the company can sustain the growth rate of the last few years.

Take the example of Bata India. The stock is currently trading at a PEG ratio (calculated using a five-year EPS growth rate) of only 0.4. But is it necessarily a bargain? The five-year PEG ratio is based on an earnings growth rate of 62 per cent. But if you look at the three-year EPS growth rate, it dwindles to 21 per cent. As a result, Bata’s (three-year) PEG ratio jumps to 1.22. Not such a bargain anymore!

International foray

Templeton started looking for opportunities in international markets long before others. His rationale? “It is commonsense that if you are going to search for these unusually good bargains, you wouldn’t just search in Canada. If you search just in Canada, you will find some, or if you search just in the United States, you will find some. But why not search everywhere? That’s what we’ve been doing for 40 years; we search anywhere in the world,” he explained.

Templeton launched the Templeton Growth Fund in 1954 with the objective of searching for value stocks globally. To illustrate how successful the fund has been, take a look at these numbers: a $10,000 investment in the fund at its launch would be worth $74,61,144 today (as on January 31, 2011).

By looking beyond a single market, an investor can bypass overheated economies or those with poorer growth prospects in favour of markets that are attractively valued or offer better growth prospects. For example, global investors who invested in the Indian markets even as late as in 2006 would have made a 75 per cent return by now (BSE Sensex returns). On the other hand, those focusing on a single economy, say the US, would have made a trifling 10 per cent over the same period (Dow Jones returns).

Templeton’s yardstick for identifying attractive markets was primarily the P/E ratio. Using this measure, he would zero in on a country that offered the highest concentration of cheap stocks and start looking for potential investments. Using this method, he identified Japan as a good investment destination as early as in the 1960s — long before the Japanese markets saw the phenomenal bull run of the eighties. (Incidentally, Templeton exited the Japanese market with profits long before the bubble burst).

Investors wanting to emulate Templeton’s strategy of foraying abroad should, however, be forewarned. This is one arena where you must do your homework. While investors from better-developed markets could find the lack of information and poor disclosure standards (especially in developing markets) frustrating, for the diligent global investor this could be a source of advantage: these inimical conditions would drive the casual investor away, thereby presenting him with an opportunity to scoop up bargains before the crowds discovered them.

By incorporating these tenets of Templeton’s approach — investing at the point of maximum pessimism and foraying abroad in search of bargains — you too can improve your track record.

Rules for investing the Templeton way

Invest for maximum total return: Investors often make the mistake of investing too much in fixed-income securities. This is particularly true in today’s environment where many fixed-income securities offer negative returns to investor after factoring in inflation.

Invest - do not trade or speculate: Investors are people who buy for fundamental value. Speculators are those who buy in the hope of selling later to someone at high prices.

Remain flexible and open-minded about types of investments: Never adopt permanently any type of asset or selection method. Try to stay flexible, open minded and skeptical. When any method for selecting stocks becomes popular, then switch to unpopular methods.

Buy low: One of the great ironies of the stock market is that when stocks drop in price, or “go on sale”, they attract fewer buyers. Conversely, when stocks become more expensive, they attract increasing numbers of buyers because of their popularity. To get a bargain price, you’ve got to look for where the public is most frightened or pessimistic.

When buying stocks search for bargains among quality stocks: The best bargains are not stocks whose prices are simply down the most, but rather stocks having the lowest prices in relation to possible earning power of future years. Look for companies with high profit margins, high returns on capital, and a sustainable competitive advantage.

Buy value: Not market trends or economic outlook. Too many investors focus on the market trend or economic outlook. But individual stocks can rise in a bear market and fall in a bull market. Therefore, more profit is made by focusing on value.

Diversify: The only investors who shouldn’t diversify are those who are right 100 per cent of the time. If you are diversified among different forms of wealth, nations, industries and companies, you will be safer in the long run.

Do your homework or hire an expert to help you:There is no substitute for doing your own homework on a company. At the same time, it remains a tremendous undertaking both from a time and skill standpoint to successfully purchase individual stocks for one’s own brokerage account. For this reason, you may choose to hire an expert who has a similar investment philosophy to your own.

Don’t panic: During a market correction, DO NOT PANIC. Don’t rush to sell the next day. The time to sell is before the crash, not after. Instead, study your portfolio. If you didn’t own these stocks now, would you buy them at current prices? The only reason to sell stocks after a market sell off is to buy other more attractive stocks.

Invest for the long term: One of the most common errors in selecting stocks for purchase, or for sale, is the tendency to emphasise the temporary outlook for sales and profits for the company. Avoid this temptation and invest with a long-term perspective.

There is NO free lunch: Never invest on sentiment and never invest solely on a tip. Investing requires an open mind, continuous study, and most of all, critical judgment. There are no free lunches!

Do not be too negative: Although Sir John M. Templeton coined the phrase “maximum pessimism” to explain the best time to invest, he remains one of the world’s biggest optimists. Look for bargains and opportunities during times of market malaise. You will be rewarded in the long run for not following the crowd.

Risk-return: two sides of a coin

You can’t have one without the other. Hence, understand the risks involved in various investments to maximise returns.

People aren’t risk-averse; they're loss-averse. Usually, occurrence of loss is more painful than happiness from gain / profit. The pain on losing Rs 50,000 is much more than the happiness in gaining the same amount.

Similarly, when people say they want to take high risk, what is going on in their mind is ‘high risk, high return’. At that stage, the probability of a loss is almost absent in their mind. People tend to forget that loss (read: risk) is an integral part of any form of investment. An investor who understands different kinds of risk and their characteristics will have a much more stable portfolio than one who invests haphazardly.

There are mainly two kinds of risk for any form of investment anywhere in the world, systematic and unsystematic. This is what they mean:

Systematic risk exists in the economic system. For example, inflation, government policies, consumer confidence, and so on. These adversely impact all forms of investment. Inflation, for instance, will always reduce the real rate of return of all forms of investment. Unfortunately, we cannot diversify away from systematic risk. Whether we buy equity, debt or real estate or any other form of asset to diversify our portfolio, systematic risk will always impact the returns.

One strategy that can be adopted to tackle systematic risk is rupee cost averaging. If we keep investing a fixed amount at a fixed interval, over a period of time, our purchase value of investment will start averaging (unless it is a unidirectional falling market for a prolonged period.) This happens because the level and constituents of systematic risk keep varying. Many mutual funds offer systematic investment plans, the best way to invest in markets.

Unsystematic risk is associated with only a particular kind of investment vehicle or instrument. For instance, by investing only in Infosys, we get exposed to unsystematic risk. Any adverse outcome will impact the performance of the company. Similarly, if a majority of investment is in real estate and if the government’s policies on real estate change, there could be an adverse impact on the portfolio.

To reduce the impact of unsystematic risk, one should diversify the portfolio. Unfortunately, different people understand diversification differently. To some, investing in fixed deposits (FDs) of different banks is diversification. There are others who invest in similar styles of schemes of different mutual fund companies. Like a portfolio where an individual had invested in nine different gilt funds of different mutual fund houses. There are still others who will have eight to ten stocks of different pharmaceutical companies. None of these can be called diversification. If the government was to change the tax rate on FDs, for instance, it would universally impact all FD investments. Similarly, all pharmaceutical companies would get impacted due to a change of policy impinging on the sector.

Diversification means investing in those classes of assets which move in opposite directions. Statistically, it is called negative correlation. Usually (though, not always), debt and equity markets have negative correlation. In the year 2008 and 2009, equity markets performed poorly. In those years, debt markets (debt funds) gave exceptionally good returns. In the recent past, debt has been giving (lower) returns but equity has performed well. An individual with only equity in his portfolio would have had disastrous years in 2008 and 2009 but extremely good years in 2009 and 2010. His / her portfolio would have been extremely volatile. Compared to this, someone with a diversified portfolio consisting of both debt and equity would have had stable returns.

An expert investor is not one who generates a phenomenal return in a few years and poor returns in the other. What is needed is stable growth of the portfolio over a prolonged period of time. This can happen by generating optimal risk-adjusted returns. And by remembering at all times that risk is an integral part of all our investments.

The Illiterate HNIs

Financial commitments based on verbal assurances are a sure way of getting into trouble.

Indians are getting richer by the day. And, perhaps sillier. Imagine giving money to a wealth management firm, or signing contract documents on verbal assurances from relationship managers that they would earn one-two per cent returns each month on their investment. That’s nothing but a willing suspension of disbelief.

The Citibank scam, perpetrated by relationship manager Shiv Raj Puri, exposed this unwarranted faith of the Indian high net worth individual (HNI). Armed with a forged document from the Securities and Exchange Board of India (Sebi), he sold schemes to investors, including HNI and the co-founder of Helion Venture Partners, Sanjeev Aggarwal. Even the Hero Group wasn’t spared.

And, it is not an isolated case. There are a number of instances where investors have claimed they were given verbal assurances of high returns, and they ended up losing money. There are complaints galore from investors with the market regulator, but little action can be taken.

How does the regulator help investors who sign documents without reading these and who invest on verbal assurances? Brokerages or wealth management firms, on their part, will claim they have not given any written assurance. But something is wrong. And, all of us know this.

The method is simple. As a finance professional and active investor-friend explains, “The executive from the brokerage who came to my house with the promise of a high-return product insisted there was a specific ‘clause’ in the agreement that promised the return. However, when I called up her seniors in the organisation, I was told there was no clause or assurance, either in the document or verbally." There are umpteen stories like this.

Mis-selling is rampant in India. Whether it was unit-linked insurance plans or mutual funds, distributors have been known to sell products by promising high returns. Both the Insurance Regulatory and Development Authority and Sebi have managed to bring it down significantly by slashing commissions.

Companies in both the industries have been forced to look at client retention to ensure a steady flow of income. So, fund houses and distributors are pushing systematic investment plans more aggressively. Insurance companies are looking at pushing more traditional plans and asking distributors to work more on retaining their clients.

Both Sebi and the Reserve Bank of India need to come out with strict guidelines to handle the rampant mis-selling in brokerages and wealth management firms, as well.

However, the important point is that investors cannot always put the ball in the regulators’ court. Financial commitments, based on verbal assurances, are a sure way of getting into trouble. Importantly, during profitable times, all’s well.

But when things go wrong, they cry foul and try to garner media support or approach the regulators. Here’s an example. A former colleague opened a brokerage account and put Rs 25,000 in it. After a week, he came and said proudly, “These brokerage guys are amazing. My account balance has risen to Rs 30,000 because they invested in some good stock." Three months later, he was cribbing and abusing the brokerage for conning him. His balance: Rs 5,000.